UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
------------ -------------
Commission File Number: 0-26130
LEGATO SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3077394
(State of incorporation) (I.R.S. Employer
Identification No.)
2350 WEST EL CAMINO REAL
MOUNTAIN VIEW, CALIFORNIA 94040
(Address of principal executive offices)
(650) 210-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
The number of shares outstanding of the registrant's common stock as of July 31,
2000 was 86,962,614.
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<CAPTION>
LEGATO SYSTEMS, INC.
INDEX
Page
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PART I: CONDENSED FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2000 and December 31, 1999 3
Condensed Consolidated Statements of Operations for the three-month and six-month periods
ended June 30, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows for the six-month periods ended June 30,
2000 and 1999 5
Notes to the Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities and Use of Proceeds 28
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURE 30
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PART I: CONDENSED FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, December 31,
2000 1999
----------- -----------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 105,380 $ 115,222
Short-term investments 45,968 42,983
Accounts receivable, net 39,767 53,387
Other current assets 9,013 10,112
Deferred tax asset 17,487 15,959
----------- -----------
Total current assets 217,615 237,663
Long-term investments 9,755 11,723
Property and equipment, net 38,392 27,090
Intangible assets, net 122,992 141,988
Deferred tax assets - long term 3,878 2,176
Other assets 2,703 2,254
----------- -----------
$ 395,335 $ 422,894
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,688 $ 5,757
Accrued compensation and benefits 11,267 16,867
Accrued liabilities 10,018 9,240
Short-term loan payable -- 6,847
Deferred revenues 40,592 46,438
----------- -----------
Total current liabilities 65,565 85,149
Stockholders' equity:
Capital stock and other comprehensive income 301,273 291,677
Retained earnings 28,497 46,068
----------- -----------
Total stockholders' equity 329,770 337,745
----------- -----------
$ 395,335 $ 422,894
=========== ===========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
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<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
----------- ----------- ---------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenue:
Product license $ 31,343 $ 30,784 $ 66,079 $ 55,523
Services and support 20,916 15,818 41,430 30,085
Royalty 6,022 4,962 11,292 9,901
----------- ----------- ---------- -----------
Total revenue 58,281 51,564 118,801 95,509
Cost of revenue:
Product license 1,582 1,450 3,144 2,982
Services and support 9,804 5,982 18,428 11,337
----------- ----------- ---------- -----------
Total cost of revenue 11,386 7,432 21,572 14,319
----------- ----------- ---------- -----------
Gross profit 46,895 44,132 97,229 81,190
Operating expenses:
Research and development 14,399 9,348 29,728 17,060
Sales and marketing 24,422 20,850 51,463 41,131
General and administrative 8,000 4,778 16,219 9,586
Amortization of intangibles 9,522 4,160 19,045 4,440
Purchased in-process research
and development -- 3,170 -- 3,170
Merger related expenses -- 4,968 1,250 4,968
----------- ----------- ---------- -----------
Total operating expenses 56,343 47,274 117,705 80,355
----------- ----------- ---------- -----------
Income (loss) from operations (9,448) (3,142) (20,476) 835
Interest and other income, net 1,790 1,216 2,731 2,620
----------- ----------- ---------- -----------
Income (loss) before provision
for income taxes (7,658) (1,926) (17,745) 3,455
Provision for (benefit from) income taxes (77) (833) (177) 1,788
----------- ----------- ---------- -----------
Net income (loss) $ (7,581) $ (1,093) $ (17,568) $ 1,667
=========== =========== ========== ===========
Other comprehensive income, net of taxes
Unrealized losses on securities (1) (52) (4) (62)
----------- ----------- ---------- -----------
Comprehensive income (loss) $ (7,582) $ (1,145) $ (17,572) $ 1,605
=========== =========== ========== ===========
Basic earnings (loss) per share $ (0.09) $ (0.01) $ (0.20) $ 0.02
=========== =========== ========== ===========
Diluted earnings (loss) per share $ (0.09) $ (0.01) $ (0.20) $ 0.02
=========== =========== ========== ===========
Shares used in basic earnings (loss)
per share calculation 86,561 81,284 86,229 80,270
=========== =========== ========== ===========
Shares used in diluted earnings (loss)
per share calculation 86,561 81,284 86,229 86,154
=========== =========== ========== ===========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
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<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months Ended
June 30,
--------------------------
2000 1999
----------- -----------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (17,568) $ 1,667
Adjustments to reconcile net income/loss to net cash provided by
operating activities:
Net deferred tax asset (3,231) (6,305)
Depreciation and amortization 25,886 10,199
Provision for doubtful accounts 1,515 120
Tax benefit from exercise of stock options -- 4,674
Purchased in-process research and development -- 3,170
Changes in operating assets and liabilities:
Accounts receivable 12,105 10,977
Other current assets 1,099 (293)
Accounts payable (2,069) (599)
Accrued compensation and benefits (5,600) (64)
Accrued liabilities 778 (15,532)
Deferred revenue (5,846) 10,618
----------- -----------
Net cash provided by operating activities 7,069 18,632
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale securities (31,983) (55,773)
Proceeds from maturity and sale of available-
for-sale securities 30,970 51,512
Acquisition of property and equipment (18,129) (5,708)
Acquisition of Intelliguard, net of cash acquired -- (9,021)
Change in other assets (511) (5,431)
----------- -----------
Net cash used in investing activities (19,653) (24,421)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 9,589 8,261
Payment of short-term loan payable (6,847) --
Other -- 4
----------- -----------
Net cash provided by financing activities 2,742 8,265
----------- -----------
Net increase/decrease in cash and cash equivalents (9,842) 2,476
Cash and cash equivalents at beginning of period 115,222 83,177
----------- -----------
Cash and cash equivalents at end of period $ 105,380 $ 85,653
=========== ===========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
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LEGATO SYSTEMS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. BASIS OF PRESENTATION AND RESTATEMENT OF QUARTERLY FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (all of which are
normal and recurring in nature) necessary to present fairly the financial
position, results of operations and cash flows of Legato Systems, Inc. and its
subsidiaries. The results of operations for the interim periods presented are
not necessarily indicative of the results that may be expected for any future
interim periods or for the full fiscal year. The Notes to the Consolidated
Financial Statements contained in the 1999 Report on Form 10-K should be read in
conjunction with these Condensed Consolidated Financial Statements.
On May 17, 2000, we filed our Form 10-K for 1999, which included our
revised financial results for fiscal 1999. On June 8, 2000, we filed our amended
Form 10-Qs for the first, second and third quarters of fiscal 1999, which
included our restated results for these periods. We revised our preliminary
fiscal 1999 results and restated results for the first, second and third
quarters of 1999 following our discovery that a number of our sales
representatives, acting outside their authority, had entered into additional
unauthorized written and oral agreements outside our standard contractual terms
with certain of our resellers. These side agreements allowed the resellers to
pay us only when they were paid by end users, to return product in the event
that a sale to an end user was not consummated, or to pay us on extended terms.
If the existence of these side agreements had been known at the time that the
transactions were signed, we would not have recognized revenue on these
transactions in the period in which they were initially recorded as the fees
involved would not have been deemed to be fixed or determinable. Accordingly, we
revised the revenue recognition for all transactions with these resellers during
fiscal 1999 to reflect the point in time when these fees were considered fixed
or determinable which coincided with the receipt of payments from resellers. The
results of our review of the transactions in 1999 were such that we concluded
that the problems surrounding unauthorized written and oral agreements did not
extend into earlier years.
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For the three-month and six-months ended June 30, 1999, the impact is as
follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1999 June 30, 1999
---------------------- ----------------------
As As As As
Reported Restated Reported Restated
<S> <C> <C> <C> <C>
Total revenue $ 62,008 $ 51,564 $ 114,360 $ 95,509
Gross profit 54,576 44,132 100,041 81,190
Net income (loss) 4,438 (1,093) 12,634 1,667
Basic earnings (loss) per share $ 0.05 $ (0.01) $ 0.16 $ 0.02
Diluted earnings (loss) per share $ 0.05 $ (0.01) $ 0.15 $ 0.02
</TABLE>
NOTE 2. EARNINGS PER SHARE
Basic earnings (loss) per share is computed by dividing net income (loss)
attributable to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings (loss) 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 exercise of stock options.
A reconciliation of the numerator and denominator of basic and diluted
earnings (loss) per share is provided as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Numerator - basic and diluted earnings per share
Net income (loss) $ (7,581) $ (1,093) $(17,568) $ 1,667
========= ========= ========= ========
Denominator - basic earnings (loss) per share
Weighted average common shares outstanding 86,561 81,284 86,229 80,270
--------- --------- --------- --------
Basic earnings (loss) per share $ (0.09) $ (0.01) $ (0.20) $ 0.02
========= ========= ========= ========
Denominator - diluted earnings (loss) per share
Weighted average common shares outstanding 86,561 81,284 86,229 80,270
Effect of dilutive securities:
Common stock options -- -- -- 5,884
--------- --------- --------- --------
Weighted average common and common
equivalent shares 86,561 81,284 86,229 86,154
========= ========= ========= ========
Diluted earnings (loss) per share $ (0.09) $ (0.01) $ (0.20) $ 0.02
========= ========= ========= ========
Options excluded from diluted net income (loss)
per share calculation 7,168 6,158 2,125 498
========= ========= ========= ========
</TABLE>
Certain shares of common stock issuable upon exercise of stock options were
excluded from the calculation of diluted net income (loss) per share, as the
impact of the options would have been anti-dilutive.
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NOTE 3. COMPREHENSIVE INCOME (LOSS)
Our unrealized loss on investments represents the only component of
comprehensive income (loss) that is excluded from net income/loss for the
quarter and six-month period ended June 30, 2000. Our comprehensive income/loss
has been presented in the consolidated financial statements.
NOTE 4. SEGMENT INFORMATION
Management uses one measurement of profitability for its business. Our
software products and related services are developed and marketed to support
heterogeneous client/server computing environments and large scale enterprises.
We market our products and related services to customers in the United States,
Canada, Europe and Asia Pacific.
Revenue information on a product basis is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- --------
(in thousands)
<S> <C> <C> <C> <C>
Product license:
NetWorker and related NetWorker products $ 27,340 $ 24,835 $ 56,617 $ 46,942
Other products 4,003 5,949 9,462 8,131
Service and support 20,916 15,818 41,430 30,085
Royalty 6,022 4,962 11,292 9,901
Other products, primarily third-party hardware
and software -- -- -- 450
--------- --------- ---------- --------
$ 58,281 $ 51,564 $ 118,801 $ 95,509
========= ========= ========== ========
The table below presents revenue information by geographic area:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- --------
(in thousands)
United States $ 45,587 $ 37,683 $ 91,032 $ 69,580
Europe 9,406 10,490 20,420 20,779
Other 3,288 3,391 7,349 5,150
--------- --------- ---------- --------
$ 58,281 $ 51,564 $ 118,801 $ 95,509
========= ========= ========== ========
The table below presents long-lived-asset information by geographic area:
June 30, December 31,
2000 1999
--------- ---------
(in thousands)
United States $154,994 $ 163,336
Europe 2,544 2,208
Other countries 3,846 3,534
--------- ---------
Total $ 161,384 $ 169,078
========= =========
</TABLE>
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NOTE 5. RECENT PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 133, or SFAS 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
We do not currently hold derivative instruments or engage in hedging activities.
In July 1999, the FASB issued Statement of Financial Accounting Standards
No. 137, or SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB No. 133. SFAS 137 deferred
the effective date of SFAS 133 until the first fiscal quarter beginning after
June 15, 2000.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, or SAB 101, Revenue Recognition in Financial
Statements. SAB 101 summarizes certain of the SEC's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
In June 2000, the SEC issued SAB 101B which defers the implementation of SAB 101
to no later than the fourth quarter of fiscal years beginning after December 15,
1999. We do not expect the adoption of SAB 101 to have a material effect on our
financial position or results of operations.
In March 2000 the Financial Accounting Standards Board, or FASB, issued
FASB Interpretation No. 44, or FIN 44, Accounting for Certain Transactions
Involving Stock Compensation an Interpretation of APB Opinion No. 25. FIN 44
clarifies the application of Opinion 25 for (a) the definition of employee for
purposes of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 is effective July 1, 2000, but certain conclusions cover
specific events that occur after either December 15, 1998, or January 12, 2000.
Management believes that that the impact of FIN 44 will not have a material
effect on the financial position or results of operations of the Company.
NOTE 6. LEGAL PROCEEDINGS
On January 20, 2000, a shareholder securities class action complaint was
filed in the U.S. District Court, Northern District of California, against us
and certain of our directors and officers. Approximately thirty other similar
class actions involving the same defendants and substantially similar
allegations were filed soon thereafter. The court has determined that all of the
cases are related and assigned them to one federal judge. On May 1, 2000, the
court consolidated all of the pending cases. On May 10, 2000, the court
appointed a lead plaintiff, who filed a consolidated amended complaint on August
7, 2000. The consolidated amended complaint alleges that, between April 22, 1999
and May 17, 2000, we and certain of our officers made false or misleading
statements of material fact about the Company's prospects and failed to follow
generally accepted accounting principles in violation of the federal securities
laws. The complaints seek an unspecified amount in damages.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our officers
and directors. We are named as nominal defendant. The complaint generally
alleges the same conduct as the shareholder class actions filed in U.S. District
Court for the period October 21, 1999 through January 19, 2000. The complaint
asserts that defendants breached their fiduciary duties and engaged in improper
insider trading. The complaint seeks unspecified damages and injunctive relief.
On June 7, 2000, the Company was served with a shareholder derivative complaint
filed in the U.S. District Court, Northern District of California, against the
Company and certain of its officers and directors. The second federal case
alleges substantially similar claims on behalf of shareholders for the period
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March 30, 2000 through April 26, 2000. The complaint seeks unspecified damages
and injunctive relief. Both federal derivative cases have been related to the
securities class action.
We have been advised by the staff of the Securities and Exchange Commission
that the Commission will enter a formal order of investigation concerning our
restatement of financial results for the first, second, and third quarters of
1999, and our revision of financial results for the fourth quarter and fiscal
1999. We have been voluntarily cooperating with the staff of the Commission in
its investigation.
On April 13, 2000, a shareholder derivative action was filed in the
Superior Court of California, County of Santa Clara, against certain of our
officers and directors. We are named as a nominal defendant. The complaint
alleges substantially similar allegations as the federal derivative actions for
the period October 21, 1999 through April 3, 2000. The complaint seeks
unspecified damages. On May 23, 2000, a shareholder derivative action was filed
in the Superior Court of California, County of San Mateo, against certain of our
officers and directors. We are named as a nominal defendant. The complaint
generally alleges the same conduct as the derivative actions filed in federal
court, and asserts that our officers and directors breached their fiduciary
duties. The complaint seeks unspecified damages and injunctive relief.
The Company and the individual defendants intend to defend all of these
actions vigorously. There can be no assurance that any of the complaints
discussed above will be resolved without costly litigation, or in a manner that
is not adverse to our financial position, results of operations or cash flows.
No estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies. Currently, no amounts
have been accrued for these matters.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The discussion in this report on Form 10-Q contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding our expectations, beliefs, intentions or strategies
regarding the future. All forward-looking statements included in this document
are based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. Our actual results
could differ materially from those described in our forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, fluctuations in quarterly operating results, uncertainty in future
operating results, litigation, product concentration, competition, technological
changes, reliance on enterprise license transactions, reliance on indirect sales
channels, dependence on international revenue, continuing attrition of sales or
other key personnel, management of our growth and expansion, integration of
recent acquisitions and other risks discussed in this item under the heading
"Risk Factors" and the risks discussed in our other Securities and Exchange
Commission filings.
RESULTS OF OPERATIONS
Overview
On May 17, 2000, we filed our Form 10-K for 1999, which included our
revised financial results for fiscal 1999. On June 8, 2000, we filed our amended
Form 10-Qs for the first, second and third quarters of fiscal 1999, which
included our restated results for these periods. We revised our preliminary
fiscal 1999 results and restated results for the first, second and third
quarters of 1999 following our discovery that a number of our sales
representatives, acting outside their authority, had entered into additional
unauthorized written and oral agreements outside our standard contractual terms
with certain of our resellers. These side agreements allowed the resellers to
pay us only when they were paid by end users, to return product in the event
that a sale to an end user was not consummated, or to pay us on extended terms.
If the existence of these side agreements had been known at the time that the
transactions were signed, we would not have recognized revenue on these
transactions in the period in which they were initially recorded as the fees
involved would not have been deemed to be fixed or determinable. Accordingly, we
have revised the revenue recognition for all transactions with these resellers
during fiscal 1999 to reflect the point in time when these fees were considered
fixed or determinable which coincided with the receipt of payments from
resellers. The results of our review of the transactions in 1999 were such that
we concluded that the problems surrounding unauthorized written and oral
agreements did not extend into earlier years.
We develop, market and support enterprise storage management software
products for heterogeneous client/server computing environments and large scale
enterprises. Our data protection products, primarily the NetWorker family of
software products, from which we derive a majority of our revenue, and data
availability products, primarily HA+, Octopus, Replication and Cluster products,
support many storage management server platforms and can accommodate a variety
of servers, clients, applications, databases and storage devices. We license our
products through resellers and directly to end users primarily located in North
America, Europe and Asia Pacific. We also license our source code to original
equipment manufacturers, or OEMs, in exchange for initial licensing fees and
receive 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.
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Selected elements of our consolidated financial statements are shown below
as a percentage of total revenue.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Revenue:
Product license 54% 60% 56% 58%
Services and Support 36 30 35 32
Royalty 10 10 9 10
-------- --------- -------- ---------
Total revenue 100 100 100 100
Cost of revenue:
Product license 3 3 3 3
Services and support 17 12 15 12
-------- --------- -------- ---------
Total cost of revenue 20 15 18 15
-------- --------- -------- ---------
Gross profit 80 85 82 85
Operating expenses:
Research and development 25 18 25 18
Sales and marketing 42 40 43 43
General and administrative 14 9 14 10
Amortization of intangibles 16 8 16 5
Purchased in-process research
and development -- 6 -- 3
Merger related expenses -- 10 1 5
-------- --------- -------- ---------
Total operating expenses 97 91 99 84
-------- --------- -------- ---------
Income(loss) from operations (16) (6) (17) 1
Interest and other income, net 3 2 2 3
-------- --------- -------- ---------
Income(loss) before provision for income taxes (13) (4) (15) 4
Provision for(benefit from) income taxes -- (2) -- 2
-------- ---------- -------- ---------
Net income(loss) (13)% (2)% (15)% 2%
========= ========== ========= =========
</TABLE>
Revenue
Total revenue for the second quarter ended June 30, 2000 increased 13% over
total revenue for the comparable period of 1999. Total revenue for the six
months ended June 30, 2000 increased 24% over total revenue for the comparable
period of 1999. The increases were attributed primarily to increased product
licenses and service and support contracts.
Product license revenue. Product license revenue was $31.3 million in the
second quarter of 2000 and $30.8 million in the second quarter of 1999,
representing an increase of 1.8%. Product license revenue was $66.1 million in
the first six months of 2000 and $55.5 million in the first six months of 1999,
representing an increase of 19%. The increase was attributed primarily to the
continued acceptance of our products. We recognize product revenue upon shipment
if a signed contract exists, the fee is fixed or determinable, collection of
resulting receivables is probable and product returns are reasonably estimable,
with the exception of sales to domestic distributors and certain value-added
resellers for 2000. We recognize revenue from domestic distributors upon sale by
the distributor since these distributors have unlimited rights of return and we
historically have not been able to make reasonable estimates of product returns
for these distributors. We also incur additional internal costs to assist our
distributors in selling our products to end users. For transactions entered into
1999 with those value-added resellers where we have determined that fees were
not fixed or determinable due to circumstances involving unauthorized written
and oral agreements outside our normal contractual terms, as discussed in Note
1, we recognize revenue when fees are fixed or determinable, which coincides
with the receipt of cash. For certain sales where the licensing fee is not due
until the customer deploys the software, revenue is recognized when the customer
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reports to us that the software has been deployed. Prior growth rates of our
product license revenue are not indicative of future product license revenue
growth rates and may not be sustainable in the future.
Services and support revenue. Services and support revenue was $20.9
million in the second quarter of 2000 and $15.8 million in the second quarter of
1999, representing an increase of 32%. Service and support revenue was $41.4
million in the first six months of 2000 and $30.1 million in the first six
months of 1999, representing an increase of 38%. The increases were primarily
attributable to the growth in the number of registered customers electing to
subscribe to support contracts and to renew existing software support contracts.
Our increase in internal staffing for software support and education and
consulting services helped to increase new sales and renewals of our software
support contracts, as well as sales of education and consulting services we
offer. We collect fees for ongoing customer support and product updates in
advance and recognize this support revenue ratably over the period of the
contract. For education and consulting services, we recognize revenue when such
services are performed. Prior growth rates of our software service and support
revenue are not indicative of future software service and support revenue growth
rates and may not be sustainable in the future.
Royalty revenue. Royalty revenue was $6.0 million in the second quarter of
2000 and $5.0 million in the second quarter of 1999, representing an increase of
21%. Royalty revenue was $11.3 million in the first six months of 2000 and $9.9
million in the first six months of 1999, representing an increase of 14%.
Royalty revenue is recognized upon receipt of quarterly royalty reports from
OEMs related to their product sales for the previous quarter. Prior growth rates
of our royalty revenue are not indicative of future royalty revenue growth rates
and may not be sustainable in the future.
International product license revenue was $12.7 million in the second
quarter of 2000 and $13.9 million in the second quarter of 1999. International
product license revenue decreased 9% from the second quarter of 1999 to the
second quarter of 2000. International product license revenue accounted for 22%
of total revenue in the second quarter of 2000 and 27% in the second quarter of
1999. International product license revenue was $27.8 million in the first six
months of 2000 and $25.9 million in the first six months of 1999. International
product license revenue increased 7% from the first six months of 1999 to the
first six months of 2000. International product license revenue accounted for
23% of total revenue in the first six months of 2000 and 27% in the first six
months of 1999. Sales in Europe and Asia accounted for the majority of our
international revenue during these periods. International product license
revenue decreased in the second quarter of 2000 from the same quarter of 1999
primarily as a result of a reorganization of our European operations and delays
in completing several large transactions in Europe.
We have expanded our international operations significantly over the past
several years. Such expansion requires significant management attention and
financial resources. Diversion of resources could materially adversely affect
our operating results. To the extent that we are unable to manage these expanded
international operations, our growth, if any, in international revenue will be
limited, and our business, operating results and financial condition could be
seriously harmed. In addition, we cannot guarantee that we will be able to
maintain or increase international market demand for our products.
Gross Profit
Gross profit was $46.9 million in the second quarter of 2000 and $44.1
million in the second quarter of 1999, representing 80% of total revenue in the
second quarter of 2000 and 85% of total revenue in the second quarter of 1999.
Gross profit was $97.2 million in the first six months of 2000 and $81.2 million
in first six months of 1999, representing 82% in the first six months of 2000
and 85% in the first six months of 1999. Gross profit consists of product
license and service and support revenue less related costs.
Gross profit from product license revenue was $29.8 million in the second
quarter of 2000 and $29.3 million in the second quarter of 1999, representing
95% of product license revenue in the second quarter of 2000 and 1999. Gross
profit from product license revenue increased 1% from the second quarter of 1999
to the same period of 2000. Gross profit from product license revenue was $62.9
million in the first six months of 2000 and $52.5 million in the first six
months of 1999, representing 95% of product license revenue in the first six
months of 2000 and 95% for the first six months of 1999. Gross profit from
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product license revenue increased 20% from the first six months of 1999 to the
first six months of 2000, consistent with the increase in product license
revenue over the comparable periods. Related costs of revenue consist primarily
of product media, documentation and packaging.
Gross profit from service and support revenue was $11.1 million in the
second quarter of 2000 and $9.8 million in the second quarter of 1999,
representing 53% of the service and support revenue in the second quarter of
2000 and 62% in the second quarter of 1999. Gross profit from service and
support revenue increased 13% from the second quarter of 1999 to the same period
of 2000. Gross profit from service and support revenue was $23.0 million in the
first six months of 2000 and $18.7 million in the first six months of 1999,
representing 56% of the service and support revenue in the first six months of
2000 and 62% in the first six months of 1999. Gross profit from service and
support revenue increased 23% from the first six months of 1999 to the same
period of 2000. Gross profit from service and support revenue as a percentage of
service and support revenue decreased primarily as a result of expense levels
being relatively fixed and based, in part, on our expectations of our future
revenue. Consequently, when revenue levels fall below our expectations, the
gross profit from service and support decreases. The increase in our costs of
service and support revenue in absolute dollars is also attributable to our
continued investment in developing new services and support offerings. The
continued investment consists of costs associated with supporting a larger
installed base of products, as well as costs to provide higher support levels to
customers. Costs of service and support revenue consist primarily of
personnel-related costs incurred in providing telephone support, consulting
services, and training to customers, costs of providing software updates and
costs of education and consulting materials.
Operating Expenses
Research and development. Research and development expenses consist
primarily of personnel-related costs. Research and development expenses were
$14.4 million in the second quarter of 2000 and $9.3 million in the second
quarter of 1999, representing 24% of total revenue in the second quarter of 2000
and 18% in the second quarter of 1999. Research and development expenses
increased 54% from the second quarter of 1999 to the second quarter of 2000.
Research and development expenses were $29.7 million in the first six months of
2000 and $17.1 million in the first six months of 1999, representing 25% of
total revenue in the first six months of 2000 and 18% in first six months of
1999. Research and development expenses increased 74% from the first six months
of 1999 to the first six months of 2000. Research and development expenses as a
percentage of revenue increased primarily as a result of expense levels being
relatively fixed and based primarily on our expectations of our future revenue.
Consequently, when revenue levels fall below our expectations, the research and
development expenses as a percentage of revenue increases. The increases in
research and development expenses in absolute dollars primarily reflect
increased staffing and associated support for engineers necessary to continue to
expand and enhance our product line. We believe that research and development
expenses will continue to increase in absolute dollars as we continue to invest
in developing 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 $24.4 million in the second quarter
of 2000 and $20.9 million in the second quarter of 1999, representing 42% of
total revenue in the second quarter of 2000 and 40% in the second quarter of
1999. Sales and marketing expenses increased 17% from the second quarter of 1999
to the second quarter of 2000. Sales and marketing expenses were $51.5 million
in the first six months of 2000 and $41.1 million in the first six months of
1999, representing 43% of total revenue in the six months of 2000 and 1999.
Sales and marketing expenses increased 25% from the six months of 1999 to the
first six months of 2000. Sales and marketing expenses as a percentage of
revenue increased primarily as a result of expense levels being tied closely to
personnel and facilities costs and based primarily on our expectations of our
future revenue. Consequently, when revenue levels fall below our expectations,
the sales and marketing expenses as a percentage of revenue increases. We
believe that sales and marketing expenses will continue to increase in absolute
dollars as the costs to hire new sales and marketing personnel increases.
General and administrative. General and administrative expenses include
personnel and other costs of our finance, human resources, legal, facilities,
information systems and other administrative departments. General and
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administrative expenses were $8.0 million in the second quarter of 2000 and $4.8
million in the second quarter of 1999, representing 14% of total revenue in the
second quarter of 2000 and 9% of total revenue in the second quarter of 1999.
General and administrative expenses increased 67% from the second quarter of
1999 to the second quarter of 2000. General and administrative expenses were
$16.2 million in the first six months of 2000 and $9.6 million in the first six
months of 1999, representing 15% of total revenue in the first six months of
2000 and 10% in the first six months of 1999. General and administrative
expenses increased 69% from the first six months of 1999 to the first six months
of 2000. The increases in general and administrative were primarily attributable
to increased staffing and related costs required to manage and support our
expanded operations and professional fees incurred in connection with the
litigation (See Notes 6 to the Notes of the Condensed Financial Statements). We
expect that general and administrative expenses will increase in dollar amount
as we continue to incur additional legal expenses in connection with the
shareholder litigation.
Amortization of intangibles. Amortization of intangibles was $9.5 million
in the second quarter of 2000 and $4.2 in the second quarter of 1999.
Amortization of intangibles was $19.0 million in the first six months of 2000
and $4.4 million in the first six months of 1999. The increase from the first
quarter of 1999 is primarily attributed to the amortization of intangibles
related to the acquisitions of Intelliguard Software, Inc. and Vinca Corporation
during 1999 . We are amortizing these intangibles on a straight-line basis
ranging from seventeen months to five years from the dates of acquisition.
In-process research and development. We did not incur any in-process
research and development costs for the second quarter and the first six months
of 2000. During the second quarter of 1999, we incurred in-process research and
development costs of $3.2 million in connection with our acquisition of
Intelliguard.
Merger-Related Expenses. We did not incur any merger-related expenses for
the second quarter and the first six months of 2000. In connection with the
merger with FullTime in 1999, we incurred $5.0 million in merger related
expenses, consisting primarily of charges for transaction fees, involuntary
termination benefits, non-cancelable lease obligations and write-offs of
leasehold improvements for sales and administrative offices that were
duplicative and vacated.
Interest and Other Income, Net. Interest and other income, net, was $1.8
million in the second quarter of 2000 and $1.2 million in the second quarter of
1999. Interest and other income, net, was $2.7 million in the first six months
of 2000 and $2.6 million in the first six months of 1999. Interest and other
income primarily represent interest income from funds available for investment.
The increase in interest and other income was primarily attributed to additional
interest income earned from higher cash and investment balances from the second
quarter of 1999.
Provision for Income Taxes. The benefit from income taxes for the second
quarter of 2000 was $77,000, compared to a benefit from income taxes of $833,000
for the second quarter of 1999. The benefit from income taxes for the first six
months of 2000 was $177,000, compared to a provision for income taxes of $1.8
million for the first six months of 1999. The effective tax rate was 1% for the
second quarter of 2000 and 43% for the second quarter of 1999. The effective tax
rate was 1% for the first six months of 2000 and 52% for the first six months of
1999. The decrease in the effective rates primarily reflects losses before
income taxes of $7.7 million for the second quarter of 2000 and $17.7 million
for the first six months of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Our cash, cash equivalents and investments totaled $161.1 million at June
30, 2000, and represented 41% 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 and
auction-rate receipts. At June 30, 2000, we had no long-term debt and
stockholders' equity was $329.8 million.
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We have financed our operations to date primarily by cash from operations
and sales of common stock. Net cash provided by operating activities was $7.1
million in the first six months of 2000. Net cash provided by operations in the
first six months of 2000 consisted primarily of net loss of $17.6 million and
net change in deferred tax assets of $3.2 million, offset by depreciation and
amortization of $25.9 million and provision for doubtful accounts of $1.5
million and the net change in operating assets and liabilities of $0.5 million.
Net cash used in investing activities was $19.7 million in the first six
months of 2000. Net cash used in investing activities primarily reflected
purchases of marketable securities of $32.0 million and purchases of property
and equipment of $18.1 million. The cash used in investing activities was offset
primarily by proceeds from the maturity and sale of marketable securities of
$31.0 million and the change in other assets of $0.5 million. Purchases of
property and equipment increased to support the growth in our operations from
the same period from 1999.
Net cash provided by financing activities was $2.7 million in the first six
months of 2000. Net cash provided by financing activities consisted primarily of
proceeds of $9.6 million received from the issuance of our common stock offset
by the payment of a short-term loan payable of $6.8 million.
We believe our current cash balances and cash flow from operations, if any,
will be sufficient to meet our working capital and capital expenditure
requirements for at least the next twelve months.
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RISK FACTORS
In addition to the other information in this Report, the following risk
factors should be considered carefully in evaluating our business and us:
Our Quarterly Operating Results Are Volatile.
Our quarterly operating results have varied in the past and may vary in the
future. Our quarterly operating results may vary depending on a number of
factors, many of which are outside of our control, including:
- The size and timing of orders;
- Increased competition;
- Personnel change or turnover;
- Continuing attrition of employees;
- Market acceptance of our new products, applications and product
enhancements or our competitors;
- Changes in pricing policies or those of our competitors;
- Our ability to develop, introduce and market new products, applications
and product enhancements;
- Implementation of new business models will result in deferring recognition
of revenue on certain transactions;
- Ability to integrate acquired businesses;
- Our ability to control costs;
- Quality control of products sold;
- Lengthy sales cycles, particularly with enterprise license transactions;
- Delay in the recognition of revenue from enterprise license and application
service provider transactions;
- Modification in reseller relationships resulting in changes to revenue
recognition policies;
- Success in expanding sales and marketing programs;
- Technological changes in our markets;
- The mix of sales among our channels;
- Deferrals of customer orders in anticipation of new products, applications
or product enhancements;
- Market readiness to deploy our products for distributed computing
environments;
- Changes in our strategy or that of our competitors;
- Customer budget cycles and changes in these budget cycles;
- Foreign currency and exchange rates;
- Acquisition costs or other non-recurring charges in connection with the
acquisition of companies, products or technologies;
- Costs and expenses related to shareholder litigation; and
- General economic factors.
Our Future Operating Results Are Uncertain.
Our historical results of operations are not necessarily indicative of our
results for any future period. Expectations, forecasts, and projections by us or
others are by nature forward-looking statements, and future results cannot be
guaranteed. Forward-looking statements that were true at the time may ultimately
prove to be incorrect or false. We will not update our forward-looking
statements. Some investors in our securities inevitably will experience gains
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while others will experience losses, depending on the prices at which they
purchase and sell securities. Prospective and existing investors are strongly
urged to carefully consider the various cautionary statements and risks set
forth in this report.
We cannot predict our future revenue with any significant degree of
certainty for several reasons including:
- Product revenue in any quarter is substantially dependent on orders booked
and shipped in that quarter, since we operate with virtually no order
backlog;
- We do not recognize revenue on sales to domestic distributors until the
products are sold through to end-users;
- Implementation of new business models will result in deferring recognition
of revenue on certain transactions;
- The storage management market is rapidly evolving;
- Our sales cycles vary substantially from customer to customer, in large
part because we are becoming increasingly dependent upon larger
company-wide enterprise license transactions to corporate customers. Such
transactions include product license, service and support components and
take a long time to complete;
- The timing of large orders can significantly affect revenue within a quarter;
- The timing of recognition of revenue from enterprise license and
application service provider transactions can significantly affect revenue
within a quarter;
- Modification in reseller relationships resulting in changes to revenue
recognition policies;
- License and royalty revenue are difficult to forecast. Our royalty
revenue is dependent upon product license sales by OEMs of their
products that incorporate our software. Accordingly, this royalty
revenue is subject to OEMs' product cycles, which are also difficult to
predict. Fluctuations in licensing activity from quarter to quarter
further impact royalty revenue, because initial license fees generally
are non-recurring and recognized upon the signing of a license
agreement; and
Our expense levels are relatively fixed and are based, in part, on our
expectations of our future revenue. Consequently, if revenue levels fall below
our expectations, our net income will decrease because only a small portion of
our expenses varies with our revenue.
We believe that period-to-period comparisons of our results of operations
are not meaningful and should not be relied upon as indications of future
performance. Our operating results will be below the expectations of public
market analysts and investors in some future quarter or quarters. Our failure to
meet such expectations would likely seriously harm the market price of our
common stock.
Litigation.
On January 20, 2000, a shareholder securities class action complaint was
filed in the U.S. District Court, Northern District of California, against us
and certain of our directors and officers. Approximately thirty other similar
class actions involving the same defendants and substantially similar
allegations were filed soon thereafter. The court has determined that all of the
cases are related and assigned them to one federal judge. On May 1, 2000, the
court consolidated all of the pending cases. On May 10, 2000, the court
appointed a lead plaintiff, who filed a consolidated amended complaint on August
7, 2000. The consolidated amended complaint alleges that, between April 22, 1999
and May 17, 2000, we and certain of our officers made false or misleading
statements of material fact about the Company's prospects and failed to follow
generally accepted accounting principles in violation of the federal securities
laws. The complaints seek an unspecified amount in damages.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our officers
and directors. We are named as nominal defendant. The complaint generally
alleges the same conduct as the shareholder class actions filed in U.S. District
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Court for the period October 21, 1999 through January 19, 2000. The complaint
asserts that defendants breached their fiduciary duties and engaged in improper
insider trading. The complaint seeks unspecified damages and injunctive relief.
On June 7, 2000, the Company was served with a shareholder derivative complaint
filed in the U.S. District Court, Northern District of California, against the
Company and certain of its officers and directors. The second federal case
alleges substantially similar claims on behalf of shareholders for the period
March 30, 2000 through April 26, 2000. The complaint seeks unspecified damages
and injunctive relief. Both federal derivative cases have been related to the
securities class action.
On April 13, 2000, a shareholder derivative action was filed in the
Superior Court of California, County of Santa Clara, against certain of our
officers and directors. We are named as a nominal defendant. The complaint
alleges substantially similar allegations as the federal derivative actions for
the period October 21, 1999 through April 3, 2000. The complaint seeks
unspecified damages. On May 23, 2000, a shareholder derivative action was filed
in the Superior Court of California, County of San Mateo, against certain of our
officers and directors. We are named as a nominal defendant. The complaint
generally alleges the same conduct as the derivative actions filed in federal
court, and asserts that our officers and directors breached their fiduciary
duties. The complaint seeks unspecified damages and injunctive relief.
We have been advised by the staff of the Securities and Exchange Commission
that the Commission will enter a formal order of investigation concerning our
restatement of financial results for the first, second, and third quarters of
1999, and our revision of financial results for the fourth quarter and fiscal
1999. We have been voluntarily cooperating with the staff of the Commission in
its investigation.
The Company and the individual defendants intend to defend all of these
actions vigorously. There can be no assurance that any of the complaints
discussed above will be resolved without costly litigation, or in a manner that
is not adverse to our financial position, results of operations or cash flows.
No estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies.
Our Management Team is in Transition
We have recently experienced and will continue to experience changes in our
management team. On April 2, 2000 we announced that Kent Smith, formerly
Executive Vice President for Strategic Alliances, would expand his role and
reassume responsibility for worldwide sales from David Malmstedt, who resigned
from the Company. On June 18, 2000, we announced a realignment of our product
operations organization into two functional units: (i) Product Development to be
headed by George Symons who was appointed Vice President of Product Development
and (ii) Product Marketing, to be headed by Terry Dickson who was appointed Vice
President of Marketing. This realignment of the product operations organization
followed the resignation of Nora Denzel, formerly senior vice president of
product operations. On July 25, 2000, we announced that we are conducting a
search for a new president and chief operating officer to assume responsibility
for the day-to-day operations of the company and that a separate search was also
underway to replace Stephen C. Wise, who will be resigning as the Company's
Chief Financial Officer. Our business could be seriously harmed if we are not
successful in recruiting executives to fill the open positions or if integration
of the recently appointed executives into our company is not successful.
Our Market is Highly Competitive.
We operate in the enterprise storage management market, which 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. Our major competitors include:
Novell NetWare and Windows NT and Windows 2000 platforms:
---------------------------------------------------------
Computer Associates (Cheyenne Software); and
Seagate (Palindrome and Arcada).
Sun Solaris/SunOS platform:
---------------------------
Computer Associates (Legent/Lachman);
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EMC2 (Epoch);
Peripheral Devices (Delta Microsystems);
Spectra Logic; and
Veritas.
AIX platform and the HP-UX platform:
------------------------------------
IBM; and
Hewlett Packard.
We expect to encounter new competitors as we enter new markets. In
addition, many of our existing competitors are broadening their platform
coverage. We also expect 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
computer market. In addition, since there are relatively low barriers to entry
in the software market, we expect additional competition from other established
and emerging companies. We also expect that competition will increase as a
result of future software industry consolidations. Increased competition could
harm us by causing, among other things:
- Price reductions;
- Reduced gross margins; and
- Loss of market share.
Many of our current and potential competitors have longer operating
histories and have substantially greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger customer
base, than we have. As a result, certain current and potential competitors can
respond more quickly to new or emerging technologies and changes in customer
requirements. They can also devote greater resources to the development,
promotion, sale and support of their products. In addition, current and
potential competitors may establish cooperative relationships among themselves
or with third parties. If so, 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 functionality offered by our products. If
so, our products could be rendered obsolete and unmarketable. For all the
foregoing reasons, we may not be able to compete successfully, which would
seriously harm our business, operating results and financial condition.
In addition, our public announcements over the past several months related
to the restatement of our 1999 financials, attrition in our sales force and
management changes have and may continue to adversely affect our ability to
compete effectively.
We Rely on Our Key Personnel.
We have recently experienced attrition of key personnel and may have
further attrition or disruption following our recent announcements. Our future
performance depends on the continued service of our key technical, sales and
senior management personnel. Most of our technical, sales or senior management
personnel are not bound by employment agreements. The loss of the services of
one or more of our officers or other key employees could seriously harm our
business, operating results and financial condition.
Our future success also depends on our continuing ability to attract and
retain highly qualified technical, sales and managerial personnel. Competition
for such personnel is intense, and we may fail to retain our key technical,
sales and managerial employees or attract, assimilate or retain other highly
qualified technical, sales and managerial personnel in the future.
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We Rely on Our Sales Personnel
We have recently experienced a number of voluntary resignations in our
sales force and may have further attrition or disruption in the sales force
following our recent announcements. On April 2, 2000 we announced that Kent
Smith, formerly Executive Vice President for Strategic Alliances, would expand
his role and reassume responsibility for worldwide sales from David Malmstedt,
who resigned from the Company. Our future success depends on our continuing
ability to attract and retain highly qualified sales personnel. Competition for
such personnel is intense, and we may fail to retain our sales personnel or
attract, assimilate or retain other highly qualified sales personnel in the
future. Any further attrition or disruption to our sales force could seriously
harm our business, operating results and financial condition.
We Depend on Our NetWorker Product Line.
We currently derive, and expect to continue to derive, a substantial
majority of our revenue from our NetWorker software products and related
services. A decline in the price of or demand for NetWorker, or failure to
achieve broad market acceptance of NetWorker, would seriously harm our business,
operating results and financial condition. We cannot reasonably predict
NetWorker's remaining life for several reasons, including:
- The recent emergence of our 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.
We Must Respond to Rapid Technological Changes with New Product Offerings.
The markets for our products are 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 our existing products obsolete and unmarketable.
To be successful, we need to develop and introduce new software products on
a timely basis that:
- Keep pace with technological developments and emerging industry
standards; and
- Address the increasingly sophisticated needs of our customers.
We may:
- Fail to develop and market new products that respond to technological changes
or evolving industry standards;
- Experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new products; or
- Fail to develop new products that adequately meet the requirements of the
marketplace or achieve market acceptance.
If so, our business, operating results and financial condition would be
seriously harmed.
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We currently plan to introduce and market several potential new products in
the next twelve months. Some of our competitors currently offer certain of these
potential new products. Such potential new products are subject to significant
technical risks. We may fail to introduce such potential new products on a
timely basis or at all. In the past, we have experienced delays in the
commencement of commercial shipments of our new products. Such delays caused
customer frustrations and delay or loss of product revenue. If potential new
products are delayed or do not achieve market acceptance, our business,
operating results and financial condition would be seriously harmed. In the
past, we have also experienced delays in purchases of our products by customers
anticipating our launch of new products. Our business, operating results and
financial condition would be seriously harmed if customers defer material orders
in anticipation of new product introductions.
Software products as complex as those we offer may contain undetected
errors or failures when first introduced or as new versions are released. We
have in the past discovered software errors in certain of our new products after
their introduction. We experienced delays or lost revenue during the period
required to correct these shipments, despite testing by us and by our current
and potential customers. This may result in loss of or delay in market
acceptance of our products, which could seriously harm our business, operating
results and financial condition.
We Rely on Enterprise License Transactions.
In the past, we marketed our products at the department level of corporate
customers. Within the last few years, we developed strategies to pursue larger
enterprise license transactions with corporate customers. We may fail to
successfully market our products in larger enterprise license transactions. Such
failure would seriously harm our business, operating results and financial
condition. Our operating results are sensitive to the timing of such orders.
Such orders are difficult to manage and predict, because:
- The sales cycle is typically lengthy, generally lasting three to six
months, and varies substantially from transaction to transaction;
- They often include multiple elements such as product licenses and service and
support;
- Recognition of revenue from enterprise license transactions may vary from
transaction to transaction;
- They typically involve significant technical evaluation and commitment of
capital and other resources; and
- Customers' internal procedures frequently cause delays in orders. Such
internal procedures include approval of large capital expenditures,
implementation of new technologies within their networks, and testing new
technologies that affect key operations.
Due to the large size of enterprise transactions, if orders forecasted for a
specific transaction for a particular quarter are not realized in that quarter,
our operating results for that quarter may be seriously harmed.
Historically, we have not had a separate large enterprise or national
accounts sales force and only within the last few years have we begun to develop
direct sales groups focused on these larger accounts. To succeed in the national
accounts market, we will be required to continue to transition our existing
sales forces into enterprise level sales groups, and attract and retain
qualified personnel. New personnel will require training to obtain knowledge of
the attributes of our products. We may not be successful in creating the
necessary sales organization or in attracting, retaining or training these
individuals. To succeed in the enterprise and national accounts market will
require, among other things, establishing and continuing to develop
relationships and contacts with senior technology officers at these accounts.
Our business, financial condition and results of operations would be seriously
harmed if our sales force is not successful in these efforts.
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We Rely on Indirect Sales Channels.
We rely significantly on our distributors, systems integrators and value
added resellers, or collectively, resellers, for the marketing and distribution
of our products. Our agreements with resellers are generally not exclusive and
in many cases may be terminated by either party without cause. Many of our
resellers carry product lines that are competitive with ours. These resellers
may not give a high priority to the marketing of our products. Rather, they may
give a higher priority to other products, including the products of competitors,
or may not continue to carry our products. Events or occurrences of this nature
could seriously harm our business, operating results and financial condition. In
addition, we may not be able to retain any of our current resellers or
successfully recruit new resellers. Any such changes in our distribution
channels could seriously harm our business, operating results and financial
condition.
Our strategy is also to increase the proportion of our customers licensed
through OEMs. We may fail to achieve this strategy. We are currently investing,
and intend to continue to invest resources to develop this channel. Such
investments could seriously harm our operating margins. We depend on our OEMs'
abilities 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. Our OEMs
may not effectively meet these technological challenges. These OEMs:
- Are not within our control;
- May incorporate the technologies of other companies in addition to, or to
the exclusion of, our technologies, and
- Are not obligated to purchase products from us. In addition, our OEMs
generally have exclusive rights to our technology on their platforms,
subject to certain minimum royalty obligations.
Our OEMs may not continue to carry our products. The inability to recruit,
or the loss of, important OEMs could seriously harm our business, operating
results and financial condition.
We Depend on International Revenue.
Our continued growth and profitability will require further expansion of
our international operations. To successfully expand international operations,
we must:
- Establish additional foreign operations;
- Hire addition personnel; and
- Recruit additional international resellers.
This will require significant management attention and financial resources
and could seriously harm our operating margins. If we fail to further expand our
international operations in a timely manner, our business, operating results and
financial condition could be seriously harmed. In addition, we may fail to
maintain or increase international market demand for our products. Our
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 our
products more expensive and, therefore, potentially less competitive in those
markets. In some markets, localization of our products is essential to achieve
market penetration. We may incur substantial costs and experience delays in
localizing our products. We may fail to generate significant revenue from
localized products.
Additional risks inherent in our international business activities
generally include:
- Significant reliance on our distributors and other resellers who do not
offer our products exclusively;
- Unexpected changes in regulatory requirements;
- Tariffs and other trade barriers;
- Lack of acceptance of localized products, if any, in foreign countries;
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- Longer accounts receivable payment cycles;
- Difficulties in managing international operations;
- Potentially adverse tax consequences, including restrictions on the
repatriation of earnings;
- The burdens of complying with a wide variety of foreign laws; and
- The risks related to the global economic turbulence.
The occurrence of such factors could seriously harm our international sales and,
consequently, our business, operating results and financial condition.
We Must Manage Our Growth and Expansion.
We have recently experienced a period of significant expansion of our
operations that has placed a significant strain upon our management systems and
resources. In addition, we have recently hired a significant number of
employees, and plan to further increase our total headcount. We also plan to
expand the geographic scope of our customer base. This expansion has resulted
and will continue to result in substantial demands on our management resources.
From time to time, we receive customer complaints about the timeliness and
accuracy of customer support. We plan to add customer support personnel in order
to address current customer support needs. If we are not successful hiring such
personnel, our business, operating results and financial condition could be
seriously harmed. Our ability to compete effectively and to manage future
expansion of our operations, if any, will require us to (a) continue to improve
our financial and management controls, reporting systems and procedures on a
timely basis, and (b) expand, train and manage our employees. Our failure to do
so would seriously harm our business, operating results and financial condition.
We Must Integrate Recent Acquisitions.
On August 6, 1998, we acquired Software Moguls, Inc. a developer of
advanced backup-retrieval products for the Windows NT and UNIX environments. On
April 1, 1999, we acquired Intelliguard, a developer of standards-based storage
management solutions for storage area networks. On April 19, 1999, we acquired
FullTime, a developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions. On July 30, 1999, we acquired Vinca, a developer in high
availability and data protection software. We may make additional acquisitions
in the future. Acquisitions of companies, products or technologies entail
numerous risks, including:
- An inability to successfully assimilate acquired operations and products;
- Diversion of management's attention;
- Loss of key employees of acquired companies;
- Substantial transaction costs; and
- Substantial additional costs charged to operations as a result of the
failure to consummate acquisitions.
Some of the products we acquired may require significant additional
development before they can be marketed and may not generate revenue at levels
we anticipate. Moreover, our future acquisitions may result in dilutive
issuances of our equity securities, the incurrence of debt, large one-time
write-offs and the creation of goodwill or other intangible assets that could
result in amortization expense. We cannot guarantee that our efforts to
consummate acquisitions or integrate acquisitions will be successful. If our
efforts are not successful, it could seriously harm our business, financial
condition and results of operations.
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We Depend on Growth in the Enterprise Storage Management Market.
All of our business is in the enterprise storage management market. The
enterprise storage management market is still an emerging market. Our future
financial performance will depend in large part on continued growth in the
number of organizations adopting company-wide storage and management solutions
for their client/server computing environments. The market for enterprise
storage management may not continue to grow. If this market fails to grow or
grows more slowly than we currently anticipate, our business, operating results
and financial condition would be seriously harmed.
We Are Affected by General Economic and Market Conditions.
During recent years, segments of the computer industry have experienced
significant economic downturns characterized by:
- Decreased product demand;
- Product overcapacity;
- Price erosion;
- Work slowdowns; and
- Layoffs.
Our operations may 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. The occurrence of such factors could
seriously harm our business, operating results or financial condition.
Protection of Our Intellectual Property is Limited.
Our success depends significantly upon proprietary technology. To protect
our proprietary rights, we rely on a combination of:
- Patents;
- Copyright and trademark laws;
- Trade secrets;
- Confidentiality procedures; and
- Contractual provisions.
We seek to protect our software, documentation and other written materials
under patent, trade secret and copyright laws, which afford only limited
protection. However,
- We may not develop proprietary products or technologies that are patentable;
- Any issued patent may not provide us with any competitive advantages or may
be challenged by third parties; or
- The patents of others may seriously impede our ability to do business.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult, and software piracy can be expected to be a persistent problem. In
licensing our products, other than in enterprise license transactions, we rely
on "shrink wrap" licenses that are not signed by licensees. Such licenses may be
unenforceable under the laws of certain jurisdictions. In addition, the laws of
some foreign countries do not protect our proprietary rights to as great an
extent as do the laws of the United States. Our means of protecting our
proprietary rights may not be adequate. Our competitors may independently
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develop similar technology, duplicate our products or design around patents
issued to us or other intellectual property rights of ours.
From time to time, we have received claims that we are infringing third
parties' intellectual property rights. In the future, we may be subject to
claims of infringement by third parties with respect to current or future
products, trademarks or other proprietary rights. We expect that software
product developers will increasingly be subject to infringement claims as the
number of products and competitors in our 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 us to enter into royalty or
licensing agreements with third parties. If such royalty or licensing
agreements, if required, are not available on terms acceptable to us, our
business, operating results and financial condition could be seriously harmed.
Defects in Our Products Would Harm Our Business.
Our products can be used to manage data critical to organizations. As a
result, the sale and support of products we offer may entail the risk of product
liability claims. A successful product liability claim brought against us could
seriously harm our business, operating results and financial condition.
Our Trading Price is Volatile.
The trading of our common stock is highly volatile, trading as high as
$82.5 and as low as $8.187 between December 1, 1999 and August 11, 2000, and the
price of our common stock will fluctuate in the future. An investment in our
common stock is subject to a variety of significant risks, including, but not
limited to the following:
- Quarterly fluctuations in financial results or results of other software
companies;
- Changes in our revenue growth rates or our competitors' growth rates;
- Announcements that our revenue or income are below analysts' expectations;
- Changes in analysts' estimates of our performance or industry performance;
- Announcements of new products by our competitors or by us;
- Developments with respect to our patents, copyrights, or proprietary rights
or those of our competitors;
- Sales of large blocks of our common stock;
- Conditions in the financial markets in general;
- Litigation;
- General business conditions and trends in the distributed computing
environment and software industry; and
- Announcements related to our restatement of 1999 financials.
In addition, the stock market may experience extreme price and volume
fluctuations, which may affect the market price for the securities of technology
companies without regard to their operating performance or any of the factors
listed above. These broad market fluctuations may seriously harm the market
price of our common stock.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a global concern, we face exposure to adverse movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could seriously harm our financial results. All of our
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 our
products more expensive and therefore, reduce the demand for our products.
Reduced demand for our products could seriously harm our financial results.
Currently, we do not hedge against any foreign currencies and as a result, could
incur unanticipated gains or losses.
We maintain an investment portfolio of various issuers, types and
maturities. Our investment portfolio consists of both fixed and variable rate
financial instruments. These securities are classified as available-for-sale,
and consequently, are recorded on the balance sheet at fair value with
unrealized gains or losses reported as a separate component of stockholders'
equity, net of taxes. At any time, a sharp rise in interest rates could
seriously harm the fair value of our investment portfolio. Conversely, declines
in interest rates could seriously harm interest earnings of our investment
portfolio. A 1% change in interest rates would result in an increase or decrease
to the annualized interest income of approximately $1.5 million. Currently, we
do not hedge these interest rate exposures.
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PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On January 20, 2000, a shareholder securities class action complaint was
filed in the U.S. District Court, Northern District of California, against us
and certain of our directors and officers. Approximately thirty other similar
class actions involving the same defendants and substantially similar
allegations were filed soon thereafter. The court has determined that all of the
cases are related and assigned them to one federal judge. On May 1, 2000, the
court consolidated all of the pending cases. On May 10, 2000, the court
appointed a lead plaintiff, who filed a consolidated amended complaint on August
7, 2000. The consolidated amended complaint alleges that, between April 22, 1999
and May 17, 2000, we and certain of our officers made false or misleading
statements of material fact about the Company's prospects and failed to follow
generally accepted accounting principles in violation of the federal securities
laws. The complaints seek an unspecified amount in damages.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our officers
and directors. We are named as nominal defendant. The complaint generally
alleges the same conduct as the shareholder class actions filed in U.S. District
Court for the period October 21, 1999 through January 19, 2000. The complaint
asserts that defendants breached their fiduciary duties and engaged in improper
insider trading. The complaint seeks unspecified damages and injunctive relief.
On June 7, 2000, the Company was served with a shareholder derivative complaint
filed in the U.S. District Court, Northern District of California, against the
Company and certain of its officers and directors. The second federal case
alleges substantially similar claims on behalf of shareholders for the period
March 30, 2000 through April 26, 2000. The complaint seeks unspecified damages
and injunctive relief. Both federal derivative cases have been related to the
securities class action.
On April 13, 2000, a shareholder derivative action was filed in the
Superior Court of California, County of Santa Clara, against certain of our
officers and directors. We are named as a nominal defendant. The complaint
alleges substantially similar allegations as the federal derivative actions for
the period October 21, 1999 through April 3, 2000. The complaint seeks
unspecified damages. On May 23, 2000, a shareholder derivative action was filed
in the Superior Court of California, County of San Mateo, against certain of our
officers and directors. We are named as a nominal defendant. The complaint
generally alleges the same conduct as the derivative actions filed in federal
court, and asserts that our officers and directors breached their fiduciary
duties. The complaint seeks unspecified damages and injunctive relief.
We have been advised by the staff of the Securities and Exchange Commission
that the Commission will enter a formal order of investigation concerning our
restatement of financial results for the first, second, and third quarters of
1999, and our revision of financial results for the fourth quarter and fiscal
1999. We have been voluntarily cooperating with the staff of the Commission in
its investigation.
The Company and the individual defendants intend to defend all of these
actions vigorously. There can be no assurance that any of the complaints
discussed above will be resolved without costly litigation, or in a manner that
is not adverse to our financial position, results of operations or cash flows.
No estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Shareholders was held on July 12, 2000 in Palo
Alto, California. Of the 86,502,921 shares outstanding as of the record date,
72,020,832 shares were present or represented by proxy at the meeting. The
following matters were submitted to a vote of security holders:
(1) To elect the following to serve as Directors of the Company:
Votes For Votes Abstaining
---------------- ----------------
Louis C. Cole 70,021,669 1,999,163
Eric A. Benhamou 70,923,312 1,097,520
H. Raymond Bingham 70,919,478 1,101,354
Kenneth A. Goldman 70,156,752 1,864,080
Christopher B. Paisley 70,132,603 1,888,229
David N. Strohm 70,922,033 1,098,799
(2) To ratify the Company's appointment of PricewaterhouseCoopers LLP as
independent accountants for the Company for the fiscal year ending
December 31, 2000:
Votes for: 70,825,677
Votes against: 1,034,913
Votes abstaining: 160,242
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports were filed by the Registrant on Form 8-K for the quarter ended
June 30, 2000.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEGATO SYSTEMS, INC.
Date: August 11, 2000 /S/ Stephen C. Wise
------------------------------
Stephen C. Wise
Senior V.P. of Finance and
Chief Financial Officer
(Duly authorized officer and
principal financial and
accounting officer)
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EXHIBIT INDEX
Exhibit No. Description
----------- -----------
27.1 Financial Data Schedule
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