<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-22712
------------------------
VERITAS SOFTWARE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 94-2823068
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
1600 PLYMOUTH STREET
MOUNTAIN VIEW, CALIFORNIA 94043
(650) 335-8000
(ADDRESS, INCLUDING ZIP CODE, OF REGISTRANT'S
PRINCIPAL EXECUTIVE OFFICES AND 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 of the Registrant's Common Stock outstanding on April
30, 1998 was 31,234,812 shares.
================================================================================
<PAGE> 2
VERITAS SOFTWARE CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of March
31, 1998 and December 31, 1997...................... 3
Condensed Consolidated Statements of Operations for
the Three Months Ended March 31, 1998 and 1997...... 4
Condensed Consolidated Statements of Cash Flows for
the Three Months Ended March 31, 1998 and 1997...... 5
Notes to Condensed Consolidated Financial
Statements.......................................... 6
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition.................. 8
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................... 22
Signature................................................... 23
</TABLE>
2
<PAGE> 3
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
VERITAS SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 67,303 $ 75,629
Short-term investments.................................... 138,380 115,131
Accounts receivable, net of allowance for doubtful
accounts of $1,625 at March 31, 1998 and $1,597 at
December 31, 1997...................................... 29,758 30,296
Prepaid expenses.......................................... 3,067 4,298
-------- --------
Total current assets........................................ 238,508 225,354
Property and equipment, net................................. 13,626 10,109
Other assets................................................ 6,749 6,417
-------- --------
Total assets................................................ $258,883 $241,880
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,960 $ 1,552
Accrued compensation and benefits......................... 4,625 6,595
Other accrued liabilities................................. 15,420 11,180
Deferred revenue.......................................... 18,524 17,449
-------- --------
Total current liabilities................................... 40,529 36,776
Deferred rent............................................... 872 911
Convertible subordinated notes.............................. 100,000 100,000
Stockholders' equity
Common stock.............................................. 190,196 185,887
Accumulated deficit....................................... (72,009) (81,064)
Deferred compensation..................................... (56) (64)
Accumulated other comprehensive income.................... (649) (566)
-------- --------
Total stockholders' equity.................................. 117,482 104,193
-------- --------
Total liabilities and stockholders' equity.................. $258,883 $241,880
======== ========
</TABLE>
See accompanying notes.
3
<PAGE> 4
VERITAS SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Net revenue:
User license fees......................................... $30,689 $20,523
Services.................................................. 7,400 3,672
Porting................................................... 993 1,415
------- -------
Total net revenue................................. 39,082 25,610
Cost of revenue:
User license fees......................................... 1,966 836
Services.................................................. 3,425 1,205
Porting................................................... 1,075 729
------- -------
Total cost of revenue............................. 6,466 2,770
------- -------
Gross profit................................................ 32,616 22,840
Operating expenses:
Selling and marketing..................................... 13,059 9,262
Research and development.................................. 7,549 5,794
General and administrative................................ 2,170 2,135
------- -------
Total operating expenses.......................... 22,778 17,191
------- -------
Income from operations...................................... 9,838 5,649
Interest expense............................................ (1,420) --
Interest and other income, net.............................. 2,685 835
------- -------
Income before income taxes.................................. 11,103 6,484
Provision for income taxes.................................. 2,048 1,067
------- -------
Net income.................................................. $ 9,055 $ 5,417
======= =======
Net income per share -- basic............................... $ 0.29 $ 0.18
======= =======
Net income per share -- diluted............................. $ 0.27 $ 0.17
======= =======
Shares used in per share calculations -- basic.............. 30,956 30,147
======= =======
Shares used in per share calculations -- diluted............ 33,967 32,406
======= =======
</TABLE>
See accompanying notes.
4
<PAGE> 5
VERITAS SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
--------- -------
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 9,055 $ 5,417
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 1,171 988
Amortization of bond issue costs.......................... 107 --
Deferred rent............................................. (39) 10
Changes in operating assets and liabilities:
Accounts receivable....................................... 463 (6,381)
Prepaid expenses.......................................... 1,207 (2,059)
Other assets.............................................. (426) 57
Accounts payable.......................................... 385 (7)
Accrued compensation and benefits......................... (1,959) 448
Other accrued liabilities................................. 4,291 1,143
Deferred revenue.......................................... 1,072 805
--------- -------
Net cash provided by operating activities................... 15,327 421
INVESTING ACTIVITIES
Purchases of short-term investments......................... (105,748) (28,986)
Sales of short-term investments............................. 82,474 28,296
Purchase of property and equipment.......................... (4,691) (1,709)
Payments received on note................................... -- 47
--------- -------
Net cash used for investing activities...................... (27,965) (2,352)
FINANCING ACTIVITIES
Payments of notes payable................................... -- (612)
Proceeds from issuance of common stock...................... 4,309 1,145
--------- -------
Net cash provided by financing activities................... 4,309 533
Effect of exchange rate changes............................. 3 (18)
--------- -------
Net decrease in cash and cash equivalents................... (8,326) (1,416)
Cash and cash equivalents at beginning of period............ 75,629 17,411
--------- -------
Cash and cash equivalents at end of period.................. $ 67,303 $15,995
========= =======
</TABLE>
See accompanying notes.
5
<PAGE> 6
VERITAS SOFTWARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for annual
financial statements. In the opinion of management, all adjustments (consisting
only of normal recurring accruals) considered necessary for a fair presentation
have been included. The results for the interim periods presented are not
necessarily indicative of the results that may be expected for any future
period. The following information should be read in conjunction with the
financial statements and notes thereto included in VERITAS Software
Corporation's annual report on Form 10-K for the year ended December 31, 1997.
The Company merged with OpenVision Technologies, Inc. on April 25, 1997
(the "Merger"). The Merger was accounted for as a "pooling of interests" for
financial reporting purposes in accordance with generally accepted accounting
principles. The Company's consolidated financial statements for prior periods
have been restated to include the financial position, results of operations and
cash flows of OpenVision.
2. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
3. NET INCOME PER SHARE
Basic earnings per share is based upon weighted-average common shares
outstanding. Diluted earnings per share is computed using the weighted-average
common shares outstanding plus any potential dilutive securities. Dilutive
securities include stock options, warrants, restricted stock, convertible debt
and convertible preferred stock. The following table sets forth the computation
of basic and diluted net income per common share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Numerator:
Net income................................................ $ 9,055 $ 5,417
======= =======
Denominator:
Denominator for basic net income per share --
weighted-average shares................................ 30,956 30,147
Common stock equivalents.................................. 3,011 2,259
------- -------
Denominator for diluted net income per share.............. 33,967 32,406
======= =======
Basic earnings per share.................................... $ 0.29 $ 0.18
======= =======
Diluted earnings per share.................................. $ 0.27 $ 0.17
======= =======
</TABLE>
4. ACCUMULATED OTHER COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of this Statement had no impact on the
Company's net income or stockholders' equity. SFAS 130 requires foreign currency
translation
6
<PAGE> 7
VERITAS SOFTWARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
adjustments, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income.
Total comprehensive income amounted to approximately $9.0 million and $5.1
million at March 31, 1998 and 1997, respectively. The following are the
components of comprehensive income:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Net income.................................................. $9,055 $5,417
Foreign currency translation adjustments.................... (83) (303)
------ ------
Comprehensive income........................................ $8,972 $5,114
====== ======
</TABLE>
Accumulated other comprehensive income is comprised of accumulated foreign
currency translation adjustments of approximately $0.6 million at March 31, 1998
and 1997.
5. SUBSEQUENT EVENT
On April 15, 1998, the Company announced a three-for-two stock split in the
form of a stock dividend which has an effective date of May 20, 1998.
7
<PAGE> 8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following discussion contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and
Section 27A of the Securities Act of 1933, as amended, that involve risks and
uncertainties. Such forward-looking statements consist of statements that are
not purely historical, including, without limitation, statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statement. There are certain
important factors that could cause actual results to differ materially from
those projected in the forward-looking statements contained in the following
discussion. Among such important factors are: (i) the timing and level of sales
by original equipment manufacturers ("OEMs") of computer systems incorporating
the Company's products and resales by OEMs of the Company's products; (ii) the
Company's timely development and market acceptance of new products; (iii) the
unpredictability of the timing and level of sales to resellers and direct
end-users; (iv) the timely creation of versions of the Company's products for
the Microsoft Windows NT operating system ("Windows NT"); (v) the timely release
by Microsoft of the next version of Windows NT ("Windows NT 5.0") and the rate
of adoption of such new version by users; (vi) the impact of Windows NT and
other operating systems on the UNIX market upon which the Company's current
products are dependent; (vii) the reliance on OEMs to continue porting and
shipping the Company's products; (viii) the impact of competitive products and
pricing; (ix) the uncertainty of the labor market and local regulations in
India, where a subsidiary of the Company, which performs research and
development activities, is located; (x) the Company's ability to hire and retain
research and development, marketing and sales personnel with appropriate skills
in a highly competitive labor market; (xi) the Company's ability to deliver
products that are Year 2000 compliant; and (xii) such risks and uncertainties as
are detailed from time to time in the Company's SEC reports and filings,
including its Annual Report on Form 10-K for the year ended December 31, 1997.
RESULTS OF OPERATIONS
OVERVIEW
VERITAS Software Corporation ("VERITAS" or the "Company") is the leading
independent supplier of enterprise data storage management solutions, providing
advanced storage management software for open system environments. The Company's
products provide performance improvement and reliability enhancement features
that are critical for many commercial applications. These products enable
protection against data loss and file corruption, rapid recovery after disk or
system failure, the ability to process large files efficiently and the ability
to manage and back-up large networks of systems without interrupting users. In
addition, the Company's products provide an automated failover between computer
systems organized in clusters sharing disk resources. The Company's highly
scalable products can be used independently, and certain products can be
combined to provide interoperable client/server storage management solutions.
The Company's products offer centralized administration with a high degree of
automation, enabling customers to manage complex, distributed environments
cost-effectively by increasing system administrator productivity and system
availability. The Company also provides a comprehensive range of services to
assist customers in planning and implementing storage management solutions. The
Company markets its products and associated services to OEM and end-user
customers through a combination of direct and indirect sales channels
(resellers, value-added resellers ("VARs"), hardware distributors, application
software vendors and systems integrators). The Company's OEM customers include
Digital Equipment Corporation ("DEC"), Hewlett-Packard Company ("HP"), Sun
Microsystems, Inc. ("Sun Microsystems"), Microsoft Corporation ("Microsoft"),
Sequent Computer Systems, Inc. and Tandem Computers, Inc. The Company's end-user
customers include AT&T Corporation, Bank of America, BMW, Boeing Company,
British Telecommunications plc, Chrysler Corporation and Motorola, Inc.
The Company derives its net revenue from user license fees, service fees
and porting fees. The Company's OEM customers either bundle the Company's
products with the OEM products licensed by such OEMs or offer them as options.
Certain OEMs also resell the Company's products. The Company generally receives
a
8
<PAGE> 9
one-time source license fee upon entering into a license agreement with an OEM,
as well as a user license fee each time the OEM licenses a copy of the OEM
products to a customer that incorporates one or more of the Company's products.
The Company's license agreements with its OEM customers generally contain no
minimum sales requirements and there can be no assurance that any OEM will
either commence or continue shipping operating systems incorporating the
Company's products in the future. Moreover, following the execution of new
agreements between the Company and OEM customers and resellers, a significant
period of time may elapse before any revenues to the Company are generated
thereunder due to the development work which the Company must generally
undertake pursuant to such agreements and the time needed for the sales and
marketing organizations within such customers and distributors to become
familiar with the Company's products.
The Company's services revenue consists of fees derived from annual
maintenance agreements, and consulting and training services. The OEM
maintenance agreements covering VERITAS products provide technical and emergency
support and minor product upgrades for a fixed annual fee. The maintenance
agreements covering the products that are licensed through non-OEM channels
provide technical support and product upgrades for an annual service fee based
on the number of user licenses purchased.
Porting fees consist of fees derived from porting and other non-recurring
engineering efforts when the Company ports (i.e., adapts) its storage management
products to an OEMs' operating system and when the Company develops certain new
product features or extensions of existing product features at the request of a
customer. In most cases, the Company retains the rights to technology derived
from porting and non-recurring engineering work for licensing to other customers
and therefore generally does such work on a relatively low margin basis.
The Company's international sales are generated primarily through its
international sales subsidiaries. International revenue outside the United
States and Canada, most of which is collectible in foreign currencies, accounted
for 22% of the Company's total revenues for both of the three month periods
ended March 31, 1998 and 1997. The Company's international revenue increased 48%
from $5.7 million for the three months ended March 31, 1997 to $8.4 million for
the three months ended March 31, 1998. Since much of the Company's international
operating expenses are also incurred in local currencies, the relative impact of
exchange rates on net income or loss is less than on revenues. Although the
Company's operating and pricing strategies take into account changes in exchange
rates over time, the Company's operating results may be significantly affected
in the short term by fluctuations in foreign currency exchange rates. The
Company believes that its success depends upon continued expansion of its
international operations. The Company currently has sales and service offices in
the United States, Canada, Japan, the United Kingdom, Germany, France, Sweden
and the Netherlands, a development center in India, and resellers located in
North America, Europe, Asia Pacific, South America and the Middle East.
International expansion may require the Company to establish additional foreign
offices, hire additional personnel and recruit additional international
resellers, resulting in the diversion of significant management attention and
the expenditure of financial resources. To the extent the Company is unable to
effect these additions efficiently, growth in international sales will be
limited, which would have a material adverse effect on the Company's business,
operating results and financial condition. International operations also subject
the Company to a number of risks inherent in developing and selling products
outside the United States, including potential loss of developed technology,
limited protection of intellectual property rights, imposition of government
regulation, imposition of export duties and restrictions, cultural differences
in the conduct of business, and political and economic instability.
The Company merged with OpenVision Technologies, Inc. ("OpenVision") on
April 25, 1997 (the "Merger"). The Merger was accounted for as a "pooling of
interests" for financial reporting purposes in accordance with generally
accepted accounting principles. The Company's consolidated financial statements
for prior periods have been restated to include the financial position, results
of operations and cash flows of OpenVision. Accordingly, the following
discussion reflects the combined results of the Company and OpenVision for all
periods covered.
9
<PAGE> 10
The following table sets forth the percentage of total revenue represented
by certain line items from the Company's Condensed Consolidated Statements of
Operations for the three months ended March 31, 1998 and 1997, respectively, and
the percentage change between the comparative periods:
<TABLE>
<CAPTION>
PERCENTAGE OF
TOTAL REVENUE
-------------- PERIOD-TO-PERIOD
THREE MONTHS PERCENTAGE CHANGE
ENDED ------------------
MARCH 31, THREE MONTHS ENDED
-------------- MARCH 31, 1998
1998 1997 COMPARED TO 1997
---- ---- ------------------
<S> <C> <C> <C>
Net revenue:
User license fees.............................. 79% 80% 50%
Services....................................... 19 14 102%
Porting........................................ 2 6 -30%
--- ---
Total revenue.......................... 100 100 53%
Cost of revenue:
User license fees.............................. 5 3 135%
Services....................................... 9 5 184%
Porting........................................ 3 3 47%
--- ---
Total cost of revenue.................. 17 11 133%
--- ---
Gross profit..................................... 83 89 43%
Operating expenses:
Selling and marketing.......................... 33 36 41%
Research and development....................... 19 23 30%
General and administrative..................... 6 8 2%
--- ---
Total operating expenses............... 58 67 33%
--- ---
Income from operations........................... 25 22
Other income, net................................ 3 3
Provision for income taxes....................... (5) (4)
--- ---
Net income....................................... 23% 21%
=== ===
Gross margin:
User license fees.............................. 94% 96%
Services....................................... 54% 67%
Porting........................................ -8% 48%
</TABLE>
Net Revenue
Total net revenue increased 53% from $25.6 million for the three months
ended March 31, 1997 to $39.1 million for the three months ended March 31, 1998.
The Company believes that the percentage increase in total revenue is not
indicative of future results. The Company's revenue is comprised of user license
fees, service revenue and porting fees. Growth in user license fees has been
driven primarily by increasing market acceptance of the Company's products and a
larger percentage of total license revenue coming through the direct sales
channel, and, to a lesser extent, the release of new products. Service revenue
is derived primarily from contracts for software maintenance and technical
support and, to a lesser extent, consulting and training services. The growth in
service revenue has been driven primarily by increased sales of service and
support contracts on new license sales and, to a lesser extent, by renewals of
these contracts as the Company's installed base of licensees has increased along
with the increase in consulting and training revenue. Porting fees are derived
from the Company's funded development efforts that are typically associated with
the licensing of source code to OEMs. User license fees for the three months
ended March 31, 1998 decreased to 79% of total net revenue from 80% for the
three months ended March 31, 1997.
User License Fees. User license fees increased 50% from $20.5 million for
the three months ended March 31, 1997 to $30.7 million for the three months
ended March 31, 1998. The increase is primarily the
10
<PAGE> 11
result of continued growth in market acceptance of the Company's products and,
to a lesser extent, the introduction of new products. In particular, the
Company's license fees from storage products increased by approximately 57%,
accounting for 95% and 90% of license revenue in the three months ended March
31, 1998 and 1997, respectively.
Service Revenue. Service revenue increased 102% from $3.7 million for the
three months ended March 31, 1997 to $7.4 million for the three months ended
March 31, 1998, primarily due to increased sales of service and support
contracts on new licenses, renewal of service and support contracts on existing
licenses and, to a lesser extent, an increase in consulting and training
services. Sales of service and support contracts increased 110%, and revenue
from consulting and training services increased 82%, for the three months ended
March 31, 1998 compared to the three months ended March 31, 1997.
Porting Fees. Porting fees decreased from $1.4 million for the three months
ended March 31, 1997 to $1.0 million for the three months ended March 31, 1998.
During the third quarter of 1996, the Company entered into an agreement with
Microsoft Corporation whereby the Company committed to develop versions of its
Volume Manager products to be included in future releases of Microsoft Windows
NT. Porting fees related to the efforts incurred in supporting the development
needs of the Microsoft project, for which revenue is being recognized under the
percentage of completion method, were greater in the three months ended March
31, 1997 than in the three months ended March 31, 1998.
Cost of Revenue
Cost of user license fees consists primarily of royalties, media, manuals
and distribution costs. Cost of service revenue consists primarily of
personnel-related costs in providing maintenance, technical support, consulting
and training to customers. Cost of porting fees consists primarily of
personnel-related costs for development efforts. Gross margin on user license
fees is substantially higher than gross margin on service revenue and porting
fees, reflecting the low materials, packaging and other costs of software
products compared with the relatively high personnel costs associated with
providing maintenance, technical support, consulting, training services and
development efforts. Cost of service revenue also varies based upon the mix of
maintenance, technical support, consulting and training services.
Cost of User License Fees. Cost of user license fees increased 135% from
$0.8 million for the three months ended March 31, 1997 to $2.0 million for the
three months ended March 31, 1998. Gross margin on user license fees decreased
from 96% for the three months ended March 31, 1997 to 94% for the three months
ended March 31, 1998. The gross margin on user license fees may vary from period
to period based on the license revenue mix and certain products having higher
royalty rates than other products. The Company does not expect improvements in
gross margin on user license fees.
Cost of Service Revenue. Cost of service revenue increased 184% from $1.2
million for the three months ended March 31, 1997 to $3.4 million for the three
months ended March 31, 1998. Gross margin on service revenue decreased from 67%
for the three months ended March 31, 1997 to 54% for the three months ended
March 31, 1998, primarily due to personnel additions to both the Company's
support organization to provide maintenance and other service and, the Company's
training and consulting organization to build the appropriate infrastructure.
Cost of Porting Fees. Cost of porting fees increased from $0.7 million for
the three months ended March 31, 1997 to $1.1 million for the three months ended
March 31, 1998. Gross margin on porting fees decreased from 48% for the three
months ended March 31, 1997 to a negative gross margin of 8% for the three
months ended March 31, 1998. The negative gross margin for the three months
ended March 31, 1998 resulted from the Company devoting technical resources to
funded porting activities beyond the amounts payable by the customer. From time
to time, the Company incurs a negative gross margin on porting fees due to the
relatively high personnel costs associated with such development efforts.
11
<PAGE> 12
Operating Expenses
Selling and Marketing. Selling and marketing expenses consist primarily of
salaries, related benefits, commissions, consultant fees and other costs
associated with the Company's sales and marketing efforts. Selling and marketing
expenses increased 41% from $9.3 million for the three months ended March 31,
1997 to $13.1 million for the three months ended March 31, 1998. Selling and
marketing expenses as a percentage of total net revenue decreased from 36% for
the three months ended March 31, 1997 to 33% for the three months ended March
31, 1998. The increase in absolute dollars is primarily attributable to
increased sales and marketing staffing and increased costs associated with
certain marketing programs. The Company intends to continue to expand its global
sales and marketing infrastructure, and accordingly, the Company expects its
selling and marketing expenses to increase in the future.
Research and Development. Research and development expenses consist
primarily of salaries, related benefits, third-party consultant fees and other
costs. Research and development expenses increased 30% from $5.8 million for the
three months ended March 31, 1997 to $7.5 million for the three months ended
March 31, 1998 primarily reflecting increased staffing levels. As a percentage
of total net revenue, research and development expenses decreased from 23% for
the three months ended March 31, 1997 to 19% for the three months ended March
31, 1998. The Company believes that a significant level of research and
development investment is required to remain competitive, and expects such
expenses will increase in future periods, although such expenses may continue to
decline as a percentage of total net revenue to the extent revenue increases.
General and Administrative. General and administrative expenses consist
primarily of salaries, related benefits and fees for professional services, such
as legal and accounting services. General and administrative expenses increased
2% from $2.1 million for the three months ended March 31, 1997 to $2.2 million
for the three months ended March 31, 1998. The increase was primarily due to
additional costs associated with the Company enhancing its infrastructure to
allow operations to expand. General and administrative expenses as a percentage
of total net revenue decreased from 8% for the three months ended March 31, 1997
to 6% for the three months ended March 31, 1998. General and administrative
expenses are expected to increase in future periods to the extent the Company
expands its operations.
Other Income, Net. Other income, net increased 52% from $0.8 million for
the three months ended March 31, 1997 to $1.3 million for the three months ended
March 31, 1998. The increase was due primarily to increased amounts of interest
income attributable to the higher level of funds available for investment,
partially offset by increased amounts of interest expense accrued for the
Company's long-term debt.
Provision for Income Taxes. The Company had an effective tax rate of 18%
and 16% for the three month periods ended March 31, 1998 and 1997, respectively.
The Company's effective tax rate is lower than the combined federal and state
statutory rates primarily due to the utilization of federal net operating loss
carry forwards, offset by the impact of non-deductible merger-related costs and
in-process research and development, as well as foreign taxes.
The Company accounts for its income taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under
SFAS 109, deferred tax liabilities and assets are recognized for the expected
future tax consequences of temporary differences between the carrying amount of
assets and liabilities for financial reporting and the amounts used for income
tax purposes. The realization of the Company's net deferred tax assets, which
relate primarily to net operating loss and tax credit carryforwards and
temporary differences, is dependent on generating sufficient taxable income in
future periods. Although realization is not assured, management believes it is
more likely than not that the net deferred tax asset will be realized. The
amount of the net deferred tax assets considered realizable, however, could be
reduced or increased in the near term if estimates of future taxable income are
changed. Management intends to evaluate the realizability of the net deferred
tax assets on a quarterly basis to assess the need for the valuation allowance.
New Accounting Pronouncements. In June 1997, the Financial Accounting
Standards Board issued Statement No. 130, "Reporting Comprehensive Income" (SFAS
130) and Statement No. 131, "Disclosures
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About Segments of An Enterprise and Related Information" (SFAS 131). SFAS 130
established rules for reporting and displaying comprehensive income. SFAS 131
will require the Company to use the "management approach" in disclosing segment
information. Both statements are effective for the Company during 1998. The
adoption of SFAS 130 or SFAS 131 did not have a material impact on the Company's
results of operations, cash flows or financial position in the three months
ended March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and short-term investments totaled
$205.7 million at March 31, 1998 and represented 79% of total assets. Cash and
cash equivalents are highly liquid with original maturities of ninety days or
less. Short-term investments consist mainly of investment grade commercial
paper. At March 31, 1998, the Company had $100.9 million of long-term
obligations and stockholders' equity was approximately $117.5 million.
Net cash provided by operating activities was $15.3 million and $0.4
million in the three months ended March 31, 1998 and 1997, respectively. Cash
provided by operating activities increased primarily as a result of higher net
income, increases in accrued liabilities and deferred revenue balances and
reductions in prepaid expenses and accounts receivable.
The Company's investing activities used cash of $28.0 million in the three
months ended March 31, 1998 due to the net increase in short-term investments of
$23.3 million and capital expenditures of $4.7 million. The Company's investing
activities used cash of $2.4 million in the three months ended March 31, 1997
and consisted primarily of $1.7 million used for capital expenditures and $0.7
million of net purchases of short-term investments.
Financing activities provided cash of $4.3 million in the three months
ended March 31, 1998 from the issuance of common stock under the Company's
employee stock plans. In the three months ended March 31, 1997, financing
activities provided cash of $0.5 million that reflects the net proceeds of $1.1
million from the issuance of common stock under the Company's employee stock
plans partially offset by payments of $0.6 million of notes payable.
In October 1997, the Company issued $100.0 million of 5.25% Convertible
Subordinated Notes due 2004 (the "Notes"), for which the Company received net
proceeds of $97.5 million. The Notes provide for semi-annual interest payments
each May 1 and November 1, commencing on May 1, 1998. The Notes are convertible
into shares of the Company's Common Stock at any time prior to the close of
business on the maturity date, unless previously redeemed or repurchased, at a
conversion price of $64.50 per share, subject to adjustment in certain events.
On or after November 5, 2002, the Notes will be redeemable over the period of
time until maturity at the option of the Company at declining premiums to par.
The debt issuance costs are being amortized over the term of the Notes using the
interest method.
The Company believes that its current cash, cash equivalents and short-term
investment balances and cash flow from operations, if any, will be sufficient to
meet the Company's working capital and capital expenditure requirements for at
least the next twelve months. Thereafter, the Company may require additional
funds to support its working capital requirements or for other purposes and may
seek to raise such additional funds through public or private equity financing
or from other sources. There can be no assurance that additional financing will
be available at all or that if available, such financing will be obtainable on
terms favorable to the Company.
FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to other information in this Report on Form 10-Q, the following
factors should be considered carefully in evaluating the Company and its
business.
Fluctuating Operating Results. The Company's operating results have
fluctuated in the past, and may fluctuate significantly in the future depending
on a number of factors. Factors that have resulted in fluctuations in operating
results include: (i) the timing and level of sales by the Company's OEM
licensees of computer systems incorporating the Company's storage management
products; (ii) a significant increase in
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dependence upon non-OEM distribution channels, which tend to be more
unpredictable than OEM channels; (iii) timing of revenue recognition related to
source code license fees; (iv) achievement of porting milestones; (v)
expenditures related to investment in new products and distribution channels,
including the hiring of additional selling and marketing personnel and outlay of
promotional expenses; and (vi) the timing and extent of sales and marketing
organizations within OEM customers and resellers becoming adept in and endorsing
the Company's products for resale.
In addition to the factors described above, factors that may contribute to
future fluctuations in quarterly operating results include, but are not limited
to: (i) development and introduction of new operating systems that require
additional development efforts; (ii) introduction or enhancement of products by
the Company or its competitors; (iii) changes in pricing policies of the Company
or its competitors; (iv) increased competition; (v) technological changes in
computer systems and environments; (vi) the ability of the Company to develop,
introduce and market new products in a timely manner including products for
Windows NT; (vii) quality control of products sold; (viii) market readiness to
deploy storage management products for distributed computing environments; (ix)
market acceptance of new products and product enhancements; (x) customer order
deferrals in anticipation of new products and product enhancements; (xi) the
Company's success in expanding its sales and marketing programs; (xii) personnel
changes; (xiii) foreign currency exchange rates; (xiv) mix of products sold;
(xv) acquisition costs; (xvi) the size and timing of orders; (xvii) seasonality
of revenue; and (xviii) general economic conditions.
The Company's operating results are highly sensitive to the timing of
larger orders. Orders typically range from a few thousand dollars to several
hundred thousand dollars. Revenue is difficult to forecast because the
client/server systems management software market is an emerging market that is
highly fragmented and subject to rapid change. The sale of the Company's
products also typically involves a significant technical evaluation and
commitment of capital and other resources, with the delays frequently associated
with customers' internal procedures, including delays to approve large capital
expenditures, to engineer deployment of new technologies within their networks,
and to test and accept new technologies that affect key operations. For these
and other reasons, the sales cycle associated with the Company's products is
typically lengthy, generally lasting three to nine months, is subject to a
number of significant risks, including customers' budgetary constraints and
internal acceptance reviews, that are beyond the Company's control, and varies
substantially from transaction to transaction. Because of the lengthy sales
cycle and the large size of certain transactions, if orders forecasted for a
specific transaction for a particular quarter are not realized in that quarter,
the Company's operating results for that quarter could be materially adversely
affected.
The Company's future revenue will continue to be difficult to predict, and
the Company has, in the past, failed to achieve its revenue expectations for
certain periods. Because the Company generally ships software products within a
short period after receipt of an order, it typically does not have a material
backlog of unfilled orders, and revenue in any quarter is substantially
dependent on orders booked and shipped in that quarter. In addition, the Company
typically recognizes a significant portion of its direct sales license revenue
in the last two weeks of a quarter. The Company's expense levels are based, in
part, on its expectations as to future revenue and to a large extent are fixed
in the short term. The Company will not be able to adjust expenses in the short
term to compensate for any unexpected revenue shortfall. Accordingly, any
significant shortfall of revenue in relation to the Company's expectations or
any material delay of customer orders would have an immediate adverse effect on
its business, operating results and financial condition. As a result of all of
the foregoing factors, the Company believes that period-to-period comparisons of
the Company's results of operations are not and will not necessarily be
meaningful and should not be relied upon as any indication of future
performance. Furthermore, it is possible that in future quarters the Company's
operating results may not meet or exceed the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
would be materially adversely affected.
Management of Growth; Dependence on Key Personnel. The Company
significantly increased in size as a result of the Merger, has continued to grow
since that time and expects to continue to experience periods of significant
growth in the future. The Company's agreements with key OEMs such as Sun
Microsystems, HP and Microsoft require the hiring of additional engineering,
sales and support personnel, and the commitment of significant staffing to the
performance of the Company's obligations under such agreements. Such growth is
likely to strain the Company's management control systems and resources
(including decision support,
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accounting, e-mail and management information systems). With future growth, the
Company will be required to continue to improve its financial and management
controls, reporting systems and procedures on a timely basis, to expand, train
and manage its employee work force and to secure additional facilities when and
if needed. There can be no assurance that the Company will be able to manage
such growth effectively. Any failure to do so could have a material adverse
effect on its business, operating results and financial condition. Competition
for qualified sales, technical and other personnel is intense, and there can be
no assurance that the Company will be able to attract, assimilate or retain
additional highly qualified employees in the future. If the Company is unable to
hire and retain such personnel, particularly those in key positions, its
business, operating results and financial condition would be materially and
adversely affected. The Company's future success also depends in significant
part upon the continued service of its key technical, sales and senior
management personnel. The loss of the services of one or more of these key
employees could have a material adverse effect on its business, operating
results and financial condition. Additions of new personnel and departures of
existing personnel, particularly in key positions, can be disruptive and can
result in departures of other existing personnel, which could have a material
adverse effect on the Company's business, operating results and financial
condition.
New Distribution Channels. A significant portion of the Company's net
revenues are derived from user license fees received from computer OEMs that
incorporate the Company's storage management software products into their
operating systems. The Company has no control over the shipping dates or volumes
of systems shipped by its OEM customers, and there can be no assurance that any
OEMs will ship operating systems incorporating the Company's products in the
future. Furthermore, the Company's license agreements with its OEM customers
generally do not require the OEMs to recommend or offer the Company's products
exclusively, have no minimum sales requirements and may be terminated by the
OEMs without cause.
The Company's strategic relationships with HP, Sun Microsystems and
Microsoft reflect a strategy for OEM product distribution involving the bundling
by OEMs of certain functional subsets or "lite" versions of the Company's
products with OEM computer systems or operating systems, cooperative direct
selling of full versions of such products by the Company and the OEMs, and the
direct sale by the Company of added value products to the OEM installed base of
customers. There can be no assurance that the Company will be able to deliver
its products to such OEMs in a timely manner despite the dedication of
significant engineering and other resources to the development of such products.
Any such failure could result in the Company having expended significant
resources with little or no return on its investment, which could have a
material adverse effect on the Company's business, operating results and
financial condition. There can further be no assurance that this distribution
strategy will achieve the desired propagation of the Company's technology in the
market place, or result in sufficient revenues to the OEMs to induce OEMs to
actively market the Company's products to their customers, which could have a
material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that the simultaneous sales
efforts of such OEMs and the Company will not create certain channel conflicts.
Furthermore, failure of the Company to timely develop and achieve market
acceptance of new products for sale to the OEM installed customer base could
lead to a significant loss of potential revenue to the Company.
In connection with the Company's agreement with Microsoft, there can be no
assurance that Microsoft will use the Company's products in any future version
of Windows NT, nor that the Company will realize any expected benefits even if
such products are used in any future version of Windows NT. If the Company's
products are not available in a timely fashion, if Microsoft does not use these
products in Windows NT, or if the Company does not receive any benefits for the
use of its products in Windows NT, the Company's business, operating results and
financial condition could be materially adversely affected. If the release by
Microsoft of Windows NT 5.0 is significantly delayed, and/or the rate of
adoption of Windows NT 5.0 by users is slow, the Company will not be in a
position to market add-on products to the Windows NT installed customer base,
thereby resulting in possible delays in, or loss of, revenue to the Company.
Moreover, the Company would have lost certain opportunities as a result of the
diversion of resources to this agreement. Under this agreement, Microsoft is
also permitted to develop enhancements to and derivative products from the
Company's products that are embedded in certain Windows NT releases, and would
retain ownership of any such enhancements or derivative products. There can be
no assurance that Microsoft will not develop any such enhancements or derivative
products and, as a result, compete with the Company in this area.
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In recent years, the Company has made significant investments in the
establishment of other distribution channels. Efforts by the Company in this
area include: (i) the introduction of shrink wrap packages of certain VERITAS
storage management software products for multiple platforms; (ii) the
distribution of end-user products for the Sun Microsystems' Solaris operating
system; (iii) the acquisition of Tidalwave Technologies, Inc. ("Tidalwave") in
April 1995, as a result of which the Company began distributing the VERITAS
FirstWatch end-user products; and (iv) the Merger with OpenVision that provided
the Company an established and significant direct sales channel.
As a result of the Merger, the Company's direct sales force is marketing
and selling the Company's products in competition with indirect sellers of its
products, such as OEMs and resellers, which could adversely affect the Company's
relations with such indirect sellers and result in such sellers being less
willing to market the Company's products aggressively. There can be no assurance
that such sales and marketing efforts by the Company's direct sales force will
not result in a decline in indirect sales as a result of actual or potential
competition between the Company's direct sales force and such indirect sellers,
or that such efforts will not have a material adverse effect on the Company's
business, operating results and financial condition. In addition, any such
decline in indirect sales may require the Company to accelerate investments for
expansion into alternative distribution channels, and no assurance can be given
that the Company will have sufficient resources to devote to such other
channels.
Increasing Product Concentration; Dependence on Growth of Storage
Management Software Market. A substantial majority of the Company's revenues
have been, and in future periods will be, derived from storage management
products. Storage management products accounted for 95% and 90% of the Company's
license revenue in the three months ended March 31, 1998 and 1997, respectively.
The Company expects that storage management products will continue to account
for a substantial majority of the Company's revenues in future periods as a
result of its strategic decision to devote greater financial and other resources
to selling, servicing and supporting its storage management products. The
allocation of greater levels of sales, service and support resources to such
products could adversely affect the Company's ability to continue enhancing and
supporting its other product lines. Any failure by the Company to enhance and
support its other product lines could result in adverse customer reactions and
the loss of an existing revenue base, and could have a material adverse effect
on the Company's business, operating results and financial condition.
The Company's future financial performance will depend in large part on
continued growth in the number of companies adopting storage management
solutions for their client/server computing environments. There can be no
assurance that the market for storage management software and services will
continue to grow. If the storage management software and services market fails
to grow or grows more slowly than the Company currently anticipates, or in the
event of a decline in unit price or demand for the Company's storage management
products, as a result of competition, technological change or other factors, the
Company's business, operating results and financial condition would be
materially and adversely affected. The Company's financial performance may, in
the future, experience substantial fluctuations as a consequence of such
industry patterns, general economic conditions affecting the timing of orders,
and other factors affecting capital spending. There can be no assurance that
such factors will not have a material adverse effect on the Company's business,
operating results and financial condition.
Inability to Integrate Current and Future Products and
Technologies. Following the Merger, the Company commenced integration of
selected products and technologies to enhance storage management functionality
and the integration of products throughout its entire product line through the
availability of common services. The Company's success is dependent in
significant part on the Company's ability to integrate its products as planned
and the resultant products achieving market acceptance by end users, resellers
and OEMs. No assurance can be given that the Company will successfully integrate
its products as planned. If the Company is unable to develop and introduce new
integrated products and technologies, or enhancements to existing products, in a
timely manner, its business, operating results and financial condition would be
materially and adversely affected.
Uncertainty in Porting Products to New Operating Systems and Expansion into
Windows NT Market. Certain of the Company's products operate primarily on
certain versions of the UNIX operating system.
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Product development activities are being directed towards developing new
products for the UNIX operating system, developing enhancements to the Company's
current products and porting new products and enhancements to other versions of
the UNIX operating system. The Company has also made and intends to continue to
make substantial investments in porting its products to new operating systems,
including Windows NT, and the Company's future success will depend on its
ability to successfully accomplish such ports. In addition, the Company's
Windows NT product development efforts may be dependent on product development
funding received from third parties. If such funding is delayed or not
ultimately received, the Company's Windows NT development efforts could be
delayed, which could adversely affect the Company's business, operating results
and financial condition.
The process of porting existing products and product enhancements to, and
developing new products for, new operating systems requires a substantial
capital investment, the devotion of substantial employee resources and the
cooperation of the owners of the operating systems to which the products are
being ported or developed. For example, the added focus on porting and
development work for the Windows NT market has required, and will require, the
Company to hire additional personnel with expertise in the Windows NT
environment and to devote its engineering resources to these projects. The
diversion of engineering personnel to this area may cause delays in other
product development efforts of the Company. Furthermore, operating system owners
have no obligation to assist in these porting or development efforts, and may
instead choose to enter into agreements with other third-party software
developers or internally develop their own products. In particular, the failure
to receive a source code license to certain portions of the operating system,
either from the operating system owner or a licensee thereof, would prevent the
Company from porting its products to or developing products for such operating
system. There can be no assurance that the Company's current or future porting
efforts will be successful or, even if successful, that the operating system to
which the Company elects to port, or for which it elects to develop products,
will achieve or maintain market acceptance. The failure of the Company to port
its products to new operating systems or to select those operating systems that
achieve and maintain market acceptance could have a material adverse effect on
the Company's business, operating results and financial condition.
The Company's agreement with Microsoft requires the Company to develop a
functional subset of the VERITAS Volume Manager product to be ported to and
embedded in Windows NT. The agreement also requires the Company to develop a
disk management graphical user interface designed specifically for Windows NT.
Microsoft is obligated to fund a significant portion of the development expenses
for this product. The Company is currently recognizing revenue under the
development contract with Microsoft on a percentage of completion basis
consistent with its policy for revenue recognition for other similar agreements.
The payment terms in the Microsoft agreement do not directly correlate to the
timing of development efforts and therefore revenue of $1.8 million has been
recognized in advance of payment as of March 31, 1998. The failure of the
Company to complete the product in sufficient time for inclusion in Windows NT
5.0 may result in a significant delay of the product being embedded in Windows
NT, and could ultimately result in Microsoft electing to omit the Company's
product from Windows NT altogether, which could have a material adverse effect
on the Company's business, operating results and financial condition. In
addition, the Microsoft relationship will require the Company's marketing and
sales departments to deal in higher volume markets and will require the Company
to service the growing needs of the Windows NT channel and customer base. The
Company's experience in these higher volume markets is limited.
Risk of Software Defects; Product Liability. Software products as complex
as those to be offered by the Company frequently contain errors or defects,
especially when first introduced or when new versions or enhancements are
released. Despite product testing, the Company has in the past released products
with defects, discovered software errors in certain of its new products after
introduction and experienced delayed or lost revenue during the period required
to correct these errors. The Company has regularly introduced, and the Company
intends to continue to introduce, new products and enhancements to existing
products. Despite testing by the Company and by current and potential customers,
there can be no assurance that defects and errors will not be found in existing
products or in new products, versions or enhancements after commencement of
commercial shipments. Any such defects and errors could result in adverse
customer reactions, negative publicity regarding the Company and its products,
harm to the Company's reputation, loss of or delay
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in market acceptance or require expensive product changes, any of which could
have a material adverse effect upon the Company's business, operating results
and financial condition. Further, the Company could be subject to liability
claims (for which it carries insurance, although such insurance may not be
sufficient to fully protect the Company against losses relating to such claims)
that could have a material adverse effect on the Company's business, operating
results and financial condition.
The Company derives a significant amount of revenue from products licensed
pursuant to "shrink wrap" licenses that are not signed by licensees and,
therefore, may be unenforceable under the laws of certain jurisdictions. The
Company's products will be generally used to manage data critical to
organizations, and, as a result, the sale and support of products by the Company
may entail the risk of product liability claims. Although the Company maintains
errors and omissions product liability insurance, such insurance may not
adequately compensate the Company for losses relating to such claims and a
successful liability claim brought against the Company could have a material
adverse effect upon the Company's business, operating results and financial
condition.
Intense Competition. The markets in which the Company competes are
intensely competitive and rapidly changing. The Company's principal competition
in the storage management market consists of internal development groups of
current and prospective OEM customers, which have the resources and capability
to develop their own storage management solutions. Among the OEMs which have
included storage management capabilities in their operating systems are Sun
Microsystems for its Solaris system, DEC for its Digital UNIX system, HP for its
HP-UX system and Microsoft for Windows NT. The Company also encounters
competition from other third party software vendors and hardware companies
offering products that incorporate certain of the features provided by the
Company's products, and from disk controller and disk subsystem manufacturers
which have included or may include similar features.
As a result of the Merger and the associated higher visibility of the
Company in certain markets, the Company faces new competitors and new
competitive factors. In particular, the Company's new competitors include: (i)
hardware and software vendors that offer a management platform or framework to
support vendor-created and third-party systems management applications; (ii)
vendors that provide systems management software for the mainframe environment
who are migrating their products to the client/server environment; (iii) vendors
that provide "point" products that address specific problems and offer specific
functionality; and (iv) vendors that provide integrated and interoperable
solutions. Specific competitors that the Company has encountered or expects to
encounter as competitors include the Cheyenne division of Computer Associates
International, Inc. ("Computer Associates"), the ADSTAR Distributed Storage
Manager division of International Business Machines Corporation ("IBM"), Legato
Systems, Inc. and EMC Corporation. Many such competitors have substantially
greater financial, technical, sales, marketing and other resources, as well as
greater name recognition and a larger installed customer base, than the Company.
The Company expects that the market for storage management software, which
historically has been large and fragmented, will become more consolidated with
larger companies being better positioned to compete in such environment in the
long term. As the open systems management software market develops, a number of
companies with greater resources than the Company could attempt to increase
their presence in this market by acquiring or forming strategic alliances with
competitors or business partners of the Company. For example, in 1996 IBM
purchased Tivoli Systems Inc. and Computer Associates purchased Cheyenne
Software; both Tivoli and Cheyenne are competitors of the Company.
The Company's success will depend significantly on its ability to adapt to
these new competing forces, to develop more advanced products more rapidly and
less expensively than its competitors, and to educate potential customers as to
the benefits of licensing the Company's products rather than developing their
own products. The Company's future and existing competitors could introduce
products with superior features, scalability and functionality at lower prices
than the Company's products and could also bundle existing or new products with
other more established products in order to compete with the Company. In
addition, because there are relatively low barriers of entry for the software
market, the Company expects additional competition from other established and
emerging companies. Increased competition is likely to result in price
reductions, reduced gross margins and loss of market share, any of which could
materially and adversely affect the Company's business, operating results and
financial condition. There can be no assurance that the
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Company will be able to compete successfully against current and future
competitors, and the failure to do so would result in the Company's business,
operating results and financial condition being materially and adversely
affected.
Rapid Technological Change and Requirement for Frequent Product
Transitions. The market for the Company's products is intensely competitive,
highly fragmented and characterized by rapid technological developments,
evolving industry standards and rapid changes in customer requirements. The
introduction of products embodying new technologies, the emergence of new
industry standards or changes in customer requirements could render the
Company's existing products obsolete and unmarketable. As a result, the
Company's success depends upon its ability to continue to enhance existing
products, respond to changing customer requirements and develop and introduce in
a timely manner new products that achieve market acceptance and keep pace with
technological developments and emerging industry standards. Customer
requirements include, but are not limited to, product operability and support
across distributed and changing heterogeneous hardware platforms, operating
systems, relational databases and networks. For example, as the Company's
customers start to utilize Windows NT or other emerging operating platforms, it
will become necessary for the Company to enhance its products to operate on such
platforms in order to meet these customers' requirements. There can be no
assurance that the Company's products will achieve market acceptance or will
adequately address the changing needs of the marketplace or that the Company
will be successful in developing and marketing enhancements to its existing
products, or new products incorporating new technology, on a timely basis. The
Company has in the past experienced delays in product development, and there can
be no assurance that the Company will not experience further delays in
connection with its current product development or future development
activities. There can be no assurance that the Company will have the resources
necessary to perform its obligations under its development agreements in a
timely and efficient manner or that its development efforts will be successful.
If the Company is unable to develop and introduce new products or enhancements
to existing products in a timely manner in response to changing market
conditions or customer requirements, the Company's business, operating results
and financial condition will be materially and adversely affected. Because the
Company has limited resources, it must restrict its product development efforts
to a relatively small number of products and operating systems. There can be no
assurance that these efforts will be successful or, even if successful, that any
resulting product or operating system will achieve market acceptance.
Dependence on Proprietary Technology; Risks of Infringement. The Company's
success depends upon its proprietary technology. The Company relies on a
combination of copyright, trademark and trade secret laws, confidentiality
procedures and licensing arrangements to establish and protect its proprietary
rights. The Company presently has no patents although it has filed several
patent applications. As part of its confidentiality procedures, the Company
generally enters into non-disclosure agreements with its employees, distributors
and corporate partners, and license agreements with respect to its software,
documentation and other proprietary information. Despite these precautions, it
may be possible for a third party to copy or otherwise obtain and use the
Company's products or technology without authorization, or to develop similar
technology independently. Policing unauthorized use of the Company's products is
difficult and although the Company is unable to determine the extent to which
piracy of its software products exists, software piracy can be expected to be a
persistent problem. In selling its products, the Company relies in part on
"shrink wrap" licenses that are not signed by licensees and, therefore, may be
unenforceable under the laws of certain jurisdictions. In addition, effective
protection of intellectual property rights is unavailable or limited in certain
foreign countries. There can be no assurance that the Company's protection of
its proprietary rights, including any patent that may be issued, will be
adequate or that the Company's competitors will not independently develop
similar technology, duplicate the Company's products or design around any
patents issued to the Company or its other intellectual property rights.
The Company is not aware that any of its products infringe the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not claim such infringement by the Company with respect to current or
future products. The Company expects that software product developers will
increasingly be subject to such claims as the number of products and competitors
in the Company's industry segment grows and the functionality of products in the
industry segment overlaps. Any such claims, with or without merit,
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could result in costly litigation that could absorb significant management time,
which could have a material adverse effect on the Company's business, operating
results and financial condition. Such claims might require the Company to enter
into royalty or license agreements. Such royalty or license agreements, if
required, may not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
Risks Associated With International Operations. International revenue (from
sales outside the United States and Canada) accounted for 22% of the Company's
total revenues for both of the three month periods ended March 31, 1998 and
1997. The Company believes that its future success depends upon continued
expansion of its international operations. The Company currently has sales and
service offices in the United States, Canada, Japan, the United Kingdom,
Germany, France, Sweden and the Netherlands and has a product development group
in India. The Company also has resellers in North America, Europe, Asia Pacific,
South America and the Middle East. International expansion may require the
Company to establish additional foreign offices, hire additional personnel and
recruit additional international resellers. This may require significant
management attention and financial resources and could adversely affect the
Company's operating margins. To the extent the Company is unable to effect these
additions efficiently and in a timely manner, its growth, if any, in
international sales will be limited, and its business, operating results and
financial condition could be materially and adversely affected. There can be no
assurance that the Company will be able to maintain or increase international
market demand for its products.
As of March 31, 1998, the Company had 45 engineers employed by its Indian
subsidiary located in Pune, India, who perform certain product development work.
These international operations subject the Company to a number of risks inherent
in developing products outside of the United States, including the potential
loss of developed technology, imposition of governmental controls, export
license requirements, restrictions on the export of critical technology,
political and economic instability, trade restrictions, difficulties in managing
international operations and lower levels of intellectual property protection.
Furthermore, if the Company were required to discontinue its product development
efforts in India, it would incur significantly higher operating expenses as a
result of having to perform such development work in the United States.
From time to time, the Company may engage in exchange rate hedging
activities. Such activities have been insignificant to date. There can be no
assurance that any hedging techniques implemented by the Company will be
successful.
The Company's international business also involves a number of additional
risks, including lack of acceptance of localized products, cultural differences
in the conduct of business, longer accounts receivable payment cycles, greater
difficulty in accounts receivable collection, seasonality due to the slow-down
in European business activity during the Company's third fiscal quarter,
unexpected changes in regulatory requirements and royalty and withholding taxes
that restrict the repatriation of earnings, tariffs and other trade barriers,
and the burden of complying with a wide variety of foreign laws. The Company's
international sales are generated primarily through its international sales
subsidiaries and are denominated in local currency, creating a risk of foreign
currency translation gains and losses. To the extent profit is generated or
losses are incurred in foreign countries, the Company's effective income tax
rate may be materially and adversely affected. In some markets, localization of
the Company's products is essential to achieve market penetration. The Company
may incur substantial costs and experience delays in localizing its products,
and there can be no assurance that any localized product will ever generate
significant revenue. There can be no assurance that any of the factors described
herein will not have a material adverse effect on the Company's future
international sales and operations and, consequently, its business, operating
results and financial condition.
Year 2000 Compliance. The Company is aware of the issues associated with
the programming code in existing computer systems as the millennium ("Year
2000") approaches. The Year 2000 problem is pervasive and complex as virtually
every computer operation will be affected in some way by the rollover of the two
digit year value to 00. Systems that do not properly recognize date sensitive
information when the year changes to 2000 could generate erroneous data or cause
a system to fail. Significant uncertainty exists in the software industry
concerning the potential effects associated with such compliance. The Company
has tested its existing products and believes that it has identified, corrected
and reprogrammed them to be Year 2000
20
<PAGE> 21
compliant, and new products are being designed to be Year 2000 compliant.
Although products have undergone, or will undergo, the Company's normal quality
testing procedures, there can, however, be no assurance that the Company's
products will contain all necessary date code changes. Any failure of the
Company's products to perform, including system malfunctions due to the onset of
the calendar year 2000, could result in claims against the Company, which could
have a material adverse effect on the Company's business, financial condition or
results of operations. Moreover, the Company's customers could choose to convert
to other calendar year 2000 compliant products or to develop their own products
in order to avoid such malfunctions, which could have a material adverse effect
on the Company's business, financial condition or results of operations.
The Company is also currently in the process of evaluating its information
technology infrastructure for Year 2000 compliance. In the event that any of the
Company's significant suppliers or customers does not successfully and timely
achieve Year 2000 compliance, the Company's business or operations could be
adversely affected. This could result in system failures or generation of
erroneous information and could cause significant disruption to business
activities. The Company is reviewing what actions are required to make all
software systems used internally Year 2000 compliant as well as actions needed
to mitigate vulnerability to problems with suppliers and other third parties'
systems. Such actions include a review of vendor contracts and formal
communication with suppliers to request certification that products are Year
2000 compliant. The Company is assessing the extent of the necessary
modifications to its computer software, and management does not anticipate that
the Company will incur significant operating expenses or be required to invest
heavily in computer system improvements to be Year 2000 compliant. There can,
however, be no assurance that such measures will alleviate the Year 2000
problems which could have a material adverse effect upon the Company's business,
operating results and financial condition.
Significant Leverage; Debt Service. In connection with the sale of 5.25%
Convertible Subordinated Notes due 2004 (the "Notes"), the Company incurred $100
million aggregate principal amount of indebtedness which resulted in a ratio of
long-term debt to total capitalization at March 31, 1998 of approximately 46.2%.
As a result of this additional indebtedness, the Company's principal and
interest payment obligations will increase substantially. The degree to which
the Company will be leveraged could materially and adversely affect the
Company's ability to obtain financing for working capital, acquisitions or other
purposes and could make it more vulnerable to industry downturns and competitive
pressures. The Company's ability to meet its debt service obligations will be
dependent upon the Company's future performance, which will be subject to
financial, business and other factors affecting the operations of the Company,
many of which are beyond its control.
The Company will require substantial amounts of cash to fund scheduled
payments of principal and interest on its indebtedness, including the Notes,
future capital expenditures and any increased working capital requirements. If
the Company is unable to meet its cash requirements out of cash flow from
operations, there can be no assurance that it will be able to obtain alternative
financing. In the absence of such financing, the Company's ability to respond to
changing business and economic conditions, to make future acquisitions, to
absorb adverse operating results or to fund capital expenditures or increased
working capital requirements may be adversely affected. If the Company does not
generate sufficient increases in cash flow from operations to repay the Notes at
maturity, it could attempt to refinance the Notes; however, no assurance can be
given that such a refinancing would be available on terms acceptable to the
Company, if at all. Any failure by the Company to satisfy its obligations with
respect to the Notes at maturity (with respect to payments of principal) or
prior thereto (with respect to payments of interest or required repurchases)
would constitute a default under the Indenture and could cause a default under
agreements governing other indebtedness, if any, of the Company.
Past and Future Acquisitions. The Company has made several acquisitions in
the past, including the Merger with OpenVision. Acquisitions of companies,
divisions of companies or products entail numerous risks, including difficulty
in successfully integrating and assimilating acquired operations, diversion of
management's attention and loss of key employees of acquired companies.
Difficulties can arise with respect to the integration of product offerings and
employees of acquired companies, including conflicts that may arise with respect
to distribution strategies, coordination of geographically separated
organizations, differences in corporate culture
21
<PAGE> 22
and integration of personnel with disparate business backgrounds. The
integration and assimilation process can cause an interruption of, or a loss of
momentum in, the activities of the Company's business. Failure to accomplish the
effective integration of the Company's operations with those of an acquired
company could adversely affect the revenues and operating results of the
Company. In the past three years, the Company has made three acquisitions and
two divestitures of product lines; the Company may make additional acquisitions
or effect additional divestitures in the future. Products acquired by the
Company in the past have required significant additional development, such as
restructuring software code to support larger scale environments, porting
products to additional operating system platforms, regression testing and
improving network and device support, before they could be marketed and some
failed to generate revenue for the Company. No assurance can be given that the
Company will not incur similar problems in future acquisitions. Any such
problems could have a material adverse effect on the Company's business,
operating results and financial condition. In addition, future acquisitions by
the Company may result in dilutive issuances of equity securities, the
incurrence of additional debt, large one-time write-offs and the creation of
goodwill or other intangible assets that could result in amortization expense.
These factors could have a material adverse effect on the Company's business,
operating results and financial condition.
Volatility of Stock Price. The market price for the Company's Common Stock
is highly volatile. The trading price of the Company's Common Stock could be
subject to wide fluctuations in response to quarterly variations in operating
and financial results, announcements of technological innovations, new products,
acquisitions or dispositions, new customer relationships or new strategic
relationships by the Company or its competitors, changes in prices of the
Company's or its competitors' products and services, changes in product mix, or
changes in revenue and revenue growth rates for the Company. Statements or
changes in opinions, ratings, or earnings estimates made by brokerage firms or
industry analysts relating to the markets in which the Company does business, or
relating to the Company specifically, have resulted, and could in the future
result, in an immediate and adverse effect on the market price of the Company's
Common Stock. In addition, the stock market has from time to time experienced
extreme price and volume fluctuations, which have particularly affected the
market price for the securities of many high-technology companies and that often
have been unrelated or disproportionate to the operating performance of these
companies. These fluctuations, as well as general economic, market and political
conditions such as recessions or military conflicts, may adversely affect the
market price of the Company's Common Stock.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed herewith:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
27.1 Financial Data Schedule (EDGAR only)
</TABLE>
(b) Reports on Form 8-K. No reports on Form 8-K were filed by the
Registrant during the quarter ended March 31, 1998.
22
<PAGE> 23
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.
Date: May 12, 1998 VERITAS SOFTWARE CORPORATION
/s/ KENNETH E. LONCHAR
--------------------------------------
Kenneth E. Lonchar
Vice President, Finance and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
23
<PAGE> 24
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 1998 AND DECEMBER 31, 1997
AND THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS
ENDED MARCH 31, 1998 AND 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1998.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 67,303
<SECURITIES> 138,380
<RECEIVABLES> 29,758
<ALLOWANCES> 1,625
<INVENTORY> 0
<CURRENT-ASSETS> 238,508
<PP&E> 27,440
<DEPRECIATION> 13,814
<TOTAL-ASSETS> 258,883
<CURRENT-LIABILITIES> 40,529
<BONDS> 100,000
0
0
<COMMON> 190,196
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 258,883
<SALES> 30,689
<TOTAL-REVENUES> 39,082
<CGS> 1,966
<TOTAL-COSTS> 29,244
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,420
<INCOME-PRETAX> 11,103
<INCOME-TAX> 2,048
<INCOME-CONTINUING> 9,055
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,055
<EPS-PRIMARY> 0.29<F1>
<EPS-DILUTED> 0.27
<FN>
<F1>For Purposes of this Exhibit, Primary means Basic.
</FN>
</TABLE>
