UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 2
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
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 April
30, 2000 was 86,828,506.
<PAGE>
<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
INDEX
Page
----
<S> <C>
PART I: CONDENSED FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998 3
Condensed Consolidated Statements of Income for the three-month periods ended March 31,
1999 and 1998 4
Condensed Consolidated Statements of Cash Flows for the three-month periods ended March 31,
1999 and 1998 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. Qualitative and Quantitative Disclosures About Market Risks 25
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURE 28
</TABLE>
Page 2
<PAGE>
PART I: CONDENSED FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands)
March 31, December 31,
1999 1998
----------- -----------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 92,835 $ 83,177
Short-term investments 30,627 33,772
Accounts receivable, net 35,573 39,982
Other current assets 6,526 6,059
Deferred tax asset 14,765 11,836
----------- -----------
Total current assets 178,514 174,826
Long-term investments 12,391 9,023
Property and equipment, net 21,164 21,119
Intangible assets, net 1,963 2,243
Other assets 3,374 536
----------- -----------
Total assets $ 219,218 $ 207,747
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,621 $ 4,577
Accrued liabilities 19,392 22,239
Deferred revenue 26,931 21,879
----------- -----------
Total current liabilities 49,944 48,695
Deferred tax liability 528 523
----------- -----------
Total liabilities 50,472 49,218
Stockholders' equity:
Capital stock and other comprehensive income 122,622 115,165
Retained earnings 46,124 43,364
----------- -----------
Total stockholders' equity 168,746 158,529
----------- -----------
Total liabilities and stockholders' equity $ 219,218 $ 207,747
=========== ===========
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
Page 3
<PAGE>
<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(in thousands, except per share amounts)
Three Months Ended
March 31,
------------------------------
1999 1998
----------- -----------
(unaudited)
<S> <C> <C>
Revenue:
Product license $ 24,739 $ 22,018
Service and support 14,267 7,624
Royalty 4,939 4,743
----------- -----------
Total revenue 43,945 34,385
Cost of revenue:
Product license 1,532 2,143
Service and support 5,355 3,035
----------- -----------
Total cost of revenue 6,887 5,178
----------- -----------
Gross profit 37,058 29,207
Operating expenses:
Research and development 7,712 5,505
Sales and marketing 20,281 15,560
General and administrative 4,808 3,700
Amortization of intangibles 279 279
----------- -----------
Total operating expenses 33,080 25,044
----------- -----------
Income from operations 3,978 4,163
Interest and other income, net 1,404 994
----------- -----------
Income before provision for income taxes 5,382 5,157
Provision for income taxes 2,622 2,039
----------- -----------
Net income $ 2,760 $ 3,118
=========== ===========
Other comprehensive income (loss), net of tax:
Unrealized gains on securities 32 32
----------- -----------
Comprehensive income $ 2,792 $ 3,150
=========== ===========
Basic earnings per share $ 0.03 $ 0.04
=========== ===========
Diluted earnings per share $ 0.03 $ 0.04
=========== ===========
Shares used in basic earnings per share calculations 78,873 75,338
=========== ===========
Shares used in diluted earnings per share calculations 85,023 81,335
=========== ===========
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
Page 4
<PAGE>
<TABLE>
<CAPTION>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended
March 31,
--------------------------
1999 1998
----------- -----------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,760 $ 3,118
Adjustments to reconcile net income to net cash provided by operating
activities:
Deferred tax asset (2,924) (646)
Depreciation and amortization 2,312 1,542
Tax benefit from exercise of stock options 2,798 3,467
Provision for sales returns 1,858 1,370
Provision for doubtful accounts - 22
Changes in operating assets and liabilities:
Accounts receivable 2,551 3,801
Other current assets (467) 433
Accounts payable (956) 2,435
Accrued liabilities (2,746) (3,129)
Deferred revenue 5,052 238
----------- -----------
Net cash provided by operating activities 10,238 12,651
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale securities (26,439) (10,204)
Maturities and sales of available-for-sale securities 26,207 22,278
Acquisition of property and equipment (2,077) (3,090)
Purchase of long-term assets and other (2,838) (230)
----------- -----------
Net cash provided by (used in) investing activities (5,147) 8,754
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 4,709 4,124
Other (142) (3)
------------ -----------
Net cash provided by financing activities 4,567 4,121
----------- -----------
Net increase in cash and cash equivalents 9,658 25,526
Cash and cash equivalents at beginning of period 83,177 38,155
----------- -----------
Cash and cash equivalents at end of period $ 92,835 $ 63,681
=========== ===========
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
Page 5
<PAGE>
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 (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 1998 Report on Form 10-K should be read in
conjunction with these Condensed Consolidated Financial Statements. The balance
sheet as of December 31, 1998 was derived from our audited financial statements
for 1998 but does not include all disclosures required by generally accepted
accounting principles.
On January 19, 2000, we announced that the we would be restating results
for the third quarter of 1999 to reflect an adjustment concerning one contract
that decreased revenue in the third quarter from $71.7 million to $65.9 million;
this agreement has been subsequently terminated. On March 31, 2000, we filed a
Form 12b-25 with the Securities and Exchange Commission stating that we were
unable to file our Form 10-K within the prescribed period because, as a result
of our regular first quarter review that included a review of past due accounts
receivables, including certain fourth quarter transactions for which payment was
due, we discovered additional information that related to such transactions and
requested our independent auditors to evaluate such transactions in light of
this additional information. On April 3, 2000, we announced that we discovered
that a number of our sales representatives, acting outside their authority, had
entered into side agreements affecting contracts signed with resellers in the
fourth quarter. These side agreements supplemented the contractual arrangements
for sales transactions with these resellers by making payment to us contingent
on sale by the reseller. As a result, we delayed filing of our 10-K pending
conclusion of our review of these matters. We also announced that we believed
our revenue for the first quarter ended March 31, 2000 would be in the range of
$54 million to $56 million, and that we expected to release complete financial
results and provide additional information relating to the first quarter on
April 19, 2000.
On April 5, 2000, our Board of Directors appointed a special investigation
committee of the board composed of two outside directors, Messrs. Bingham and
Strohm, to investigate, with the assistance of outside counsel, the nature and
extent of the side agreements and our revenue recognition practices. On April
17, 2000, we announced that although we had previously anticipated that we would
file our Form 10-K by April 14th, we would be delaying the filing of our Form
10-K pending completion of the evaluation of transactions throughout fiscal
1999. We also announced that, as a result of our ongoing investigation, we would
delay the release of our financial results for the first quarter of 2000 until
we had filed our Form 10-K. During its investigation, the committee discovered
certain facts indicating 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.
As a result of the revisions discussed above, we are restating our revenues
and results of operations for the quarters ended September 30, 1999, June 30,
1999 and March 31, 1999 . The effect of these adjustments is a decrease in
revenue of $23.0 million and a decrease in net income of $12.3 million for the
year ended December 31, 1999.
Page 6
<PAGE>
For the quarter ended March 31, 1999, the impact is as follows:
Three Months Ended
March 31, 1999
----------------------
As As
Reported Restated
Total revenue $ 52,351 $ 43,945
Gross profit 45,464 37,058
Net income 8,197 2,760
Basic earnings per share $ 0.10 $ 0.03
Diluted earnings per share $ 0.10 $ 0.03
NOTE 2. COMPUTATION OF EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share is computed giving effect to all
dilutive potential common shares that were outstanding during the period.
Dilutive potential common equivalent shares consist of the incremental common
shares issuable upon exercise of stock options.
A reconciliation of the numerator and denominator of basic and diluted
earnings per share is provided as follows (in thousands, except per share
amounts):
Three Months Ended
March 31,
----------------------
1999 1998
--------- ---------
Numerator - basic and diluted earnings per share
------------------------------------------------
Net income $ 2,760 $ 3,118
========= =========
Denominator - basic earnings per share
--------------------------------------
Weighted average common shares outstanding 78,873 75,338
--------- ---------
Basic earnings per share $ 0.03 $ 0.04
========= =========
Denominator - diluted earnings per share
----------------------------------------
Weighted average common shares outstanding 78,873 75,338
Effect of dilutive securities:
Common stock options 6,150 5,997
--------- ---------
Weighted average common and common
equivalent shares 85,023 81,335
========= =========
Diluted earnings per share $ 0.03 $ 0.04
========= =========
Options excluded from diluted earnings
per share calculation 384 281
========= =========
Certain shares of common stock issuable upon exercise of stock options were
excluded from the calculation of diluted earnings per share because the options'
exercise price was greater than the average market price of the common shares.
Page 7
<PAGE>
NOTE 3. COMPREHENSIVE INCOME
Our unrealized gains on investments represents the only component of
comprehensive income that is excluded from net income for the three-month
periods ended March 31, 1999 and 1998. Our comprehensive income 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.
The table below presents revenue information by geographic area:
3 Months Ended
March 31,
1999 1998
--------- ---------
(in thousands)
Revenue:
United States............................... $ 31,897 $ 24,913
Europe...................................... 10,289 7,893
Other countries............................. 1,759 1,579
---------- ---------
Total................................... $ 43,945 $ 34,385
========= =========
March 31, December 31,
1999 1998
---------- ----------
Long-lived assets:
United States............................... $ 18,087 $ 18,390
Europe...................................... 1,259 1,113
Other countries............................. 3,781 3,859
---------- ---------
Total................................... $ 23,127 $ 23,362
========== ==========
The revenue information by geographical area is based on the country of
destination. Other than the United States, no country accounted for more than 10
percent of our total revenue for the quarters ended March 31, 1999 and 1998.
NOTE 5. QUALIX GROUP, INC. MERGER
On April 19, 1999, we completed the merger with Qualix Group, Inc. (dba
FullTime Software, Inc.), or FullTime, a developer of distributed,
enterprise-wide, cross-platform, adaptive computing solutions that enable
customers to proactively manage application service level availability into a
wholly-owned subsidiary of Legato. We issued 3,442,000 shares of our common
stock in exchange for all the common stock and options of FullTime. We accounted
for the transaction as a pooling-of-interests. Accordingly, we restated the
accompanying financial statements to represent the combined results of the
previously separate entities for the periods presented.
The table below presents the separate results of operations of Legato
and FullTime for the periods prior to the combination:
Three Months Ended
March 31,
----------------------
1999 1998
--------- ---------
(in thousands)
Revenue:
Legato Systems, Inc. $ 39,873 $ 28,414
FullTime Software, Inc. 4,072 5,971
--------- ---------
Total $ 43,945 $ 34,385
========= =========
Page 8
<PAGE>
Net income (loss):
Legato Systems, Inc. $ 4,691 $ 5,195
FullTime Software, Inc. (1,931) (2,077)
---------- ----------
Total $ 2,760 $ 3,118
========= =========
NOTE 6. 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 1998, AcSEC released Statement of Position 98-9, or SOP 98-9,
Modification of SOP 97-2, "Software Revenue Recognition," with Respect to
Certain Transactions, effective March 15, 1999. SOP 98-9 amended SOP 97-2 to
require that an entity recognize revenue for multiple element arrangements by
means of the "residual method" when (1) there is vendor-specific objective
evidence, or VSOE, of the fair values of all the undelivered elements that are
not accounted for by means of long-term contract accounting, (2) VSOE of fair
value does not exist for one or more of the delivered elements, and (3) all
revenue recognition criteria of SOP 97-2 (other than the requirement for VSOE of
the fair value of each delivered element) are satisfied. These paragraphs of SOP
97-2 and SOP 98-9 were effective for transactions that were entered into in
fiscal years beginning after March 15, 1999. Retroactive application is
prohibited. The effect of the adoption in fiscal year 2000 was not material.
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 ending 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.
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 7. SUBSEQUENT EVENTS
On April 1, 1999, we completed the acquisition of Intelliguard Software,
Inc. and O.R.P., Inc., developers of standards-based storage management
solutions for storage area networks. In this document, we refer to Intelliguard
Software, Inc. and O.R.P., Inc. collectively as "Intelliguard." We issued
1,440,000 shares of our common stock and provided cash consideration of $9.0
million for all of the outstanding stock and stock rights of Intelliguard. We
accounted for the transaction as a business purchase combination.
Page 9
<PAGE>
On July 30, 1999, we completed the acquisition of Vinca Corporation, a
Utah-based leader in high availability and data protection software. The
transaction was accounted for as a purchase business combination. We issued
1,531,000 shares of our common stock and provided cash consideration of $18.8
million in exchange for all the stock and options of Vinca Corporation. We
accounted for the transaction as a purchase business combination.
On August 13, 1999, we effected a two-for-one stock split (in the form of a
stock dividend). This stock split has been retroactively reflected in the
accompanying Condensed Consolidated Financial Statements.
On November 18, 1999, the Company entered into a definitive agreement to
acquire Ontrack Data International, Inc. ("Ontrack"), a developer of data
recovery software and a provider of storage service solutions. On January 24,
2000, we entered into a Mutual Termination Agreement with Ontrack to immediately
terminate the Agreement and Plan of Reorganization dated November 18, 1999.
On January 20, 2000, a shareholder securities class action complaint was
filed in the U.S. District Court, Northern District of California, against
Legato and certain of its directors and officers. Other similar class actions
involving the same defendants and substantially similar allegations were filed
soon thereafter. The complaints generally allege that, between October 21, 1999
and January 19, 2000, the defendants made false or misleading statements of
material fact about our prospects and failed to follow generally accepted
accounting principles. The complaints assert claims under the federal securities
laws. The complaints seek an unspecified amount in damages. The court has
determined that all of the cases are related and assigned them to one federal
judge. Two plaintiffs filed motions to be appointed as lead plaintiff. On May 1,
2000, the court held a hearing and consolidated all of the pending cases. On May
10, 2000, the court entered an order appointing a lead plaintiff; the other
proposed lead plaintiff has appealed that decision.
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. The complaint asserts that as a result of this conduct certain of our
officers and directors breached their fiduciary duties to us and engaged in
improper insider trading. The complaint seeks an unspecified amount in damages
and injunctive relief on our behalf. The court determined that the derivative
action is related to the class actions and has assigned it to the same federal
judge. In June 2000 we were served with another shareholder derivative complaint
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 and claims as the shareholder class
actions filed in U.S. District Court and the earlier derivative action filed in
federal court. The complaint seeks an unspecified amount in damages and
injunctive relief on our behalf.
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 nominal defendant. The complaint
generally alleges the same conduct as the shareholder class actions filed in
U.S. District Court. The complaint asserts that as a result of this conduct
certain of our officers and directors breached their fiduciary duties to us and
engaged in improper insider trading. The complaint seeks an unspecified amount
in damages and injunctive relief on our behalf.
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 shareholder class actions filed in U.S. District Court.
The complaint asserts that as a result of this conduct certain of our officers
and directors breached their fiduciary duties to us, abused their control, were
unjustly enriched, and violated provisions of the California Corporations Code.
The complaint seeks an unspecified amount in damages and injunctive relief on
our behalf.
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.
Page 10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The discussion in this report on Form 10-Q/A contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding 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, 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 January 19, 2000, we announced that the we would be restating results
for the third quarter of 1999 to reflect an adjustment concerning one contract
that decreased revenue in the third quarter from $71.7 million to $65.9 million;
this agreement has been subsequently terminated. On March 31, 2000, we filed a
Form 12b-25 with the Securities and Exchange Commission stating that we were
unable to file our Form 10-K within the prescribed period because, as a result
of our regular first quarter review that included a review of past due accounts
receivables, including certain fourth quarter transactions for which payment was
due, we discovered additional information that related to such transactions and
requested our independent auditors to evaluate such transactions in light of
this additional information. On April 3, 2000, we announced that we discovered
that a number of our sales representatives, acting outside their authority, had
entered into side agreements affecting contracts signed with resellers in the
fourth quarter. These side agreements supplemented the contractual arrangements
for sales transactions with these resellers by making payment to us contingent
on sale by the reseller. As a result, we delayed filing of our 10-K pending
conclusion of our review of these matters. We also announced that we believed
our revenue for the first quarter ended March 31, 2000 would be in the range of
$54 million to $56 million, and that we expected to release complete financial
results and provide additional information relating to the first quarter on
April 19, 2000.
On April 5, 2000, our Board of Directors appointed a special investigation
committee of the board composed of two outside directors, Messrs. Bingham and
Strohm, to investigate, with the assistance of outside counsel, the nature and
extent of the side agreements and our revenue recognition practices. On April
17, 2000, we announced that although we had previously anticipated that we would
file our Form 10-K by April 14th, we would be delaying the filing of our Form
10-K pending completion of the evaluation of transactions throughout fiscal
1999. We also announced that, as a result of our ongoing investigation, we would
delay the release of our financial results for the first quarter of 2000 until
we had filed our Form 10-K. During its investigation, the committee discovered
certain facts indicating 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.
Page 11
<PAGE>
As a result of the revisions discussed above, we are restating our revenues
and results of operations for the quarters ended September 30, 1999, June 30,
1999 and March 31, 1999. The effect of these adjustments is a decrease in
revenue of $23.0 million and a decrease in net income of $12.3 million for the
year ended December 31, 1999.
We develop, license, market and support network 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 substantial 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 receives ongoing royalties from the OEMs' product sales.
Substantially all of the OEMs are large computer system and software suppliers
located in the United States, Europe and Asia Pacific.
We acquired Fulltime in 1999 primarily for its respective product offerings
and research and development teams. We accounted for the merger with Fulltime as
a pooling-of-interests. Accordingly, we restated the financial statements to
represent the combined financial results of the previously separate entities for
all periods presented.
Selected elements of our consolidated financial statements are shown below
as a percentage of total revenue.
Three Months Ended
March 31,
-----------------------------
1999 1998
----------- -----------
Revenue:
Product license 56% 64%
Service and support 33 22
Royalty 11 14
----------- -----------
Total revenue 100 100
Cost of revenue:
Product license 3 6
Service and support 12 9
----------- -----------
Total cost of revenue 15 15
----------- -----------
Gross profit 85 85
Operating expenses:
Research and development 18 16
Sales and marketing 46 45
General and administrative 11 11
Amortization of intangibles 1 1
----------- -----------
Total operating expenses 76 73
----------- -----------
Income from operations 9 12
Interest and other, net 3 3
--------- -----------
Income before provision for income taxes 12 15
Provision for income taxes 6 6
----------- -----------
Net income 6% 9%
============ ============
Revenue
Total revenue for the first quarter of 1999 increased 28% percent over
total revenue for the comparable period of 1998. The increase was attributable
to the continued acceptance of our NetWorker family of products, increased
product license sales to large-scale enterprises and increased sales of service
and support contracts.
Product license revenue. Product license revenue were $24.7 million in the
first quarter of 1999 and $22.0 million in the first quarter of 1998. Product
license revenue increased 12 percent from the first quarter of 1998 to the first
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quarter of 1999 primarily as a result of the continued acceptance of our
products and increased product sales to large-scale enterprises. The increases
were primarily attributable to the continued acceptance of our family of
products, expansion of our product lines resulting from research and development
efforts and integration of products from acquired companies and increased
product sales to large-scale enterprises. 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 for 1999. 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 are 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 upon 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 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.
Service and Support Revenue. Service and support revenue was $14.3 million
in the first quarter of 1999 and $7.6 million in the first quarter of 1998.
Service and support revenue increased 87 percent from the first quarter of 1998
to the first quarter of 1999 primarily as a result of the growth in the number
of registered customers electing to subscribe to support contracts and to renew
software support contracts after the initial one-year term. 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 $4.9 million in the first quarter of
1999 and $4.7 million in the first quarter of 1998. 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 revenue was $12.0 million in the first quarter of 1999 and
$9.5 million in the first quarter of 1998. International revenue increased 27
percent from the first quarter of 1998 to the first quarter of 1999.
International revenue accounted for 27 percent of total revenue in the first
quarter of 1999 and 1998. International license revenue increased in absolute
dollars primarily as a result of the continued market acceptance of our products
overseas. An increase in the number of international sales offices and
international distributors and resellers marketing our products helped increase
the market acceptance of our products overseas. The majority of international
revenue during these periods was generated in Europe. We continue to expand our
international operations, which requires significant management attention and
financial resources and could materially adversely affect our operating results.
To the extent that we are unable to effect these additions in a timely manner,
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 $37.1 million in the first quarter of 1999 and $29.2
million in the first quarter of 1998, representing 85 percent of total revenue
in the first quarters of 1999 and 1998. Gross profit consists of product
license, service and support and other revenue less related costs.
Gross profit from product license revenue was $23.2 million in the first
quarter of 1999 and $19.9 million in the first quarter of 1998, representing 94
percent of product license in the first quarter of 1999 and 90 percent in the
first quarter of 1998. Gross profit from product license increased 17 percent
from the first quarter of 1998 to the first quarter of 1999. Gross profit from
product license consists of primarily of product license revenue less the
related costs. Related costs of revenue consist primarily of product media,
documentation and packaging.
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Gross profit from service and support revenue was $8.9 million in the first
quarter of 1999 and $4.6 million in 1998, representing 62 percent of the service
and support revenue in the first quarter of 1999 and 60 percent in 1998. Gross
profit from service and support revenue increased 94 percent from the first
quarter of 1998 to the same period of 1999. Gross profit from service and
support revenue as a percentage of service and support revenue increased
primarily as a result of leveraging the costs of service and support revenue
over a larger revenue base. The rate of increase in service and support revenue
was greater than the rate of increase in the related costs of service and
support revenue. 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
$7.7 million in the first quarter of 1999 and $5.5 million in the first quarter
of 1998, representing 18 percent of total revenue in the first quarter of 1999
and 16 percent in the first quarter of 1998. Research and development expenses
increased 40 percent from the first quarter of 1998 to the first quarter of
1999. The increases in research and development expenses primarily reflect
increased staffing and associated support for engineers necessary to continue to
expand, enhance and maintain our product lines. The increase in research and
development expenses as a percentage of revenue reflect growth rates of such
expenses exceeding revenue growth rates from the first quarter of 1998. We
believe that research and development expenses may 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 $20.3 million in the first quarter
of 1999 and $15.6 million in the first quarter of 1998, representing 46 percent
of total revenue in the first quarter of 1999 and 45 percent in 1998. Sales and
marketing expenses increased 30 percent from the first quarter of 1998 to the
first quarter of 1999. The increases in sales and marketing expenses were
primarily attributable to the continued growth of our sales force and associated
support personnel. The increase in sales and marketing expenses from the first
quarter of 1998 to the first quarter of 1999 is also attributed to additional
marketing and promotional activities to increase awareness of our products. We
believe that sales and marketing expenses may continue to increase in absolute
dollars as we may continue to expand our sales and marketing staff.
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 $4.8 million in the first quarter of 1999 and $3.7
million in the first quarter of 1998, representing 11 percent of total revenue
in the first quarter of 1999 and 1998. General and administrative expenses
increased 30 percent from the first quarter of 1998 to the first quarter of
1999. The increases in general and administrative expenses from the first
quarter of 1998 to the first quarter of 1999 was primarily attributable to
increased staffing and related costs required to manage and support our
expansion. We believe that general and administrative expenses may increase in
dollar amount as we may continue to expand our operations.
Amortization of Intangibles. Amortization of intangibles was $279,000 in
the first quarter of 1999 and 1998. We recorded the related intangibles
following an acquisition in the first quarter of 1996. We amortize these
intangibles on a straight-line basis over five years.
Interest and Other Income, Net. Interest and other income, net, was $1.4
million in the first quarter of 1999 and $1.0 million in the first quarter of
1998. Interest and other income primarily represent interest income from funds
available for investment. The increase in interest income relates primarily to
interest earned from increased purchases of available for sale securities.
Provision for Income Taxes. The provision for income taxes for the first
quarter of 1999 was $2.6 million, compared to $2.0 million for the first quarter
of 1998. The effective tax rate was 49 percent for the first quarter of 1999 and
40 percent for the first quarter of 1998.
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LIQUIDITY AND CAPITAL RESOURCES
Our cash, cash equivalents and investments totaled $135.9 million at March
31, 1999, and represented 62 percent of total assets. Cash and cash equivalents
are highly liquid investments with original maturities of ninety days or less.
Investments consist mainly of short-term and long-term municipal securities and
auction rate receipts. At March 31, 1999, we had no long-term debt and
stockholders' equity was $168.7 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 $10.2
million in the first quarter of 1999. Net cash provided by operations in the
first quarter of 1999 consisted primarily of net income of $2.8 million, the tax
benefit from exercise of stock options of $2.8 million, depreciation and
amortization of $2.3 million and the net change in operating assets and
liabilities of $5.3 million, offset by net deferred tax assets of $2.9 million.
Net cash used in investing activities was $5.1 million in the first quarter
of 1999. Net cash used in investing activities primarily reflected net purchases
of marketable securities of $0.2 million, purchases of property and equipment of
$2.1 million and a partial payment of $2.5 million for the acquisition of
Intelliguard which closed on April 1, 1999.
Net cash provided by financing activities was $4.6 million in the first
quarter of 1999. Net cash provided by financing activities consisted primarily
of proceeds received from the issuance of our common stock.
We believe our current cash balances and cash flow from operations, if any,
will be sufficient to meet its working capital and capital expenditure
requirements for at least the next twelve months.
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;
- 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;
- 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;
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- 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 class action litigation;
- Personnel changes; 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
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;
- 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
Legato and certain of its directors and officers. Other similar class actions
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involving the same defendants and substantially similar allegations were filed
soon thereafter. The complaints generally allege that, between October 21, 1999
and January 19, 2000, the defendants made false or misleading statements of
material fact about our prospects and failed to follow generally accepted
accounting principles; one amended complaint alleges that the wrongdoing
occurred between October 21, 1999 and March 31, 2000. The complaints assert
claims under the federal securities laws. The complaints seek an unspecified
amount in damages. The court has determined that all of the cases are related
and assigned them to one federal judge. Two plaintiffs filed motions to be
appointed as lead plaintiff. On May 1, 2000, the court held a hearing and
consolidated all of the pending cases. On May 10, 2000, the court entered an
order appointing a lead plaintiff; the other proposed lead plaintiff has
appealed that decision.
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. The complaint asserts that as a result of this conduct certain of our
officers and directors breached their fiduciary duties to us and engaged in
improper insider trading. The complaint seeks an unspecified amount in damages
and injunctive relief on our behalf. The court determined that the derivative
action is related to the class actions and has assigned it to the same federal
judge. In June 2000 we were served with another shareholder derivative complaint
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 and claims as the shareholder class
actions filed in U.S. District Court and the earlier derivative action filed in
federal court. The complaint seeks an unspecified amount in damages and
injunctive relief on our behalf.
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 nominal defendant. The complaint
generally alleges the same conduct as the shareholder class actions filed in
U.S. District Court. The complaint asserts that as a result of this conduct
certain of our officers and directors breached their fiduciary duties to us and
engaged in improper insider trading. The complaint seeks an unspecified amount
in damages and injunctive relief on our behalf.
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 shareholder class actions filed in U.S. District Court.
The complaint asserts that as a result of this conduct certain of our officers
and directors breached their fiduciary duties to us, abused their control, were
unjustly enriched, and violated provisions of the California Corporations Code.
The complaint seeks an unspecified amount in damages and injunctive relief on
our behalf.
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 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.
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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 announcement of a review of 1999 transactions,
delays in filing our Annual Report on Form 10-K for 1999 and in reporting
operating results for the first quarter of 2000 while this review was being
completed, commencement of de-listing of our common stock from the Nasdaq
National Market as a result of our failure to satisfy our public reporting
obligations in a timely manner and resulting customer uncertainty regarding our
financial condition may adversely affect our ability to sell our products.
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.
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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
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 muliple 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.
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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.
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
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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;
- 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
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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.
We Rely on Our Key Personnel.
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 an 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 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. 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 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:
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- 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.
Year 2000 Issues Could Affect Our Business.
Many currently installed computer systems and software products include
coding to accept only two digit entries in the date code field. These date code
fields need to accept four digit entries to distinguish 21st century dates from
20th century dates. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail. Some uncertainty
existed in the software industry concerning the potential effects associated
with such problems, although much of that uncertainty has now been allayed
following the roll-over to the Year 2000.
The risks posed by Year 2000 issues could still adversely affect our
business in a number of significant ways. We believe after examining and testing
our products that our internally developed technology, as well as the
third-party technology incorporated into our products, is Year 2000 compliant.
Moreover, to date, we have not detected any disruptions in our software
applications or in the applications of our vendors arising from the roll-over to
the Year 2000. Nonetheless, our products could experience unexpected Year 2000
issues that we have failed to uncover to date, which could cause our products to
be impaired. We also use third party financial and other systems in our internal
business operations. To our knowledge, these products have not experienced Year
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2000 disruptions following the roll-over to the Year 2000. Nonetheless these
systems could suffer from unexpected Year 2000 issues. Any such Year 2000 issues
could materially adversely affect our business. Moreover, we may in the future
be required to defend our products or services in litigation or arbitration
proceedings involving our products or services related to Year 2000 compliance
issues, or to negotiate resolutions of claims based on Year 2000 issues.
Defending or resolving Year 2000 related disputes, regardless of the merits of
such disputes, and any liability we have for Year 2000 related damages,
including consequential damages, could be expensive.
Our Trading Price is Volatile.
The trading of our common stock is highly volatile, closing as high as
$79.25 and as low as $9.25 since December 1, 1999, 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
- Costs and resources required to address potential Year 2000 problems
relating to our products or our internal use software and hardware.
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. Substantially
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. 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
Legato and certain of its directors and officers. Other similar class actions
involving the same defendants and substantially similar allegations were filed
soon thereafter. The complaints generally allege that, between October 21, 1999
and January 19, 2000, the defendants made false or misleading statements of
material fact about our prospects and failed to follow generally accepted
accounting principles; one amended complaint alleges that the wrongdoing
occurred between October 21, 1999 and March 31, 2000. The complaints assert
claims under the federal securities laws. The complaints seek an unspecified
amount in damages. The court has determined that all of the cases are related
and assigned them to one federal judge. Two plaintiffs filed motions to be
appointed as lead plaintiff. On May 1, 2000, the court held a hearing and
consolidated all of the pending cases. On May 10, 2000, the court entered an
order appointing a lead plaintiff; the other proposed lead plaintiff has
appealed that decision.
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. The complaint asserts that as a result of this conduct certain of our
officers and directors breached their fiduciary duties to us and engaged in
improper insider trading. The complaint seeks an unspecified amount in damages
and injunctive relief on our behalf. The court determined that the derivative
action is related to the class actions and has assigned it to the same federal
judge. In June 2000 we were served with another shareholder derivative complaint
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 and claims as the shareholder class
actions filed in U.S. District Court and the earlier derivative action filed in
federal court. The complaint seeks an unspecified amount in damages and
injunctive relief on our behalf.
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 nominal defendant. The complaint
generally alleges the same conduct as the shareholder class actions filed in
U.S. District Court. The complaint asserts that as a result of this conduct
certain of our officers and directors breached their fiduciary duties to us and
engaged in improper insider trading. The complaint seeks an unspecified amount
in damages and injunctive relief on our behalf.
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 shareholder class actions filed in U.S. District Court.
The complaint asserts that as a result of this conduct certain of our officers
and directors breached their fiduciary duties to us, abused their control, were
unjustly enriched, and violated provisions of the California Corporations Code.
The complaint seeks an unspecified amount in damages and injunctive relief on
our behalf.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended March 31, 1999.
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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: June 8, 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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