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, 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 October
30, 1998 was 37,428,905.
<PAGE>
<TABLE>
LEGATO SYSTEMS, INC.
INDEX
<CAPTION>
<S> <C>
Page
PART I: Condensed Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997 3
Condensed Consolidated Statements of Income for the three and nine
month periods ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows for the nine month
periods ended September 30, 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 9
PART II: Other Information
Item 6. Exhibits and Reports on Form 8-K 22
Signature 23
</TABLE>
<PAGE>
PART I: Condensed Financial Information
Item 1: Financial Statements
<TABLE>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<CAPTION>
September 30, December 31,
1998 1997
(unaudited)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 64,716 $ 34,891
Short-term investments 29,409 28,147
Accounts receivable, net 30,597 21,426
Other current assets 4,571 4,365
Deferred tax asset 4,099 2,702
----------- -----------
Total current assets 133,392 91,531
Long-term investments 9,206 8,953
Property and equipment, net 15,164 10,515
Intangible assets, net 2,540 3,431
Other assets 515 362
----------- -----------
Total assets $ 160,817 $ 114,792
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 16,373 $ 8,224
Deferred revenues 16,885 12,491
----------- -----------
Total current liabilities 33,258 20,715
Deferred tax liability 531 768
Stockholders' equity:
Capital stock 81,919 66,326
Retained earnings 45,109 26,983
----------- -----------
Total stockholders' equity 127,028 93,309
----------- -----------
Total liabilities and stockholders' equity $ 160,817 $ 114,792
=========== ===========
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
<PAGE>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ---------------------------
1998 1997 1998 1997
-------------- ------------- ------------- ------------
REVENUES:
<S> <C> <C> <C> <C>
Product $28,770 $17,415 $76,874 $45,573
Service and support 8,722 4,573 21,764 12,228
-------------- ------------- ------------- ------------
Total revenues 37,492 21,988 98,638 57,801
COST OF REVENUES:
Product 1,155 773 2,917 1,938
Service and support 3,481 1,830 9,169 4,682
-------------- ------------- ------------- ------------
Total cost of revenues 4,636 2,603 12,086 6,620
-------------- ------------- ------------- ------------
GROSS PROFIT 32,856 19,385 86,552 51,181
OPERATING EXPENSES:
Research and development 6,018 3,719 15,567 10,482
Sales and marketing 12,614 7,438 36,052 20,116
General and administrative 2,483 1,824 7,434 4,785
Amortization of intangibles 279 279 838 838
Merger related expenses 645 0 645 0
-------------- ------------- ------------- ------------
Total operating expenses 22,039 13,260 60,536 36,221
-------------- ------------- ------------- ------------
INCOME FROM OPERATIONS 10,817 6,125 26,016 14,960
Interest income, net 1,130 543 2,994 1,492
-------------- ------------- ------------- ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 11,947 6,668 29,010 16,452
Provision for income taxes 4,420 2,395 10,883 6,254
-------------- ------------- ------------- ------------
NET INCOME $ 7,527 $ 4,273 $ 18,127 $ 10,198
============== ============= ============= ============
Basic earnings per share $ 0.20 $ 0.12 $ 0.49 $ 0.29
============== ============= ============= ============
Diluted earnings per share $ 0.19 $ 0.11 $ 0.46 $ 0.27
============== ============= ============= ============
Shares used in the calculation of basic
earnings per share 37,143 35,247 36,693 34,873
============== ============= ============= ============
Shares used in the calculation of
diluted earnings per share 40,348 37,961 39,813 37,710
============== ============= ============= ============
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1998 1997
Cash flows from operating activities:
<S> <C> <C>
Net income $ 18,127 $ 10,198
Adjustments to reconcile net income to net cash provided
by operating activities:
Net deferred tax asset (1,634) (224)
Depreciation and amortization 4,144 2,572
Tax benefit from exercise of stock options 8,252 1,496
Changes in operating assets and liabilities:
Accounts receivable (9,171) (6,005)
Other current assets (206) (1,881)
Deferred revenues 4,394 2,863
Accounts payable and current liabilities 8,148 4,083
----------- -----------
Net cash provided by operating activities 32,054 13,102
----------- -----------
Cash flows from investing activities:
Purchase of available-for-sale securities (40,726) (24,964)
Proceeds from maturity and sale of available-
for-sale securities 39,353 23,967
Acquisition of property and equipment (7,955) (5,388)
Other (101) (439)
----------- -----------
Net cash used in investing activities (9,429) (6,824)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 7,185 2,832
Other 15 15
----------- -----------
Net cash provided by financing activities 7,200 2,847
----------- -----------
Net increase in cash and cash equivalents 29,825 9,125
Cash and cash equivalents at beginning of period 34,891 27,770
----------- -----------
Cash and cash equivalents at end of period $ 64,716 $ 36,895
</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 normal and recurring adjustments
necessary to fairly present the financial position, results of operations and
cash flows of Legato Systems, Inc. and its subsidiaries ("the Company"). The
results of operations for the quarterly and nine month periods presented are not
necessarily indicative of the results that may be expected for quarterly or
annual periods in the future. The Notes to the Consolidated Financial Statements
contained in the 1997 Report on Form 10-K should be read in conjunction with
these Condensed Consolidated Financial Statements. The Company derived the
balance sheet at December 31, 1997, 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 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. As required, the Company computes basic earnings per share by dividing
net income available to common stockholders by the weighted average number of
common shares outstanding for the period and computes diluted earnings per share
by giving effect to all dilutive potential common shares outstanding during the
period. Dilutive potential common equivalent shares consist of the incremental
common shares issuable upon conversion of stock options. The Company restated
prior period earnings per share amounts to comply with SFAS 128.
As required by SFAS 128, the following table reconciles the numerator and
denominator of basic and diluted earnings per (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
Numerator - basic and diluted earnings per share
<S> <C> <C> <C> <C>
Net income $ 7,527 $ 4,273 $ 18,127 $ 10,198
========= ========= ========= ========
Denominator - basic earning per share
Weighted average common shares outstanding 37,143 35,247 36,693 34,873
========= ========= ========= ========
Basic earnings per share $ 0.20 $ 0.12 $ 0.49 $ 0.29
========= ========= ========= ========
Denominator - diluted earnings per share
Weighted average common shares outstanding 37,143 35,247 36,693 34,873
Effect of dilutive securities:
Common stock options 3,205 2,714 3,120 2,837
--------- --------- --------- --------
Weighted average common and common
equivalent shares 40,348 37,961 39,813 37,710
========= ========= ========= ========
Diluted earnings per share $ 0.19 $ 0.11 $ 0.46 $ 0.27
========= ========= ========= ========
Shares excluded from diluted earnings per shares calculation 28 47 52 1,106
- ------------------------------------------------------------ ========= ========= ========= ========
</TABLE>
Certain shares of common stock options were excluded from the calculation
of diluted earnings per share because the options' exercise prices were greater
than the average market price of the common shares during these periods.
Note 3. Stock Split
The Company effected a two-for-one stock split (in the form of a stock
dividend) on April 17, 1998. The accompanying Condensed Consolidated Financial
Statements retroactively reflect the two-for-one stock split.
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 Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
Revenues:
<S> <C> <C> <C> <C>
Legato Systems, Inc. $ 37,492 $ 21,436 $ 97,693 $ 56,207
Software Moguls, Inc. -- 552 945 1,594
--------- --------- --------- --------
Total $ 37,492 $ 21,988 $ 98,638 $ 57,801
========= ========= ========= ========
Net Income (Loss):
Legato Systems, Inc. $ 7,527 $ 4,352 $ 18,530 $ 10,648
Software Moguls, Inc. -- (79) (403) (450)
--------- -------- --------- -------
Total $ 7,527 $ 4,273 $ 18,127 $ 10,198
========= ========= ========= ========
</TABLE>
Note 5. Other Matters
Comprehensive Income
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), effective
January 1, 1998. This statement requires the disclosure of comprehensive income
and its components in a full set of general-purpose financial statements. SFAS
130 defines comprehensive income as net income plus revenues, expenses, gains
and losses that, under generally accepted accounting principles, are excluded
from net income. The components of the Company's comprehensive income excluded
from net income are not significant, individually or in aggregate. Therefore, no
separate statement of comprehensive income has been presented.
Revenue Recognition
The Company adopted the provisions of Statement of Position 97-2, Software
Revenue Recognition ("SOP 97-2"), as amended by Statement of Position 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 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 distributor to end-users.
For contracts with multiple obligations (e.g. deliverable and undeliverable
products, maintenance and other services), the Company allocates revenue to each
component of the contract based on objective evidence of its fair value, which
is specific to the Company, or for products not being sold separately, the price
established by management. The Company recognizes revenue allocated to
undelivered products when the criteria for product revenue set forth above are
met. The Company recognizes revenue allocated to maintenance fees for ongoing
customer support and product updates ratably over the period of the maintenance
contract. Payments for maintenance fees are generally made in advance and are
non-refundable. For revenue allocated to other services, the Company recognizes
revenues 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"), effective for fiscal years
beginning after December 15, 1997. SFAS 131 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 to base segment reporting and also requires interim
reporting of segment information. The statement does not require interim
reporting disclosures until the first quarter immediately subsequent to the
fiscal year in which SFAS 131 is effective.
Reclassifications
The Company made certain reclassifications to prior period consolidated
financial statements to conform to the current presentation. The
reclassifications have no significant effect on previously reported financial
position, results of operations or cash flows.
Note 6. Subsequent Event
On October 25, 1998, the Company entered into a definitive agreement to
acquire Qualix Group, Inc. (dba FullTime Software, Inc.), a market leader and
leading developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions that enable customers to proactively manage application
service level availability. The agreement provides for the issuance of 1,721,000
shares of the Company's common stock in exchange for all the common stock and
options of Qualix Group, Inc. The transaction is expected to be completed by
December 1998 or shortly thereafter, and is subject to the satisfaction of
standard closing conditions, including regulatory approval and the approval of
Qualix Group, Inc. stockholders. The transaction is expected to be accounted for
as a pooling of interests.
<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 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 on 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. The
Company assumes no obligation to update any such forward-looking statements. The
Company's actual results could differ materially from those indicated in such
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to fluctuations in quarterly operating
results, uncertainty in future operating results, product concentration,
competition, and other risks discussed in this item under the heading "Risk
Factors" and the risks discussed in the Company's other Securities and Exchange
Commission filings.
RESULTS OF OPERATIONS
OVERVIEW
The Company develops, licenses, 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 primarily located in North
America, Europe and Asia Pacific. The Company also licenses its source code to
original equipment manufacturers ("OEMs") in exchange for initial licensing fees
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.
<PAGE>
The following table shows selected elements of the Company's consolidated
financial statements as a percentage of total revenues.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
----------- ----------- ----------- -------
Revenues:
<S> <C> <C> <C> <C>
Product 76.7% 79.2% 77.9% 78.8%
Service and support 23.3 20.8 22.1 21.2
---------- ----------- ---------- -----------
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues:
Product 3.1 3.5 3.0 3.4
Service and support 9.3 8.3 9.3 8.1
---------- ----------- ---------- -----------
Total cost of revenues 12.4 11.8 12.3 11.5
---------- ----------- ---------- -----------
Gross profit 87.6 88.2 87.7 88.5
Operating expenses:
Research and development 16.1 16.9 15.8 18.1
Sales and marketing 33.6 33.8 36.5 34.8
General and administrative 6.6 8.3 7.5 8.3
Merger related expenses 1.7 -- 0.7 --
Amortization of intangibles 0.7 1.3 0.8 1.4
---------- ----------- ---------- -----------
Total operating expenses 58.7 60.3 61.3 62.6
---------- ----------- ---------- -----------
Income from operations 28.9 27.9 26.4 25.9
Interest and other income, net 3.0 2.5 3.0 2.6
---------- --------- ---------- -----------
Income before provision for income taxes 31.9 30.4 29.4 28.5
Provision for income taxes 11.8 10.9 11.0 10.8
---------- ----------- ---------- -----------
Net income 20.1% 19.5% 18.4% 17.7%
========== =========== ========== ===========
</TABLE>
REVENUES
Revenues for the third quarter ended September 30, 1998, increased 70.5
percent to $37.5 million, from $22.0 million for the comparable period in 1997.
Revenues for the first nine months ended September 30, 1998, grew 70.7 percent
to $98.6 million, from $57.8 million from the comparable period in 1997.
Revenues increased primarily as a result of the continued acceptance of the
Company's Networker family of products and G.E.M.S. product and increased sales
of service and support contracts.
Product Revenues. Product revenues increased 65.2 percent to $28.8 million
for the third quarter of 1998, from $17.4 million for the comparable period in
1997. Product revenues increased 68.7 percent to $76.9 million for the first
nine months of 1998, from $45.6 million for the comparable period in 1997.
Product revenue increased primarily as a result of the continued market
acceptance of the Company's products. The Company recognizes product revenues
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 end-users. Product revenues also include
royalty payments received from product sales by OEMs. The Company recognizes
product revenues from royalty payments upon receipt of quarterly royalty reports
from OEMs related to their product sales for the previous quarter. Prior growth
rates of the Company's product revenues are not indicative of future product
revenue growth rates and may not be sustainable in the future.
Service and Support Revenues. Service and support revenues increased 90.7
percent to $8.7 million for the third quarter of 1998, from $4.6 million for the
comparable period in 1997. For the first nine months of 1998, service and
support revenues increased 78.0 percent to $21.8 million, from $12.2 million for
the comparable period in 1997. Service and support revenues increased primarily
as a result of an increase in sales of certain of the Company's products that
include one-year of software support, an increase in the number of registered
customers for the Company's products electing to subscribe to support contracts,
an increase in the renewal of software support after the initial one-year term,
an increase in internal staffing for software support sales and an increase in
demand for the education and consulting services offered by the Company. The
Company collects fees for ongoing customer support and product updates in
advance and recognizes these support revenues ratably over the period of the
contract. For education and consulting services, the Company recognizes revenues
when such services are performed. Prior growth rates of the Company's software
service and support revenues are not indicative of future software service and
support revenue growth rates and may not be sustainable in the future.
International product revenues increased 100.0 percent to $10.4 million for
the third quarter of 1998, from $5.2 million for the comparable period in 1997.
International product revenues accounted for 27.7 percent of total product
revenues for the third quarter of 1998 and 23.6 percent of total product
revenues for the comparable period in 1997. For the first nine months of 1998,
international product revenues increased 90.0 percent to $27.7 million, from
$14.6 million for the comparable period in 1997. International product revenues
accounted for 28.1 percent of total product revenues for the first nine months
of 1998 and 25.2 percent of total product revenues for the comparable period in
1997. International license revenues increased primarily as a result of the
increase in the market acceptance of the Company's products overseas, the
increase in the number of international sales offices, and the increase in the
number of international distributors and resellers marketing the Company's
products. Sales in Europe and Canada during these periods accounted for a
majority of the Company's international sales. 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 successfully
expand its international operations, 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 increased 69.5 percent to $32.9 million, representing 87.6
percent of total revenues, for the third quarter of 1998, from $19.4 million,
representing 88.2 percent of total revenues, for the comparable period in 1997.
For the first nine months of 1998, gross profit increased 69.1 percent to $86.6
million, representing 87.7 percent of total revenues, from $51.2 million,
representing 88.5 percent of total revenues, for the comparable period in 1997.
Gross profit consists of product and service and support revenues less related
costs.
Gross profit from product revenues increased 65.9 percent to $27.6 million
for the third quarter of 1998, from $16.6 million for the comparable period in
1997. For the first nine months of 1998, gross profit from product revenues
increased 69.5 percent to $74.0 million, from $43.6 million for the comparable
period in 1997. Gross profit as a percentage of product revenues increased to
96.0 percent for the third quarter of 1998, from 95.6 percent for the comparable
period in 1997. Gross profit from product revenues as a percentage of product
revenues increased to 96.2 percent for the first nine months of 1998, from 95.8
percent for the comparable period in 1997. Gross profit from product revenues
consists of product revenues less the related costs. Related costs of revenues
consist primarily of product media, documentation and packaging. Gross profit
from product revenues as a percentage of product revenues increased primarily
due to leveraging the costs of products over a larger revenue base.
Gross profit from service and support revenues increased 91.1 percent to
$5.2 million during the third quarter of 1998, from $2.7 million for the
comparable period in 1997. Gross profit from service and support revenue
increased 66.9 percent to $12.6 million during the first nine months of 1998,
from $7.5 million for the comparable period in 1997. Gross profit from service
and support revenues as a percentage of service and support revenues represented
60.0 percent for the third quarters of 1998 and 1997. Gross profit from service
and support revenues as a percentage of service and support revenues decreased
to 57.9 percent during the first nine months of 1998, from 61.7 percent for the
comparable period in 1997. Gross profit from service and support revenues as a
percentage of service and support revenues decreased primarily as a result of
the Company's continued investment in developing new services and support
offerings. The continued investment consists of additional costs associated with
supporting a larger installed base of products, as well as additional costs to
provide higher support levels to customers. Costs of service and support
revenues consist primarily of personnel-related costs incurred in providing
telephone support, consulting services, and training to customers, costs of
providing software updates and costs of education and consulting materials.
OPERATING EXPENSES
Research and Development. Research and development expenses increased 61.8
percent to $6.0 million in the third quarter of 1998, from $3.7 million for the
comparable period in 1997. Research and development expenses increased 48.5
percent to $15.6 million in the first nine months of 1998, from $10.5 million
for the comparable period in 1997. The increases in research and development
expenses in absolute dollars primarily reflect 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 expenses
decreased to 16.1 percent in the third quarter of 1998, from 16.9 percent in the
third quarter of 1997. As a percentage of total revenues, research and
development expenses decreased to 15.8 percent in the first nine months of 1998,
from 18.1 percent for the comparable period in 1997. Research and development
expenses as a percentage of total revenues decreased 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
continue to increase in absolute dollars as it continues to invest in developing
new products, applications, and product enhancements.
Sales and Marketing. Sales and marketing expenses increased 69.6 percent to
$12.6 million in the third quarter of 1998, from $7.4 million in the third
quarter of 1997. Sales and marketing expenses increased 79.2 percent to $36.1
million in the first nine months of 1998, from $20.1 million for the comparable
period in 1997. As a percentage of total revenues, sales and marketing expenses
decreased to 33.6 percent in the third quarter of 1998, from 33.8 percent in the
comparable 1997. As a percentage of total revenues, sales and marketing expenses
increased to 36.5 percent in the first nine months of 1998, from 34.8 percent
for the comparable period in 1997 primarily as a result of the growth in the
Company's sales force and increased marketing and promotional activities. 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 increased
36.1 percent to $2.5 million in the third quarter of 1998, from $1.8 million for
the comparable period of 1997. General and administrative expenses increased
55.4 percent to $7.4 million for the first nine months of 1998, from $4.8
million for the comparable period of 1997. As a percentage of total revenues,
general and administrative expenses decreased to 6.6 percent in the third
quarter of 1998, from 8.3 percent in the comparable 1997 period, and decreased
to 7.5 percent for the first nine months in 1998, from 8.3 percent in the
comparable 1997 period. General and administrative expenses as a percentage of
total revenues decreased primarily as a result of the Company leveraging general
and administrative expenses over a larger revenue base. The Company expects that
general and administrative expenses will increase in absolute dollars from the
third quarter of 1998 level as the Company continues to expand its staffing and
other support operations.
Amortization of Intangibles. Amortization of intangibles was $279,000 for
the third quarters of both 1998 and 1997. Amortization of intangibles was
$838,000 for the first nine months of both 1998 and 1997. The Company recorded
the related intangibles following an acquisition in the first quarter of 1996.
The Company amortizes these intangibles on a straight-line basis over five
years.
Interest and Other Income, Net. Interest and other income, net, increased
to $1.1 million in the third quarter of 1998, from $543,000 for the comparable
period in 1997. Interest and other income, net, increased to $3.0 million for
the first nine months of 1998, from $1.5 million for the comparable period in
1997. 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 increased to
$4.4 million in the third quarter of 1998, from $2.4 million for the comparable
period in 1997. The provision for income taxes increased to $10.9 million for
the first nine months of 1998, from $6.3 million for the comparable period in
1997. The effective tax rate increased to 37 percent for the third quarter of
1998, from 36 percent for the comparable period in 1997. The effective tax rates
for the first nine months of 1998 and 1997 were both 38 percent. The increase in
the effective tax rate from the third quarter of 1997 to 1998 primarily relates
to the restatement of the Company's historical financial statement in connection
with the acquisition of Software Moguls, Inc. during the third quarter of 1998.
Merger-Related Expenses. In connection with the Company's acquisition of
Software Moguls during the third quarter of 1998, the Company incurred
merger-related expenses of $645,000 consisting primarily of investment
bankers, attorneys and accountants fees. The Company did not incur any
merger-related expenses for the three-month and nine-month periods ended
September 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and investments totaled $103.3 million
at September 30, 1998 and represented 64.3 percent of total assets. Cash
equivalents consist of highly liquid financial instruments with original
maturities of ninety days or less. Investments consist mainly of short-term and
long-term municipal securities. At September 30, 1998, the Company had no
long-term debt and stockholders' equity was $127.0 million.
The Company has generated sufficient cash from operations and sales of
common stock to finance the Company's operations to date. Cash and cash
equivalents increased $29.8 million during the first nine months of 1998. The
Company derived cash provided by operating activities of $32.1 million,
primarily from net income of $18.1 million, tax benefit from the exercise of
stock options of $8.3 million and changes in operating assets and liabilities of
$3.2 million. Cash used in investing activities of $9.4 million primarily
reflected the purchases of available-for-sale securities (net of maturities and
sales of available-for-sale securities), of $1.4 million and the acquisition of
property and equipment of $8.0 million. Cash from financing activities of $7.2
million reflected 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 fifteen months, 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,
but not limited to, 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 license 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 licenses and software services
and support revenues are difficult to forecast because the network storage
management market is rapidly evolving and the Company's sales cycle varies
substantially from customer to customer. The Company has become increasingly
dependent upon the larger enterprise license transactions to corporate
customers, which often include product license, service and support components.
The Company's operating results are sensitive to the timing of such orders and
are subject to purchasing cycles and budgetary constraints of the customer,
which are difficult to predict. Due to the lengthier sales cycle and the larger
size of enterprise license transactions, if orders forecasted for a particular
quarter are not realized in that quarter, the Company's operating results for
that quarter may be adversely affected. Royalty revenues are substantially
dependent upon product license sales by OEMs of their products that incorporate
the Company's software. Accordingly, royalty revenues are subject to OEMs'
product cycles, which are also difficult to predict. Royalty 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 quarters 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 and licensing NetWorker or any new products,
applications, product enhancements and related services.
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), 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 and are expected to occur in the future.
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 or 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, which could have a
material adverse effect upon the Company's business, operating results and
financial condition.
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 Reliance on Enterprise License Transactions; Resellers;
Strategy of Expanding OEM Channel
An integral part of the Company's strategy is to pursue larger enterprise
license transactions with corporate customers. As there has been an increasing
number of larger enterprise license transactions, which may often include
product license, service and support components, the Company's operating results
are sensitive to the timing of such orders. These transactions are typically
difficult to manage and predict. The execution of such larger enterprise license
transactions typically involves significant technical evaluation and commitment
of capital and other resources, with the delays frequently associated with
customers' internal procedures, including delays to approve large capital
expenditures, to implement the deployment of new technologies within their
networks, and to test and accept new technologies that affect key operations.
For these and other reasons, the sales cycle associated with the completing an
enterprise license transaction is typically lengthy, generally lasting three to
six months, is subject to a number of significant risks, including customers'
budgetary constraints and internal acceptance reviews, that are beyond the
Company's control, and varies substantially from transaction to transaction. Due
to the lengthy sales cycle and the large size of certain transactions, if orders
forecasted for a specific transaction for a particular quarter are not realized
in that quarter, the Company's operating results for that quarter may be
adversely affected. There can be no assurance that the Company will continue to
complete or increase the number of such larger enterprise license transactions,
and the inability to do so could materially adversely affect the Company's
business, operating results and financial condition.
The Company 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
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.
The Company's strategy is also to increase the proportion of the Company's
customers licensed through OEMs. The Company is currently investing, and intends
to continue to invest, 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.
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 licensing its products
(other than in enterprise license transactions), 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 licensing its products (other than in enterprise license
transactions), 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 fifteen months, 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. The volatility of the market has often 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 5. Other Information
Stockholder Proposals
Pursuant to new amendments to Rule 14a-4(c) of the Securities Exchange Act of
1934, as amended, if a stockholder who intends to present a proposal at the 1999
annual meeting of stockholders does not notify the Company of such proposal on
or prior to March 15, then management proxies would be allowed to use their
discretionary voting authority to vote on the proposal when the proposal is
raised at the annual meeting, even though there is no discussion of the proposal
in the 1999 proxy statement. The Company currently believes that the 1999 annual
meeting of stockholders will be held during the first two weeks of May, 1999.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports of Form 8-K were filed during the quarter ended September 30,
1998.
<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 12, 1998 /s/ Stephen C. Wise
-------------------
Stephen C. Wise
Senior Vice President of Finance and
Chief Financial Officer
(Duly authorized officer and principal
financial and accounting officer)
<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-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 64,716
<SECURITIES> 38,615
<RECEIVABLES> 30,597
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 133,392
<PP&E> 15,164
<DEPRECIATION> 0
<TOTAL-ASSETS> 160,817
<CURRENT-LIABILITIES> 33,258
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 127,028
<TOTAL-LIABILITY-AND-EQUITY> 160,817
<SALES> 0
<TOTAL-REVENUES> 98,638
<CGS> 12,086
<TOTAL-COSTS> 72,622
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 29,010
<INCOME-TAX> 10,883
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 18,127
<EPS-PRIMARY> 0.49
<EPS-DILUTED> 0.46
</TABLE>
