UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 November
8, 2000 was 87,329,855.
<PAGE>
<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
INDEX
Page
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<S> <C>
PART I: CONDENSED FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheet as of September 30, 2000 and
December 31, 1999 3
Condensed Consolidated Statement of Operations for the three-month and
nine-month periods ended September 30, 2000 and 1999 4
Condensed Consolidated Statement of Cash Flows for the nine-month
periods ended September 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 26
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURE 29
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PART I: CONDENSED FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands)
September 30, December 31,
2000 1999
----------- -----------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 114,342 $ 115,222
Short-term investments 42,385 42,983
Accounts receivable, net 38,577 53,387
Other current assets 10,415 10,112
Deferred tax asset 30,514 15,959
----------- -----------
Total current assets 236,233 237,663
Long-term investments 12,152 11,723
Property and equipment, net 37,355 27,090
Intangible assets, net 113,466 141,988
Deferred tax assets - long term 1,268 2,176
Other assets 2,073 2,254
----------- -----------
$ 402,547 $ 422,894
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,002 $ 5,757
Accrued compensation and benefits 9,070 16,867
Accrued liabilities 8,311 9,240
Loan payable -- 6,847
Income taxes payable 2,383 --
Deferred revenues 44,620 46,438
----------- -----------
Total current liabilities 69,386 85,149
Stockholders' equity:
Capital stock and other comprehensive income 308,408 291,677
Retained earnings 24,753 46,068
----------- -----------
Total stockholders' equity 333,161 337,745
----------- -----------
$ 402,547 $ 422,894
=========== ===========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
Page 3
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<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
----------- ----------- ---------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenue:
Product license $ 27,365 $ 43,896 $ 93,444 $ 99,418
Service and support 21,234 17,621 62,664 47,706
Royalty 5,571 6,414 16,863 16,315
----------- ----------- ---------- -----------
Total revenue 54,170 67,931 172,971 163,439
Cost of revenue:
Product license 1,387 1,381 4,531 4,363
Service and support 9,708 6,643 28,136 17,980
----------- ----------- ---------- -----------
Total cost of revenue 11,095 8,024 32,667 22,343
----------- ----------- ---------- -----------
Gross profit 43,075 59,907 140,304 141,096
Operating expenses:
Research and development 13,472 10,354 43,200 27,414
Sales and marketing 25,269 24,128 76,732 65,259
General and administrative 7,954 4,552 24,173 14,137
Amortization of intangibles 9,522 7,722 28,567 12,162
Purchased in-process research
and development -- 8,300 -- 11,470
Merger related expenses -- -- 1,250 4,968
----------- ----------- ---------- -----------
Total operating expenses 56,217 55,056 173,922 135,410
----------- ----------- ---------- -----------
Income (loss) from operations (13,142) 4,851 (33,618) 5,686
Interest and other income, net 1,923 1,257 4,654 3,877
----------- ----------- ---------- -----------
Income (loss) before provision
for income taxes (11,219) 6,108 (28,964) 9,563
Provision for (benefit from) income taxes (7,475) 4,712 (7,652) 6,500
----------- ----------- ---------- -----------
Net income (loss) $ (3,744) $ 1,396 $ (21,312) $ 3,063
=========== =========== ============ ===========
Other comprehensive income, net of taxes
Unrealized gains (losses) on investments 33 (14) 37 (74)
----------- ----------- ---------- -----------
Comprehensive income (loss) $ (3,711) $ 1,382 $ (21,275) $ 2,989
=========== =========== ========== ===========
Basic earnings (loss) per share $ (0.04) $ 0.02 $ (0.25) $ 0.04
=========== =========== ========== ===========
Diluted earnings (loss) per share $ (0.04) $ 0.02 $ (0.25) $ 0.03
=========== =========== ========== ===========
Shares used in basic earnings (loss)
per share calculation 86,956 83,766 86,527 81,353
=========== =========== ========== ===========
Shares used in diluted earnings (loss)
per share calculation 86,956 90,694 86,527 87,802
=========== =========== ========== ===========
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
Page 4
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<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended
September 30,
--------------------------
2000 1999
----------- -----------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (21,312) $ 3,063
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Net deferred tax asset (13,648) (2,305)
Depreciation and amortization 39,428 20,421
Provision for doubtful accounts 1,182 45
Provision for sales returns 735 4,940
Tax benefit from exercise of stock options 2,197 19,088
Purchased in-process research and development -- 11,470
Changes in operating assets and liabilities:
Accounts receivable 12,892 (1,875)
Other current assets (303) (11,045)
Accounts payable (755) (2,320)
Accrued liabilities (6,343) (26,643)
Deferred revenue (1,818) 16,810
----------- -----------
Net cash provided by operating activities 12,255 31,649
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments (49,905) (77,283)
Proceeds from maturity and sale of investments 50,111 72,598
Acquisition of property and equipment (21,105) (8,539)
Acquisition of subsidiaries, net of cash acquired -- (22,908)
Change in other assets 114 (1,671)
----------- -----------
Net cash used in investing activities (20,785) (37,803)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 14,482 20,292
Payment of short term loan payable (6,847) --
Other 15 4
----------- -----------
Net cash provided by financing activities 7,650 20,296
----------- -----------
Net increase (decrease) in cash and cash equivalents (880) 14,142
Cash and cash equivalents at beginning of period 115,222 83,177
----------- -----------
Cash and cash equivalents at end of period $ 114,342 $ 97,319
=========== ===========
Supplemental cash flow information:
Issuance of common stock and stock options exchanged in a
purchase business combination $ -- $ 114,344
---------- -----------
Net deferred taxes recorded in a purchase business combination $ -- $ 22,740
----------- -----------
</TABLE>
The accompanying notes are an integral part of the condensed
consolidated financial statements.
Page 5
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LEGATO SYSTEMS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. BASIS OF PRESENTATION AND RESTATEMENT OF FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments, 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.
We restated our revenues and results of operations for the quarters ended
March 31, 1999, June 30, 1999 and September 30, 1999 and revised our results for
the quarter ended December 31, 1999 for the reasons set forth in our annual
report on Form 10-K for the period ended December 31, 1999 and in our amended
quarterly reports on Form 10-Q for the quarters ended March 31, 1999, June 30,
1999, and September 30, 1999. The effect of these adjustments is a decrease in
revenue of $23.0 million and a decrease in net income of $13.0 million for the
twelve months ended December 31, 1999. A portion of our revenue for the quarter
ended September 30, 2000 is the result of deferred revenue being recognized on
the basis of cash received or otherwise from some carryover that is a
consequence of this restatement.
For the three-month and nine-months ended September 30, 1999, the impact is
as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1999 September 30, 1999
---------------------- ----------------------
As As As As
Reported Restated Reported Restated
<S> <C> <C> <C> <C>
Total revenue $ 71,688 $ 67,931 $ 186,047 $ 163,439
Gross profit 63,664 59,907 163,704 141,096
Net income 3,438 1,396 16,072 3,063
Basic earnings per share $ 0.04 $ 0.02 $ 0.19 $ 0.04
Diluted earnings per share $ 0.04 $ 0.02 $ 0.18 $ 0.03
</TABLE>
Page 6
<PAGE>
NOTE 2. COMPUTATION OF EARNINGS (LOSS) 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 net income (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 as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Numerator - basic and diluted earnings (loss) per share
-------------------------------------------------------
Net income (loss) $ (3,744) $ 1,396 $(21,312) $ 3,063
========= ========= ========= ========
Denominator - basic earnings (loss) per share
---------------------------------------------
Weighted average common shares outstanding 86,956 83,766 86,527 81,353
--------- --------- --------- --------
Basic earnings (loss) per share $ (0.04) $ 0.02 $ (0.25) $ 0.04
========= ========= ========= ========
Denominator - diluted earnings (loss) per share
-----------------------------------------------
Weighted average common shares outstanding 86,956 83,766 86,527 81,353
Effect of dilutive securities:
Common stock options -- 6,928 -- 6,449
--------- --------- --------- --------
Weighted average common and common
equivalent shares 86,956 90,694 86,527 87,802
========= ========= ========= ========
Diluted earnings (loss) per share $ (0.04) $ 0.02 $ (0.25) $ 0.03
========= ========= ========= ========
Options excluded from diluted earnings (loss)
per share calculation 8,466 46 7,064 328
========= ========= ========= ========
</TABLE>
Certain shares of common stock issuable upon exercise of stock options were
excluded from the calculation of diluted earnings (loss) per share as the impact
of the options would have been anti-dilutive.
NOTE 3. COMPREHENSIVE INCOME (LOSS)
Our unrealized gain (loss) on investments represents the only component of
comprehensive income (loss) that is excluded from net income (loss) for the
quarters and nine-month periods ended September 30, 2000 and 1999. Our
comprehensive income (loss) has been presented in the condensed consolidated
financial statements.
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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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- --------
(in thousands)
<S> <C> <C> <C> <C>
Product license:
NetWorker and NetWorker-related products $ 23,281 $ 36,806 $ 79,898 $ 83,747
Other products 4,084 7,090 13,546 15,221
Service and support 21,234 17,621 62,664 47,706
Royalty 5,571 6,414 16,863 16,315
Discontinued products -- -- -- 450
--------- --------- ---------- --------
Total $ 54,170 $ 67,931 $ 172,971 $163,439
========= ========= ========== ========
</TABLE>
The table below presents revenue information by geographic area:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- --------
(in thousands)
<S> <C> <C> <C> <C>
United States $ 38,823 $ 48,458 $ 129,855 $118,037
Europe 10,649 14,575 30,510 35,354
Other countries 4,698 4,898 12,606 10,048
--------- --------- ---------- --------
Total $ 54,170 $ 67,931 $ 172,971 $163,439
========= ========= ========== ========
</TABLE>
The table below presents long-lived-asset information by geographic area:
<TABLE>
<CAPTION>
September 30, December 30,
2000 1999
--------- --------
(in thousands)
<S> <C> <C>
United States $ 144,814 $163,335
Europe 2,581 2,206
Other countries 3,426 3,536
--------- --------
Total $ 150,821 $169,077
========= ========
</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 quarter of the fiscal year
beginning after June 15, 2000.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, or SAB 101, Revenue Recognition in Financial
Statements. SAB 101 provides guidance for revenue recognition under certain
circumstances. We are currently evaluating the impact of SAB 101 on our
financial statements and related disclosures. The accounting and disclosures
prescribed by SAB 101 will be effective for our fiscal year ended December 31,
2000.
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. The
effect of the adoption was not material.
In March 2000, the Emerging Issues Task Force (the "EITF") published their
consensus on Issue No. 00-2, "Accounting for Web Site Development Costs, " which
requires that costs incurred during the development of web site applications and
infrastructure, involving developing software to operate the web site, including
graphics that affect the "look and feel" of the web page and all costs relating
to software used to operate a web site should be accounted for under Statement
of Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." The Company will be required to adopt Issue No. 00-2
in its first fiscal quarter of 2001, beginning after December 1, 2000. The
Company has capitalized $2.8 million of web site development costs during the
first nine months of 2000 in accordance with SOP 98-1. The Company does not
expect the adoption of Issue No. 00-2 to have a material impact on its financial
position or results of operations.
In May 2000, the EITF reached a consensus on Issue No. 00-14, "Accounting
for Coupons, Rebates, and Discounts." Issue No. 00-14 addresses the recognition,
measurement, and income statement classification for sales incentives offered
voluntarily by a vendor without charge to customers that can be used in, or that
are exercisable by a customer as a result of a single exchange transaction.
Issue No. 00-14 will be adopted in the same quarter as SAB No. 101. The Company
does not expect the adoption of Issue No. 00-14 to have a material impact on its
financial position or results of operations.
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. On May 1, 2000, the court
consolidated all of the pending cases and, on May 10, 2000, 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,
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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. Defendants have moved to
dismiss the complaint.
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, and seeks unspecified damages and injunctive relief. The
federal derivative case has been related to the securities class action. On June
7, 2000, the Company was served with a second shareholder derivative complaint
filed in the U.S. District Court, Northern District of California, against the
Company and certain of its officers and directors alleging substantially similar
claims on behalf of shareholders for the period March 30, 2000 through April 26,
2000. The second complaint was voluntarily dismissed.
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 action for
the period October 21, 1999 through April 3, 2000, and 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, which asserts that our officers and directors breached their fiduciary
duties, and seeks unspecified damages and injunctive relief.
Plaintiffs have transferred the Santa Clara derivative action to San Mateo
County and consolidated it with the San Mateo derivative case. Plaintiffs in the
federal derivative action have moved to stay their case in favor of the San
Mateo case. Defendants oppose a stay of the federal derivative action.
The Securities and Exchange Commission has entered 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.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The discussion in this report on Form 10-Q contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements 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 disclaim any
obligation to update these forward-looking statements as a result of financial,
business or any other developments occurring after the date of this report. Our
actual results could differ materially from those described in our
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, demand for the Company's products, customers' acceptance
of terms that result in deferred revenue, integration of new executives and
employees, unexpected fluctuations in quarterly operating results, product
concentration, competition from other companies, employee attrition, rapid
technological change, and negative reactions of potential customers to the
Company's restated fiscal results for 1999 and other risks discussed in this
item under the heading "Risk Factors" and the risks discussed in our other
Securities and Exchange Commission filings.
Overview
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.
We restated our revenues and results of operations for the quarters ended
March 31, 1999, June 30, 1999 and September 30, 1999 and revised our results for
the quarter ended December 31, 1999 for the reasons set forth in our annual
report on Form 10-K for the period ended December 31, 1999 and in our amended
quarterly reports on Form 10-Q for the quarters ended March 31, 1999, June 30,
1999, and September 30, 1999. The effect of these adjustments is a decrease in
revenue of $23.0 million and a decrease in net income of $13.0 million for the
twelve months ended December 31, 1999. A portion of our revenue for the quarter
ended September 30, 2000 is the result of deferred revenue being recognized on
the basis of cash received or otherwise from some carryover that is a
consequence of this restatement.
Page 11
<PAGE>
RESULTS OF OPERTIONS
Selected elements of our consolidated financial statements are shown below
as a percentage of total revenue.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Revenue:
Product license 51% 65% 54% 61%
Service and support 39 26 36 29
Royalty 10 9 10 10
-------- --------- -------- ---------
Total revenue 100 100 100 100
Cost of revenue:
Product license 2 2 3 3
Service and support 18 10 16 11
-------- --------- -------- ---------
Total cost of revenue 20 12 19 14
-------- --------- -------- ---------
Gross profit 80 88 81 86
Operating expenses:
Research and development 25 15 25 17
Sales and marketing 46 36 44 40
General and administrative 15 7 14 9
Amortization of intangibles 18 11 16 7
Purchased in-process research
and development -- 12 -- 7
Merger related expenses -- -- 1 3
-------- --------- -------- ---------
Total operating expenses 104 81 100 83
-------- --------- -------- ---------
Income (loss) from operations (24) 7 (19) 3
Interest and other income, net 3 2 3 3
-------- ------- -------- ---------
Income (loss) before provision for income taxes (21) 9 (16) 6
Provision for income taxes (14) 7 (4) 4
--------- --------- --------- ---------
Net income (loss) (7)% 2% (12)% 2%
========= ========= ========= =========
</TABLE>
Revenue
Total revenue for the third quarter ended September 30, 2000 decreased 20%
compared with total revenue for the comparable period of 1999. Total revenue for
the nine months ended September 30, 2000 increased 6% over total revenue for the
comparable period of 1999. The decrease in revenue in the quarter over quarter
period was primarily attributed to a lower level of license revenue.
Product license revenue. Product license revenue was $27.4 million in the
third quarter of 2000 and $43.9 million in the third quarter of 1999,
representing a decrease of 38%. Product license revenue was $93.4 million in the
first nine months of 2000 and $99.4 million in the first nine months of 1999,
representing a decrease of 6%. The decrease is attributed primarily to lower
levels of license revenue. This resulted from two factors. One factor was a
change in the structure of enterprise contracts that results in recognizing
product revenue ratably over the term of the contract. The second factor was
lower sales force productivity in North America, which was a result of high
attrition in prior periods.
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, except for sales to domestic
distributors and certain value-added resellers. 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 since January 1999 with those
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value-added resellers where we have determined that fees are not fixed or
determinable due to circumstances involving unauthorized written and oral
agreements outside our normal contractual terms, as discussed in our previous
filings with the Securities and Exchange Commission, we recognize revenue upon
receipt of cash payments. For certain sales where the licensing fee is not due
until the customer deploys the software, revenue is recognized when the customer
reports to us that the software has been deployed.
International product license revenue was $14.0 million in the third
quarter of 2000 and $18.0 million in the third quarter of 1999. International
product license revenue decreased 22% from the third quarter of 1999 to the
third quarter of 2000. International product license revenue accounted for 26%
of total revenue in the third quarter of 2000 and 27% in the third quarter of
1999. International product license revenue was $39.4 million in the first nine
months of 2000 and $42.2 million in the first nine months of 1999. International
product license revenue decreased 7% from the first nine months of 1999 to the
first nine months of 2000. International product license revenue accounted for
23% of total revenue in the first nine months of 2000 and 26% in the first nine
months of 1999. Sales in Europe and Asia accounted for the majority of our
international revenue during these periods. International license revenue
decreased in the third quarter of 2000 from the same quarter of 1999 primarily
as a result of a reorganization of our European operations.
Service and support revenue. Service and support revenue was $21.2 million
in the third quarter of 2000 and $17.6 million in the third quarter of 1999,
representing an increase of 21%. Service and support revenue was $62.7 million
in the first nine months of 2000 and $47.7 million in the first nine months of
1999, representing an increase of 31%. 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 $5.6 million in the third quarter of
2000 and $6.4 million in the third quarter of 1999, representing a decrease of
13%. Royalty revenue was $16.9 million in the first nine months of 2000 and
$16.3 million in the first nine months of 1999, representing an increase of 3%.
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.
Gross Profit
Gross profit was $43.1 million in the third quarter of 2000 and $59.9
million in the third quarter of 1999, representing 80% of total revenue in the
third quarter of 2000 and 88% of total revenue in the third quarter of 1999.
Gross profit was $140.3 million in the first nine months of 2000 and $141.1
million in first nine months of 1999, representing 81% in the first nine months
of 2000 and 86% in the first nine months of 1999. Gross profit consists of
product license and service and support revenue less related costs.
Gross profit from product license revenue was $26.0 million in the third
quarter of 2000 and $42.5 million in the third quarter of 1999, representing 95%
of product license revenue in the third quarter of 2000 and 97% in the third
quarter of 1999. Gross profit from product license revenue was $88.9 million in
the first nine months of 2000 and $95.1 million in the first nine months of
1999, representing 95% of product license revenue in the first nine months of
2000 and 96% in the first nine months of 1999. Gross profit from product license
revenue decreased 7% from the first nine months of 1999 to the first nine months
of 2000, consistent with the decrease 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 $11.5 million in the
third quarter of 2000 and $11.0 million in 1999, representing 54% of the service
and support revenue in the third quarter of 2000 and 62% in the third quarter of
1999. Gross profit from service and support revenue increased 5% from the third
quarter of 1999 to the same period of 2000. Gross profit from service and
support revenue was $34.5 million in the first nine months of 2000 and $29.7
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million in the first nine months of 1999, representing 55% of the service and
support revenue in the first nine months of 2000 and 62% in 1999. Gross profit
from service and support revenue increased 16% from the first nine 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. Consequently, when revenue levels
fall, 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
$13.5 million in the third quarter of 2000 and $10.4 million in the third
quarter of 1999, representing 25% of total revenue in the third quarter of 2000
and 15% in the third quarter of 1999. Research and development expenses
increased 30% from the third quarter of 1999 to the third quarter of 2000.
Research and development expenses were $43.2 million in the first nine months of
2000 and $27.4 million in the first nine months of 1999, representing 25% of
total revenue in the first nine months of 2000 and 17% in first nine months of
1999. Research and development expenses increased 58 % from the first nine
months of 1999 to the first nine months of 2000. Research and development
expenses as a percentage of revenue increased primarily as a result of expense
levels being relatively fixed. Consequently, when revenue levels fall, 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 $25.3 million in the third quarter
of 2000 and $24.1 million in the third quarter of 1999, representing 46% of
total revenue in the third quarter of 2000 and 36% in the third quarter of 1999.
Sales and marketing expenses increased 5% from the third quarter of 1999 to the
third quarter of 2000. Sales and marketing expenses were $76.7 million in the
first nine months of 2000 and $65.3 million in the first nine months of 1999,
representing 44% of total revenue in the nine months of 2000 and 40% of total
revenue in the first nine months of 1999. Sales and marketing expenses increased
18% from the nine months of 1999 to the first nine months of 2000. Sales and
marketing expenses as a percentage of revenue increased primarily as a result of
expense levels being relatively fixed. Consequently, when revenue levels fall,
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, facilities,
information systems and other administrative departments. General and
administrative expenses were $8.0 million in the third quarter of 2000 and $4.6
million in the third quarter of 1999, representing 15% of total revenue in the
third quarter of 2000 and 7% of total revenue in the third quarter of 1999.
General and administrative expenses increased 75% from the third quarter of 1999
to the third quarter of 2000. General and administrative expenses were $24.2
million in the first nine months of 2000 and $14.1 million in the first nine
months of 1999, representing 14% of total revenue in the first nine months of
2000 and 9% in the first nine months of 1999. General and administrative
expenses increased 71% from the first nine months of 1999 to the first nine
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 costs related to recruiting new management.
Amortization of intangibles. Amortization of intangibles was $9.5 million
in the third quarter of 2000 and $7.7 million in the third quarter of 1999.
Amortization of intangibles was $28.6 million in the first nine months of 2000
and $12.2 million in the first nine months of 1999. The increase from the third
quarter of 1999 is primarily attributed to the amortization of intangibles
related to the acquisitions of Intelliguard Software, Inc. and Vinca Corporation
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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 third quarter and the first nine months
of 2000. During the third quarter of 1999, we purchased in-process research and
development costs of $8.3 million in connection with our acquisition of Vinca
Corporation. The first nine months of 1999 also included $3.2 million in
connection with our second quarter acquisition of Intelliguard for a nine month
total of $11.5 million.
Merger-Related Expenses. We incurred $1.3 million in merger-related
expenses for the first nine months of 2000. These costs consisted primarily of
legal fees. 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 $1.9
million in the third quarter of 2000 and $1.3 million in the third quarter of
1999. Interest and other income, net, was $4.7 million in the first nine months
of 2000 and $3.9 million in the first nine 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 third
quarter of 1999.
Provision for Income Taxes. The benefit from income taxes for the third
quarter of 2000 was $7.5 million, compared to provision for income taxes of $4.7
million for the third quarter of 1999. The benefit from income taxes for the
first nine months of 2000 was $7.7 million, compared to provision for income
taxes of $6.5 million for the first nine months of 1999. The effective tax rate
was a 67% benefit for the third quarter of 2000 and a 77% provision for the
third quarter of 1999. The effective tax rate was a 26% benefit for the first
nine months of 2000 and 68% provision for the first nine months of 1999. The
change in the effective rates primarily reflects losses before income taxes of
$11.2 million for the third quarter of 2000 and $29.0 million for the first nine
months of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Our cash, cash equivalents and investments totaled $168.9 million at
September 30, 2000, and represented 42% 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 September 30, 2000, we had no long-term
debt and stockholders' equity was $333.2 million.
We have financed our operations to date primarily by cash from operations
and sales of common stock. Net cash provided by operating activities was $12.3
million in the first nine months of 2000. Net cash provided by operations in the
first nine months of 2000 consisted primarily of net loss of $21.3 million and
net change in deferred tax assets of $13.7 million, decreased by depreciation
and amortization of $39.4 million, tax benefit from the exercise of stock
options of $2.2 million, provision for doubtful accounts of $1.2 million,
provision for sales returns of $0.7 million and the net change in operating
assets and liabilities of $3.7 million.
Net cash used in investing activities was $20.8 million in the first nine
months of 2000. Net cash used in investing activities primarily reflected
purchases of marketable securities of $49.9 million and purchases of property
and equipment of $21.1 million. The cash used in investing activities was
offset, primarily by proceeds from the maturity and sale of marketable
securities of $50.1 million and the change in other assets of $0.1 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 $7.6 million in the first
nine months of 2000. Net cash provided by financing activities consisted
primarily of proceeds of $14.5 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. If we need to raise additional
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funds prior to the end of the next twelve months or at a later date, we cannot
assure you that any additional financing we may need will be available on terms
favorable to us, if at all.
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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:
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;
- Integration of new employees and executive management;
- Personnel change or turnover;
- Continuing attrition of employees;
- Negative reactions of potential customers to the Company's restated fiscal
results for 1999;
- 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 that may result in deferring
recognition of revenue on certain transactions;
- Customers' acceptance of terms that result in deferred recognition of
revenue;
- 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 when made may
ultimately prove to be incorrect or false. We disclaim any obligation to update
our forward-looking statements as a result of financial, business or any other
developments occurring after the date of this report. Some investors in our
securities inevitably will experience gains while others will experience losses,
depending on the prices at which they purchase and sell securities.
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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;
- We do not recognize revenue on sales to domestic distributors until the
products are sold through to end-users;
- Implementation of new business models that may 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. 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. On May 1, 2000, the court
consolidated all of the pending cases and, on May 10, 2000, 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. Defendants have moved to
dismiss the complaint.
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, and seeks unspecified damages and injunctive relief. The
federal derivative case has been related to the securities class action. On June
7, 2000, the Company was served with a second shareholder derivative complaint
filed in the U.S. District Court, Northern District of California, against the
Company and certain of its officers and directors alleging substantially similar
claims on behalf of shareholders for the period March 30, 2000 through April 26,
2000. The second complaint was voluntarily dismissed.
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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 action for
the period October 21, 1999 through April 3, 2000, and 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, which asserts that our officers and directors breached their fiduciary
duties, and seeks unspecified damages and injunctive relief.
Plaintiffs have transferred the Santa Clara derivative action to San Mateo
County and consolidated it with the San Mateo derivative case. Plaintiffs in the
federal derivative action have moved to stay their case in favor of the San
Mateo case. Defendants oppose a stay of the federal derivative action.
The Securities and Exchange Commission has entered 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 may continue to experience changes in our
management team. On October 4, 2000 we announced the appointments of a new chief
executive officer, as well as a new chief financial officer to our executive
team. David B. Wright, formerly the president and CEO of Amdahl Corporation
joined the Company as president and CEO. Andrew Brown, former CFO of Adaptec,
Inc., joined the Company as CFO. Louis C. Cole will remain as Chairman of the
Board of Directors. Our business could be seriously harmed if we are not
successful in integrating the recently appointed executives into our company.
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);
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
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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 quarters
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. 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.
We Rely on Our Sales Organization and Need to Attract and Retain
Additional Sales Personnel.
Our products and services require a sophisticated sales effort targeted at
senior management and chief information officers of our customers. We have
recently experienced a number of voluntary resignations in our sales force and
may experience further attrition or disruption in the future. Although we have
hired a significant number of sales personnel to replace those who have left the
Company, newly hired sales personnel frequently require extensive training
before they achieve desired levels of productivity, so a continued high employee
turnover rate could seriously impair our ability to operate and manage our
business. We intend to hire additional personnel in our sales organization in
order to increase revenue. 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. In the past, we have experienced
difficulty in recruiting a sufficient number of qualified sales persons. Any
further attrition or disruption to our sales force, including our ability to
attract and retain additional sales personnel, could seriously harm our
business, operating results and financial condition.
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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.
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
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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;
- Such orders 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;
- Such orders 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.
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.
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:
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- 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;
- 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 Systems and Resources.
Our expansion in operations has placed a significant strain upon our
management systems and resources. This expansion has resulted and any future
expansion 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 have hired additional technical
support personnel and plan to add 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 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.
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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
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
$82.50 and as low as $8.125 between December 1, 1999 and November 8, 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;
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- 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 related 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. On May 1, 2000, the court
consolidated all of the pending cases and, on May 10, 2000, 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. Defendants have moved to
dismiss the complaint.
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, and seeks unspecified damages and injunctive relief. The
federal derivative case has been related to the securities class action. On June
7, 2000, the Company was served with a second shareholder derivative complaint
filed in the U.S. District Court, Northern District of California, against the
Company and certain of its officers and directors alleging substantially similar
claims on behalf of shareholders for the period March 30, 2000 through April 26,
2000. The second complaint was voluntarily dismissed.
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 action for
the period October 21, 1999 through April 3, 2000, and 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, which asserts that our officers and directors breached their fiduciary
duties, and seeks unspecified damages and injunctive relief.
Plaintiffs have transferred the Santa Clara derivative action to San Mateo
County and consolidated it with the San Mateo derivative case. Plaintiffs in the
federal derivative action have moved to stay their case in favor of the San
Mateo case. Defendants oppose a stay of the federal derivative action.
The Securities and Exchange Commission has entered 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
September 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: November 13, 2000 /S/ Andrew J. Brown
-------------------
Andrew J. Brown
Senior V.P. of Finance and
Chief Financial Officer
(Duly authorized officer and
principal financial and
accounting officer)
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