-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K9WDQXWJQYXn0u6esLSCi0++zTqpwfxYJ6CMFOV3ax2DpCyCSlAH0gpNExrJyUGM INlS3DrW6Ow97isqoDzTnA== 0001012870-00-002945.txt : 20000518 0001012870-00-002945.hdr.sgml : 20000518 ACCESSION NUMBER: 0001012870-00-002945 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEGATO SYSTEMS INC CENTRAL INDEX KEY: 0000859360 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 943077394 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26130 FILM NUMBER: 639008 BUSINESS ADDRESS: STREET 1: 3210 PORTER DR CITY: PALO ALTO STATE: CA ZIP: 94304 BUSINESS PHONE: 4158126000 MAIL ADDRESS: STREET 1: 3210 PORTER DRIVE CITY: PALO ALTO STATE: CA ZIP: 94304 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2000 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to _____________. Commission File Number: 0-26130 LEGATO SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 94-3077394 (State of incorporation) (I.R.S. Employer Identification No.) 2350 West El Camino Real Mountain View, California 94040 (Address of principal executive offices) (650) 210-7000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of shares outstanding of the registrant's common stock as of March 31, 2000 was 86,774,992. Legato Systems, Inc. Index
Page PART I: Condensed Financial Information Item 1. Financial Statements: Condensed Consolidated Balance Sheet as of March 31, 2000 and December 31, 1999 3 Condensed Consolidated Statement of Operations for the three-month periods ended March 31, 2000 and 1999 4 Condensed Consolidated Statement of Cash Flows for the three-month periods ended March 31, 2000 and 1999 5 Notes to the Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Qualitative and Quantitative Disclosures About Market Risks 26 PART II: Other Information Item 1. Legal Proceedings 27 Items 2,3,4, and 5 N/A 27 Item 6. Exhibits and Reports on Form 8-K 28 Signature 28
Page 2 PART I: Condensed Financial Information Item 1: Financial Statements LEGATO SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEET (in thousands)
March 31, December 31, 2000 1999 ----------- ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents $ 120,205 $ 115,222 Short-term investments 45,648 42,983 Accounts receivable, net 47,731 53,387 Other current assets 10,739 10,112 Deferred tax asset 16,225 15,959 ----------- ---------- Total current assets 240,548 237,663 Long-term investments 9,595 11,723 Property and equipment, net 37,018 27,090 Intangible assets, net 132,528 141,988 Deferred tax assets - long term 3,878 2,176 Deposits and other assets 2,294 2,254 ----------- ---------- Total assets $ 425,861 $ 422,894 =========== ========== Liabilities and Stockholders' equity Current liabilities: Accounts payable $ 9,166 $ 5,757 Accrued compensation and benefits 12,915 16,867 Accrued liabilities 11,049 9,240 Short-term loan payable 6,847 6,847 Deferred revenue 47,703 46,438 ----------- ---------- Total current liabilities 87,680 85,149 Stockholders' equity: Capital stock and other comprehensive income 302,100 291,677 Retained earnings 36,081 46,068 ----------- ---------- Total stockholders' equity 338,181 337,745 ----------- ---------- Total liabilities and stockholders' equity $ 425,861 $ 422,894 =========== ==========
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements. Page 3 LEGATO SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (in thousands, except per share amounts)
Three Months Ended March 31, ------------------------------ 2000 1999 ----------- ----------- (unaudited) Revenue: Product license $ 34,736 $ 24,739 Service and support 20,514 14,267 Royalty 5,270 4,939 ----------- ----------- Total revenue 60,520 43,945 Cost of revenue: Product license 1,562 1,532 Service and support 8,624 5,355 ----------- ----------- Total cost of revenue 10,186 6,887 ----------- ----------- Gross profit 50,334 37,058 Operating expenses: Research and development 15,329 7,712 Sales and marketing 27,041 20,281 General and administrative 9,469 4,808 Amortization of intangibles 9,523 279 ----------- ----------- Total operating expenses 61,362 33,080 ----------- ----------- Income (loss) from operations (11,028) 3,978 Interest and other income, net 941 1,404 ----------- ----------- Income (loss) before provision for income taxes (10,087) 5,382 Provision (benefit from) for income taxes (100) 2,622 ----------- ----------- Net income (loss) $ (9,987) $ 2,760 =========== =========== Other comprehensive income (loss), net of tax: Unrealized gains on securities 3 32 ----------- ----------- Comprehensive income (loss) $ (9,984) $ 2,792 =========== =========== Basic earnings (loss) per share $ (0.12) $ 0.03 =========== =========== Diluted earnings (loss) per share $ (0.12) $ 0.03 =========== =========== Shares used in basic earnings (loss) per share calculations 86,394 78,873 =========== =========== Shares used in diluted earnings (loss) per share calculations 86,394 85,023 =========== ===========
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements. Page 4 LEGATO SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Three Months Ended March 31, ------------------------------ 2000 1999 ----------- ----------- Cash flows from operating activities: Net (loss) income $ (9,987) $ 2,760 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Net deferred tax asset (1,968) (2,924) Depreciation and amortization 12,609 2,312 Provision for doubtful accounts 150 150 Tax benefit from exercise of stock options 1,228 2,798 Changes in operating assets and liabilities: Accounts receivable 5,506 4,259 Other current assets (627) (467) Accounts payable 3,779 (956) Accrued compensation and benefits (3,952) (1,187) Accrued liabilities 1,439 (1,559) Deferred revenue 1,265 5,052 ----------- ----------- Net cash provided by operating activities 9,442 10,238 Cash flows from investing activities: Purchase of available-for-sale securities (14,475) (26,439) Maturities and sales of available-for-sale securities 13,941 26,207 Acquisition of property and equipment (13,008) (2,077) Purchase of long-term assets and other (109) (2,838) ----------- ----------- Net cash used in investing activities (13,651) (5,147) Cash flows from financing activities: Proceeds from issuance of common stock 9,192 4,709 Other -- (142) ----------- ----------- Net cash provided by financing activities 9,192 4,567 ----------- ----------- Net increase in cash and cash equivalents 4,983 9,658 Cash and cash equivalents at beginning of period 115,222 83,177 ----------- ----------- Cash and cash equivalents at end of period $ 120,205 $ 92,835 =========== ===========
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements. Page 5 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 1999 Report on Form 10-K should be read in conjunction with these Condensed Consolidated Financial Statements. 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 14, 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 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 these 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 will restate our revenues and results of operations for the quarters ended September 30, 1999, June 30, 1999 and March 31, 1999 and will revise our results for the quarter ended December 31, 1999 previously announced on January 19, 2000. 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 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 (Loss) Per Share Basic earnings (loss) per share is computed by dividing net (loss) income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is computed giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common equivalent shares consist of the incremental common shares issuable upon exercise of stock options. A reconciliation of the numerator and denominator of basic and diluted earnings (loss) per share is provided as follows (in thousands, except per share amounts): Three Months Ended March 31, ------------------ 2000 1999 -------- ------- Numerator - basic and diluted earnings (loss) per share - ------------------------------------------------------- Net (loss) income $ (9,987) $ 2,760 ======== ======== Denominator - basic earnings (loss) per share - --------------------------------------------- Weighted average common shares outstanding 86,394 78,873 -------- -------- Basic earnings (loss) per share $ (0.12) $ 0.03 ======== ======== Denominator - diluted earnings (loss) per share - ----------------------------------------------- Weighted average common shares outstanding 86,394 78,873 Effect of dilutive securities: Common stock options -- 6,150 -------- -------- Weighted average common and common equivalent shares 86,394 85,023 ======== ======== Diluted earnings (loss) per share $ (0.12) $ 0.03 ======== ======== Options excluded from diluted net income per share calculation 5,639 281 ======== ======== Page 7 Certain shares of common stock issuable upon exercise of stock options were excluded from the calculation of diluted net (loss) income per share as the impact of the options would have been anti-dilutive. Note 3. Comprehensive Income (Loss) Our unrealized gains on investments represents the only component of comprehensive (loss) income that is excluded from net (loss) income for the three-month period ended March 31, 2000. Our comprehensive(loss) 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. Revenue information on a product basis is as follows for the three-months ended: 2000 1999 -------- -------- (in thousands) Product license NetWorker and related NetWorker products...... $ 31,222 $ 22,107 Other products................................ 3,514 2,182 Service and support............................... 20,514 14,267 Royalty........................................... 5,270 4,939 Other products, primarily third-party hardware and software...................................... -- 450 -------- -------- Total......................................... $ 60,520 $ 43,945 ======== ======== We market our products and related services to customers in the United States, Canada, Europe and Asia Pacific. Product revenue and long-lived-asset information by geographic areas are as follows for the three-months ended March 31: 2000 1999 -------- -------- (in thousands) Revenue: United States....................................... $ 45,500 $ 31,897 Europe.............................................. 11,003 10,289 Other countries..................................... 4,017 1,759 -------- -------- Total........................................... $ 60,520 $ 43,945 ======== ======== Long-lived assets: United States....................................... $163,479 $ 18,087 Europe.............................................. 2,512 1,259 Other countries..................................... 3,555 3,781 -------- -------- Total........................................... $169,546 $ 23,127 ======== ======== 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, 2000 and 1999. Note 5. Recent Pronouncements In June 1998, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 133, or SFAS 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133 Page 8 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 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 ended December 31, 2000. In March 2000 the Financial Accounting Standards Board, or FASB, issued FASB Interpretation No. 44, or FIN 44, Accounting for Certain Transactions Involving Stock Compensation an Interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion 25 for (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998, or January 12, 2000. Management believes that that the impact of FIN 44 will not have a material effect on the financial position or results of operations of the Company. Note 6. Legal Proceedings On January 20, 2000, a shareholder securities class action complaint was filed in the U.S. District Court, Northern District of California, against 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; the court took under submission the lead plaintiff motions. The lead plaintiff will file a consolidated amended complaint. On February 1, 2000, a shareholder derivative action was filed in the U.S. District Court, Northern District of California, against certain of our officers and directors. We are named as nominal defendant. The complaint generally alleges the same conduct as the shareholder class actions filed in U.S. District Court. The complaint asserts that as a result of this conduct certain of our officers and directors breached their fiduciary duties to us and Page 9 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. 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. 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 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion in this report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those described in our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, fluctuations in quarterly operating results, uncertainty in future operating results, litigation, product concentration, competition,technological changes, reliance on enterprise license transactions, reliance on indirect sales channels, dependence on international revenue, 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 first quarter review that included a review of past due accounts receivables; including certain fourth quarter transaction 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 14, 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 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 these 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 will restate our revenues and results of operations for the quarters ended September 30, 1999, June 30, 1999 and March 31, 1999 and will revise our results for the quarter ended December 31, 1999 previously announced on January 19, 2000. 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 Page 11 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. Page 12 Selected elements of our consolidated financial statements are shown below as a percentage of total revenue.
Three Months Ended March 31, ------------------------ 2000 1999 -------- -------- Revenue: Product license 57% 56% Service and support 34 33 Royalty 9 11 -------- -------- Total revenue 100 100 Cost of revenue: Product license 3 3 Service and support 14 12 -------- -------- Total cost of revenue 17 15 -------- -------- Gross profit 83 85 Operating expenses: Research and development 25 18 Sales and marketing 45 46 General and administrative 15 11 Amortization of intangibles 16 1 -------- -------- Total operating expenses 101 76 -------- -------- Income (loss) from operations (18) 9 Interest and other, net 2 3 -------- -------- Income (loss) before provision for income taxes (16) 12 Provision for (benefit from) income taxes - 6 -------- -------- Net income (loss) (16)% 6% ======== ========
Revenue Total revenue for the first quarter of 2000 increased 38% percent over total revenue for the comparable period of 1999. 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 $34.7 million in the first quarter of 2000 and $24.7 million in the first quarter of 1999. Product license revenue increased 40 percent from the first quarter of 1999 to the first quarter of 2000 primarily as a result of the continued acceptance of our products 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 were not fixed or determinable due to circumstances involving unauthorized written and oral agreements outside our normal contractual terms, as discussed in Note 1, we recognize revenue upon receipt of cash. A total of $7.1 million has been billed to those resellers for transactions entered into in 1999 and for which products have been delivered but for which the receivable and revenue has not been recognized. 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 $20.5 million in the first quarter of 2000 and $14.3 million in the first quarter of 1999. Service and support revenue increased 44 percent from the first quarter of Page 13 1999 to the first quarter of 2000 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 $5.3 million in the first quarter of 2000 and $4.9 million in the first quarter of 1999. 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 $15.0 million in the first quarter of 2000 and $12.0 million in the first quarter of 1999. International revenue increased 25 percent from the first quarter of 1999 to the first quarter of 2000. International revenue accounted for 25 percent of total revenue in the first quarter of 2000 and 27 percent in the first quarter of 1999. 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 made 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 $50.3 million in the first quarter of 2000 and $37.1 million in the first quarter of 1999, representing 83 percent of total revenue in the first quarter of 2000 and 85 percent of total revenue in the first quarter of 1999. Gross profit consists of product license, service and support and other revenue less related costs. Gross profit from product license revenue was $33.2 million in the first quarter of 2000 and $23.2 million in the first quarter of 1999, representing 95 percent of product license in the first quarter of 2000 and 94 percent in the first quarter of 1999. Gross profit from product license increased 43 percent from the first quarter of 1999 to the first quarter of 2000. 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. Gross profit from service and support revenue was $11.9 million in the first quarter of 2000 and $8.9 million in 1999, representing 58 percent of the service and support revenue in the first quarter of 2000 and 62 percent in 1999. Gross profit from service and support revenue increased 33 percent from the first quarter of 1999 to the same period of 2000. Gross profit from service and support revenue as a percentage of service and support revenue decreased primarily as a result of increased costs attributed to our continued investment in developing new service and support offering and providing consulting services. The continued investment consists of costs associated with supporting a larger installed base of products, as well as costs to provide higher support levels to customers. Costs of service and support revenue consist primarily of personnel-related costs incurred in providing telephone support, consulting services, and training to customers, costs of providing software updates and costs of education and consulting materials. Operating Expenses Research and Development. Research and development expenses consist primarily of personnel-related costs. Research and development expenses were $15.3 million in the first quarter of 2000 and $7.7 million in the first quarter of 1999, representing 25 percent of total revenue in the first quarter of 2000 and 18 percent in the first quarter of 1999. Research and development expenses increased 99 percent from the first quarter of 1999 to the first Page 14 quarter of 2000. The increases in research and development expenses in absolute dollars reflect increased staffing and associated support for engineers necessary to continue to expand, enhance and maintain our product lines. The increases 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 1999. 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 $27.0 million in the first quarter of 2000 and $20.3 million in the first quarter of 1999, representing 45 percent of total revenue in the first quarter of 2000 and 46 percent in 1999. Sales and marketing expenses increased 33 percent from the first quarter of 1999 to the first quarter of 2000. 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 1999 to the first quarter of 2000 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 $9.5 million in the first quarter of 2000 and $4.8 million in the first quarter of 1999, representing 15 percent of total revenue in the first quarter of 2000 and 11 percent of total revenue in the first quarter of 1999. General and administrative expenses increased 97 percent from the first quarter of 1999 to the first quarter of 2000. The increases in general and administrative expenses from the first quarter of 1999 to the first quarter of 2000 was primarily attributable to increased staffing and related costs required to manage and support our expansion. Increases from the first quarter of 1999 were also attributed to professional fees incurred in connection with the special investigation committee appointed by our Board of Directors and threatened shareholder litigation (See Notes 1 and 6 to the Notes of the Condensed Consolidated Financial Statements). We believe that general and administrative expenses may increase in dollar amount as we may continue to expand our operations and incur additional legal expenses in connection with the threatened shareholder litigation. Amortization of Intangibles. Amortization of intangibles was $9.5 million in the first quarter of 2000 and $279,000 in the first quarter of 1999. The increase from the first quarter of 1999 is primarily attributed to the amortization of intangibles related to the acquisitions of Intelliguard Software, Inc. and Vinca Corporation during 1999. We are amortizing these intangibles on a straight-line basis over periods ranging from seventeen months to five years from the dates of acquisition. Interest and Other Income, Net. Interest and other income, net, was $0.9 million in the first quarter of 2000 and $1.4 million in the first quarter of 1999. Interest and other income primarily represent interest income from funds available for investment. The decrease in interest and other income, net, relates primarily to increased interest earned from our short-term and long-term investments offset by losses from unfavorable foreign currency translation and interest expense from a short-term loan. Provision for Income Taxes. The benefit from income taxes for the first quarter of 2000 was $0.1 million, compared to a provision for income tax of $2.5 million for the first quarter of 1999. The effective tax rate was 1 percent for the first quarter of 2000 and 47 percent for the first quarter of 1999. The decrease primarily reflects a loss before income taxes of $10.1 million for the three-months ended March 31, 2000 compared to income before income taxes of $5.4 million for the same period in 1999. LIQUIDITY AND CAPITAL RESOURCES Our cash, cash equivalents and investments totaled $175.4 million at March 31, 2000, and represented 41 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, 2000, we had no long-term debt and stockholders' equity was $338.2 million. We have financed our operations to date primarily by cash from operations and sales of common stock. Net cash provided by operating activities was $9.4 million in the first quarter of 2000. Net cash provided by operations in the first quarter of 2000 consisted primarily of net loss of $10.0 million, the tax benefit from exercise of stock Page 15 options of $1.2 million and depreciation and amortization of $12.6 million and the net change in operating assets and liabilities of $7.4 million, offset by net deferred tax assets of $2.0 million. Net cash used in investing activities was $13.7 million in the first quarter of 2000. Net cash used in investing activities primarily reflected net purchases of marketable securities of $0.5 million and purchases of property and equipment of $13.0 million. Net cash provided by financing activities was $9.2 million in the first quarter of 2000. 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; . 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; . Cost and expenses related to class action litigation; . Personnel changes; and . General economic factors. Page 16 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 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; the court took under submission the lead plaintiff motions. The lead plaintiff will file a consolidated amended complaint. Page 17 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. 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. 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. 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. Page 18 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. 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 Page 19 . 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 multiple elements such as product licenses and service and support; . Recognition of revenue from enterprise license transactions may vary from transaction to transaction; o They typically involve significant technical evaluation and commitment of capital and other resources; and . Customers' internal procedures frequently cause delays in orders. Such internal procedures include approval of large capital expenditures, implementation of new technologies within their networks, and testing new technologies that affect key operations. Due to the large size of enterprise transactions, if orders forecasted for a specific transaction for a particular quarter are not realized in that quarter, our operating results for that quarter may be seriously harmed. Historically, we have not had a separate large enterprise or national accounts sales force and only within the last few years have we begun to develop direct sales groups focused on these larger accounts. To succeed in the national accounts market, we will be required to continue to transition our existing sales forces into enterprise level sales groups, and attract and retain qualified personnel. New personnel will require training to obtain knowledge of the attributes of our products. We may not be successful in creating the necessary sales organization or in attracting, retaining or training these individuals. To succeed in the enterprise and national accounts market will require, among other things, establishing and continuing to develop relationships and contacts with senior technology officers at these accounts. Our business, financial condition and results of operations would be seriously harmed if our sales force is not successful in these efforts. Page 20 We Rely on Indirect Sales Channels. We rely significantly on our distributors, systems integrators and value added resellers, or collectively, resellers, for the marketing and distribution of our products. Our agreements with resellers are generally not exclusive and in many cases may be terminated by either party without cause. Many of our resellers carry product lines that are competitive with ours. These resellers may not give a high priority to the marketing of our products. Rather, they may give a higher priority to other products, including the products of competitors, or may not continue to carry our products. Events or occurrences of this nature could seriously harm our business, operating results and financial condition. In addition, we may not be able to retain any of our current resellers or successfully recruit new resellers. Any such changes in our distribution channels could seriously harm our business, operating results and financial condition. Our strategy is also to increase the proportion of our customers licensed through OEMs. We may fail to achieve this strategy. We are currently investing, and intend to continue to invest resources to develop this channel. Such investments could seriously harm our operating margins. We depend on our OEMs' abilities to develop new products, applications and product enhancements on a timely and cost-effective basis that will meet changing customer needs and respond to emerging industry standards and other technological changes. Our OEMs may not effectively meet these technological challenges. These OEMs: . Are not within our control; . May incorporate the technologies of other companies in addition to, or to the exclusion of, our technologies, and . Are not obligated to purchase products from us. In addition, our OEMs generally have exclusive rights to our technology on their platforms, subject to certain minimum royalty obligations. Our OEMs may not continue to carry our products. The inability to recruit, or the loss of, important OEMs could seriously harm our business, operating results and financial condition. We Depend on International Revenue. Our continued growth and profitability will require further expansion of our international operations. To successfully expand international operations, we must: . Establish additional foreign operations; . Hire addition personnel; and . Recruit additional international resellers. This will require significant management attention and financial resources and could seriously harm our operating margins. If we fail to further expand our international operations in a timely manner, our business, operating results and financial condition could be seriously harmed. In addition, we may fail to maintain or increase international market demand for our products. Our international sales are currently denominated in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, potentially less competitive in those markets. In some markets, localization of our products is essential to achieve market penetration. We may incur substantial costs and experience delays in localizing our products. We may fail to generate significant revenue from localized products. Additional risks inherent in our international business activities generally include: . Significant reliance on our distributors and other resellers who do not offer our products exclusively; . Unexpected changes in regulatory requirements; . Tariffs and other trade barriers; . Lack of acceptance of localized products, if any, in foreign countries; . Longer accounts receivable payment cycles; . Difficulties in managing international operations; Page 21 . Potentially adverse tax consequences, including restrictions on the repatriation of earnings; . The burdens of complying with a wide variety of foreign laws; and . The risks related to the global economic turbulence. The occurrence of such factors could seriously harm our international sales and, consequently, our business, operating results and financial condition. We Must Manage Our Growth and Expansion. We have recently experienced a period of significant expansion of our operations that has placed a significant strain upon our management systems and resources. In addition, we have recently hired a significant number of employees, and plan to further increase our total headcount. We also plan to expand the geographic scope of our customer base. This expansion has resulted and will continue to result in substantial demands on our management resources. From time to time, we receive customer complaints about the timeliness and accuracy of customer support. We plan to add customer support personnel in order to address current customer support needs. If we are not successful hiring such personnel, our business, operating results and financial condition could be seriously harmed. Our ability to compete effectively and to manage future expansion of our operations, if any, will require us to (a) continue to improve our financial and management controls, reporting systems and procedures on a timely basis, and (b) expand, train and manage our employees. Our failure to do so would seriously harm our business, operating results and financial condition. We Must Integrate Recent Acquisitions. On August 6, 1998, we acquired Software Moguls, Inc. a developer of advanced backup-retrieval products for the Windows NT and UNIX environments. On April 1, 1999, we acquired Intelliguard, a developer of standards-based storage management solutions for storage area networks. On April 19, 1999, we acquired FullTime, a developer of distributed, enterprise-wide, cross-platform, adaptive computing solutions. On July 30, 1999, we acquired Vinca, a developer in high availability and data protection software. We may make additional acquisitions in the future. Acquisitions of companies, products or technologies entail numerous risks, including: . An inability to successfully assimilate acquired operations and products; . Diversion of management's attention; . Loss of key employees of acquired companies; . Substantial transaction costs; and . Substantial additional costs charged to operations as a result of the failure to consummate acquisitions. Some of the products we acquired may require significant additional development before they can be marketed and may not generate revenue at levels we anticipate. Moreover, our future acquisitions may result in dilutive issuances of our equity securities, the incurrence of debt, large one-time write-offs and the creation of goodwill or other intangible assets that could result in amortization expense. We cannot guarantee that our efforts to consummate acquisitions or integrate acquisitions will be successful. If our efforts are not successful, it could seriously harm our business, financial condition and results of operations. 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, Page 22 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: . Patents; . Copyright and trademark laws; . Trade secrets; . Confidentiality procedures; and . Contractual provisions. Page 23 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 21/st/ century dates from 20/th/ 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 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. Page 24 Our Trading Price is Volatile. The trading of our common stock is highly volatile, closing as high as $79.25 and as low as $10.625 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. Page 25 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. As a global concern, we face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and could seriously harm our financial results. All of our international sales are currently denominated in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore, reduce the demand for our products. Reduced demand for our products could seriously harm our financial results. Currently, we do not hedge against any foreign currencies and as a result, could incur unanticipated gains or losses. We maintain an investment portfolio of various issuers, types and maturities. Our investment portfolio consists of both fixed and variable rate financial instruments. These securities are classified as available-for-sale, and consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of stockholders' equity, net of taxes. At any time, a sharp rise in interest rates could seriously harm the fair value of our investment portfolio. Conversely, declines in interest rates could seriously harm interest earnings of our investment portfolio. Currently, we do not hedge these interest rate exposures. Page 26 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; the court took under submission the lead plaintiff motions. The lead plaintiff will file a consolidated amended complaint. On February 1, 2000, a shareholder derivative action was filed in the U.S. District Court, Northern District of California, against certain of our officers and directors. We are named as nominal defendant. The complaint generally alleges the same conduct as the shareholder class actions filed in U.S. District Court. 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. 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. 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. Page 27 Item 6. Exhibits and reports on Form 8-K (a) Exhibits 27.1 Financial Data Schedule (b) Reports on Form 8-K The Registrant filed a report on Form 8-K, dated January 28, 2000, in connection with the Registrant's Termination Agreement with Ontrack Data International, Inc. The Registrant filed a report on Form 8-K, dated January 20, 2000, in connection with the Registrant's announcement of financial results for the fourth quarter and the twelve-months ended December 31, 1999 and a restatement of the financial results for the third quarter and nine-months ended September 30, 1999. 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: May 17, 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) Page 28 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED UNAUDITED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-2000 JAN-01-2000 MAR-31-2000 120,205 55,243 47,731 0 0 240,548 37,018 0 425,861 87,680 0 0 0 0 338,181 425,861 0 60,520 10,186 71,548 0 0 0 (10,087) (100) 0 0 0 0 (9,987) (0.12) (0.12)
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