Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1997
[ ] 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)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Preferred Share Purchase Rights
Common Stock, $.0001 par value
(Title of each class).
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 28, 1998 was approximately $841,756,692. Shares of
Common Stock held by each officer and director have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
The number of shares outstanding of the registrant's common stock as of
February 28, 1998 was 18,118,862.
DOCUMENTS INCORPORATED BY REFERENCE
Part III - Portions of the registrant's definitive Proxy Statement to be issued
in conjunction with the registrant's Annual Meeting of Stockholders to be held
on May 14, 1998.
LEGATO SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1997
Table of Contents
PART I
Item 1. Business....................................................................................... 1
Item 2. Properties..................................................................................... 14
Item 3. Legal Proceedings.............................................................................. 14
Item 4. Submission of Matters to a Vote of Security Holders............................................ 14
Item 4a. Executive Officers of the Registrant........................................................... 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................... 15
Item 6. Selected Consolidated Financial Data........................................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 16
Item 8. Consolidated Financial Statements and Supplementary Data....................................... 21
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........... 21
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 39
Item 11. Executive Compensation......................................................................... 39
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 39
Item 13. Certain Relationships and Related Transactions................................................. 39
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K................................. 40
Signatures ............................................................................................... 44
PART I
ITEM 1. BUSINESS
The discussion in this report on Form 10-K 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" as well as those discussed elsewhere in this Report,
and the risks discussed in the Company's Securities Exchange Commission filings.
Legato Systems, Inc. ("Legato" or the "Company") was incorporated in
Delaware in September 1988. The Company develops, markets and supports network
storage management software products for heterogeneous client/server computing
environments. The Company believes it is currently a technology leader in the
network storage management software market because of the scalability,
heterogeneity, performance, ease of use and central administration of its
software products. The Company's NetWorker family of products and Global
Enterprise Management Systems ("G.E.M.S.") software supports many storage
management server platforms and can accommodate a variety of clients, servers,
applications, databases and storage devices. The Company's long term strategy is
to create an integrated set of solutions centered around storage management that
enhance and simplify network computing as a whole.
The Company utilizes multiple distribution channels, including resellers,
OEMs and direct sales, as a part of the Company's strategy to achieve
comprehensive coverage in the market. The Company licenses its source code to
leading computer system and software suppliers, including Amdahl, Banyan, Data
General, Digital, ICL, Nihon-Unisys, NEC, Siemens Nixdorf, Silicon Graphics,
Sony, Sun Microsystems, Tandem and Unisys, which port the products to their
proprietary platforms, sell the products through their direct and indirect
distribution channels and provide primary support for the products after
installation. These relationships enable the Company to reach a broad customer
base, while reducing development, support and product costs. The Company also
has established strategic partnerships with Hewlett-Packard, Informix, Netscape
and Oracle.
Background
The Company's NetWorker software has been designed to address the emerging
requirements of storage management in client/server computing environments.
NetWorker employs a client/server architecture in which a server centralizes
storage management services for a wide variety of clients, including servers and
desktop computers. NetWorker provides a cost-effective storage management
solution that scales to support large networks, supports heterogeneous
client/server computing environments, accomplishes storage management tasks
within stringent time constraints, reduces the cost of network administration
and employs an easy-to-use graphical user interface. The core elements of the
Legato solution include:
Scalability. The Company's storage management architecture, also referred
to as Enterprise Storage Management Architecture ("ESMA"), is designed to be
scalable so that it can grow with an expanding network and accommodate a wide
range of storage management needs. The Company's storage server family can be
configured or expanded to meet the storage requirement needs of a changing and
dynamic network. The Company's architecture is modular, so that clients, servers
and storage devices can be upgraded or added without requiring redesign of the
entire system. An existing server can be quickly upgraded to a more powerful
server with minimal modification. Furthermore, the Company's architecture can
adapt to growing networks with its ability to easily add clients to a given
storage management server. For example, a single NetWorker storage management
server has been employed to manage data located on hundreds of clients ranging
from desktop computers to large file servers.
Heterogeneity. The Company's storage management solutions are designed to
support a wide range of servers, clients, applications, databases and storage
devices. Servers, clients, applications, databases and storage devices supported
by the Company's BusinesSuite products include Informix, Microsoft Exchange,
Microsoft SQL, Oracle, SAP R/3 and Sybase. The Company's family of storage
management server products operates on NetWare, Windows NT, and UNIX systems
(Solaris, AIX, HP-UX and SCO UNIX), as well as on UNIX systems and Windows NT
offered by the Company's OEMs such as Banyan, Data General, Digital, ICL, NEC,
Siemens Nixdorf, Silicon Graphics, Sony, Sun Microsystems, Tandem and Unisys.
Server and desktop computer clients supported include DOS, NetWare, Macintosh,
OS/2, UNIX, Vines, Windows and Windows NT. Storage devices supported include all
popular tape drives, and optical and tape robotic storage devices. All NetWorker
server platforms inter-operate with all supported clients. As a result,
customers can mix and match clients and servers as necessary to meet their
specific requirements.
Performance. Organizations usually need to accomplish storage management
functions (which tend to consume network bandwidth as large amounts of data are
transferred over the network) during a network's off-peak hours. The Company's
NetWorker storage management server can process data from many clients in
parallel, allowing high volumes of network data to be managed within stringent
time constraints. NetWorker is designed to take advantage of improvements in the
physical environment to deliver higher performance. As networks employ
higher-speed computers, faster and increased capacity storage devices and higher
bandwidth networking technologies, NetWorker can exploit these capabilities to
move data quickly. In 1996, the Company began shipping a series of optimized
storage servers, Power Edition, which is based upon its core technology and is
targeted for very large databases or data centers that further increases the
performance and scalability of the Company's products.
Ease of Use. The Company's storage management solutions have been designed
to be easy to use for both network administrators and end users. The Company's
architecture permits a network administrator to perform the storage management
function for the entire network either from the storage server or a client. The
network administrator can access the Company's products through a number of
graphical user interfaces, including Windows, Windows NT and Motif. Network
administrators can also automate their storage operations by adding robotic
storage libraries, further reducing the need for human intervention. Finally,
the Company's architecture supports a simple user interface that permits end
users to access or recover copies of their files without the need for
intervention by the network administrator.
Central Administration. The Company's recently shipped G.E.M.S. product
allows information system organizations the ability to globally manage hundreds
and even thousands of Networker storage servers. G.E.M.S. provides services such
as policy management, software distribution, universal licensing and advanced
media management and can be integrated with management frameworks including CA
Unicenter, HP Openview, Siemens Transview, Sun Enterprise Manager and Tivoli
TME.
Architecture
The most basic function of a storage management system is data protection.
The process of data protection involves making backup copies of data stored on
hard disks onto low-cost, high capacity removable media such as tapes and
optical disks.
The Company's extensible architecture provides reliable data protection
services. Data may be managed according to the application that produces it. For
example, a relational database may be frequently updated. To back up this kind
of database efficiently, it is necessary to understand how the database is
constructed, so that a consistent copy of the database can be made while it is
undergoing change and while the database is "on-line." The Company's
architecture can accommodate the data produced by different applications because
of its Application Specific Module ("ASM") technology. Each ASM can be tailored
to the specific storage management needs of a particular kind of application
data, and all ASMs are implemented using a modular architecture designed to
permit new ASMs to be easily integrated into the Company's storage offerings.
Once data is read from the client hard disk, it is transmitted to the
storage management software that resides on the storage server using
industry-standard communications protocols such as TCP/IP and SPX/IPX. A
high-performance, integrated database is fundamental to the storage management
server engine. This database has two roles: to keep track of where the storage
management server has stored the data, and to keep track of what data is stored.
The Company's architecture makes it possible for clients to query the database
as to what data is under management and to access this data themselves. This
enables novice users to directly access the system, thereby reducing the burden
on network administrators.
One of the most critical ways the Company's architecture achieves its
ability to accommodate an increasing number of clients while retaining high
performance is by implementing parallel data transfers from the clients to the
storage management server in the same way that adding more tellers to serve
customers allows a bank to process more transactions in the same amount of time.
When an additional client's data is managed, it may be scheduled for processing
by the storage management server at the same time as the data from other
clients. Thus, one slow client need not slow down the entire storage management
process. The Company's architecture achieves this parallelism by writing
multiple client data streams to the tape simultaneously. This allows the full
bandwidth of the tape drive to be used as the data from many clients can be
delivered to the tape drive in the same amount of time as the data from one
client. As a result, one high-capacity tape drive can be shared effectively by
more than one client on the network, and therefore, it may not be necessary to
purchase several tape drives to accomplish data protection in the required
amount of time.
An increasingly important function of the architecture to some end users is
to facilitate the management of data according to its criticality. As an
example, a set of quarterly reports may be grouped together and filed away. This
data may not need to be accessed on a regular basis, but may need to be
retrievable for a period of years because of certain regulatory requirements.
This class of data is termed "archive" data, because it may be filed away for
future reference and need not be kept on-line. When archived data is needed, it
must be explicitly retrieved, typically from offsite storage. It is also
possible to archive data in such a way that it appears to be on-line, when it in
reality is stored elsewhere. This process is referred to as "hierarchical
storage management." The indexing technology embedded within the Company's
storage products is designed to support the management of protected, archived,
and hierarchically managed data.
To reduce the burden on expensive administrative staff, the Company's
architecture allows the storage management server to be managed remotely, from
an easy-to-use, graphical user interface familiar to the administrator. The use
of a common administrative protocol developed by the Company greatly facilitates
the development of diverse user interfaces that support remote administration.
The Company's family of storage management products can also automate a wide
range of storage management functions and can employ robotic storage devices to
remove the need for human intervention to retrieve a particular piece of
removable storage media.
Products
The Company's family of storage management server software - NetWorker -
provides network storage management services for a wide variety of platforms.
NetWorker consists of two basic components: a client module that accesses the
data being managed, and a server module that performs the protection, management
and control of network data. Typically, the server module is selected to run on
the platform most familiar to the administrative staff in an organization; the
client modules are selected according to the type of computers installed on the
network. Server software is available from the Company for NetWare, Windows NT
and several UNIX platforms, including IBM, HP and Sun versions of UNIX. A number
of applications and enhancements options are available for the storage server.
The base NetWorker server product provides data protection services for
clients and includes client software for the same platform as the NetWorker
server, as well as support for a set of popular non-robotic storage devices. In
multiple platform environments, client software for dissimilar platforms must be
purchased. The following client packages are currently available: (i) ClientPak
for UNIX, which supports a diverse set of UNIX clients; (ii) ClientPak for PC
Desktops, which supports DOS, OS/2, Windows and Windows NT; (iii) ClientPak for
Windows NT; (iv) ClientPak for NetWare and (v) ClientPak for Macintosh.
NetWorker for UNIX is licensed by the number of clients to be supported and
has the following storage management server options available: (i) Client
Connections - the ability to increase the number of clients of the storage
management server beyond the ten supported by the base product; (ii) Archive -
the ability to archive data; (iii) Autochanger - the ability to employ tape and
optical jukeboxes of varying capacities; (iv) StorSuite - the ability to manage
migrated files to less costly media; (v) BusinesSuite - the ability to utilize a
family of add-on modules tailored for databases and business applications; (vi)
SNMP Modules - the ability to integrate with leading system management
offerings; (vii) Silo Support - the ability to leverage mainframe-class storage
silos; (viii) High Speed Device Support - the ability to utilize high speed
devices; (ix) Storage Nodes - the ability to perform very high-speed backup
locally which is managed centrally.
NetWorker for Windows NT is Microsoft BackOffice certified and licensed by
the number of clients to be supported and it has the following storage
management server options available: (i) Client Connections - the ability to
increase the number of clients of the storage management server beyond the ten
supported by the base product; (ii) Archive - the ability to archive data; (iii)
Autochanger - the ability to employ tape and optical jukeboxes of varying
capacities; (iv) BusinesSuite - the ability to utilize a family of add-on
modules tailored for databases and business applications such as SQL Server and
Exchange Server; (v) SNMP Module - the ability to integrate with leading system
management offerings; and (vi) Open File Manager - the ability to protect open
files.
NetWorker for NetWare is licensed by the number of clients to be supported
and has the following storage management server options available: (i) Client
Connections - the ability to increase the number of clients of the storage
management server beyond the ten supported by the base product; (ii) Archive -
the ability to archive data; (iii) Autochanger - the ability to employ tape and
optical jukeboxes of varying capacities; (iv) Mainframe Module -- the ability to
store data on storage devices attached to a mainframe; and (v) Open File Manager
- - the ability to protect open files.
NetWorker for server software has an entry end user list price from $2,000
to $6,000, while a fully configured NetWorker system can have an end user list
price of over $100,000.
Sales and Marketing
The Company's strategy is to deploy a comprehensive sales, marketing and
support infrastructure to meet the storage management needs of users of complex
client/server networks, both in North America and overseas. The Company uses
multiple distribution channels to reach end user customers, which range in size
from individual corporate departments or small businesses to large multinational
corporations. Network storage management software may be utilized in a broad
range of industries. The range of distribution channels includes resellers, OEMs
and direct sales. The Company has established regional sales offices to increase
the effectiveness of and support to the Company's channel partners. The Company
has recently established a dedicated sales force to penetrate large
enterprise-wide opportunities.
Resellers
North America Premier Reseller Program. The Company's North America Premier
Reseller program is a significant source of revenue in North America. The
Premier Reseller program enables third-party integrators specializing in storage
management and client/server network solutions to provide end user customers
with complete solutions, including systems and storage hardware, complementary
software and the Company's software. The reseller is responsible for managing
the sales and installation process in each customer situation. In large, complex
opportunities, the Company's support personnel work with the reseller to provide
technical support. This approach enables the Company to cost effectively achieve
broader market coverage, while maintaining close contact with end user customers
in order to obtain input on product direction and to monitor customer
satisfaction. The Company provides sales and pre-sale technical support to
business partners and end user customers from the Company's headquarters in Palo
Alto and from regional offices in the Boston, Chicago, Dallas, Los Angeles, New
York, Seattle, Toronto, and Washington, D.C. metropolitan areas.
North America Distributor Program. To further expand coverage in the
marketplace, the Company sells its products to large regional and national
distributors who sell the Company's products to resellers with expertise in
integrating network solutions for end users. The Company provides support to
these network solutions resellers. The Company currently has relationships with
various major distributors, including Access Graphics, Anthem Electronics,
Gates/Arrow, Ingram Micro, TechData and Tenex Data.
International Reseller and Distributor Programs. The Company has similar
reseller and distributor programs internationally. The Company currently
operates regional offices for the United Kingdom (London), Central Europe
(Munich), Southern Europe (Paris), Scandinavia (Sweden) and Benelux (Amsterdam)
to support resellers and distributors throughout Europe. The Company also has
opened sales offices in Australia and Japan for sales and support to the Pacific
Rim. Sales and support to Latin America are headquartered out of Miami.
International product sales were $19.8 million, $10.7 million and $4.7
million, representing 24 percent, 20 percent and 16 percent of total revenues in
1997, 1996 and 1995, respectively. The majority of international sales during
these periods were made in Europe and Canada. The Company believes that
international markets present an attractive growth opportunity and is expanding
the scope of its international operations. The Company has engaged, and intends
to add, international resellers and distributors in targeted countries and is
developing joint marketing programs with certain resellers and distributors. To
facilitate penetration in certain markets, the Company, on its own and in
cooperation with certain international distributors, is in the process of
localizing certain of its products to targeted languages.
The Company also relies significantly on its 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
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.
OEMs
Source Code OEM Program. The source code OEM program generates significant
royalty revenues for the Company. Under this program, the Company licenses its
software products, in source code form, to leading computer system and software
suppliers from which the Company receives an initial license fee and ongoing
royalty revenue. The OEM partner is then responsible for porting the Company's
software to its unique operating system environment, testing it, selling it
through the OEM partner's direct sales force and distribution channels and
providing the primary customer support after installation. The OEM partners
generally have exclusive rights to the products on their proprietary platforms
(subject to certain minimum royalty obligations), but in certain cases, work
cooperatively to incorporate their enhancements into the Company's storage
products on an ongoing basis. The benefit of this approach for end users is that
they can acquire the Company's family of storage management products as part of
a complete systems solution from a single vendor, with such vendor providing a
single point of contact for customer support. The benefit to the Company has
been access to its OEM partners' customer bases, both in North America and
overseas, without a commensurate investment in fixed expense. The Company
currently has source code OEM agreements in place with several computer system
and software suppliers, including Amdahl, Banyan, Data General, Digital, ICL,
Nihon-Unisys, NEC, Siemens Nixdorf, Silicon Graphics, Sony, Sun Microsystems,
Tandem and Unisys.
Strategic Partner Program. The Strategic Partner program is an alternative
to the source code OEM program for major system providers who wish to offer the
Company's products along with theirs, but prefer not to make an investment in
enhancing the base Legato product. For example, SunSoft, a private label
reseller, licenses the object code for the standard Legato products and sells
and supports the products under the SunSoft logo as described above for the
source code OEM program. The Company also has established strategic partnerships
with Hewlett-Packard, Informix, Netscape and Oracle.
The source code OEMs and strategic partner programs accounted for
approximately $16.7 million, $12.9 million and $8.4 million in 1997, 1996 and
1995, respectively. SunSoft accounted for approximately 11 percent of total
revenues for each of the years ended December 31, 1997, 1996 and 1995. There can
be no assurance that such customers, including SunSoft 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. 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.
Enterprise Sales and Marketing
Enterprise Sales Program. As storage management applications increase in
strategic importance to major enterprises, the Company has recognized the need
to establish even closer relationships with its largest corporate clients.
Customers participating in the Company's enterprise sales program have an
assigned salesperson and Company executive contact, participate in the Company's
technical exchange program and work closely with the Company to develop large
projects for installations over a period of time. The enterprise sales
representatives coordinate business partner activity across the customer's
enterprise and closely monitors customer satisfaction.
Corporate Marketing. The Company supports its resellers and OEMs with
extensive marketing programs designed to establish the Company's image in key
markets and to generate end user demand. The Company participates in trade shows
and advertises in key network systems publications and on the Internet. Leads
are qualified by the Company's inside sales staff and provided to its channel
partners. Additionally, resellers and distributors are provided with promotional
and educational materials and can qualify for market development funding for
specific promotional activities tailored for their solutions and geography.
Customer Service and Support
The Company employs systems engineers who work closely with the Company's
direct sales personnel to assist resellers and end users with pre-sales and
post-sales support matters. In addition, Legato employs a centralized support
organization which provides customers with technical support, education,
training and consulting services.
Technical Support. The Company offers software updates, telephone and
electronic support and on-site reviews to its customers. Customers who register
the Company's products receive software updates and technical support free of
charge for one month after initial purchase. Beyond the initial one month
period, customers may purchase remote technical support and software updates as
needed. Customers also have the option to purchase annual Software Subscriptions
that extend the covered support period for an additional 12 month period.
Software Subscription customers receive software updates and telephone or
electronic support from 6 a.m. to 6 p.m. Pacific time. Software Subscription
annual fees are generally equivalent to 18 percent of the current list price of
the products under license to such customers. The Company also offers premium
technical support, which includes a one year contract covering five-day, 24-hour
technical phone support, one annual on-site review, and a monthly teleconference
with a designated Senior Legato Technical Engineer and Problem Escalation
Manager. Premium technical support pricing begins at $20,000 per year, in
addition to the basic software subscription fee. Premium technical support
customers have the option to purchase seven-day, 24-hour technical phone support
for an incremental cost of $10,000 per year. The customer service and support
organization consists of an experienced staff of technical support engineers
providing telephone and electronic support via electronic mail, facsimile and
CompuServe from the Company's offices in Palo Alto, California and Toronto,
Canada. The sales and customer support organizations at the Company work closely
together to ensure overall customer satisfaction.
In recent years, the Company's installed base of customers has
significantly increased, as have the number of customers purchasing software
subscription contracts. 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.
Education and Training. The Company offers education and training to end
users and resellers. Training classes are offered through in-house facilities at
the Company's offices in Palo Alto, as well as at off-site locations. The
Company also provides on-site training services upon request by customers. Fees
for education and training services are charged separately from the Company's
software products. Although the Company intends to add education and training
personnel in order to meet customer needs, there can be no assurance that these
efforts will be successful. If the Company's efforts are not successful, it
could have a potential adverse effect on the Company's business, operating
results and financial condition.
Consulting. The Company's consultants are available to work closely with
customers' information systems organizations. These consulting services
generally consist of assisting customers in setting up more complex
installations or tailoring the Company's software products to achieve higher
performance or a higher degree of automation. Fees for consulting services are
charged separately from the Company's software products. While the Company
continues to allocate resources in order to provide customers with additional
value-added services, there can be no assurance that these efforts will be
successful. Although the Company intends to add consulting personnel in order to
meet customer needs, there can be no assurance that these efforts will be
successful. If the Company's efforts are not successful, it could have a
potential adverse effect on the Company's business, operating results and
financial condition.
Research and Development
Since its inception, the Company has made substantial investments in
product development. In addition, the Company receives the benefits of
additional testing and product enhancements from each source code OEM's
development group. 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. In particular, the Company's
strategy is to continue to leverage the NetWorker architecture to enhance the
functionality of the product through new releases, applications and product
enhancements to meet the ongoing storage management requirements of its
customers. There can be no assurance that the Company will be successful in
developing and marketing new products that respond to technological change 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.
As part of the Company's ongoing development process, the Company released
several new versions of NetWorker during 1997, and intends to release additional
versions of NetWorker, generally on an annual basis. In addition, the Company
released several new products, including new high performance database backup
modules, called BusinesSuite, for Oracle, Informix and SQL, as well as modules
for backup of SAP R/3 applications and Microsoft Exchange. Also, the Company
released an expanded set of autoloader support including mainframe silos and
high speed devices aimed at enterprise installations. Finally, the Company
released a new optimized server platform, Power Edition, for very large
databases. 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.
The Company has development centers in Palo Alto, California, Seattle,
Washington and Burlington, Canada. Total expenses for research and development
were $14.4 million, $9.2 million and $4.5 million in 1997, 1996 and 1995,
respectively. The Company anticipates that it will continue to commit
substantial resources to research and development in the future. To date, the
Company's development efforts have not resulted in any capitalized software
development costs.
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 Veritas,
Peripheral Devices (Delta Microsystems), Software Moguls, EMC2 (Epoch), Spectra
Logic and Computer Associates (Legent/Lachman); 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.
The Company believes that the principal competitive factors affecting its
market include product features (such as heterogeneity, scalability,
performance, ease of use and central administration), brand name recognition,
quality, price, customer service and support and the effectiveness of sales and
marketing efforts. Although the Company believes that its products currently
compete favorably with respect to certain of these factors, there can be no
assurance that the Company can maintain its competitive position against current
and potential competitors, especially those with significantly greater
financial, marketing, service, support, technical and other resources.
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.
Employees
As of December 31, 1997, the Company had a total of 457 employees. Of the
total, 171 were in sales and marketing, 138 in research and development, 59 in
finance and administration, 57 in customer service and support, 19 in consulting
and educational services and 13 in operations. The Company's future success
depends in significant part upon the continued service of its key technical and
senior management personnel and 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.
None of the Company's employees are represented by a labor union. The Company
has not experienced any work stoppages and considers its relations with its
employees to be good.
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 Veritas,
Peripheral Devices (Delta Microsystems), Software Moguls, EMC2 (Epoch), Spectra
Logic and Computer Associates (Legent/Lachman); 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 copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect its proprietary
rights. The Company seeks to protect its software, documentation and other
written materials under trade secret and copyright laws, which afford only
limited protection. 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 has also been substantial amounts of litigation in the software
industry regarding intellectual property rights. The Company has from time to
time received claims that it is infringing third parties' intellectual property
rights, and there can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
trademarks or other proprietary rights. The Company expects that software
product developers will increasingly be subject to infringement claims as the
number of products and competitors in the Company's industry segment grows and
the functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation, cause product shipment delays or require the Company to enter into
royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
Product Liability
The Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims. In selling its products, the Company relies primarily on
"shrink wrap" licenses that are not signed by licensees, and, therefore, such
licenses may be unenforceable under the laws of certain jurisdictions. As a
result of these and other factors, the limitation of liability provisions
contained in the Company's license agreements may not be effective. The
Company's products can be used to manage data critical to organizations, and, as
a result, the sale and support of products by the Company may entail the risk of
product liability claims. A successful product liability claim brought against
the Company could have a material adverse effect upon the Company's business,
operating results and financial condition.
Year 2000 Compliance
Many currently installed computer systems and software products are coded
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. 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. Although the Company
believes its software products are Year 2000 compliant, there can be no
assurance that the Company's software products contain all the necessary
software routines and programs for the accurate calculation, display, storage
and manipulation of data involving dates. The Company believes that the
purchasing patterns of customers and potential customers may be affected by Year
2000 issues as companies expend significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase products such as those offered by the
Company. The occurrence of any of the foregoing could have a material adverse
effect on the Company's business, operating results or financial condition.
Although 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, there can be no assurances that the Company will not
experience serious, unanticipated negative consequences and/or 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.
Possible Volatility of Stock Price
The trading price of the Company's common stock has been subject to wide
fluctuations in 1997. 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.
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, research and
development facility is located in approximately 96,000 square feet of space in
Palo Alto, California. This facility is leased through September 2006. The
Company currently leases other domestic sales offices throughout the United
States, as well as international offices in Australia, Belgium, Canada, England,
France, Germany, Holland, Hong Kong, Japan and Sweden.
ITEM 3. LEGAL PROCEEDINGS
The Company is engaged in certain legal and administrative proceedings
incidental to the Company's business, the outcome of which, individually or in
the aggregate, is not expected to have a material adverse effect on the
Company's business, results of operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders during
the fourth quarter of the fiscal year ended December 31, 1997.
ITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are biographical summaries of the executive officers of the
Company as of December 31, 1997:
Louis C. Cole, 54, joined the Company as President, Chief Executive Officer
and a Director in June 1989. Since April 1995, Mr. Cole has also served as
Chairman of the Board. Before joining the Company, from March 1987 until July
1988, Mr. Cole served as Executive Vice President responsible for all operating
divisions of Novell, Inc. ("Novell"), a publicly held manufacturer of computer
networking and software products. Mr. Cole serves as a director of Qualix Group,
Inc. and Rogue Wave Software, both publicly held software companies. Mr. Cole
holds a B.S. in mathematics and education from Pennsylvania State University at
Edinboro.
Kent D. Smith, 48, has served as Executive Vice President and Chief
Operating Officer of the Company since May 1996. He served as Executive Vice
President of Customer Operations from March 1995 to May 1996. Before joining the
Company, from March 1994 until March 1995, Mr. Smith served as Vice President of
Emerging Markets at VeriFone, Inc. ("VeriFone"), a publicly held transaction
automation company. Prior to joining VeriFone, Mr. Smith held a range of sales
and marketing positions in the United States and overseas with IBM Corporation
("IBM"), a publicly held manufacturer of computers and related products, from
1974 to 1994. Mr. Smith holds a B.A. in German from California State University
at Fullerton and an M.B.A. from the University of Southern California.
Stephen C. Wise, 43, joined the Company in September 1996 as Senior Vice
President of Finance and Administration and Chief Financial Officer. Before
joining the Company, Mr. Wise served as Senior Vice President, Finance at Novell
from December 1993 to September 1996. He was Vice President and Corporate
Controller of Novell from January 1991 to December 1993 and was Vice President,
Accounting and Planning from January 1990 to January 1991. Mr. Wise holds a B.S.
in Accounting from San Jose State University and an M.B.A. from Santa Clara
University.
Nora M. Denzel, 35, joined the Company in January 1997 as Senior Vice
President of Product Operations. Before joining the Company, Ms. Denzel served
as the director of IBM's storage management software products and held a range
of operations, development and marketing positions with IBM from 1984 to 1996.
Ms. Denzel holds a B.S. in Computer Science from the State University of New
York and an M.B.A. from Santa Clara University.
John Ferraro, 36, joined the Company in December 1997 as Senior Vice
President of Worldwide Sales Operations. Before joining the Company, Mr. Ferraro
held the position of Vice President of Sales for Unison Software, a publicly
held network management software company, where he was responsible for
developing the North America sales organization on both a direct and channel
basis from December 1994 to December 1997. Prior to that, Mr. Ferraro's
experience includes seven years in sales and management at Computer Associates,
as Vice President of the Systems Management division. Mr. Ferraro holds a B.S.
in Accounting from the University of Colorado.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded on the Nasdaq National Market
under the symbol LGTO. The Company completed its initial public offering and
commenced trading of its common stock on July 6, 1995. The following table sets
forth the high and low closing sales prices of the Company's common stock from
July 6, 1995 through December 31, 1997. Such prices represent prices between
dealers, do not include retail mark-ups, mark-downs or commissions and may not
represent actual transactions.
Share prices have been adjusted to reflect the two-for-one split of the
Company's common stock which was effected July 5, 1996.
High Low
Fiscal 1995
Third Quarter* $14.75 $11.50
Fourth Quarter $19.88 $11.50
Fiscal 1996
First Quarter $21.50 $11.63
Second Quarter $27.50 $17.50
Third Quarter $48.00 $18.25
Fourth Quarter $47.00 $26.75
Fiscal 1997
First Quarter $32.88 $16.13
Second Quarter $24.88 $11.00
Third Quarter $35.75 $17.38
Fourth Quarter $46.63 $32.25
*Commencing July 6, 1995
As of February 28, 1998, there were approximately 75 holders of record of
the Company's common stock. The Company believes that a significant number of
beneficial owners of its common stock hold shares in street name.
The Company has never paid a cash dividend on its common stock and does not
intend to pay cash dividends on its common stock in the foreseeable future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Five Year Summary
December 31,
1997 1996 1995 1994 1993
-------- -------- -------- ------- -----
(in thousands, except per share amounts)
Revenues........................................ $ 81,834 $ 54,249 $ 29,777 $16,405 $ 12,152
Gross profit.................................... 72,675 49,132 26,734 14,403 9,796
Income from operations.......................... 22,690 13,334 7,382 1,574 268
Net income...................................... 15,658 8,620 5,831 1,773 176
Net income per share - basic (1)................ 0.90 0.52 0.59 0.46 0.05
Shares used in per share calculations - basic (1) 17,410 16,549 9,962 3,850 3,796
Net income per share - diluted (1).............. 0.83 0.46 0.39 0.15 0.01
Shares used in per share calculations-diluted (1) 18,863 18,771 15,109 11,836 11,864
Cash, cash equivalents and investments.......... 71,409 57,081 49,526 4,031 1,173
Working capital................................. 70,871 51,925 38,896 3,113 1,409
Total assets.................................... 113,765 83,142 58,827 8,274 4,883
Retained earnings (accumulated deficit)......... 27,466 11,808 3,188 (2,643) (4,416)
Total stockholders' equity...................... 92,792 68,388 50,542 4,145 2,347
- ----------
(1) See Note 1 of Notes to Consolidated Financial Statements
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The discussion in this report on Form 10-K 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. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed elsewhere in item 1 under the heading
"Risk Factors" as well as those discussed elsewhere in this Report, and the
risks discussed in the Company's Securities Exchange Commission filings.
Results of Operations
Overview
The Company develops, markets and supports network storage management
software products for heterogeneous client/server computing environments. The
Company's NetWorker family of software products, from which the Company derives
a substantial majority of its revenues, supports many storage management server
platforms and can accommodate a variety of 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 for the last three years as a percentage of total revenues and as a
percentage change from year to year.
% Increase
% of Total Revenues 1997 1996
Years Ended December 31, Compared Compared
1997 1996 1995 to 1996 to 1995
---------- ---------- ---------- -------- -------
Revenues:
Product and other 60.3% 59.3% 57.0% 54% 89%
Royalty and license 20.4 23.7 28.4 29 52
Software subscription 19.3 17.0 14.6 71 112
---------- ---------- ---------- ------ ------
Total revenues 100.0 100.0 100.0 51 82
Cost of revenues:
Product and other 5.8 3.8 4.7 126 49
Software subscription 5.4 5.6 5.5 46 84
---------- ---------- ---------- ------ ------
Gross profit 88.8 90.6 89.8 48 84
Operating expenses:
Research and development 17.6 17.0 15.0 57 106
Sales and marketing 34.5 31.7 36.4 64 59
General and administrative 7.6 11.9 13.6 (4) 59
Amortization of intangibles 1.4 2.0 -- 2 --
In-process research and development -- 3.4 -- (100) --
---------- ---------- ---------- ------- ------
Total operating expenses 61.1 66.0 65.0 40 85
---------- ---------- ---------- ------ ------
Income from operations 27.7 24.6 24.8 70 81
Interest income, net 2.6 3.3 4.0 21 52
Provision for income taxes 11.2 12.0 9.2 41 138
---------- ---------- ---------- ------ ------
Net income 19.1% 15.9% 19.6% 82% 48%
========== ========== ========== ====== ======
Revenues
Total revenues were $81.8 million, $54.2 million and $29.8 million in 1997,
1996 and 1995, respectively, representing an increase of 51 percent from 1996 to
1997 and 82 percent from 1995 to 1996. The increases principally reflect
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 $49.4 million,
$32.1 million and $17.0 million in 1997, 1996 and 1995, respectively,
representing increases of 54 percent from 1996 to 1997 and 89 percent from 1995
to 1996. The increases in product and other revenues from 1996 to 1997 and from
1995 to 1996 primarily represent the continued acceptance of the Company's
products. Other revenues were less than 5 percent of product and other revenues
in 1997, 1996 and 1995. Product revenues are generally recognized upon shipment
of the product, unless the Company has significant future obligations, in which
case revenues are recognized when such obligations are satisfied. Sales to
domestic distributors are recognized upon sale by the distributors to their
customers. Other revenues are generally recognized when services are performed.
Prior growth rates of the Company's product and other revenues are not
indicative of future software subscription revenue growth rates and may not be
sustainable in the future.
Royalty and License Revenues. Royalty and license revenues were $16.7
million, $12.9 million and $8.4 million in 1997, 1996 and 1995, respectively,
representing increases of 29 percent from 1996 to 1997 and 52 percent from 1995
to 1996. Royalty fees were $15.9 million, $11.2 million and $7.6 million in
1997, 1996 and 1995, respectively, and license fee revenue was $750,000, $1.7
million and $850,000 in 1997, 1996 and 1995, respectively. The increases in
royalty and license revenues from 1996 to 1997 primarily relate to increased
royalties from product sales by SunSoft and other OEMs. The increase in royalty
and license revenues from 1995 to 1996 is attributable to increased royalties
from product sales by SunSoft and increased licenses from new OEMs and licenses
from existing OEMs adding NetWorker for the Windows NT platform to their product
offerings. Generally, the Company's license agreements provide for an initial
non-recurring license fee, with subsequent royalty payments based upon future
sales of the licensees' product. There is typically a time lag from the
consummation of the license arrangement until the receipt of royalty payments,
due to the OEMs' product development cycles. Initial license fees are generally
recognized upon shipment of the product, unless the Company has significant
future obligations, in which case revenues are recognized when such obligations
are satisfied. Royalty revenues are recognized upon receipt of quarterly royalty
reports from source code OEMs and SunSoft with respect to their product sales
for the previous quarter. Prior growth rates of the Company's royalty and
license revenues are not indicative of future software subscription revenue
growth rates and may not be sustainable in the future.
Software Subscriptions. Software subscription revenues were $15.8 million,
$9.2 million and $4.4 million in 1997, 1996 and 1995, respectively, representing
increases of 71 percent from 1996 to 1997 and 112 percent from 1995 to 1996.
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 as well as the renewal of software subscriptions after the
initial one-year term and increased 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 accounted for 24 percent, 20 percent and 16
percent of total revenues in 1997, 1996 and 1995, respectively. The increasing
volume of international sales 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 established a sales office in Germany during 1994, sales offices in
France, England and Australia during 1995, sales offices in Canada and the
Netherlands during 1996, and sales offices in Japan and Sweden during 1997. The
Company believes that its continued growth and profitability will require
further expansion of its international operations. In order to successfully
expand international sales in 1998 and subsequent periods, the Company must
continue to 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 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. 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.
Gross Profit
Gross profit was $72.7 million, $49.1 million and $26.7 million,
representing 88.8 percent, 90.6 percent and 89.8 percent of total revenues in
1997, 1996 and 1995, respectively. The increases in total gross profit were
attributable to the higher levels of revenues from all sources, including
royalties and licenses, which do not generate any material cost of revenues.
Gross profit from product and other revenues was $44.7 million, $30.1
million and $15.6 million, representing 90.4 percent, 93.5 percent and 91.8
percent of product and other revenues in 1997, 1996 and 1995, 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 in 1997 from the same period in 1996
was primarily due to increases in training and consulting costs. In the first
three quarters of 1996, product costs include clinical research expenses,
reflecting the principal activity of Innovus, Inc., which was acquired along
with Innovus Technologies, Inc. in January 1996. Substantially all of the net
assets of Innovus, Inc., the Company's clinical research business, were sold in
September 1996 and the Company has discontinued all clinical research
activities. The discontinuance did not have a significant effect on the
operating results of the Company.
Gross profit from software subscription revenues was $11.4 million, $6.2
million and $2.7 million in 1997, 1996 and 1995, representing 71.9 percent, 67.2
percent and 62.3 percent of the related revenue in 1997, 1996 and 1995,
respectively. Gross profit from software subscription revenues consists of
software subscription revenues less the related cost, which consists primarily
of personnel-related costs incurred in providing telephone support and the costs
of providing software updates. The increase in gross profit from software
subscriptions as a percentage of the related revenue was primarily attributable
to the Company's leveraging of its installed base through subscription renewals,
as well as more efficient utilization of resources devoted to this activity.
Operating Expenses
Research and Development. Research and development expenses consist
primarily of personnel-related costs. Research and development expenses were
$14.4 million, $9.2 million and $4.5 million, representing 17.6 percent, 17.0
percent and 15.0 percent of total revenues in 1997, 1996 and 1995, respectively.
Research and development expenses increased 57 percent from 1996 to 1997 and 106
percent from 1995 to 1996, reflecting increased staffing and associated support
for engineers necessary to expand and enhance the Company's product line. The
Company believes that research and development expenses will continue to
increase in dollar amounts from the levels experienced in 1997 as the Company
continues to invest in the development of new products, applications and product
enhancements.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and commissions for sales and marketing personnel and promotional
expenses. Sales and marketing expenses were $28.2 million, $17.2 million and
$10.8 million, representing 34.5 percent, 31.7 percent and 36.4 percent of total
revenues in 1997, 1996 and 1995, respectively. The increases in sales and
marketing expenses in 1997 and 1996 were 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 decrease in
1996, as a percentage of total revenues, was primarily due to promotional
expenses increasing significantly less than the increase in total revenues. The
Company believes that sales and marketing expenses will increase in dollar
amounts as the Company continues to expand its sales and marketing staff.
General and Administrative. General and administrative expenses include the
personnel and other costs of the finance, human resources, information systems
and administrative departments of the Company. General and administrative
expenses were $6.2 million, $6.4 million and $4.0 million, representing 7.6
percent, 11.9 percent, and 13.6 percent of total revenues in 1997, 1996 and
1995, respectively. The decreases in general and administrative expenses as a
percentage of total revenues were attributable to leveraging general and
administrative expenses over a larger revenue base. The decrease in dollar
amount in 1997 from the same period in 1996 was due to allocating a greater
amount of central operating expenses to benefiting departments within the
Company. The increase in dollar amount of general and administrative expenses in
1996 from the same period in 1995 was attributable to increased staffing and
related costs required to manage and support the Company's expansion. In
addition, 1995 includes litigation related costs in connection with a lawsuit
settled in November 1995. The Company expects that general and administrative
expenses will increase in dollar amount as the Company expands its staffing.
Interest Income, Net
Interest income, net, was $2.2 million, $1.8 million, and $1.2 million
for 1997, 1996 and 1995, respectively. The increases in interest income relate
primarily to interest earned from the investment of available cash from
operations and the proceeds from the Company's initial public offering in July,
1995.
Provision for Income Taxes
The provisions for income taxes for 1997, 1996 and 1995 were $9.2 million,
$6.5 million and $2.7 million, respectively. The effective tax rates in 1997,
1996 and 1995 were 37 percent, 43 percent and 32 percent, respectively. The
effective tax rate for 1996, excluding the effect of a non-tax deductible
write-off of in-process research and development, was 38 percent. The 1997
effective tax rate decreased from 1996 primarily as a result of the
reinstatement of the federal research and experimental tax credit. The Company
anticipates no significant change in its tax rate for 1998.
Liquidity and Capital Resources
The Company's cash, cash equivalents and investments totaled $71.4 million
at December 31, 1997 and represented 63 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 December 31, 1997, the Company had no long-term debt and
stockholders' equity was $92.8 million.
Cash generated from operations and sales of common stock has been
sufficient to finance the Company's operations. Cash and cash equivalents
increased $7.1 million during 1997. Net cash provided by operating activities of
$18.0 million was derived primarily from net income of $15.7 million. Cash used
in investing activities of $14.7 million primarily reflected the acquisition of
property and equipment of $7.2 million and purchases of available-for- sale
securities, net of maturities and sales of available-for-sale securities, of
$7.2 million. Cash from financing activities of $3.8 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 are coded
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. 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. Although the Company
believes its software products are Year 2000 compliant, there can be no
assurance that the Company's software products contain all the necessary
software routines and programs for the accurate calculation, display, storage
and manipulation of data involving dates. The Company believes that the
purchasing patterns of customers and potential customers may be affected by Year
2000 issues as companies expend significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase products such as those offered by the
Company. The occurrence of any of the foregoing could have a material adverse
effect on the Company's business, operating results or financial condition.
Although 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, there can be no assurances that the Company will not
experience serious, unanticipated negative consequences and/or 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.
Subsequent Event
In March 1998, the Company announced that its Board of Directors approved a
two-for-one stock split (in the form of a dividend) that is payable to
stockholders of record on April 3, 1998 and will be effective on April 17, 1998.
Share and per share data presented here have not been adjusted to give effect to
this two-for-one split.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 1997 and 1996 ................ 22
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1997 ............................... 23
Consolidated Statements of Stockholders' Equity for each of the
three years in the period ended December 31, 1997 ................... 24
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 1997 ................... 25
Notes to the Consolidated Financial Statements ........................... 26
Report of Independent Accountants ........................................ 38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
LEGATO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
December 31,
1997 1996
---------- -------
ASSETS
Current assets:
Cash and cash equivalents ................................................... $ 34,763 $ 27,673
Short-term investments....................................................... 28,147 22,391
Accounts receivable, net..................................................... 21,109 9,839
Other current assets......................................................... 4,355 2,870
Deferred tax asset........................................................... 2,702 2,652
---------- ---------
Total current assets..................................................... 91,076 65,425
Long-term investments............................................................. 8,499 7,017
Property and equipment, net....................................................... 10,397 6,029
Intangible assets, net............................................................ 3,431 4,470
Other assets...................................................................... 362 201
---------- ---------
Total assets........................................................ $ 113,765 $ 83,142
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................. $ 2,025 $ 1,205
Accrued compensation and benefits............................................ 3,874 2,394
Accrued liabilities.......................................................... 2,216 2,320
Deferred revenues............................................................ 12,090 7,581
---------- ---------
Total current liabilities................................................ 20,205 13,500
Deferred tax liability............................................................ 768 1,254
Commitments (Note 4)
Common stock, $.0001 par value: 50,000 shares authorized and
17,774 and 16,938 shares issued and outstanding at December 31, 1997
and 1996, respectively......................................................... 2 2
Additional paid-in capital........................................................ 65,316 56,592
Retained earnings................................................................. 27,466 11,808
Deferred stock compensation....................................................... (22) (40)
Unrealized gain on investments, net............................................... 30 26
---------- ---------
Total stockholders' equity............................................... 92,792 68,388
---------- ---------
Total liabilities and stockholders' equity.......................... $ 113,765 $ 83,142
========== =========
The accompanying notes are an integral part of these consolidated
financial statements.
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
Year Ended December 31,
1997 1996 1995
--------- --------- ------
Revenues:
Product and other................................................ $ 49,375 $ 32,138 $ 16,972
Royalty and license.............................................. 16,661 12,872 8,443
Software subscription............................................ 15,798 9,239 4,362
--------- --------- --------
Total revenues................................................ 81,834 54,249 29,777
Cost of revenues:
Product and other................................................ 4,725 2,087 1,398
Software subscription............................................ 4,434 3,030 1,645
--------- --------- --------
Total cost of revenues........................................ 9,159 5,117 3,043
--------- --------- --------
Gross profit......................................................... 72,675 49,132 26,734
Operating expenses:
Research and development......................................... 14,428 9,199 4,464
Sales and marketing.............................................. 28,228 17,210 10,839
General and administrative....................................... 6,211 6,443 4,049
Amortization of intangibles...................................... 1,118 1,097 --
In-process research and development.............................. -- 1,849 --
--------- --------- --------
Total operating expenses...................................... 49,985 35,798 19,352
--------- --------- --------
Income from operations............................................... 22,690 13,334 7,382
Interest income, net................................................. 2,164 1,790 1,178
--------- --------- --------
Income before provision for income taxes............................. 24,854 15,124 8,560
Provision for income taxes........................................... 9,196 6,504 2,729
--------- --------- --------
Net income........................................................... $ 15,658 $ 8,620 $ 5,831
========= ========= ========
Net income per share - basic......................................... $ 0.90 $ 0.52 $ 0.59
========= ========= ========
Net income per share - diluted....................................... $ 0.83 $ 0.46 $ 0.39
========= ========= ========
Shares used in per share calculations - basic........................ 17,410 16,549 9,962
========= ========= ========
Shares used in per share calculations - diluted...................... 18,863 18,771 15,109
========= ========= ========
The accompanying notes are an integral part of these consolidated
financial statements.
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Retained Deferred Unrealized
Convertible- Additional Earnings/ Stock Gain (Loss)
Preferred Stock Common Stock Paid-in (Accumulated Compen- on Invest-
Shares Amount Shares Amount Capital Deficit) sation ments, Net Total
Balances, December 31, 1994.... 3,600 $ -- 3,884 $ -- $ 6,788 $ (2,643) $ -- $ -- $ 4,145
Stock issued under option plans -- -- 382 -- 147 -- -- -- 147
Stock issued in IPO, net of
issuance costs of $3,883.... -- -- 4,600 1 39,814 -- -- -- 39,815
Conversion of preferred stock
to common stock............. (3,600) -- 7,200 1 -- -- -- -- 1
Tax benefit from exercise of
stock options............... -- -- -- -- 560 -- -- -- 560
Deferred stock compensation.... -- -- -- -- 74 -- (58) -- 16
Unrealized gain on investments. -- -- -- -- -- -- -- 27 27
Net income..................... -- -- -- -- -- 5,831 -- -- 5,831
------ ---- ------ ---- -------- -------- -------- -------- -------
Balances, December 31, 1995.... -- -- 16,066 2 47,383 3,188 (58) 27 50,542
Stock issued under option plans -- -- 767 -- 1,044 -- -- -- 1,044
Stock issued under employee
stock purchase plan......... -- -- 105 -- 887 -- -- -- 887
Tax benefit from exercise of
stock options............... -- -- -- -- 7,115 -- -- -- 7,115
Deferred stock compensation.... -- -- -- -- 163 -- 18 -- 181
Unrealized loss on investments. -- -- -- -- -- -- -- (1) (1)
Net income..................... -- -- -- -- -- 8,620 -- -- 8,620
------ ---- ------ ---- -------- -------- -------- -------- -------
Balances, December 31, 1996.... -- -- 16,938 2 56,592 11,808 (40) 26 68,388
Stock issued under option plans -- -- 705 -- 2,335 -- -- -- 2,335
Stock issued under employee
stock purchase plan......... -- -- 131 -- 1,419 -- -- -- 1,419
Tax benefit from exercise of
stock options............... -- -- -- -- 4,970 -- -- -- 4,970
Deferred stock compensation.... -- -- -- -- -- -- 18 -- 18
Unrealized loss on investments. -- -- -- -- -- -- -- 4 4
Net income..................... -- -- -- -- -- 15,658 -- -- 15,658
------ ---- ------ ---- -------- -------- -------- -------- -------
Balances, December 31, 1997.... -- $ -- 17,774 $ 2 $ 65,316 $ 27,466 $ (22) $ 30 $92,792
====== ==== ====== ==== ========= ======== ======== ======== =======
The accompanying notes are an integral part of these consolidated
financial statements.
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
1997 1996 1995
--------- --------- ------
Cash flows from operating activities:
Net income...................................................... $ 15,658 $ 8,620 $ 5,831
Adjustments to reconcile net income to net cash provided by
operating activities:
Net deferred tax assets..................................... (536) (1,308) (1,169)
Depreciation and amortization............................... 3,948 2,130 677
Write-off of in-process research and development............ -- 1,849 --
Provision for doubtful accounts............................. 260 197 440
Tax benefit from exercise of stock options.................. 4,970 7,115 560
Other....................................................... -- 163 --
Changes in operating assets and liabilities:
Accounts receivable.................................... (11,530) (3,725) (3,359)
Other current assets................................... (1,485) (1,790) (775)
Accounts payable....................................... 820 354 376
Deferred revenues...................................... 4,509 2,530 2,220
Accrued expenses....................................... 1,376 981 1,883
--------- --------- --------
Net cash provided by operating activities.............. 17,990 17,116 6,684
Cash flows from investing activities:
Purchase of available-for-sale securities....................... (44,066) (47,943) (163,570)
Maturities and sales of available-for-sale securities........... 36,832 38,228 143,914
Acquisition of property and equipment........................... (7,198) (5,412) (1,260)
Payment for purchase of subsidiaries, net of cash acquired...... -- (5,924) --
Other........................................................... (240) (173) 54
---------- --------- --------
Net cash used in investing activities.................. (14,672) (21,224) (20,862)
Cash flows from financing activities:
Proceeds from issuance of common stock.......................... 3,754 1,931 39,963
Other........................................................... 18 18 16
--------- --------- --------
Net cash provided by financing activities.............. 3,772 1,949 39,979
--------- --------- --------
Net increase (decrease) in cash and cash equivalents... 7,090 (2,159) 25,801
Cash and cash equivalents at beginning of period..................... 27,673 29,832 4,031
--------- --------- --------
Cash and cash equivalents at end of period........................... $ 34,763 $ 27,673 $ 29,832
========= ========= ========
Supplemental Cash Flow Information:
Cash transaction:
Cash paid for income taxes...................................... $ 4,910 $ 3,080 $ 1,017
Non-cash transactions
Conversion of preferred stock................................... -- -- 6,785
Deferred tax liability.......................................... -- 1,568 --
The accompanying notes are an integral part of these consolidated
financial statements.
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Operations
The Company develops, markets and supports network storage management
software products for heterogeneous client/server computing environments and
large scale enterprises. The Company's NetWorker family of software products,
from which the Company derives a substantial majority of its revenues, supports
many storage management server platforms and can accommodate a variety of
clients, servers, 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.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries and branch offices. All significant
intercompany balances and transactions have been eliminated. Accounts
denominated in foreign currencies have been remeasured into the functional
currency, using the U. S. dollar as the functional currency. Foreign currency
gains and losses from remeasurement, which have been insignificant, are included
in the consolidated statements of income.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Financial Instruments
Cash equivalents are highly liquid investments with original or remaining
maturities of three months or less as of the date of purchase. Cash equivalents
present insignificant risk of changes in value because of interest rate changes.
The Company maintains its cash balances at a variety of financial institutions
and has not experienced any material losses relating to such instruments.
Short-term and long-term investments on the balance sheet are classified as
available-for-sale and are carried at fair value, with the unrealized gains or
losses, net of tax, reported in stockholders' equity. The amortized cost of debt
securities is adjusted for amortization of premiums and accretion of discounts
to maturity, both of which are included in interest income. Realized gains and
losses are recorded on the specific identification method.
The amounts reported for cash equivalents, receivables and other financial
instruments are considered to approximate fair values based upon comparable
market information available at the respective balance sheet dates. Financial
instruments that potentially subject the Company to concentrations of credit
risks comprise principally cash, investments and trade accounts receivable. The
Company invests its excess cash in accordance with its investment policy that is
approved by the Board of Directors and reviewed periodically to minimize credit
risk. The policy authorizes the investment of excess cash in government
securities, tax exempt municipal securities, Eurodollar notes and bonds, time
deposits, certificates of deposit, commercial paper rated Aa or better and other
specific money market and corporate instruments of similar liquidity and credit
quality.
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the respective
assets, which is generally three years.
Intangible Assets
Intangible assets include goodwill and purchased technology, recorded in
connection with the acquisition of Innovus, Inc., Innovus Technologies, Inc. and
815598 Ontario, Inc. (collectively "Innovus"), which are being amortized on a
straight-line basis over five years. The Company periodically assesses the
recoverability of intangible assets by determining whether the amortization of
the asset balance over its remaining life can be recovered through undiscounted
future operating cash flows of the acquired operation. The amount of impairment,
if any, is measured based on projected discounted future operating cash flows
and is recognized as a write down of the asset to a net realizable value.
Revenue Recognition
The Company's revenues are derived from three sources, across many
industries: (i) product and other revenues, which are derived primarily from
product sales to resellers and end users, as well as from services such as
consulting; (ii) royalty and license revenues, which are derived primarily from
initial license fees and ongoing royalties from product sales by source code
OEMs; and (iii) software subscription revenues, which are derived primarily from
contracts providing for software updates, maintenance and support to end users
and which are charged separately from the Company's software products.
The Company recognizes product revenues and license fees, including
advanced royalty payments, upon shipment if remaining obligations are
insignificant, collection of the resulting receivables is probable, and product
returns are reasonably estimable, except for sales to domestic distributors,
which are recognized upon sale by the distributors to their customers. Estimated
sales returns are recorded upon recognition of revenues from customers having
rights of return, including exchange rights for unsold products and product
upgrades. Provisions for estimated warranty costs, insignificant vendor
obligations and anticipated retroactive price adjustments are recorded at the
time products are shipped.
Royalty revenues that are contingent upon sale to an end user by OEMs are
recognized upon receipt of a report of sale by the Company from the OEM.
Customer maintenance fees for ongoing customer support and product updates,
including such fees bundled with the initial license fee, are recognized ratably
over the period of the contract. Payments for maintenance fees are generally
made in advance and are non-refundable. Other service revenue is recognized as
the related service is performed.
The Company performs ongoing credit evaluations of its customers' financial
condition and does not require collateral. The Company maintains allowances for
potential credit losses and such losses have been within management's
expectations.
Research and Development Costs
Costs incurred in the research and development of new software products are
expensed as incurred until technological feasibility is established. To date,
the establishment of technological feasibility of the Company's products and
general release substantially coincide.
Income Taxes
The Company's provision for income taxes is comprised of its current tax
liability and the change in deferred tax assets and liabilities. Deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
Advertising and Promotional Costs
The Company expenses advertising and promotional costs as they are
incurred. Advertising expense for 1997, 1996 and 1995 was $2,209,000, $1,749,000
and $1,475,000, respectively.
Computation of Net Income 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 net income per
share. Basic net income 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 net income 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 convertible preferred stock (using the
"if converted" method) and exercise of stock options and warrants. All prior
period net income 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 net income
per share is provided as follows (in thousands, except per share amounts):
Year Ended December 31,
1997 1996 1995
--------- --------- ------
Numerator - Net income per share, basic and diluted
Net income...................................................... $ 15,658 $ 8,620 $ 5,831
========= ========= ========
Denominator - Net income per share, basic
Weighted average common shares outstanding...................... 17,410 16,549 9,962
--------- --------- --------
Net income per share - basic.................................... $ 0.90 $ 0.52 $ 0.59
======== ========= ========
Denominator - Net income per share, diluted
Weighted average common shares outstanding...................... 17,410 16,549 9,962
Effect of dilutive securities:..................................
Common stock options................................... 1,453 2,222 1,547
Convertible preferred shares........................... -- -- 3,600
--------- --------- --------
Weighted average common and common equivalent shares............ 18,863 18,771 15,109
--------- --------- --------
Net income per share - diluted.................................. $ 0.83 $ 0.46 $ 0.39
======== ========= ========
Options to purchase 96,000, 38,000 and 20,000 shares of common stock were
outstanding at December 31, 1997, 1996 and 1995, respectively, but were not
included in the calculation of diluted net income per share because the options'
exercise price was greater than the average market price of the common shares.
Recent Pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130, "Accounting for
Comprehensive Income." This statement establishes standards for reporting and
display of comprehensive income and its components (including revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. This statement is effective for fiscal years beginning after
December 15, 1997.
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.
In October 1997, the Accounting Standards Executive Committee issued
Statement of Position 97-2, Software Revenue Recognition ("SOP 97-2"), which
delineates the accounting for software product and maintenance revenues. SOP
97-2 supersedes the Accounting Standards Executive Committee Statement of
Position 91-1, Software Revenue Recognition, and is effective for transactions
entered into in fiscal years beginning after December 15, 1997. The Company is
evaluating the requirements of SOP 97-2 and the effects, if any, on the
Company's current revenue recognition policies.
Reclassifications
Certain reclassifications were made to the 1995 and 1996 consolidated
financial statements to conform to the 1997 presentation. The reclassifications
have no significant effect on previously reported financial position, results of
operations or cash flows.
2. Consolidated Balance Sheet Detail
December 31,
1997 1996
---------- -------
(in thousands)
Accounts receivable:
Trade accounts receivable.................................................... $ 21,908 $ 10,651
Allowance for doubtful accounts.............................................. (799) (812)
----------- ---------
$ 21,109 $ 9,839
========== =========
Property and equipment:
Computer equipment........................................................... $ 9,606 $ 5,670
Furniture and fixtures....................................................... 2,065 1,663
Office equipment............................................................. 1,448 1,040
Leasehold improvements....................................................... 2,671 936
---------- ---------
15,790 9,309
Accumulated depreciation..................................................... (5,393) (3,280)
----------- ---------
$ 10,397 $ 6,029
========== =========
3. Investments
The following table summarizes the fair value and unrealized gains and
losses of debt securities at December 31, 1997 and 1996. All debt securities
have been classified as available-for-sale:
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
(in thousands)
December 31, 1997:
Municipal securities............................ $ 29,001 $ 47 $ (2) $ 29,046
U.S. government agency securities............... 5,000 -- -- 5,000
Auction rate receipts........................... 2,600 -- -- 2,600
--------- ---------- ---------- ----------
$ 36,601 $ 47 $ (2) $ 36,646
========= ========== ========== ==========
December 31, 1996:
Municipal securities............................ $ 26,570 $ 41 $ (3) $ 26,608
Auction rate receipts........................... 2,800 -- -- 2,800
--------- ---------- ---------- ----------
$ 29,370 $ 41 $ (3) $ 29,408
========= ========== ========== ==========
The amortized cost and estimated fair value of investments in debt securities
at December 31, 1997 and 1996, by contractual maturity, are as follows:
Estimated
Cost Fair Value
(in thousands)
December 31, 1997:
Due in 1 year or less.................................................. $ 28,125 $ 28,147
Due in 1 - 3 years..................................................... 8,476 8,499
------------ ------------
Total investment in debt securities.................................... $ 36,601 $ 36,646
============ ============
December 31, 1996:
Due in 1 year or less.................................................. $ 22,362 $ 22,391
Due in 1 - 3 years..................................................... 7,008 7,017
------------ ------------
Total investment in debt securities.................................... $ 29,370 $ 29,408
============ ============
4. Commitments
The Company leases its operating facilities under non-cancelable operating
leases that expire at various dates through September 2006. Minimum lease
commitments at December 31, 1997 were as follows:
1998 $ 2,891
1999 2,877
2000 2,883
2001 2,940
2002 and thereafter 11,535
---------
Total minimum lease commitments $ 23,126
=========
Rent expense for 1997, 1996 and 1995 was $2,780,000, $1,852,000 and
$1,200,000, respectively.
The Company is engaged in certain legal and administrative proceedings
incidental to its normal business activities. While it is not possible to
determine the ultimate outcome of these actions at this time, management
believes that any liabilities resulting from such proceedings, or claims which
are pending or known to be threatened, will not have a material adverse effect
on the Company's financial position or results of operations.
5. Acquisition of Innovus
On January 5, 1996, the Company completed its acquisition of Innovus, Inc.,
Innovus Technologies, Inc. and 815598 Ontario, Inc. (collectively "Innovus"),
each based in Canada, for approximately $6,687,000, including acquisition costs.
Prior to the acquisition, Innovus (except for 815598 Ontario, Inc.) was in the
business of (i) the porting of licensed software for Hewlett-Packard HP9000 and
HP3000 series computers and the sale and distribution of such ported software,
and (ii) supplying clinical trials and research services on contract in the
Canadian pharmaceutical industry. Prior to the acquisition, 815598 Ontario, Inc.
did not conduct any business other than holding shares of capital stock of
Innovus, Inc. The acquisition was accounted for using the purchase method and on
that basis, resulted in a one-time write-off of $1,849,000 for purchased
in-process research and development for which there was no alternative future
use and technological feasibility was not established. The balance of the
purchase price in excess of net assets acquired was allocated to purchased
technology and goodwill totaling $4,060,000. Additional goodwill of $1,568,000
arises as a result of recording a deferred tax liability related to timing
differences in the amortization of purchased technology for book and tax
purposes. The Company is amortizing purchased technology and goodwill on a
straight-line basis over five years. The operating results of Innovus have been
consolidated with the Company's operating results beginning as of the
acquisition date. Substantially all of the net assets of Innovus, Inc., the
Company's clinical research business, were sold in September 1996 for
approximately $150,000, which approximated the carrying amount of those net
assets. The Company has discontinued all clinical research activities. The
discontinuance did not have a significant effect on the operating results of the
Company. At December 31, 1997 and 1996, purchased technology and goodwill, net
of accumulated amortization of $2,186,000 and $1,067,000, were $3,351,000 and
$4,470,000, respectively.
Pro forma results of operations of the Company for the year ended December
31, 1995, assuming the acquisition of Innovus had occurred at the beginning of
that period, include revenues of $33.2 million, net income of $3.5 million,
basic net income per share of $0.35 and diluted net income per share of $0.23.
6. Stockholders' Equity
Preferred Stock
The Company is authorized to issue 5,000,000 shares of preferred stock,
none of which are issued or outstanding. The Board of Directors has the
authority to issue the preferred stock in one or more series and to fix rights,
preferences, privileges and restrictions, and the number of shares constituting
any series and the designation of such series, without any further vote or
action by the stockholders.
Stock Option/Stock Issuance Plan
The Company's 1995 Stock Option/Stock Issuance Plan (the "1995 Plan") is
the successor equity incentive program to the Company's 1989 Stock Option and
Restricted Stock Plan and became effective on July 5, 1995. Approximately
4,184,000 shares of common stock were authorized for issuance under the 1995
Plan. The share reserve will automatically increase on the first trading day in
each calendar year, beginning with the 1997 calendar year, by the number of
shares equal to three percent of the total number of shares of the Company's
common stock outstanding on December 31 of the immediately preceding calendar
year. Options to purchase shares may be granted and shares may be issued
directly under the 1995 Plan. Options must have an exercise price not less than
100% and 85% of fair market value of the common stock on the date of grant for
incentive stock options and non-statutory stock options, respectively. The
purchase price for shares issued directly may not be less than 85% of fair
market value on the date of grant. Options generally vest over four years and
terminate ten years after their original grant dates.
The 1995 Plan is divided into three separate components: (i) the
Discretionary Option Grant Program under which employees, non-employee Board
members who are not serving on the Company's Compensation Committee and
consultants may, at the discretion of the Compensation Committee, be granted
options to purchase shares of common stock, (ii) the Stock Issuance Program
under which such persons may, at the Compensation Committee's discretion, be
issued shares of common stock directly, through the purchase of such shares or
in consideration of the past performance of services, and (iii) the Automatic
Option Grant Program under which option grants will automatically be made at
periodic intervals to eligible non-employee Board members to purchase shares of
common stock at an exercise price equal to 100 percent of their fair market
value on the grant date. Under the Automatic Option Grant Program, each
non-employee Board member received an option grant to purchase 24,000 shares on
the effective date of the initial public offering (IPO). Each individual who
first becomes a non-employee Board member thereafter will receive a 24,000 share
option grant on the date such individual joins the Board, provided such
individual has not been previously employed by the Company. In addition, at each
Annual Stockholders Meeting, each individual who has served as a non-employee
Board member for at least six months prior to such Annual Meeting and who is to
continue to serve as a non-employee Board member after the meeting will receive
an additional option grant to purchase 6,000 shares of common stock, whether or
not such individual has been in the prior employ of the Company.
Options granted under the 1995 plan generally become exercisable over a
four year period, whereby 25 percent of the shares become exercisable one year
after the grant date and ratably thereafter over 36 months. Options granted
prior to July 5, 1995 contain provisions allowing for early exercise of unvested
options. Shares issued upon such early exercise are subject to vesting and
repurchase rights by the Company. At December 31, 1997 and 1996, none of the
shares outstanding were subject to repurchase by the Company. Upon exercise,
approximately 494,000 and 1,013,000 option shares under grant were subject to
repurchase by the Company at December 31, 1997 and 1996 respectively.
The following is a summary of option activity:
Number Weighted Options
of Average Price Price
Shares Per Share Per Share
(in thousands)
Outstanding at December 31, 1994 1,940 $ 0.74 $ 0.05 - $ 1.75
Options granted 1,392 $ 4.64 $ 1.75 - $18.75
Options exercised (382) $ 0.39 $ 0.05 - $ l.75
Options canceled (149) $ 2.25 $ 0.13 - $18.75
---------
Outstanding at December 31, 1995 2,801 $ 2.84 $ 0.05 - $18.75
Options granted 695 $ 21.12 $ 11.84 - $44.50
Options exercised (767) $ 1.36 $ 0.05 - $18.75
Options canceled (146) $ 8.99 $ 0.75 - $44.50
---------
Outstanding at December 31, 1996 2,583 $ 7.85 $ 0.10 - $44.50
Options granted 1,244 $ 28.00 $ 12.13 - $46.63
Options exercised (705) $ 3.30 $ 0.10 - $24.00
Options canceled (454) $ 22.06 $ 0.75 - $44.50
---------
Outstanding at December 31, 1997 2,668 $ 16.03 $ 0.10 - $46.63
=========
At December 31, 1997, approximately 376,000 shares of common stock remained
available for grant under the 1995 Plan. At December 31, 1997, 1996 and 1995,
approximately 816,000, 813,000 and 957,000 options were exercisable,
respectively. Approximately 3,044,000 shares of common stock were reserved for
future issuance as of December 31, 1997.
The options outstanding and currently exercisable by exercise price at
December 31, 1997 are as follows:
Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
(in thousands, except per share amounts)
$ 0.10 - $ 1.75 300 5.87 $ 1.18 257 $ 1.08
$ 2.25 - $ 3.13 638 7.14 $ 3.11 286 $ 3.12
$ 5.63 - $13.50 423 7.78 $ 10.53 191 $ 10.31
$13.88 - $23.75 682 8.92 $ 22.53 76 $ 21.58
$24.00 - $34.00 446 9.70 $ 30.54 6 $ 24.52
$34.44 - $46.63 179 9.84 $ 39.07 0 $ 0.00
-------------- ----------
2,668 816
============== ==========
The Company has elected to continue to follow the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", for
financial reporting purposes and has adopted the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). Accordingly, no compensation cost has been
recognized for the options granted under the 1995 Plan. The fair value of the
Company's stock options was estimated using a Black-Scholes option pricing
model. The Black-Scholes option pricing model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, the Black-Scholes model requires the
input of highly subjective assumptions including the expected stock price
volatility. Since the Company's stock options granted to employees have
characteristics significantly different from those of traded options, and
because changes in the subjective assumptions can materially affect the fair
value estimate, in management's opinion, the existing models do not necessarily
provide a reasonable single measure of the fair value of its stock options. The
fair value of each option grant is estimated on the date of grant using a type
of Black-Scholes option pricing model with the following assumptions used for
grants:
1997 1996 1995
--------- --------- ------
Expected volatility............................................. 0.647 0.645 0.645
Weighted-average risk-free interest rate........................ 6.18% 6.12% 6.61%
Expected life (from vesting date)............................... 1 year 1 year 1 year
Expected dividends.............................................. -- -- --
Based on the above assumptions, the aggregate fair value and weighted
average fair value of options granted in 1997, 1996 and 1995 were $16,237,000,
$7,283,000 and $3,296,000, and $14.00, $10.47 and $2.37, respectively.
For pro forma purposes, had compensation cost for the 1995 Plan been
determined based on the fair value at the grant date for awards in 1997, 1996
and 1995 consistent with the provisions of SFAS No. 123, the Company's net
income, basic and diluted net income per share for 1997, 1996 and 1995 would
have been as follows:
1997 1996 1995
--------- --------- ------
(in thousands, except per share data)
Net income - as reported........................................ $ 15,658 $ 8,620 $ 5,831
========= ========= ========
Net income - pro forma.......................................... $ 11,928 $ 6,798 $ 5,261
========= ========= ========
Net income per share - basic as reported........................ $ 0.90 $ 0.52 $ 0.59
======== ========= ========
Net income per share - basic pro forma.......................... $ 0.69 $ 0.41 $ 0.53
======== ========= ========
Net income per share - diluted as reported...................... $ 0.83 $ 0.46 $ 0.39
======== ========= ========
Net income per share - diluted pro forma........................ $ 0.63 $ 0.36 $ 0.35
======== ========= ========
As the provisions of SFAS 123 are only applied to stock options granted
after January 1, 1995 in the above pro forma amounts, the impact of pro forma
stock compensation cost will likely continue to increase as the vesting period
for the Company's options and the period over which the stock compensation is
charged to expense is generally four years.
Employee Stock Purchase Plan
The Company maintains an Employee Stock Purchase Plan (the "Purchase Plan")
under which 800,000 shares of common stock are reserved for future issuance. The
Purchase Plan is administered over offering periods of 24 months each, with each
offering period divided into four consecutive six-month purchase periods
beginning August 1 and February 1 of each year. Eligible employees may designate
not more than 10 percent of their cash compensation to be deducted each pay
period for the purchase of common stock under the Purchase Plan, and
participants may not purchase more than 1,000 shares of stock in any one
six-month purchase period. On the last business day of each purchase period,
shares of common stock are purchased with the employee's payroll deductions
accumulated during the six months, generally at a price per share of 85 percent
of the market price of the common stock on the employee's entry date of the
applicable offering period or the last day of the applicable purchase period,
whichever is lower. For the year ended December 31, 1997 and 1996, 131,000 and
105,000 shares were issued under the plan, respectively. At December 31, 1997,
564,000 shares were reserved for future issuance under the plan.
Under SFAS 123, compensation cost is also recognized for the fair value of
employee's purchase rights under the Employee Stock Purchase Plan, which was
estimated using the following assumptions for 1997, 1996 and 1995, respectively:
a weighted-average expected life of 2.0 years, 0.9 years and 1.3 years; expected
volatility of 0.647, 0.645 and 0.645; and weighted-average risk-free interest
rates of 6.05 percent, 5.86 percent and 5.85 percent. The fair value of those
purchase rights granted in 1997, 1996 and 1995 was $2,437,000, $298,000 and
$839,000, respectively.
7. Employee Benefit Plans
Profit Sharing Plan
The Company has a 401(k) Profit Sharing Plan (the Plan) covering all of its
employees. Under the Plan, participating employees may elect to contribute up to
15 percent of their cash compensation, subject to certain limitations. The
Company may make contributions to the Plan at the discretion of the Board of
Directors. In 1997, the Company contributed $260,000 to the Plan. No
contributions were made to the Plan for 1996 and 1995.
8. Income Taxes
The provision for income taxes consists of the following:
1997 1996 1995
--------- --------- ------
(in thousands)
Current:
Federal......................................................... $ 7,342 $ 5,855 $ 2,935
State........................................................... 1,990 1,514 878
Foreign......................................................... 400 443 74
--------- --------- --------
9,732 7,812 3,887
Deferred:
Federal......................................................... (194) (937) (1,114)
State........................................................... (28) (57) (44)
Foreign......................................................... (314) (314) --
---------- --------- --------
(536) (1,308) (1,158)
---------- --------- --------
$ 9,196 $ 6,504 $ 2,729
========= ========= ========
In 1997, income before provision for income taxes consisted of $24,648,000
of income from U.S. operations and $206,000 of income from foreign operations.
In 1996, income before provision for income taxes consisted of $17,321,000 of
income from U.S. operations and $2,197,000 of losses from foreign operations.
Substantially all of the Company's income before provision for income taxes in
the year ended December 31, 1995 was generated by domestic operations. The tax
benefit associated with dispositions from employee stock plans reduced taxes
currently payable for 1997, 1996 and 1995 by $4,970,000, $7,115,000 and
$560,000, respectively. Such benefit was recorded to additional paid-in capital.
The Company's effective tax rate differs from the statutory federal income
tax rate as follows:
1997 1996 1995
--------- --------- ------
Statutory federal income tax rate............................... 35.0% 35.0% 34.0%
State income taxes, net of federal benefit...................... 5.1 5.4 5.7
Tax exempt interest income...................................... (2.9) (3.4) (1.1)
Research and experimental credit................................ (1.6) (0.8) (1.0)
Benefit of operating loss and tax credit carryforwards.......... -- -- (7.2)
Change in valuation allowance................................... -- -- (1.7)
Other........................................................... 1.4 2.1 3.2
------- -------- -------
Subtotal.................................................... 37.0% 38.3% 31.9%
In-process research and development............................. -- 4.7 --
-------- -------- -------
Effective tax rate.......................................... 37.0% 43.0% 31.9%
======= ======== =======
Significant components of the Company's deferred tax assets and liabilities
are as follows:
December 31,
1997 1996
---------- -------
(in thousands)
Deferred tax assets:
Allowances, accrued liabilities and other................................ $ 1,073 $ 1,247
Accrued compensation and benefits........................................ 360 394
State taxes.............................................................. 567 461
Deferred revenue......................................................... 874 550
---------- ---------
2,874 2,652
Deferred tax liabilities:
Intangible asset - purchased technology.................................. (940) (1,254)
----------- ---------
Net deferred tax asset....................................................... $ 1,934 $ 1,398
========== =========
9. Industry and Geographic Segment Information
The Company operates in a single industry segment developing, marketing and
supporting network storage management software products for heterogeneous
client/server computing environments and large scale enterprises. The Company
markets its products and services to customers in the United States, Canada,
Europe and Asia Pacific. Net revenues from export sales were $19.8 million,
$10.7 million, and $4.7 million in 1997, 1996 and 1995, respectively. The
majority of export sales were made to Europe and Canada.
One customer accounted for 11 percent of total revenues for 1997, 1996 and
1995.
10. Selected Quarterly Financial Data (unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
(in thousands, except per share data)
1997:
Total revenues........................................ $ 16,620 $ 18,150 $ 21,436 $ 25,627
Gross profit.......................................... 14,878 16,173 18,940 22,683
Net income............................................ 3,164 3,132 4,352 5,010
Net income per share - basic.......................... $ 0.18 $ 0.18 $ 0.25 $ 0.28
Net income per share - diluted........................ $ 0.17 $ 0.17 $ 0.23 $ 0.26
1996:
Total revenues........................................ $ 10,925 $ 12,573 $ 14,549 $ 16,202
Gross profit.......................................... 9,749 11,393 13,132 14,858
Net income (loss)..................................... (127) 2,343 2,961 3,443
Net income (loss) per share - basic................... $ (0.01) $ 0.14 $ 0.18 $ 0.20
Net income (loss) per share - diluted................. $ (0.01) $ 0.13 $ 0.16 $ 0.18
11. Subsequent Event (unaudited)
In March 1998, the Company announced that its Board of Directors approved a
two-for-one stock split (in the form of a dividend) that is payable to
stockholders of record on April 3, 1998 and will be effective on April 17, 1998.
Share and per share data presented here have not been adjusted to give effect to
this two-for-one split.
The pro forma shares used in calculating net income per share and the
resulting basic and diluted net income per share if the stock split had been
effective for the periods ended December 31, 1997, 1996 and 1995 would have been
as follows:
1997 1996 1995
--------- --------- ------
(in thousands, except per share data)
Net income per share - basic......................................... $ 0.45 $ 0.26 $ 0.29
========= ========= ========
Net income per share - diluted....................................... $ 0.42 $ 0.23 $ 0.19
========= ========= ========
Shares used in per share calculations - basic........................ 34,820 33,098 19,924
========= ========= ========
Shares used in per share calculations - diluted...................... 37,726 37,542 30,218
========= ========= ========
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Legato Systems, Inc.:
We have audited the consolidated balance sheets of Legato Systems, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Legato Systems, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 19, 1998
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors is incorporated herein by reference
from the section entitled "Election of Directors" of the Company's definitive
Proxy Statement to be filed pursuant to Regulation 14A of the Securities
Exchange Act of 1934, as amended, for the registrant's Annual Meeting of
Stockholders to be held on May 14, 1998 (the "Proxy Statement"). The Proxy
Statement is anticipated to be filed within 120 days after the end of the
registrant's fiscal year ended December 31, 1997. For information regarding
executive officers of the Company, see the information appearing under the
caption "Executive Officers of the Registrant" in Part I, Item 4a of this Report
on Form 10K.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated herein by
reference from the section entitled "Executive Compensation" of the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management is incorporated herein by reference from the section entitled "Stock
Ownership of Certain Beneficial Owners and Management" of the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
incorporated herein by reference from the section entitled "Certain
Relationships and Related Transactions" of the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The consolidated financial statements of the registrant as set forth under
Item 8 are filed as part of this Annual Report on Form 10-K.
(a) (2) Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts is filed on page 43 of this
Report on Form 10-K.
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are omitted
because they are not required under the related instructions or are
inapplicable.
The independent accountant's report with respect to the above listed
financial statements and financial statement schedule listed in Items 14 (a) (1)
and 14 (a) (2), respectively, is filed on page 38 of this Report on Form 10-K.
(a) (3) Exhibits
2.1 (3) Stock Purchase Agreement, dated as of January 5, 1996, among the
Registrant, Innovus, Inc., 815598 Ontario, Inc., the stockholders of
Innovus, Inc., and the stockholders of 815598 Ontario, Inc.
2.2 (3) Stock Purchase Agreement, dated as of January 5, 1996, among the
Registrant, Innovus Technologies, Inc., and the stockholders of Innovus
Technologies, Inc.
3.1 (6) Amended and Restated Certificate of Incorporation of the Registrant, as
amended to date
3.2 (8) Amended and Restated Bylaws of the Registrant adopted on May 23, 1997
3.3 (9) Form of Certificate of Designation filed in connection with Rights
Agreement, dated May 23, 1997
4.2 (1) Specimen Common Stock certificate
4.6 (1) Restated Investor Rights Agreement, dated September 8, 1993, among the
Registrant and the investors and the founders named therein, as amended
January 28, 1994 and February 13, 1995
4.7 (9) Rights Agreement, dated May 23, 1997 between the Company and Harris
Trust and Savings Bank, including the Certificate of Designation of Series
A Junior Participating Preferred Stock, Form of Right Certificate and
Summary of Rights to Purchase Preferred Shares attached thereto as Exhibit
A, B and C, respectively.
10.1 (1) Form of Indemnification Agreement entered into between the Registrant
and it directors and officers
10.3 (1) (5) The Registrant's 1995 Stock Option/Stock Issuance Plan
10.4 (1) (5) The Registrant's Employee Stock Purchase Plan
10.6 (1) Form of United States Reseller Terms and Conditions for Purchase of
Legato Products
10.7 (1) Form of International Authorized Systems Integrator Agreement
10.8 (1) Form of Shrinkwrap License Agreement
10.9 (1) (2) Technology License and Distribution agreement, dated January 20,
1994, between the Registrant and SunSoft, Inc.
10.10(1) Master Software License and Support Agreement between the Registrant
and Open Software Foundation
10.11(1) License Agreement, dated February 24, 1989, between the Registrant and
The Regents of the University of California
10.12(1) Software Agreement, dated January 20, 1989, between the Registrant and
AT&T Information Systems, Inc.
10.13 (4) (5) The Registrant's International Employee Stock Purchase Plan
10.14(6) Lease agreement dated March 14, 1996 between the Registrant and
Coherent, Inc., a Delaware corporation, and Legato Systems, Inc., a
Delaware corporation, regarding the space located at 3210 Porter Drive,
Palo Alto, California
21.1 Subsidiaries of the Registrant
23.1 Consent of Coopers and Lybrand L.L.P., Independent Accountants
27.1 Financial Data Schedule
(1) Incorporated by reference to the registrant's Registration Statement on
Form S-1, filed May 9, 1995 (File No. 33-92072).
(2) Confidential treatment requested as to certain portions of this exhibit.
(3) Incorporated by reference to the registrant's Current Report on Form 8-K,
dated January 19, 1996.
(4) Incorporated by reference to the registrant's Registration Statement on
Form S-8, filed March 14, 1996 (File No. 333-2378).
(5) Compensatory plan or arrangement.
(6) Incorporated by reference to the registrant's definitive Proxy Statement
for Special Meeting of Stockholders, dated May 31, 1996.
(7) Incorporated by reference to the registrant's Quarterly Report on Form 10Q,
dated August 7, 1996.
(8) Incorporated by reference to the registrant's Current Report on Form 8-K,
dated June 6, 1997.
(9) Incorporated by reference to the registrant's Form 8-A, dated May 30, 1997.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the fourth quarter of
the fiscal year ended December 31, 1997.
(c) Exhibits
See (a) (3) above.
(d) Financial Statement Schedule
See (a) (2) above.
REPORT ON FINANCIAL STATEMENT SCHEDULE
Our report on the consolidated financial statements of Legato Systems,
Inc. is included on page 38 of this Form 10-K. In connection with our audits of
such financial statements, we have also audited the related consolidated
financial statement schedule listed in Item 14 (a)(2) of this Form 10-K.
In our opinion, the consolidated financial statement schedule referred
to above, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly, in all material respects, the
information required to be included therein.
/S/ COOPERS & LYBRAND L.L.P.
San Jose, California
January 19, 1998
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Charged to Balance at
Beginning of Costs and End of
Description Period Expenses Deductions Period
Allowance for Doubtful Accounts:
Year ended December 31, 1995 $ (293) $ (440) $ 66 $ (667)
Year ended December 31, 1996 (667) (197) 52 (812)
Year ended December 31, 1997 (812) (260) 273 (799)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ Louis C. Cole March 27, 1998
-------------------- --------------
Louis C. Cole Date
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Louis C. Cole Chairman of the Board, President and Chief March 27, 1998
- ------------------- Executive Officer (Principal Executive Officer)
Louis C. Cole
/s/ Stephen C. Wise Senior Vice President of Finance and March 27, 1998
- ------------------- Administration and Chief Financial Officer
Stephen C. Wise (Principal Financial and Accounting Officer)
/s/ Eric A. Benhamou Director March 27, 1998
- --------------------
Eric A. Benhamou
/s/ Kevin A. Fong Director March 27, 1998
- -----------------
Kevin A. Fong
/s/ David N. Strohm Director March 27, 1998
- -------------------
David N. Strohm
/s/ Phillip E. White Director March 27, 1998
- --------------------
Phillip E. White
EXHIBIT 21.1
LEGATO SYSTEMS, INC.
SUBSIDIARIES OF THE REGISTRANT
Legato Systems Deutschland GmbH - Germany
LGTO S.A.R.L. - France
Legato Systems Pty. Ltd. - Australia
Legato Systems (Canada), Inc. - Canada
Legato Systems International, Inc. - Barbados
Legato Systems KK - Japan
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement
of Legato Systems, Inc. on Form S-8 (File No. 333-28405, 333-02378 and
333-94306) of our reports dated January 19, 1998 on our audits of the
consolidated financial statements of Legato Systems, Inc. and subsidiaries as of
December 31, 1997 and 1996, and for each of the three years in the period ended
December 31, 1997 and of our reports dated January 19, 1998 on our audit of the
consolidated financial statement schedule, both of which reports are included in
this Annual Report on Form 10-K.
/S/ COOPERS & LYBRAND L.L.P.
San Jose, California
March 27, 1998