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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
[_]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
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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)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Preferred Share Purchase Rights
Common Stock, $.0001 par value
(Title of each class).
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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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 31, 2000 was approximately $1,080,000,000. Shares
of Common Stock held by each officer and director have been excluded in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
The number of shares outstanding of the registrant's common stock as of
March 31, 2000 was 86,774,992.
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LEGATO SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1999
Table of Contents
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 26
Item 3. Legal Proceedings.............................................. 26
Item 4. Submission of Matters to a Vote of Security Holders............ 26
Item 4a. Executive Officers of the Registrant........................... 26
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder 28
Matters........................................................
Item 6. Selected Consolidated Financial Data........................... 29
Item 7. Management's Discussion and Analysis of Financial Condition and 30
Results of Operations..........................................
Item 8. Consolidated Financial Statements and Supplementary Data....... 40
Item 9. Changes in and Disagreements with Accountants on Accounting and 40
Financial Disclosure...........................................
PART III
Item 10. Directors and Executive Officers of the Registrant............. 68
Item 11. Executive Compensation......................................... 69
Item 12. Security Ownership of Certain Beneficial Owners and 75
Management.....................................................
Item 13. Certain Relationships and Related Transactions................. 76
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8- 77
K..............................................................
Schedule II--Valuation and Qualifying Accounts........................... 80
Signatures............................................................... 81
PART I
ITEM 1. BUSINESS
The discussion in this report on Form 10-K 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 on 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. We assume no obligation to
update any such forward-looking statements. Our actual results could differ
materially from those indicated in such 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.
Legato Systems, Inc. was incorporated in Delaware in September 1988. We
develop, market and support network storage management software products for
heterogeneous client/server computing environments and large scale enterprises.
We believe we are currently a technology leader in the network storage
management software market because of the scalability, heterogeneity,
performance, ease of use, central administration and data availability of our
software products. Our data protection products, primarily the NetWorker family
of products, and our data availability products, primarily our HA+, Octopus,
Replication and Cluster products, support many storage management server
platforms and accommodate a variety of clients, servers, applications,
databases and storage devices. Our long term strategy is to create an
integrated set of solutions centered around storage management that enhance and
simplify network computing as a whole.
In the third quarter of 1998, we acquired Software Moguls, Inc, a developer
of advanced backup-retrieval products for Window NT and UNIX environments. In
the second quarter of 1999, we acquired Intelliguard Software, Inc., or
Intelliguard, a developer of standards-based storage management solutions for
storage area networks and Qualix Group, Inc. (dba FullTime Software, Inc.), or
FullTime, a developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions. On July 30, 1999, we acquired Vinca Corporation, or Vinca,
a developer of high availability and data protection software. These
acquisitions are intended to enable us to continue to provide customers with
storage management technologies to protect their data with ease and confidence.
The research and development resources and product lines from these
acquisitions potentially provide us with opportunities to enhance the core
elements of our enterprise storage management solution.
We utilize multiple distribution channels, including direct sales, resellers
and original equipment manufacturers, or OEMs, as a part of our strategy to
achieve comprehensive coverage in the market. We license our source code to
leading computer system and software suppliers, including:
. Amdahl;
. Banyan;
. Compaq (Digital);
. Compaq (Tandem);
. EMC (Data General);
. Fujitsu-ICL;
. Nihon-Unisys;
. NEC;
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. Siemens Nixdorf;
. Silicon Graphics;
. Sony;
. Sun Microsystems; and
. Unisys.
These leading computer system and software suppliers port our products to
their proprietary platforms, sell the products through their direct and
indirect distribution channels and provide primary support for the products
after installation. These relationships enable us to reach a broad customer
base, while reducing development, support and product costs. We have also
established strategic partnerships with EMC Corporation, Hewlett-Packard,
Network Appliance and Oracle.
The Legato Solution
Our data protection and data availability software products have been
designed to address the emerging requirements of storage management in
client/server computing environments. These products employ a client/server
architecture in which a server centralizes storage management services,
including failover and recovery management as well as replication capabilities,
for a wide variety of clients, including servers and desktop computers. We
believe our products provide a cost-effective storage management solution that
scales to support large networks, supports heterogeneous client/server
computing environments, accomplishes storage management tasks within stringent
time constraints, reduces the cost of network administration and employs an
easy-to-use graphical user interface. The core elements of the our solution
include:
. Scalability;
. Heterogeneity;
. Performance;
. Ease of use;
. Central administration; and
. Data availability.
Scalability. Our storage management architecture, also referred to as
Enterprise Storage Management Architecture, or ESMA, is designed to be scalable
so that it can grow with an expanding network and accommodate a wide range of
storage management needs. Our storage server family can be configured or
expanded to meet the storage requirement needs of a changing and dynamic
network. Our architecture is modular, so that clients, servers and storage
devices can be upgraded or added without requiring redesign of the entire
system. An existing server can be quickly upgraded to a more powerful server
with minimal modification. Furthermore, our architecture can adapt to growing
networks with its ability to easily add clients to a given storage management
server. For example, a single NetWorker storage management server has been
employed to manage data located on hundreds of clients ranging from desktop
computers to large file servers.
Heterogeneity. Our storage management solutions are designed to support a
wide range of servers, clients, applications, databases and storage devices.
Servers, clients, applications, databases and storage devices supported by our
BusinesSuite products include:
. DB2;
. Informix;
. Lotus Notes;
. Microsoft Exchange;
. Microsoft SQL;
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. Oracle;
. SAP R/3; and
. Sybase.
Our family of storage management server products operates on the following
platforms:
. Compaq Tru64;
. Linux;
. NetWare;
. Windows NT;
. Windows 2000;
. UNIX systems (AIX, Dynix/ptx, HP-UX, Irix, SGI and Solaris); and
. UNIX systems and Windows NT and Windows 2000 offered by our OEMs.
Server and desktop computer clients supported include:
. DOS;
. Macintosh;
. Mac OS'
. NetWare;
. Network Appliance;
. OS/2;
. UNIX;
. MPE/iX;
. Windows;
. Windows NT; and
. Windows 2000.
Storage devices supported include most popular tape drives, and optical and
tape robotic storage devices. All NetWorker server platforms inter-operate with
all supported clients. As a result, customers can mix and match clients and
servers as necessary to meet their specific requirements. In addition,
NetWorker's interoperability enables the flexibility to change storage
management server platforms, without disrupting any client systems.
Performance. Organizations usually need to accomplish storage management
functions (which tend to consume network bandwidth as large amounts of data are
transferred over the network) during a network's off-peak hours. Our NetWorker
storage management server can process data from many clients in parallel,
allowing high volumes of network data to be managed within stringent time
constraints. NetWorker is designed to take advantage of improvements in the
physical environment to deliver higher performance. As networks employ higher-
speed computers, faster and increased capacity storage devices and higher
bandwidth networking technologies, NetWorker is designed to exploit these
capabilities to move data quickly. Our data availability products, including
Replication, Cluster, HA+ and Octopus, provide for real-time replication for
data exchange and synchronization for local applications, data exchange among
remote sites and disaster recovery without significant downtime and create
collaborative clusters of server resources across platforms, networks and
applications to ensure resource availability.
Ease of Use. Our storage management solutions have been designed to be easy
to use for both network administrators and end users. Our architecture permits
a network administrator to perform the storage management function for the
entire network either from the storage server or a client. The network
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administrator can access our products through a number of graphical user
interfaces, including Windows, Windows NT and Windows 2000 and Motif. Network
administrators can also automate their storage operations by adding robotic
storage libraries, further reducing the need for human intervention. Finally,
our architecture supports a simple user interface that permits end users to
access or recover copies of their files without the need for intervention by
the network administrator.
Central Administration. Our Global Enterprise Management Systems, or
G.E.M.S., product allows information system organizations the ability to
globally manage hundreds and even thousands of NetWorker storage servers.
G.E.M.S. provides services such as policy management, software distribution,
universal licensing and advanced media management and can be integrated with
management frameworks including CA Unicenter, HP Openview, and Tivoli TME.
Data Availability. Our data availability products, including our HA+,
Octupus, Replication and Cluster products, help to minimize the impact of
failures caused by system malfunction, human error, sabotage or natural
disasters. These data availability products are designed to monitor, replicate
and support a variety of UNIX-based and Windows NT and Windows 2000 operating
systems, hardware platforms, disk configurations, networks, applications and
databases. For example, if a server goes down, or for any reason stops
providing service to an application, HA+ can promptly elect another server to
carry on service and allow users to continually access their data and
applications.
Architecture
The most basic function of a storage management system is data protection.
The process of data protection involves making backup copies of data stored on
hard disks onto low-cost, high capacity removable media such as tapes and
optical disks.
Our architecture provides reliable data protection services. Data may be
managed according to the application that produces it. For example, a
relational database may be frequently updated. To back up this kind of database
efficiently, it is necessary to understand how the database is constructed, so
that a consistent copy of the database can be made while it is undergoing
change and while the database is "on-line." Our architecture can accommodate
the data produced by different applications because of its Application Specific
Module, or ASM, technology. Each ASM can be tailored to the specific storage
management needs of a particular kind of application data, and all ASMs are
implemented using a modular architecture designed to permit new ASMs to be
easily integrated into our storage offerings.
Once data is read from the client's hard disk, it is transmitted to the
storage management software that resides on the storage server using industry-
standard communications protocols such as TCP/IP and SPX/IPX. A high-
performance, integrated database is fundamental to the storage management
server engine. This database has two roles: to keep track of where the storage
management server has stored the data, and to keep track of what data is
stored. Our architecture makes it possible for clients to query the database as
to what data is under management and for clients to access this data
themselves. This enables novice users to directly access the system, thereby
reducing the burden on network administrators.
One of the most critical ways our architecture achieves its ability to
accommodate an increasing number of clients while retaining high performance is
by implementing parallel data transfers from the clients to the storage
management server in the same way that adding more tellers to serve customers
allows a bank to process more transactions in the same amount of time. When an
additional client's data is managed, it may be scheduled for processing by the
storage management server at the same time as the data from other clients.
Thus, one slow client need not slow down the entire storage management process.
Our architecture achieves this parallelism by writing multiple client data
streams to the tape simultaneously. This allows the full bandwidth of the tape
drive to be used as the data from many clients can be delivered to the tape
drive in the same amount of time as the data from one client. As a result, one
high-capacity tape drive can be shared effectively by more than one client on
the network, and, therefore, it may not be necessary to purchase several tape
drives to accomplish data protection in the required amount of time.
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An increasingly important function of the architecture to some end users is
to facilitate the management of data according to its criticality. As an
example, a set of quarterly reports may be grouped together and filed away.
This data may not need to be accessed on a regular basis, but may need to be
retrievable for a period of years because of certain regulatory requirements.
This class of data is termed "archive" data, because it may be filed away for
future reference and need not be kept on-line. When archived data is needed, it
must be explicitly retrieved, typically from offsite storage. It is also
possible to archive data in such a way that it appears to be on-line, when it
in reality is stored elsewhere. This process is referred to as "hierarchical
storage management." The indexing technology embedded within our storage
products is designed to support the management of protected, archived, and
hierarchically managed data.
In addition to data protection, an important function of the architecture is
data availability, which provides end users access to the computing power, data
and applications they need, when and where they need them, including times when
data protection actually takes place. As organizations migrate or consider
migrating business-critical applications to distributed computing environments,
they frequently need to ensure that such applications are fully operational
around the clock. In order to facilitate data availability without significant
downtime, open application interfaces take place so that other applications can
share data. Open application interfaces layer over existing computing
environments, including data, systems, standard TCP/IP networks and
applications, without requiring additional programming or changes to the
existing applications. Therefore, the data protection process, as well as the
implementation of system and software upgrades, can occur without the
traditional downtime.
To reduce the burden on expensive administrative staff, our architecture
allows the storage management server to be managed remotely, from an easy-to-
use, graphical user interface familiar to the administrator. The use of a
common administrative protocol developed by us greatly facilitates the
development of diverse user interfaces that support remote administration. Our
family of storage management products can also automate a wide range of storage
management functions and can employ robotic storage devices to remove the need
for human intervention to retrieve a particular piece of removable storage
media.
Products
Our family of storage management server software--NetWorker--provides
network storage management services for a wide variety of platforms. NetWorker
consists of two basic components: a client module that accesses the data being
managed, and a server module that performs the protection, management and
control of network data. Typically, the server module is selected to run on the
platform most familiar to the administrative staff in an organization; the
client modules are selected according to the type of computers installed on the
network. Our server software is available for NetWare, Windows NT, Windows
2000, several UNIX platforms, including Compaq (Digital), HP, IBM, Silicon
Graphics, Sequent and Sun versions of UNIX. A number of applications and
enhancements options are available for the storage server.
The base NetWorker server product provides data protection services for
clients and includes client software for the same platform as the NetWorker
server, as well as support for a set of popular non-robotic storage devices. In
multiple platform environments, client software for dissimilar platforms must
be purchased. The following client packages are currently available:
. ClientPak for UNIX, which supports a diverse set of UNIX clients,
including Linux, Hewlett-Packard, Compaq (Digital), IBM and Sequent;
. ClientPak for PC Desktops, which supports OS/2, Windows 95, Windows 98,
Windows NT and Windows 2000;
. ClientPak for Windows NT and Windows 2000, which supports Window NT and
Windows 2000 workstations and Windows NT and Windows 2000 Servers;
. ClientPak for MPE/iX, which supports HP3000 MPE/iX systems;
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. ClientPak for Network Appliance, which supports Network Appliance filers
via TCP/IP ethernet connections;
. ClientPak for NetWare, which supports NetWare; and
. ClientPak for Macintosh, which supports MacOS.
The base NetWorker server product for Windows NT and Windows 2000 , UNIX and
NetWare is also available through the following offerings, which support a
variety of NetWorker options:
. Workgroup Edition--a storage management solution for small networks in
corporate environments. Workgroup Edition provides support for up to four
client connections and two storage devices;
. Network Edition--an enterprise-strength storage management solution for
distributed networks. Network Edition supports up to ten clients, as well
as options that add client connections, expand client platform coverage,
and deliver advanced data management services; and
. Power Edition--a storage management solution for customers with very
large servers, clusters, or the requirement to drive high-speed devices.
Power Edition features enhanced architecture to increase throughput while
minimizing use of system resources and supports all standard NetWorker
options.
NetWorker for UNIX is licensed by the number of clients to be supported and
has the following storage management server options available:
. Archive--the ability to archive data;
. Autochanger--the ability to employ tape and optical jukeboxes of varying
capacities;
. BusinesSuite--the ability to utilize a family of add-on modules tailored
for databases and business applications;
. Client Connections--the ability to increase the number of clients of the
storage management server beyond the ten supported by the base product;
. High Speed Device Support--the ability to utilize high speed devices;
. Silo Support--the ability to leverage mainframe-class storage silos;
. SNMP Modules--the ability to integrate with leading system management
offerings; and
. Storage Nodes--the ability to perform very high-speed backup locally
which is managed centrally.
NetWorker for Windows NT and Windows 2000 is Microsoft BackOffice certified
and licensed by the number of clients to be supported and it has the following
storage management server options available:
. Archive--the ability to archive data;
. Autochanger--the ability to employ tape and optical jukeboxes of varying
capacities;
. BusinesSuite--the ability to utilize a family of add-on modules tailored
for databases and business applications such as SQL Server and Exchange
Server;
. Client Connections--the ability to increase the number of clients of the
storage management server beyond the ten supported by the base product;
. Open File Manager--the ability to protect open files;
. Silo Support--the ability to leverage mainframe-class storage silos;
. SNMP Module--the ability to integrate with leading system management
offerings; and
. Storage Nodes--the ability to perform very high-speed backup locally
which is managed centrally.
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NetWorker for NetWare is licensed by the number of clients to be supported
and has the following storage management server options available:
. Archive--the ability to archive data;
. Autochanger--the ability to employ tape and optical jukeboxes of varying
capacities; and
. Client Connections--the ability to increase the number of clients of the
storage management server beyond the ten supported by the base product.
NetWorker server software has an entry end user list price from $1,150 to
$22,425, while a fully configured NetWorker system can have an end user list
price of over $100,000.
Our G.E.M.S. product complements the NetWorker family of products by
providing an approach to managing enterprise-wide storage from Java-enabled Web
browsers via a central console. G.E.M.S allows systems administrators to
centrally configure, control, and manage storage in geographically dispersed
areas. The main features of G.E.M.S. include policy-based administration,
software management and flexible software licensing across the enterprise.
G.E.M.S. provides system administrators the ability to control multiple data
zones managed by NetWorker servers.
Our data availability products, including our HA+, Octopus, Replication and
Cluster products, complement the NetWorker family of products by providing
users with continual real-time access to data and applications and allow
systems to be backed up without the traditional downtime. Resources can be
transparently relocated to continue to provide services to users while system
changes are applied.
Our Celestra products allow users the ability to move data directly from
disk to disk or disk to tape without interrupting the server that owns the
data. The capability of our Celestra products may be useful for companies'
electronic commerce environments, where servers require accessibility 24 hours
a day, 7 days a week.
Our SmartMedia products allow customers to share tape libraries between
applications, which may be useful in storage area network environments, where
several servers share a single tape library.
Sales and Marketing
Our strategy is to deploy a comprehensive sales, marketing and support
infrastructure to meet the storage management needs of users of complex
client/server networks worldwide. We use a multi-tier distribution model to
reach end user customers, which range in size from individual corporate
departments or small businesses to large multinational corporations. Network
storage management software is an application that may be utilized across many
industries segments.
We provide sales and pre-sale technical support to business partners and end
user customers from our Palo Alto office and from regional offices in the
following metropolitan areas:
. Atlanta;
. Boston;
. Chicago;
. Dallas;
. Denver;
. Los Angeles;
. New York;
. Seattle;
. Toronto; and
. Washington, D.C.
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The range of distribution channels includes:
. Direct sales;
. Resellers; and
. OEMs.
Direct Sales
We have established a dedicated sales force to penetrate large enterprise-
wide opportunities. As storage requirements increase, storage management
applications increase in strategic importance to major enterprises. We have
recognized the need to establish even closer relationships with our largest
corporate clients. Customers participating in our enterprise sales program have
an assigned salesperson and an executive contact, participate in our technical
exchange program and work closely with us to develop large projects for
installations over a period of time. An enterprise sales representative
coordinates business partner activities across the customer's enterprise and
closely monitors customer satisfaction.
Resellers
We have established regional sales offices to increase the effectiveness of
and support to our channel partners.
North America Enterprise Solution Partners. Our North America Enterprise
Solution Partners program provides a significant source of revenue in North
America. The Enterprise Solution Partners program enables third-party
integrators specializing in storage management and client/server network
solutions to provide end user customers with complete solutions, including
systems and storage hardware, complementary software and our software. The
reseller is responsible for managing the sales and installation process in each
customer situation. In large, complex opportunities, our support personnel work
with the reseller to provide technical support. This approach enables us to
cost effectively achieve broader market coverage, while maintaining close
contact with end user customers in order to obtain input on product direction
and to monitor customer satisfaction.
North America Distributor Program. To further expand coverage in the
marketplace, we sell our products to large regional and national distributors
who sell the products to resellers with expertise in storage management and
integrating network solutions for end users. We provide support to these
network solutions resellers. We currently have relationships with various major
distributors, including Access Graphics, Gates/Arrow, Ingram Micro and
TechData.
International Reseller and Distributor Programs. We have similar reseller
and distributor programs internationally. We currently operate sales offices in
the following countries to support resellers and distributors throughout
various regions of the world, including, but not limited to:
. Australia;
. Belgium;
. Canada;
. China;
. France;
. Germany;
. Japan;
. Italy;
. Netherlands;
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. Poland;
. Singapore;
. Sweden;
. Switzerland; and
. United Kingdom.
International product sales were $65.8 million in 1999, $45.5 million in
1998 and $27.7 million in 1997, representing 29 percent of total revenue in
1999, 27% in 1998 and 23 percent in 1997. The majority of international sales
during these periods were made in Europe and Asia. We believe that
international markets present an attractive growth opportunity and are
expanding the scope of our international operations. We have engaged, and
intend to add international resellers and distributors in targeted countries
and are developing joint marketing programs with certain resellers and
distributors. In order to facilitate penetration in certain markets, we, along
with cooperation from certain international distributors, are in the process of
localizing certain products to certain targeted languages.
We also rely significantly on our 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 our competitors' product lines. We cannot guarantee
that these resellers will give a high priority to the marketing of our products
or that they will continue to carry our products. Events or occurrences of this
nature could seriously harm our business, operating results and financial
condition.
OEMs
Source Code OEM Program. Our source code OEM program generates significant
royalty revenue. Under this program, we license our software products, in
source code form, to leading computer system and software suppliers from which
we receive an initial license fee and ongoing royalty revenue. The OEM partner
is then responsible for porting our software to its unique operating system
environment, testing it, selling it through the OEM partner's direct sales
force and distribution channels and providing the primary customer support
after installation. The OEM partners generally have exclusive rights to the
products on their proprietary platforms (subject to certain minimum royalty
obligations), but, in certain cases, work cooperatively to incorporate their
enhancements into our storage products on an ongoing basis. The benefit of this
approach for end users is that they can acquire our family of storage
management products as part of a complete systems solution from a single
vendor, with such vendor providing a single point of contact for customer
support. The benefit to us has been access to our OEM partners' customer bases,
both in North America and overseas, without a commensurate investment in fixed
expense. We currently have source code OEM agreements in place with several
computer system and software suppliers, including:
. Amdahl;
. Banyan;
. Compaq (Digital);
. Compaq (Tandem);
. EMC (Data General);
. Fujitsu-ICL;
. Nihon-Unisys;
. NEC;
. Siemens Nixdorf;
. Silicon Graphics;
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. Sony;
. Sun Microsystems; and
. Unisys.
Strategic Partner Program. The Strategic Partner program is an alternative
to the source code OEM program for major system providers who wish to offer our
products along with theirs, but prefer not to make an investment in enhancing
the base Legato product. For example, SunSoft, a private label reseller,
licenses the object code for the standard Legato products and sells and
supports the products under the SunSoft logo as described above for the source
code OEM program. We also have established strategic partnerships with Hewlett-
Packard, Informix, Netscape and Oracle.
The source code OEMs and strategic partner programs accounted for
approximately $23.3 million in 1999, $19.2 million in 1998 and $16.7 million in
1997. We are currently investing, and intend to continue to invest resources to
develop this channel, which could seriously harm our operating margins if such
efforts are not successful. We cannot guarantee that we will be successful in
our efforts to increase the revenue represented by this channel. We are
dependent upon our OEMs' ability 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. We cannot guarantee that our OEMs will effectively meet
these technological challenges. These OEMs are not within our control, may
incorporate into their products the technologies of other companies in addition
to those of ours and are not obligated to purchase products from us. We cannot
guarantee that any OEM will continue to carry our products, and the inability
to recruit, or the loss of, important OEMs could seriously harm our business,
operating results and financial condition.
No one customer accounted for more than 10 percent of our total revenue for
1999, 1998 and 1997.
Corporate Marketing
We support our multi-tiered distribution efforts with extensive marketing
programs designed to establish our image in key markets, differentiate our
products, and to generate end user demand. Marketing programs include channel
marketing, product marketing, as well as programs specifically targeted to the
North American, Asian and other intercontinental markets. We participate in
industry forums and events, trade shows and advertise in key network systems
publications and on the Internet. We work directly with industry analysts to
update them on our products. Leads are qualified by our inside sales staff and
provided to our channel partners. Additionally, resellers and distributors are
provided with promotional and educational materials and can qualify for market
development funding for specific promotional activities tailored for their
solutions and geography.
Customer Support and Professional Services
We employ systems engineers who work closely with our direct sales personnel
to assist resellers and end users with pre-sales and post-sales support
matters. In addition, we employ a centralized support organization, which
provides customers with technical support and professional services including
education, training and consulting.
Customer Support. We offer product update services and help desk services.
Product updates services may be purchased pre-bundled with our software
products or separately after the products are registered. Customers may renew
product update services annually or purchase future updates on an as-needed
basis. Product update service customers receive updates, enhancements and
improvements to supported software, including support for new operating systems
once available. Annual fees for product update services are generally
equivalent to 15 percent of the price of the products under license paid by
customers.
Generally, basic help desk service customers may receive telephone or
electronic support from 8 a.m. to 5 p.m. in the customer's local time zone,
Monday through Friday. Response times for open cases are based on service level
objectives and the severity level that the customer sets at the time the case
is opened. We also
12
offer premium help-desk service, which includes a one year contract covering
seven-day, 24-hour technical support, enhanced service level objectives,
priority escalation management and a designated premium support account
manager, or PSAM. The PSAM conducts monthly conference calls with the
customers, maintains familiarity with their environment, and facilitates
communication between the customer and us. Depending on the type of help desk
service desired, the pricing ranges from $500 to $2,500 for per-incident help
desk service and from $1,000 to more than $30,000 for annual support
agreements. Premium help-desk service customers can purchase PSAM visits on an
annual, quarterly, or monthly interval with prices from $2,000 to $20,000. For
our highest level of support, we offer customers the opportunity to purchase
either a six-month or one-year onsite PSAM contract, for $150,000 and $200,000,
respectively.
The customer service and support organization consists of an experienced
staff of technical support engineers providing telephone and electronic support
via electronic mail from our offices in Palo Alto, California and Toronto,
Canada. Our sales and customer support organizations work closely together to
ensure overall customer satisfaction.
In recent years, our installed base of customers has significantly
increased, as have the number of customers purchasing software support
contracts. From time to time, we receive customer complaints about the
timeliness and accuracy of customer support. Although we plan to add customer
support personnel in order to address current customer support needs and intend
to closely monitor progress in this area, we cannot guarantee that these
efforts will be successful.
Education and Training. Our professional services organization offers
education and training to end users and resellers. Education and training
classes include covering theory, installation, operations, configuration, and
planning on information protection, information availability and information
management. Training classes are offered through in-house facilities at our
offices in Palo Alto, as well as at off-site locations. We also provide on-site
training services upon request by customers. Fees for education and training
services are charged separately from our software products. Although we intend
to add education and training personnel in order to meet customer needs, we
cannot guarantee that these efforts will be successful. If our efforts are not
successful, it could seriously harm our business, operating results and
financial condition.
Consulting. Our consultants are available to work closely with customers'
information systems organizations. These consulting services generally consist
of assisting customers in setting up more complex installations or tailoring
our software products to achieve higher performance or a higher degree of
automation. We also offer a number of consulting packages that provide
customers with more specific topics, such as enterprise analysis, storage
network health check, replication and tape conversion. Fees for consulting
services are charged separately from our software products. While we continue
to allocate resources in order to provide customers with additional value-added
services, we cannot guarantee that these efforts will be successful. Although
we intend to add consulting personnel in order to meet customer needs, we
cannot guarantee that these efforts will be successful. If our efforts are not
successful, it could seriously harm our business, operating results and
financial condition.
Research and Development
Since our inception, we have made substantial investments in product
development. In addition, we receive the benefits of additional testing and
product enhancements from each source code OEM's development group. Our future
success will depend upon our ability to develop and introduce new software
products, including new releases, applications and enhancements, on a timely
basis that keep pace with technological developments and emerging industry
standards and address the increasingly sophisticated needs of our customers. In
particular, our strategy is to continue to leverage the NetWorker architecture
to enhance the functionality of the product through new releases, applications
and product enhancements to meet the ongoing storage management requirements of
our customers. We cannot guarantee that we will be successful in developing and
marketing new products that respond to technological change or evolving
industry standards, that we will not experience difficulties that could delay
or prevent the successful development, introduction and marketing of these new
products, or that our new products will adequately meet the requirements of the
13
marketplace and achieve market acceptance. If we are unable, for technological
or other reasons, to develop and introduce new products in a timely manner in
response to changing market conditions or customer requirements, our business,
operating results and financial condition will be seriously harmed.
Also, some of our competitors currently offer certain of these potential new
products. Due to the complexity of client/server software and the difficulty in
gauging the engineering effort required to produce these potential new
products, such potential new products are subject to significant technical
risks. We cannot guarantee that such potential new products will be introduced
on a timely basis or at all.
As part of our ongoing development process, we released several new versions
of NetWorker during 1999, and intend to release additional versions of
NetWorker. In addition, we released several new products that support the base
NetWorker software, including, but not limited to:
. Cluster 4.3--server-based software solution for high availability
clustering on Windows NT, Windows 2000, Solaris, HP-UX and AIX;
. G.E.M.S. Reporter--designed to deliver essential Legato NetWorker Server
monitoring and reporting, including information about back-up times,
amounts of data saved and backup success or failure for individual files
and databases; and
. NetApp ClientPak--provides a solution for backing up UNIX and NT file
systems hosted on Network Appliance filers.
We cannot guarantee that these and future new products will achieve market
acceptance. The lack of market acceptance for these and future new products
will seriously harm our business, operating results and financial condition.
We have research and development centers in the following locations:
. Boulder, Colorado;
. Burlington, Canada;
. Dublin, California;
. Eden Prairie, Minnesota;
. Marlborough, Massachusetts;
. New Dehli, India;
. Orem, Utah;
. Palo Alto, California; and
. Seattle, Washington.
Total expenses for research and development were $40.1 million in 1999, $25.6
million in 1998 and $17.8 million in 1997. We anticipate that we will continue
to commit substantial resources to research and development in the future. To
date, our development efforts have not resulted in any capitalized software
development costs.
Competition
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
Veritas (Seagate, Palindrome and Arcada).
14
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 market. In
addition, since there are relatively low barriers to entry in the software
market, we expect additional competition from other established and emerging
companies. We also expect that competition will increase as a result of future
software industry consolidations. Increased competition could harm us by
causing, among other things:
. Price reductions;
. Reduced gross margins; and
. Loss of market share.
Many of our current and potential competitors have longer operating
histories and have substantially greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger customer
base, than we have. As a result, certain current and potential competitors can
respond more quickly to new or emerging technologies and changes in customer
requirements. They can also devote greater resources to the development,
promotion, sale and support of their products. In addition, current and
potential competitors may establish cooperative relationships among themselves
or with third parties. If so, new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. In addition, network
operating system vendors could introduce new or upgrade existing operating
systems or environments that include functionality offered by our products. If
so, our products could be rendered obsolete and unmarketable. For all the
foregoing reasons, we may not be able to compete successfully, which would
seriously harm our business, operating results and financial condition.
Employees
As of March 31, 2000, we had a total of 1,265 employees. Of the total, 453
were in sales and marketing, 400 in research and development, 183 in technical
support, 169 in finance, administration and operations and 60 in consulting and
education services. Our future success depends, in significant part, upon the
continued service of our key technical and senior management personnel and our
continuing ability to attract and retain highly qualified technical, sales and
managerial personnel. Competition for such personnel is intense, and we cannot
guarantee that we can retain our key technical and managerial employees or that
we can attract, assimilate or retain other highly qualified technical, sales
and managerial personnel in the future. None of our employees are represented
by a labor union. We have not experienced any work stoppages and consider our
relations with our employees to be good.
15
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;
. Costs and expenses related to class action litigation;
. Personnel changes; and
. General economic factors.
Our Future Operating Results Are Uncertain.
Our historical results of operations are not necessarily indicative of our
results for any future period. Expectations, forecasts, and projections by us
or others are by nature forward-looking statements, and future results cannot
be guaranteed. Forward-looking statements that were true at the time may
ultimately prove to be incorrect or false. We will not update our forward-
looking statements. Some investors in our securities inevitably will experience
gains while others will experience losses, depending on the prices at which
they purchase and sell securities. Prospective and existing investors are
strongly urged to carefully consider the various cautionary statements and
risks set forth in this report.
16
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.
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
17
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.
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.
19
We may:
. Fail to develop and market new products that respond to technological
changes or evolving industry standards;
. Experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new products; or
. Fail to develop new products that adequately meet the requirements of the
marketplace or achieve market acceptance
If so, our business, operating results and financial condition would be
seriously harmed.
We currently plan to introduce and market several potential new products in
the next twelve months. Some of our competitors currently offer certain of
these potential new products. Such potential new products are subject to
significant technical risks. We may fail to introduce such potential new
products on a timely basis or at all. In the past, we have experienced delays
in the commencement of commercial shipments of our new products. Such delays
caused customer frustrations and delay or loss of product revenue. If potential
new products are delayed or do not achieve market acceptance, our business,
operating results and financial condition would be seriously harmed. In the
past, we have also experienced delays in purchases of our products by customers
anticipating our launch of new products. Our business, operating results and
financial condition would be seriously harmed if customers defer material
orders in anticipation of new product introductions.
Software products as complex as those we offer may contain undetected errors
or failures when first introduced or as new versions are released. We have in
the past discovered software errors in certain of our new products after their
introduction. We experienced delays or lost revenue during the period required
to correct these shipments, despite testing by us and by our current and
potential customers. This may result in loss of or delay in market acceptance
of our products, which could seriously harm our business, operating results and
financial condition.
We Rely on Enterprise License Transactions.
In the past, we marketed our products at the department level of corporate
customers. Within the last few years, we developed strategies to pursue larger
enterprise license transactions with corporate customers. We may fail to
successfully market our products in larger enterprise license transactions.
Such failure would seriously harm our business, operating results and financial
condition. Our operating results are sensitive to the timing of such orders.
Such orders are difficult to manage and predict, because:
. The sales cycle is typically lengthy, generally lasting three to six
months, and varies substantially from transaction to transaction;
. They often include muliple elements such as product licenses and service
and support;
. Recognition of revenue from enterprise license transactions may vary from
transaction to transaction;
. They typically involve significant technical evaluation and commitment of
capital and other resources; and
. Customers' internal procedures frequently cause delays in orders. Such
internal procedures include approval of large capital expenditures,
implementation of new technologies within their networks, and testing new
technologies that affect key operations.
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
20
enterprise level sales groups, and attract and retain qualified personnel. New
personnel will require training to obtain knowledge of the attributes of our
products. We may not be successful in creating the necessary sales organization
or in attracting, retaining or training these individuals. To succeed in the
enterprise and national accounts market will require, among other things,
establishing and continuing to develop relationships and contacts with senior
technology officers at these accounts. Our business, financial condition and
results of operations would be seriously harmed if our sales force is not
successful in these efforts.
We Rely on Indirect Sales Channels.
We rely significantly on our distributors, systems integrators and value
added resellers, or collectively, resellers, for the marketing and distribution
of our products. Our agreements with resellers are generally not exclusive and
in many cases may be terminated by either party without cause. Many of our
resellers carry product lines that are competitive with ours. These resellers
may not give a high priority to the marketing of our products. Rather, they may
give a higher priority to other products, including the products of
competitors, or may not continue to carry our products. Events or occurrences
of this nature could seriously harm our business, operating results and
financial condition. In addition, we may not be able to retain any of our
current resellers or successfully recruit new resellers. Any such changes in
our distribution channels could seriously harm our business, operating results
and financial condition.
Our strategy is also to increase the proportion of our customers licensed
through OEMs. We may fail to achieve this strategy. We are currently investing,
and intend to continue to invest resources to develop this channel. Such
investments could seriously harm our operating margins. We depend on our OEMs'
abilities to develop new products, applications and product enhancements on a
timely and cost-effective basis that will meet changing customer needs and
respond to emerging industry standards and other technological changes. Our
OEMs may not effectively meet these technological challenges. These OEMs:
. Are not within our control;
. May incorporate the technologies of other companies in addition to, or to
the exclusion of, our technologies, and
. Are not obligated to purchase products from us. In addition, our OEMs
generally have exclusive rights to our technology on their platforms,
subject to certain minimum royalty obligations.
Our OEMs may not continue to carry our products. The inability to recruit,
or the loss of, important OEMs could seriously harm our business, operating
results and financial condition.
We Depend on International Revenue.
Our continued growth and profitability will require further expansion of our
international operations. To successfully expand international operations, we
must:
. Establish additional foreign operations;
. Hire addition personnel; and
. Recruit additional international resellers.
This will require significant management attention and financial resources
and could seriously harm our operating margins. If we fail to further expand
our international operations in a timely manner, our business, operating
results and financial condition could be seriously harmed. In addition, we may
fail to maintain or increase international market demand for our products. Our
international sales are currently denominated in U.S. dollars. An increase in
the value of the U.S. dollar relative to foreign currencies could make our
products more expensive and, therefore, potentially less competitive in those
markets. In some markets, localization of our products is essential to achieve
market penetration. We may incur substantial costs and experience delays in
localizing our products. We may fail to generate significant revenue from
localized products.
21
Additional risks inherent in our international business activities generally
include:
. Significant reliance on our distributors and other resellers who do not
offer our products exclusively;
. Unexpected changes in regulatory requirements;
. Tariffs and other trade barriers;
. Lack of acceptance of localized products, if any, in foreign countries;
. Longer accounts receivable payment cycles;
. Difficulties in managing international operations;
. Potentially adverse tax consequences, including restrictions on the
repatriation of earnings;
. The burdens of complying with a wide variety of foreign laws; and
. The risks related to the global economic turbulence.
The occurrence of such factors could seriously harm our international sales
and, consequently, our business, operating results and financial condition.
We Must Manage Our Growth and Expansion.
We have recently experienced a period of significant expansion of our
operations that has placed a significant strain upon our management systems and
resources. In addition, we have recently hired a significant number of
employees, and plan to further increase our total headcount. We also plan to
expand the geographic scope of our customer base. This expansion has resulted
and will continue to result in substantial demands on our management resources.
From time to time, we receive customer complaints about the timeliness and
accuracy of customer support. We plan to add customer support personnel in
order to address current customer support needs. If we are not successful
hiring such personnel, our business, operating results and financial condition
could be seriously harmed. Our ability to compete effectively and to manage
future expansion of our operations, if any, will require us to (a) continue to
improve our financial and management controls, reporting systems and procedures
on a timely basis, and (b) expand, train and manage our employees. Our failure
to do so would seriously harm our business, operating results and financial
condition.
We Must Integrate Recent Acquisitions.
On August 6, 1998, we acquired Software Moguls, Inc. a developer of advanced
backup-retrieval products for the Windows NT and UNIX environments. On April 1,
1999, we acquired Intelliguard, a developer of standards-based storage
management solutions for storage area networks. On April 19, 1999, we acquired
FullTime, a developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions. On July 30, 1999, we acquired Vinca, a developer in high
availability and data protection software. We may make additional acquisitions
in the future. Acquisitions of companies, products or technologies entail
numerous risks, including:
. An inability to successfully assimilate acquired operations and products;
. Diversion of management's attention;
. Loss of key employees of acquired companies;
. Substantial transaction costs; and
. Substantial additional costs charged to operations as a result of the
failure to consummate acquisitions.
22
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,
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 disruptions 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.
23
Our operations may experience substantial fluctuations from period-to-period
as a consequence of such industry patterns, general economic conditions
affecting the timing of orders from major customers, and other factors
affecting capital spending. The occurrence of such factors could seriously harm
our business, operating results or financial condition.
Protection of Our Intellectual Property is Limited.
Our success depends significantly upon proprietary technology. To protect
our proprietary rights, we rely on a combination of:
. Patents;
. Copyright and trademark laws;
. Trade secrets;
. Confidentiality procedures; and
. Contractual provisions.
We seek to protect our software, documentation and other written materials
under patent, trade secret and copyright laws, which afford only limited
protection. However,
. We may not develop proprietary products or technologies that are
patentable;
. Any issued patent may not provide us with any competitive advantages or
may be challenged by third parties; or
. The patents of others may seriously impede our ability to do business.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult, and software piracy can be expected to be a persistent problem. In
licensing our products, other than in enterprise license transactions, we rely
on "shrink wrap" licenses that are not signed by licensees. Such licenses may
be unenforceable under the laws of certain jurisdictions. In addition, the laws
of some foreign countries do not protect our proprietary rights to as great an
extent as do the laws of the United States. Our means of protecting our
proprietary rights may not be adequate. Our competitors may independently
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.
24
Year 2000 Issues Could Affect Our Business.
Many currently installed computer systems and software products include
coding to accept only two digit entries in the date code field. These date code
fields need to accept four digit entries to distinguish 21st century dates from
20th century dates. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail. Some uncertainty
existed in the software industry concerning the potential effects associated
with such problems, although much of that uncertainty has now been allayed
following the roll-over to the Year 2000.
The risks posed by Year 2000 issues could still adversely affect our
business in a number of significant ways. We believe after examining and
testing our products that our internally developed technology, as well as the
third-party technology incorporated into our products, is Year 2000 compliant.
Moreover, to date, we have not detected any disruptions in our software
applications or in the applications of our vendors arising from the roll-over
to the Year 2000. Nonetheless, our products could experience unexpected Year
2000 issues that we have failed to uncover to date, which could cause our
products to be impaired. We also use third party financial and other systems in
our internal business operations. To our knowledge, these products have not
experienced Year 2000 disruptions following the roll-over to the Year 2000.
Nonetheless these systems could suffer from unexpected Year 2000 issues. Any
such Year 2000 issues could materially adversely affect our business. Moreover,
we may in the future be required to defend our products or services in
litigation or arbitration proceedings involving our products or services
related to Year 2000 compliance issues, or to negotiate resolutions of claims
based on Year 2000 issues. Defending or resolving Year 2000 related disputes,
regardless of the merits of such disputes, and any liability we have for Year
2000 related damages, including consequential damages, could be expensive.
Our Trading Price is Volatile.
The trading of our common stock is highly volatile, closing as high as
$79.25 and as low as $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.
25
ITEM 2. PROPERTIES
Our principal headquarters, beginning in March 2000, is located in
approximately 105,000 square feet of space in Mountain View, California. This
facility is leased through December 2009. Our principal research and
development facility is located in approximately 96,000 square feet of space in
Palo Alto, California. This facility is leased through September 2006. Our
principal sales and marketing office is located in approximately 52,500 square
feet of space in Sunnyvale, California. This office is leased through February
2007. We also currently lease other domestic offices throughout the United
States, as well as international offices throughout the world.
ITEM 3. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 1999.
ITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are biographical summaries of our executive officers as of
April 3, 2000:
Louis C. Cole, 56, joined Legato, as President, Chief Executive Officer and
a Director in June 1989. Since April 1995, Mr. Cole has also served as Chairman
of the Board. Before joining Legato, from March 1987 until
26
July 1988, Mr. Cole served as Executive Vice President responsible for all
operating divisions of Novell, Inc., or Novell, a manufacturer of computer
networking and software products. Mr. Cole serves as a director of Inference
Corp., Rogue Wave Software and NetIQ, all publicly held software companies. Mr.
Cole holds a B.S. in mathematics and education from Pennsylvania State
University at Edinboro.
Kent D. Smith, 51, has served as Executive Vice President of Strategic
Alliances of Legato since October 1999. In April 2000, Mr. Smith also assumed
responsibilities as Executive Vice President of Worldwide Sales, Support and
Corporate Marketing. He served as Executive Vice President and Chief Operating
Officer from May 1996 until October 1999. He served as Executive Vice President
of Customer Operations from March 1995 to May 1996. Before joining Legato, from
March 1994 until March 1995, Mr. Smith served as Vice President of Emerging
Markets at VeriFone, Inc., or VeriFone, a transaction automation company. Prior
to joining VeriFone, Mr. Smith held a range of sales and marketing positions in
the United States and overseas with IBM Corporation, or IBM, a publicly held
manufacturer of computers and related products, from 1974 to 1994. Mr. Smith
holds a B.A. in German from California State University at Fullerton and an
M.B.A. from the University of Southern California.
Nora M. Denzel, 37, has served as Senior Vice President and General Manager
of the Data Protection and Management Division since October 1999. In April
2000, Ms. Denzel also assumed responsibilities as General Manager of the Data
Availability Management Division. She served as Senior Vice President of
Product Operations from January 1997 to October 1999. Before joining Legato,
Ms. Denzel served as the director of IBM's storage management software products
and held a range of operations, engineering and marketing positions with IBM
from 1984 to 1996. She serves on the boards of a private software company,
Women in Technology International and the University of Santa Clara Business
School. Ms. Denzel holds a B.S. in Computer Science from the State University
of New York and an M.B.A. from Santa Clara University.
Thomas L. Panozzo, 52, joined Legato in July 1999 as Senior Vice President
of Worldwide Customer Support, Prior to joining Legato, Mr. Panazzo served as
Vice President, Customer Support, of Candle Corporation, a systems management
software company, from January 1997 to June 1999. From June 1966 to January
1997, he served in various positions at IBM, including Senior Project
Executive, Manager and Regional Manager. Mr. Panozzo holds a B.S. from the
Illinois Institute of Technology and a M.B.A. from Pepperdine University.
Stephen C. Wise, 45, joined Legato Systems, Inc., in September 1996 as
Senior Vice President of Finance and Administration and Chief Financial
Officer. Before joining Legato, Mr. Wise served as Senior Vice President,
Finance of Novell from December 1994 to September 1996. He was Vice President
and Corporate Controller of Novell from January 1991 to December 1994 and was
Vice President, Accounting and Planning from January 1990 to January 1991. Mr.
Wise holds a B.S. in Accounting from San Jose State University and an M.B.A.
from Santa Clara University.
James Chappell, 39, joined Legato Systems, in June 1992. In April 2000, Mr.
Chappell became the Vice President of Plans and Controls. From October 1999
until April 2000, he served as Vice President and General Manager of the Data
Availability Division. From August 1998 to October 1999, he served as our Vice
President of Business Development. From June 1992 to July 1998, Mr. Chappell
held various sales and marketing management positions with Legato, including
general manager, manager of strategic businesses and director of worldwide
channel marketing. Prior to joining Legato, Mr. Chappell served as President of
The Connectivity Lab, a data communications consulting firm, from March 1989 to
March 1991. Mr. Chappell holds a B.S. in Computer Science from Cal Poly
University, San Luis Obispo, California.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol
LGTO. Since April 20, 2000, an "E" has been appended to our trading symbol,
indicating that we have become subject to Nasdaq delisting procedures as a
result of our delay in filing our Form 10-K for fiscal 1999. The following
table sets forth the high and low closing sales prices of our common stock from
January 1, 1997 through December 31, 1999. Such prices represent prices between
dealers, do not include retail mark-ups, mark-downs or commissions and may not
represent actual transactions.
Share prices have been adjusted to reflect the two-for-one splits of our
common stock, which were effected July 5, 1996, April 17, 1998 and August 13,
1999.
High Low
------ ------
Fiscal 1997
-----------
First Quarter.................................................. $ 8.22 $ 4.04
Second Quarter................................................. $ 6.22 $ 2.75
Third Quarter.................................................. $ 8.94 $ 4.35
Fourth Quarter................................................. $11.66 $ 8.07
Fiscal 1998
-----------
First Quarter.................................................. $14.97 $10.03
Second Quarter................................................. $19.75 $12.88
Third Quarter.................................................. $27.37 $17.57
Fourth Quarter................................................. $32.97 $15.13
Fiscal 1999
-----------
First Quarter.................................................. $32.75 $20.75
Second Quarter................................................. $29.75 $15.25
Third Quarter.................................................. $49.13 $28.31
Fourth Quarter................................................. $79.25 $41.09
As of April 30, 2000, there were approximately 200 holders of record of our
common stock. We believe that a significant number of beneficial owners of our
common stock hold shares in street name.
We have never paid a cash dividend on our common stock and do not intend to
pay cash dividends on our common stock in the foreseeable future.
28
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Five Year Summary
December 31,
-------------------------------------------
1999 1998(3) 1997(3) 1996(2) 1995(2)
-------- -------- -------- -------- -------
(in thousands, except per share amounts)
Revenue.......................... $228,567 $167,907 $118,499 $ 88,920 $49,066
Gross profit..................... 196,790 143,114 97,812 70,457 36,591
Income from operations........... 2,991 27,815 21,589 15,747 7,288
Net income....................... 2,704 19,869 15,066 10,814 8,628
Basic earnings per share(1)...... 0.03 0.26 0.21 0.16 0.21
Shares used in basic earnings per
share calculations.............. 82,420 76,762 72,849 68,565 41,100
Diluted earnings per share(1).... 0.03 0.24 0.19 0.14 0.14
Shares used in diluted earnings
per share
calculations(1)................. 89,351 83,074 78,886 78,215 63,246
Cash, cash equivalents and
investments..................... 169,928 125,972 87,433 76,945 53,805
Working capital.................. 152,514 119,717 87,848 71,427 41,156
Total assets..................... 422,894 207,224 141,908 111,704 69,946
Retained earnings (accumulated
deficit)........................ 46,068 43,364 23,495 9,741 (1,073)
Total stockholders' equity....... 337,745 158,529 114,737 90,813 56,229
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements
(2) Selected financial data for the year-ended December 31, 1996 and 1995 was
derived by combining Legato's selected financial data for the year-ended
December 31, 1996 and 1995 with FullTime's financial data for the fiscal
year-ended June 30, 1997 and 1996, respectively.
(3) Selected financial data for the year-ended December 31, 1998 and 1997 was
derived by combining Legato's selected financial data for the year-ended
December 31, 1998 and 1997 with FullTime's financial data for the twelve-
months ended December 31, 1998 and 1997, respectively.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in this report on Form 10-K 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 discussed. 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 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 quarter of
fiscal 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
30
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, market and support network storage management software products
for heterogeneous client/server computing environments and large scale
enterprises. Our data protection products, primarily the NetWorker family of
software products, from which we derive a substantial majority of our revenue,
and our data availability products primarily our HA+, Octopus, Replication and
Cluster products, support many storage management server platforms and can
accommodate a variety of servers, clients, applications, databases and storage
devices. We license our products through resellers and directly to end users
primarily located in North America, Europe and Asia Pacific. We also license
our source code to original equipment manufacturers, or OEMs, in exchange for
initial licensing fees and receive ongoing royalties from the OEMs' product
sales. Substantially all of the OEMs are large computer system and software
suppliers located in the United States, Europe and Asia Pacific.
We acquired Software Moguls, Inc. in August 1998 and FullTime in April 1999,
primarily for their product offerings and research and development teams. We
accounted for the acquisitions as poolings-of-interests. Accordingly, we
restated the financial statements to represent the combined financial results
of previously separate entities for all periods presented.
31
Selected elements of our consolidated financial statements are shown below
for the last three years as a percentage of total revenue and as a percentage
change from year to year.
% Increase
% of Total Revenue (Decrease)
for Years ------------------
Ended December 31, 1999 1998
------------------------ Compared Compared
1999 1998 1997 to 1998 to 1997
------ ------ ------ -------- --------
Revenue:
Product license............... 60% 62% 58% 32% 51%
Service and support........... 30 23 20 74 68
Royalty....................... 10 11 14 22 15
Other products................ -- 4 8 (93) (39)
------ ------ ------
Total revenue............... 100 100 100 36 42
Cost of revenue:
Product license............... 3 3 4 5 14
Service and support........... 11 9 7 71 71
Other products................ -- 3 6 (93) (39)
------ ------ ------
Total cost of revenue....... 14 15 17 28 20
------ ------ ------
Gross profit.................... 86 85 83 38 46
Operating expenses:
Research and development...... 17 15 15 56 44
Sales and marketing........... 41 43 38 30 58
General and administrative.... 9 10 10 29 36
Amortization of intangibles... 10 1 1 1,849 --
Merger-related expenses....... 3 -- -- 867 --
In-process research and
development.................. 5 -- -- -- --
------ ------ ------
Total operating expenses.... 85 69 64 68 51
------ ------ ------
Income from operations.......... 1 16 19 (89) 29
Interest income, net............ 3 3 3 14 38
------ ------ ------
Income before provision for
income taxes................... 4 19 22 (74) 30
Provision for income taxes...... 3 8 8 (57) 27
------ ------ ------
Net income...................... 1% 11% 14% (86)% 32%
====== ====== ======
Revenue
Total revenue was $228.6 million in 1999, $167.9 million in 1998 and $118.5
million in 1997. Total revenue increased 36 percent from 1998 to 1999 and 42
percent from 1997 to 1998. Total revenue increased primarily as a result of the
continued acceptance of our Networker family of products, increased sales of
service and support contracts, as well as increased royalty revenue.
Product License Revenue. Product license revenue was $137.4 million in 1999,
$103.8 million in 1998 and $68.8 million in 1997. Product license revenue
increased 32 percent from 1998 to 1999 and 51 percent from 1997 to 1998.
Product license revenue increased primarily as a result of the continued market
acceptance of our products. Product license revenue also increased as a result
of increased product sales to large-scale enterprises. The increase in our
number of sales and marketing personnel, as well as sales and marketing
programs helped to increase the market acceptance of our products and product
sales. Our sales and marketing personnel increased from 266 employees in 1997
to 449 employees in 1999. 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
32
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 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 $67.5 million
in 1999, $38.8 million in 1998 and $23.1 million in 1997. Service and support
revenue increased 74 percent from 1998 to 1999 and 68 percent from 1997 to
1998. Service and support revenue increased 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 helped to increase
new sales and renewals of our software support contracts. Our increase in
internal staffing for education and consulting services resulted in increased
sales of the education and consulting services we offer. Our technical support
personnel increased from 80 employees in 1997 to 183 employees in 1999. Our
consulting and education services personnel increased from 19 employees in 1997
to 55 employees in 1999. 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 as 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 $23.3 million in 1999, $19.2 million in
1998 and $16.7 million in 1997. Royalty revenue increased 22 percent from 1998
to 1999 and 15 percent from 1997 to 1998. The increase in royalty revenue is
attributed to increased product sales by OEMs, including new OEM partners from
our acquisition of Vinca in July 1999. Royalty revenues are 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.
Other Product Revenue. Revenue from sales of other products was $0.5 million
in 1999, $6.2 million in 1998 and $10.0 million in 1997. Other product revenue
decreased 93 percent from 1998 to 1999 and 39 percent from 1997 to 1998. Other
product revenue represented less than 1 percent of total revenue in 1999, 4
percent in 1998 and 8 percent in 1997. Other product revenue consists primarily
of third-party ancillary hardware and software products for distributed
computing systems that are resold by Qualix Direct, the telesales organization
of FullTime, acquired in April 1999. The decrease in other revenue is primarily
attributable to the continued focus on sales of internally developed software
products rather than third party products sold through Qualix Direct.
International product license revenue accounted for 41 percent of total
revenue in 1999 and 1998 and 37 percent in 1997. International license revenue
in absolute dollars increased 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 sales during these periods were made in Europe and
Canada. To date, we have established foreign offices in the following
countries:
. Australia;
. Belgium;
. Canada;
33
. China;
. France;
. Germany;
. Japan;
. Italy;
. Netherlands;
. Poland;
. Singapore;
. Sweden;
. Switzerland; and
. United Kingdom.
We believe that our continued growth and profitability will require further
expansion of our international operations. In order to successfully expand
international sales in 2000 and subsequent periods, we must continue to
establish additional foreign operations, hire additional personnel for these
operations and recruit additional international resellers. Expansion and
management of our international operations will require significant management
attention and financial resources and could seriously harm certain operating
results if such efforts are not successful. 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. 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, and we cannot guarantee that any localized
product will ever generate significant revenue.
Gross Profit
Gross profit was $196.8 million in 1999, $143.1 million in 1998 and $97.8
million in 1997, representing 86 percent of total revenue in 1999, 85 percent
in 1998 and 83 percent in 1997. Gross profit consists of product license,
service and support and other product revenue less related costs.
Gross profit from product license revenue was $131.8 million in 1999, $98.5
million in 1998 and $64.1 million in 1997, representing 96 percent of product
license revenue in 1999, 95 percent in 1998 and 93 percent in 1997. Gross
profit from product license revenue increased 34 percent from 1998 to 1999 and
54 percent from 1997 to 1998. Gross profit from product license revenue
consists of product license revenue less the related costs. Related costs of
revenue consist primarily of product media, documentation and packaging. Gross
profit from product license revenue as a percentage of product license revenue
increased primarily as a result leveraging the costs of sales over a higher
product license revenue base.
Gross profit from service and support revenue was $41.6 million in 1999,
$23.7 million in 1998 and $14.2 million in 1997, representing 62 percent of the
service and support revenue in 1999, 61 percent in 1998 and 62 percent in 1997.
Gross profit from service and support revenue increased 76 percent from 1998 to
1999 and 66 percent from 1997 to 1998. The continued investment consists of
additional 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.
Gross profit from other product revenue was $0.1 million in 1999, $1.8
million in 1998 and $2.8 million in 1997, representing 29 percent of other
product revenue in 1999 and 1998 and 28 percent in 1997. Gross
34
profit from other product revenue decreased 93 percent from 1998 to 1999 and 39
percent from 1997 to 1998. Gross profit from other product revenue decreased in
absolute dollars primarily as a result of FullTime's continued focus on sales
of internally developed software products rather than third party products sold
through Qualix Direct telesales organization prior to our acquisition in April
1999.
Operating Expenses
Research and Development. Research and development expenses consist
primarily of personnel-related costs. Research and development expenses were
$40.1 million in 1999, $25.6 million in 1998 and $17.8 million in 1997,
representing 17 percent of total revenue in 1999, 15 percent in 1998 and 15
percent in 1997. Research and development expenses increased 56 percent from
1999 to 1998 and 44 percent from 1997 to 1998. The increases in research and
development expenses primarily reflect increased staffing and associated
support for engineers necessary to expand and enhance our product line. The
number of research and development personnel increased from 160 employees in
1997 to 384 employees in 1999. Research and development expenses, in absolute
dollars, increased primarily as a result of our continuing efforts to invest in
developing new products, applications and product enhancements. We believe that
research and development expenses will continue to increase in absolute dollars
as we continue to invest in developing new products and enhancing existing
products.
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 $93.8 million in 1999, $72.0
million in 1998 and $45.6 million in 1997, representing 41 percent of total
revenue in 1999, 43 percent in 1998 and 38 percent in 1997. Sales and marketing
expenses increased 30 percent from 1998 to 1999 and 58 percent from 1997 to
1998. The increases in sales and marketing expenses, in absolute dollars, were
primarily attributable to the growth of our sales force and associated support
personnel from 266 employees in 1997 to 449 employees in 1999. Sales and
marketing expenses also increased from 1997 to 1999 as a result of additional
marketing and promotional activities to increase awareness of our products. We
believe that sales and marketing expenses will increase in absolute dollars as
we 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 $20.5 million in 1999, $15.9 million in 1998 and
$11.7 million in 1997, representing 9 percent of total revenue in 1999, 10
percent in 1998 and 10 percent in 1997. General and administrative expenses
increased 29 percent from 1998 to 1999 and 36 percent from 1997 to 1998. The
decrease in general and administrative expenses as a percentage of total
revenue was attributable to leveraging general and administrative expenses over
a larger revenue base. The increases in absolute dollars of general and
administrative expenses from 1997 to 1999 were primarily attributable to
increased staffing and related costs required to manage and support our
expansion. General and administrative personnel increased from 83 employees in
1997 to 165 employees in 1999. We expect that general and administrative
expenses will increase in dollar amount as we continue to expand our
operations.
Amortization of Intangibles. Amortization of intangibles was $21.8 million
in 1999 and $1.1 million in 1998 and 1997. During 1999, we recorded additional
intangibles related to the acquisitions of Intelliguard totaling $58.7 million
and Vinca totaling $102.7 million (See Note 6 in the Notes to the Consolidated
Financial Statements). We are amortizing these intangibles on a straight-line
basis over periods ranging from seventeen months to five years from the dates
of acquisition resulting in additional amortization of $20.7 million in 1999.
Merger and Acquisition-Related Expenses. In connection with the our
acquisitions of FullTime during the second quarter of 1999 and Software Moguls,
Inc. during the third quarter of 1998, both accounted for as poolings-of-
interests, we incurred merger-related expenses of $5.0 million and $645,000,
respectively, consisting primarily of investment bankers', attorneys' and
accountants' fees and costs relating to closure of duplicative facilities and
severance costs. In addition, during 1999, we incurred $1.3 million in
expenses,
35
consisting primarily of investment bankers', attorneys' and accountants' fees,
in connection with our proposed acquisition of Ontrack Data International, Inc.
during the fourth quarter of 1999. In January 2000, we entered into a Mutual
Termination Agreement with Ontrack Data International, Inc. to immediately
terminate the proposed acquisition. (See Note 6 of the Notes to the
Consolidated Financial Statements)
In-process Research and Development. In connection with our acquisitions of
Intelliguard during the second quarter of 1999 and Vinca during the third
quarter of 1999, we incurred purchased in-process research and development
costs of $3.2 million and $8.3 million, respectively, during 1999. During 1998
and 1997, we did not incur any purchased in-process research and development
costs.
The fair value of Intelliguard's and Vinca's core technologies, existing
products, as well as the technology currently under development were determined
by independent appraisers using the income approach, which discounts expected
future cash flows to present value. The discount rates used in the present
value calculations were derived from a weighted average cost of capital
analysis, adjusted upward by a premium of 5% for the in-process projects from
the Intelliguard acquisition and 8.5% to 26% for the in-process projects from
Vinca acquisition to reflect additional risks inherent in the development life
cycle. We expect that the pricing models related to these acquisitions will be
considered standard within the high-technology industry. However, we do not
expect to achieve a material amount of expense reductions or synergies as a
result of integrating the acquired in-process technology. Therefore, the
valuation assumptions do not include anticipated cost savings.
The Intelliguard projects included in in-process research and development
and the percent complete, the estimated cost to complete and the value assigned
to each project follows (in thousands):
Estimate Percent Estimated Cost Value
Project Completion To Complete Assigned
------- ---------------- -------------- --------
A 9% $340 $ 780
B 50% $680 1,660
C 17% $170 730
------
Total purchased in-process research and development $3,170
======
The Vinca projects included in in-process research and development and the
percent complete, the estimated cost to complete and the value assigned to each
project as follows (in thousands):
Estimate Estimated
Percent Cost To Value
Project Completion Complete Assigned
------- ---------- --------- --------
A 60% $ 800 $ 700
B 60% 180 600
C 90% 175 2,200
D 90% 150 2,200
E 90% 300 1,000
F 30% 1,035 300
G 80% 2,065 800
H 40% 5,471 200
I 20% 2,450 300
------
Total purchased in-process research and
development $8,300
======
Depending on the project, we expect that products incorporating the acquired
technology will be completed and begin to generate cash flows within six months
to twenty-four months after the time of the acquisitions. However, development
of these technologies remains a significant risk to Legato due to the remaining
effort to achieve technical viability, rapidly changing customer markets,
uncertain standards for new products and significant competitive threats from
numerous companies. The nature of efforts to develop the
36
acquired technology into commercially viable products consists principally of
planning, designing, coding and testing activities necessary to determine that
the product can meet market expectations, including functionality and technical
requirements. Failure to achieve the expected levels of revenue and net income
from these products will negatively impact the return on investment expected at
the time of the acquisition and potentially result in impairment of any other
assets related to the development activities.
Interest Income, Net
Interest income, net, was $5.4 million in 1999. Interest income, net, was
$4.8 million in 1998 and $3.5 million in 1997. The increase in interest income
relates primarily to interest earned from the increased cash balances.
Provision for Income Taxes
The provision for income taxes was $5.7 million in 1999, $12.7 million in
1998 and $10.0 million in 1997, with an effective rate of 68 percent in 1999,
39 percent in 1998 and 40 percent in 1997. The increase in the effective tax
rate from 1998 to 1999 was primarily attributable to the impact of non-
deductible merger and amortization expenses incurred in connection with the
acquisitions of FullTime, Intelliguard and Vinca during 1999. The decrease in
the effective rate from 1997 to 1998 was primarily attributable to the
acquisition of Software Moguls, Inc. which was an S-corporation for income tax
purposes, and, therefore, did not record a provision for or benefit from income
taxes. Rather, income tax attributes of these losses were used by Software
Moguls, Inc. shareholders. If the losses of Software Moguls, Inc., had been
reflected in our financial statements in 1997, the effective tax rate would
have been 37 percent. (See Note 9 of the Notes to the Consolidated Financial
Statements).
Liquidity and Capital Resources
Our cash, cash equivalents and investments totaled $169.9 million at
December 31, 1999 and represented 40 percent of total assets. Cash and cash
equivalents increased $32.0 million during 1999. Cash and cash equivalents are
highly liquid investments with original maturities or remaining maturities at
the date of purchase of ninety days or less. Investments consist mainly of
short-term and long-term municipal, U.S. agency securities and auction rate
receipts. At December 31, 1999, we had no long-term debt and stockholders'
equity was $337.7 million.
We have financed our operations to date primarily by cash from operations
and sales of common stock. Net cash provided by operating activities was $51.9
million in 1999. Net cash provided from operations in 1999 consisted primarily
of net income of $2.7 million plus the tax benefit from exercise of stock
options of $36.4 million, depreciation and amortization of $32.9 million,
write-off of purchased in-process research and development costs of $11.5
million and provisions for sales returns of $9.5 million, offset by a change in
operating assets and liabilities of $12.9 million and by $28.5 million
attributable to the change in deferred taxes. Net cash provided by operating
activities was $42.1 million in 1998. Net cash provided from operations in 1998
consisted primarily of net income of $19.9 million plus the tax benefit from
exercise of stock options of $12.8 million, depreciation and amortization of
$7.2 million and the change in operating assets and liabilities of $2.0
million, offset by $8.4 million attributable to the change in deferred taxes.
Net cash provided by operating activities was $15.5 million in 1997. Net cash
provided from operations in 1997 consisted primarily of net income of $15.0
million plus the tax benefit from exercise of stock options of $5.0 million and
depreciation and amortization of $4.5 million, offset by the change in
operating assets and liabilities of $11.1 million. Accounts payables increased
in 1999 primarily as a result of increased purchasing commitments to support
our growth. Accounts payable and accrued liabilities increased during 1998 and
1997 because of increased purchases to support the growth in our operations.
Accrued compensation and benefits increased during 1999, 1998 and 1997
primarily as a result of the continued growth in the number of employees
worldwide. Accounts receivable and deferred revenue increased during 1999, 1998
and 1997, because of increasing sales of our product licenses as well as
service and support contracts.
37
Net cash used in investing activities was $52.6 million in 1999, $8.0
million in 1998 and $28.3 million in 1997. During 1998 and 1997, the net cash
used in investing activities primarily reflected net purchases of marketable
securities and property and equipment. In 1999, investing activities also
consisted of net payments of $24.3 million for the purchases of Intelliguard
and Vinca as well as a $5.0 million investment in a closely held private
company. Purchases of property and equipment increased during 1999, 1998 and
1997 to support the growth in our operations.
Net cash provided by financing activities was $32.7 million in 1999, $10.9
million in 1998 and $20.1 million in 1997. Net cash provided by financing
activities consisted primarily of proceeds received from the issuance of our
common stock. During 1999, we received $6.8 million in connection with the sale
of one qualifying accounts receivable on a non-recourse basis. However,
subsequent to year end, the agreement and related receivable was cancelled. As
a result, the proceeds received have been presented as a financing activity
rather than cash from operating activities .
We believe our current cash balances and cash flow from operations, if any,
will be sufficient to meet our working capital and capital expenditure
requirements for at least the next twelve months.
Year 2000 Compliance
Many currently installed computer systems and software products include
coding to accept only two digit entries in the date code field. These date code
fields need to accept four digit entries to distinguish 21st century dates from
20th century dates. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail. Some uncertainty
existed in the software industry concerning the potential effects associated
with such problems, although much of that uncertainty has now been allayed
following the roll-over of the Year 2000.
The risks posed by Year 2000 issues could 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.
Financial Risk Management
As a global concern, we face exposure to adverse movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could seriously harm our financial results. Substantially
all of our international sales are currently denominated in U.S. dollars. An
increase in the value of the U.S. dollar relative to foreign currencies could
make our products more expensive and therefore, reduce the demand for our
products. Reduced demand for our products could seriously harm our financial
results. Currently, we do not hedge against any foreign currencies and as a
result, could incur unanticipated gains or losses.
We maintain an investment portfolio of various issuers, types and
maturities. Our investment portfolio consists of both fixed and variable rate
financial instruments. These securities are classified as available-for-sale,
and consequently, are recorded on the balance sheet at fair value with
unrealized gains or losses reported in accumulated other comprehensive income
(loss), net of taxes. At any time, a sharp rise in interest rates could
38
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.
The table below presents principal amounts and related weighted average
interest rates by year of maturity for our investment portfolio.
2000 2001 2002 2003 2004 Thereafter Total
------- ------ ---- ---- ---- ---------- -------
Municipal securities.... $24,476 $6,655 -- -- -- -- $31,131
Average interest
rate................. 4.86% 5.34% -- -- -- -- 4.96%
Auction rate receipts &
other short-term
investments............ $18,415 -- -- -- -- -- $18,415
Average interest
rate................. 4.32% -- -- -- -- -- 4.32%
Recent Pronouncements
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 133, or SFAS 133, Accounting
for Derivative Instruments and Hedging Activities. SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statement of operations or as a component of
comprehensive income (loss), 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 a 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 the impact of FIN 44 will not have a material effect
on the financial position or results of operations of the Company.
39
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at December 31, 1999 and 1998.................. 41
Consolidated Statements of Income and Comprehensive Income for each of the
three years in the period ended December 31, 1999......................... 42
Consolidated Statements of Stockholders' Equity for each of the three years
in the period ended December 31, 1999..................................... 43
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1999............................................ 44
Notes to the Consolidated Financial Statements............................. 45
Report of Independent Accountants.......................................... 67
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
40
LEGATO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amount)
December 31,
------------------
1999 1998
-------- --------
ASSETS
------
Current assets:
Cash and cash equivalents................................ $115,222 $ 83,177
Short-term investments................................... 42,983 31,730
Accounts receivable, net................................. 53,387 39,982
Other current assets..................................... 10,112 6,059
Deferred tax assets...................................... 15,959 7,464
-------- --------
Total current assets................................... 237,663 168,412
Long-term investments...................................... 11,723 11,065
Property and equipment, net................................ 27,090 21,119
Intangible assets, net..................................... 141,988 2,243
Deferred tax assets--long-term............................. 2,176 3,849
Other assets............................................... 2,254 536
-------- --------
Total assets......................................... $422,894 $207,224
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable......................................... $ 5,757 $ 4,577
Accrued compensation and benefits........................ 16,867 10,796
Accrued liabilities...................................... 9,240 11,443
Short-term loan payable.................................. 6,847 --
Deferred revenue......................................... 46,438 21,879
-------- --------
Total current liabilities.............................. 85,149 48,695
Commitments and contingencies (Notes 5 and 12)
Common stock, $.0001 par value: 100,000 shares authorized
and 85,711 and 78,696 shares issued and outstanding at De-
cember 31, 1999 and 1998, respectively.................... 8 8
Additional paid-in capital................................. 292,045 115,435
Retained earnings.......................................... 46,068 43,364
Deferred stock compensation................................ -- (4)
Accumulated other comprehensive income (loss).............. (31) 71
Notes receivable from sale of stock........................ (345) (345)
-------- --------
Total stockholders' equity............................. 337,745 158,529
-------- --------
Total liabilities and stockholders' equity........... $422,894 $207,224
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
41
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except per share data)
Year Ended December 31,
---------------------------
1999 1998 1997
-------- -------- --------
Revenue:
Product license................................. $137,365 $103,828 $ 68,752
Service and support............................. 67,473 38,774 23,085
Royalty......................................... 23,279 19,155 16,661
Other products.................................. 450 6,150 10,001
-------- -------- --------
Total revenue................................. 228,567 167,907 118,499
Cost of revenue:
Product license................................. 5,589 5,304 4,672
Service and support............................. 25,870 15,097 8,848
Other products.................................. 318 4,392 7,167
-------- -------- --------
Total cost of revenue......................... 31,777 24,793 20,687
-------- -------- --------
Gross profit...................................... 196,790 143,114 97,812
Operating expenses:
Research and development........................ 40,057 25,645 17,826
Sales and marketing............................. 93,764 72,017 45,594
General and administrative...................... 20,484 15,874 11,686
Amortization of intangibles..................... 21,785 1,118 1,117
Merger and acquisition related expenses......... 6,239 645 --
In-process research and development............. 11,470 -- --
-------- -------- --------
Total operating expenses...................... 193,799 115,299 76,223
-------- -------- --------
Income from operations............................ 2,991 27,815 21,589
Interest income, net.............................. 5,448 4,799 3,481
-------- -------- --------
Income before provision for income taxes.......... 8,439 32,614 25,070
Provision for income taxes........................ 5,735 12,745 10,004
-------- -------- --------
Net income........................................ $ 2,704 $ 19,869 $ 15,066
======== ======== ========
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities......... (102) 165 457
-------- -------- --------
Comprehensive income.............................. $ 2,602 $ 20,034 $ 15,523
======== ======== ========
Basic earnings per share.......................... $ 0.03 $ 0.26 $ 0.21
======== ======== ========
Diluted earnings per share........................ $ 0.03 $ 0.24 $ 0.19
======== ======== ========
Shares used in basic earnings per share
calculations..................................... 82,420 76,762 72,849
======== ======== ========
Shares used in diluted earnings per share
calculations..................................... 89,351 83,074 78,886
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
42
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock
--------------
Deferred Accumulated Notes
Additional Stock Other Receivable
Paid-in Retained Compen- Comprehsive From
Shares Amount Capital Earnings sation Income (Loss) Sale of Stock Total
------ ------ ---------- -------- -------- ------------- ------------- --------
Balances, December 31,
1996................... 71,162 $ 7 $ 81,456 $ 9,741 $(40) $(176) $(175) $ 90,813
Adjustment to conform
fiscal year of pooled
entity--FullTime....... (306) (1) (14,964) (1,312) -- (375) -- (16,652)
Issuance of common stock
in FullTime initial
public offering........ 622 -- 14,950 -- -- -- -- 14,950
Stock issued under
option plans........... 2,901 2 3,464 -- -- -- -- 3,466
Stock issued under em-
ployee stock purchase
plan................... 538 -- 1,649 -- -- -- -- 1,649
Tax benefit from exer-
cise of stock options.. -- -- 4,970 -- -- -- -- 4,970
Deferred stock
compensation........... -- -- -- -- 18 -- -- 18
Unrealized gain on
investments............ -- -- -- -- -- 457 -- 457
Net income.............. -- -- -- 15,066 -- -- -- 15,066
------ ---- -------- ------- ---- ----- ----- --------
Balances, December 31,
1997................... 74,917 8 91,525 23,495 (22) (94) (175) 114,737
Stock issued under
option plans........... 3,345 -- 8,913 -- -- -- (170) 8,743
Stock issued under em-
ployee stock purchase
plan................... 434 -- 2,183 -- -- -- -- 2,183
Tax benefit from exer-
cise of stock options.. -- -- 12,814 -- -- -- -- 12,814
Deferred stock
compensation........... -- -- -- -- 18 -- -- 18
Unrealized gain on
investments............ -- -- -- -- -- 165 -- 165
Net income.............. -- -- -- 19,869 -- -- -- 19,869
------ ---- -------- ------- ---- ----- ----- --------
Balances, December 31,
1998................... 78,696 8 115,435 43,364 (4) 71 (345) 158,529
Stock issued under
option plans........... 3,483 -- 21,296 -- -- -- -- 21,296
Stock issued under em-
ployee stock purchase
plan................... 561 -- 4,524 -- -- -- -- 4,524
Stock issued for
acquisitions........... 2,971 -- 114,344 -- -- -- -- 114,344
Tax benefit from exer-
cise of stock options.. -- -- 36,446 -- -- -- -- 36,446
Deferred stock
compensation........... -- -- -- -- 4 -- -- 4
Unrealized loss on
investments............ -- -- -- -- -- (102) -- (102)
Net income.............. -- -- -- 2,704 -- -- -- 2,704
------ ---- -------- ------- ---- ----- ----- --------
Balances, December 31,
1999................... 85,711 $ 8 $292,045 $46,068 $-- $ (31) $(345) $337,745
====== ==== ======== ======= ==== ===== ===== ========
The accompanying notes are an integral part of these consolidated financial
statements.
43
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
-----------------------------
1999 1998 1997
--------- -------- --------
Cash flows from operating activities:
Net income.................................... $ 2,704 $ 19,869 $ 15,066
Adjustments to reconcile net income to net
cash provided by operating activities:
Deferred taxes (net of effect of
acquisitions)............................... (28,514) (8,427) (133)
Depreciation and amortization................ 32,930 7,190 4,529
Write-off of in-process research and
development................................. 11,470 -- --
Provision for sales returns.................. 9,531 7,578 2,135
Provision for doubtful accounts.............. 306 833 628
Gain on sale of available-for-sale
securities.................................. -- -- (528)
Tax benefit from exercise of stock options... 36,446 12,814 4,970
Other........................................ -- 204 --
Changes in operating assets and liabilities:
Accounts receivable......................... (19,116) (18,972) (17,476)
Other current assets........................ (3,493) (1,111) (1,454)
Accounts payable............................ 502 1,289 546
Accrued compensation and benefits........... 5,075 5,398 2,321
Accrued liabilities......................... (15,180) 7,916 (149)
Deferred revenue............................ 19,268 7,506 5,083
--------- -------- --------
Net cash provided by operating activities... 51,929 42,087 15,538
Cash flows from investing activities:
Purchase of available-for-sale securities.... (103,886) (64,491) (73,648)
Maturities of available-for-sale securities.. 96,873 71,139 54,126
Sales of available-for-sale securities....... -- -- 828
Acquisition of property and equipment........ (14,618) (14,514) (9,360)
Payment for purchase of subsidiaries, net of
cash acquired............................... (24,252) -- --
Investment in other securities............... (5,000) -- --
Other........................................ (1,672) (129) (240)
--------- -------- --------
Net cash used in investing activities....... (52,555) (7,995) (28,294)
Cash flows from financing activities:
Proceeds from issuance of common stock....... 25,820 10,930 20,065
Proceeds from short-term loan................ 6,847 -- --
Other........................................ 4 -- (8)
--------- -------- --------
Net cash provided by financing activities .. 32,671 10,930 20,057
--------- -------- --------
Net increase in cash and cash
equivalents.............................. 32,045 45,022 7,301
Cash and cash equivalents at beginning of
period........................................ 83,177 38,155 30,854
--------- -------- --------
Cash and cash equivalents at end of period..... $ 115,222 $ 83,177 $ 38,155
========= ======== ========
Supplemental Cash Flow Information:
Cash Transaction:
Cash paid for income taxes................... $ 3,702 $ 13 $ 5,278
Non-cash transactions
Issuance of common stock and stock options
exchanged in purchase business
combinations................................ 114,344 -- --
Deferred tax liability recorded in business
combinations................................ 22,740 -- 41
Unrealized gains (losses) on investments..... (102) 165 457
Common stock exchanged for notes receivable.. -- 170 --
The accompanying notes are an integral part of these consolidated financial
statements.
44
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Overview
On January 19, 2000, we announced that 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 quarter of
fiscal 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 twelve months ended December 31, 1999.
2. Summary of Significant Accounting Policies
Nature of Operations
We develop, license, market and support network storage management software
products for heterogeneous client/server computing environments and large-scale
enterprises. Our data protection products, primarily the NetWorker family of
software products, from which we derive a substantial majority of our
45
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
revenue, and data availability products, primarily HA+, Octopus, Replication
and Cluster products, support many storage management server platforms and can
accommodate a variety of servers, clients, applications, databases and storage
devices. We license our products through resellers and directly to end users
primarily located in North AMerica, Europe and Asia Pacific. We also license
our source code to original equipment manufacturers, or OEMs, in exchange for
initial licensing fees and receive ongoing royalties from the OEMs' product
sales. Substantially all of the OEMs are large computer system and software
suppliers located in the United States, Europe and Asia Pacific.
We acquired Software Moguls, Inc. in August 1998 and FullTime in April 1999,
primarily for their product offerings and research and development teams. The
acquisitions were accounted for as poolings-of-interests. Accordingly, we
restated the financial statements to represent the combined financial results
of previously separate entities for all periods presented. (See Note 6 of Notes
to Consolidated Financial Statements)
Basis of Presentation
The consolidated financial statements include our accounts and the accounts
of our wholly-owned subsidiaries and branch offices. All significant
intercompany balances and transactions have been eliminated. Accounts
denominated in foreign currencies have been remeasured into the functional
currency, using the U. S. dollar as the functional currency. Foreign currency
gains and losses from remeasurement, which have been insignificant, are
included in the consolidated statements of income.
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 reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Financial Instruments
Cash equivalents are highly liquid investments with original or remaining
maturities of three months or less as of the date of purchase. Cash equivalents
present insignificant risk of changes in value because of interest rate
changes. We maintain our cash balances at a variety of financial institutions
and have not experienced any material losses relating to such instruments.
Short-term and long-term investments in debt securities on the balance sheet
are classified as available-for-sale and are carried at fair value, with the
unrealized gains or losses, net of tax, reported in accumulated other
comprehensive income (loss). The amortized cost of debt securities is adjusted
for amortization of premiums and accretion of discounts to maturity, both of
which are included in interest income. Realized gains and losses are recorded
on the specific identification method. Realized gains or losses were not
significant in 1999 and 1998. Realized gains for 1997 were $528,000.
The amounts reported for cash equivalents, receivables and other financial
instruments are considered to approximate fair values based upon comparable
market information available at the respective balance sheet dates. Financial
instruments that potentially subject us to concentrations of credit risks
comprise principally cash, investments and trade accounts receivable. We invest
our excess cash in accordance with our investment policy that has been approved
by the Board of Directors and is reviewed periodically to minimize credit risk.
The policy authorizes the investment of excess cash in government securities,
tax exempt municipal securities, Eurodollar notes and bonds, time deposits,
certificates of deposit, commercial paper rated Aa or better and other
46
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
specific money market and corporate instruments of similar liquidity and credit
quality (See Note 4 of Notes to Consolidated Financial Statements). Our short-
term loan payable carrying amount approximates fair value as it is short-term
and its interest rate is at the approximate current market rate.
Investments in equity securities, that are not traded on public markets are
accounted for under the cost method of accounting. Dividends and other
distributions of earnings from the investee, if any, are included in income
when declared. We periodically evaluate the carrying value of such equity
investments and when a decline in the value is other than temporary, the
securities are reduced to their net realizable value.
Financing
We entered into a factoring agreement during 1999 under which we sold one
qualifying accounts receivable with a balance of $7,000,000, for which we have
not recognized the related revenue, to a large financing institution on a non-
recourse basis. This transfer was initially recorded as a transfer of an asset
and accounted for in accordance with SFAS No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." The
transfer of the accounts receivable for cash are reported in our statements of
cash flows as an operating activity. However, subsequent to year end, the
agreement and related receivable was cancelled. As a result, the $7,000,000 has
been presented as a short-term loan. The amount was net of discount for
interest and fees of $153,000 and was repaid in April 2000.
Property and Equipment
Property and equipment are stated at cost. Depreciation for property and
equipment is provided using the straight-line method over the estimated useful
lives of the respective assets, which is generally three years for computer
equipment, computer software and office furniture and three to ten years for
furniture and fixtures. Depreciation for leasehold improvements is provided
using the straight-line method over the shorter of the estimated useful lives
of the respective assets or the remaining lease term, generally seven to ten
years. Depreciation expense for 1999, 1998 and 1997 was $11,145,000, $6,072,000
and $3,412,000, respectively.
Effective January 1, 1999, we adopted the provisions of Accounting Standards
Executive Committee, or AcSEC, Statement of Position 98-1, or SOP 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. SOP 98-1 requires companies to capitalize certain costs of
computer software developed or obtained for internal use, provided that those
costs are not research and development. The adoption of SOP 98-1 did not have a
material impact on our financial statements.
Intangible Assets
Intangible assets include goodwill and other intangibles, recorded in
connection with the acquisitions of Intelliguard Software, Inc. and Vinca
Corporation, which are being amortized on a straight-line basis over periods
ranging from seventeen months to five years from the date of acquisitions (See
Note 3 of Notes to Consolidate Financial Statements). Whenever events or
circumstances indicate the carrying value of a long-lived asset, including
property and equipment, goodwill and other intangible assets might not be
recoverable, we assess the recoverability of intangible assets by determining
whether the amortization of the asset balance over its remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operations. The amount of impairment, if any, is recognized to the extent that
the carrying value exceeds the projected discounted future operating cash flows
and is recognized as a write down of the asset. To date, we have not recorded
any impairment charges against the value of our intangible assets.
47
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue Recognition
Our revenue is derived from primarily two sources, across many industries:
(i) product license revenue, derived primarily from product sales to resellers
and end users, including large scale enterprises, and royalty revenue, derived
primarily from initial license fees and ongoing royalties from product sales by
source code OEMs; and (ii) service and support revenue, derived primarily from
providing software updates, support and education and consulting services to
end users. Other product revenue consists primarily of third-party ancillary
hardware and software products for distributed computing systems that are
resold by Qualix Direct, the telesales organization of FullTime.
We adopted the provisions of Statement of Position 97-2, or SOP 97-2,
Software Revenue Recognition, as amended by Statement of Position 98-4,
Deferral of the Effective Date of Certain Provisions of SOP 97-2, effective
January 1, 1998. SOP 97-2 supercedes Statement of Position 91-1, Software
Revenue Recognition, and delineates the accounting for software product and
maintenance revenue. Under SOP 97-2, 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 for 1999, certain value-added
resellers. We have recognized 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 resellers where we have determined that fees are not fixed
or determinable due to circumstances involving unauthorized written and oral
agreements outside our normal contractual terms, as discussed in Note 1, we
recognized revenue upon receipt of cash. For certain sales where the licensing
fee is not due until the customer deploys the software, revenue is recognized
when the customer reports to us that the software has been deployed. Estimated
product returns are recorded upon recognition of revenue from customers having
rights of return, including exchange rights for unsold products and product
upgrades. Provisions for estimated warranty costs and anticipated retroactive
price adjustments are recorded at the time products are shipped. In 1997, our
revenue recognition policy was the same as set forth above.
For contracts with multiple obligations (e.g. deliverable and undeliverable
products, maintenance and other services), we allocate revenue to the
undelivered components of the contract based on objective evidence of its fair
value, which is specific to us. We recognize revenue allocated to undelivered
products when the criteria for product revenue set forth above are met. We
recognize revenue from maintenance fees for ongoing customer support and
product updates ratably over the period of the maintenance contract. Payments
for maintenance fees are generally made in advance and are non-refundable. For
revenue allocated to education and consulting services, or derived from the
separate sales of these services, we recognize revenue as the related services
are performed. In 1997, our revenue recognition policy for education and
support services was the same as set forth above.
We recognize product revenue from royalty payments upon receipt of quarterly
royalty reports from OEMs related to their product sales for the previous
quarter.
We perform ongoing credit evaluations of our customers' financial condition
and do not require collateral. We maintain allowances for potential credit
losses and such losses have been within our expectations.
Research and Development Costs
Costs incurred in the research and development of new software products are
expensed as incurred until technological feasibility is established.
Development costs are capitalized beginning when a products technological
feasibility has been established and ending when the product is available for
general release to
48
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
customers. Technological feasibility is reached when the product reaches the
beta stage. To date, products and enhancements have generally reached
technological feasibility and have been released for sale at substantially the
same time.
Income Taxes
Our provision for income taxes is comprised of our current tax liability and
the change in deferred tax assets and liabilities. Deferred tax assets and
liabilities are determined based on differences between financial reporting and
tax bases of assets and liabilities and are measured using the enacted tax
rates and laws that will be in effect when the differences are expected to
reverse.
Advertising and Promotional Costs
We expense advertising and promotional costs as they are incurred.
Advertising expense for 1999, 1998 and 1997 was $3,701,000, $3,104,000 and
$3,633,000, respectively.
Computation of Earnings Per Share
Basic earnings per share is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share is computed giving effect to all
dilutive potential common shares that were outstanding during the period.
Dilutive potential common equivalent shares consist of the incremental common
shares issuable upon exercise of stock options.
A reconciliation of the numerator and denominator of basic and diluted
earnings per share is provided as follows (in thousands, except per share
amounts):
1999 1998 1997
------- ------- -------
Numerator--Basic and diluted earnings per share,
Net income....................................... $ 2,704 $19,869 $15,066
======= ======= =======
Denominator--Basic earnings per share
Weighted average common shares outstanding....... 82,420 76,762 72,849
------- ------- -------
Basic earnings per share......................... $ 0.03 $ 0.26 $ 0.21
======= ======= =======
Denominator--Diluted earnings per share
Weighted average common shares outstanding....... 82,420 76,762 72,849
Effect of dilutive securities--common stock
options......................................... 6,931 6,312 6,037
------- ------- -------
Weighted average common and common equivalent
shares.......................................... 89,351 83,074 78,886
------- ------- -------
Diluted earnings per share....................... $ 0.03 $ 0.24 $ 0.19
======= ======= =======
Options excluded from diluted earnings per share
calculation....................................... 115 485 440
======= ======= =======
Certain shares of common stock issuable upon exercise of stock options were
excluded from the calculation of diluted net income per share because the
options' exercise price was greater than the average market price of the common
shares.
49
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Comprehensive Income (Loss)
Our unrealized gains (losses) on investments represent the only component of
comprehensive income (loss) that are excluded from net income for 1999 and
prior years. Our comprehensive income (loss) has been presented in the
consolidated financial statements. The tax effects allocated to the component
of other comprehensive income (loss) and accumulated other comprehensive income
balances are as follows:
Tax
Before-Tax Benefit Net of Tax
Amount (Expense) Amount
------------- --------- ----------
(in thousands)
1999:
Unrealized losses on securities........... $(164) $ 62 $(102)
----- ----- -----
Total other comprehensive loss............ $(164) $ 62 $(102)
===== ===== =====
1998:
Unrealized gains on securities............ $ 275 $(110) $ 165
----- ----- -----
Total other comprehensive income.......... $ 275 $(110) $ 165
===== ===== =====
1997:
Unrealized losses on securities........... $ 234 $(105) $ 129
Realized gains on securities.............. 528 (200) 328
----- ----- -----
Total other comprehensive income.......... $ 762 $(305) $ 457
===== ===== =====
Accumulated
Other
Comprehensive
Income (Loss)
-------------
Balance, December 31, 1996................ $(176)
Pooling adjustment........................ (375)
Current period change..................... 457
-----
Balance, December 31, 1997................ (94)
Current period change..................... 165
-----
Balance, December 31, 1998................ 71
Current period change..................... (102)
-----
Balance, December 31, 1999................ $ (31)
=====
Recent Pronouncements
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 133, or SFAS 133, Accounting
for Derivative Instruments and Hedging Activities. SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that
exists. We do not currently hold derivative instruments or engage in hedging
activities.
In July 1999, the FASB issued Statement of Financial Accounting Standards
No. 137, or SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB No. 133. SFAS 137 deferred
the effective date of SFAS 133 until the first fiscal quarter beginning after
June 15, 2000.
50
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
51
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Consolidated Balance Sheet Detail
December 31,
------------------
1999 1998
-------- --------
(in thousands)
Accounts receivable:
Trade accounts receivable............................. $ 54,303 $ 41,810
Allowance for doubtful accounts....................... (916) (1,828)
-------- --------
$ 53,387 $ 39,982
======== ========
Property and equipment:
Computer equipment and software....................... $ 31,926 $ 20,844
Furniture and fixtures................................ 6,181 4,812
Office equipment...................................... 2,668 1,879
Leasehold improvements and construction in process.... 7,117 6,416
-------- --------
47,892 33,951
Accumulated depreciation.............................. (20,802) (12,832)
-------- --------
$ 27,090 $ 21,119
======== ========
Intangible assets:
Goodwill (useful life of 5 years)..................... $ 87,257 $ 2,283
Patents (useful life of 5 years)...................... 23,600 --
Distribution channel (useful life of 5 years)......... 21,800 --
Purchased technology (useful life of 2-5 years)....... 20,430 3,300
Trademarks (useful life of 5 years)................... 7,300 --
Assembled workforce (useful life of 3 years).......... 5,360 --
Other intangible assets (useful life of 3-5 years).... 1,390 --
-------- --------
167,137 5,583
Accumulated amortization................................ (25,149) (3,340)
-------- --------
$141,988 $ 2,243
======== ========
4. Investments
The following table summarizes the fair value and unrealized gains and
losses of debt securities at December 31, 1999 and 1998. All debt securities
have been classified as available-for-sale:
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
------- ---------- ---------- ---------
(in thousands)
December 31, 1999:
Municipal securities............. $31,342 $ -- $(34) $31,308
Auction rate receipts and other
short-term investments.......... 18,436 -- (38) 18,398
------- ----- ---- -------
$49,778 $ -- $(72) $49,706
======= ===== ==== =======
December 31, 1998:
Municipal securities............. $31,987 $ 116 $ (8) $32,095
Auction rate receipts and other
short-term investments.......... 10,690 10 -- 10,700
------- ----- ---- -------
$42,677 $ 126 $ (8) $42,795
======= ===== ==== =======
52
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The amortized cost and estimated fair value of investments in debt
securities at December 31, 1999 and 1998, by contractual maturity, are as
follows:
Estimated
Fair
Cost Value
------- ---------
(in thousands)
December 31, 1999:
Due in 1 year or less.................................... $43,035 $42,983
Due in 1-2 years......................................... 6,743 6,723
------- -------
Total investment in debt securities...................... $49,778 $49,706
======= =======
December 31, 1998:
Due in 1 year or less.................................... $31,659 $31,730
Due in 1-5 years......................................... 10,618 10,665
Due in more than 5 years................................. 400 400
------- -------
Total investment in debt securities...................... $42,677 $42,795
======= =======
Also included in long-term investments at December 31, 1999, is an amount of
$5 million representing an investment in the preferred stock of a private
company. This is recorded at cost and was purchased in November 1999.
5. Commitments and Contingencies
We lease our operating facilities under non-cancelable operating leases that
expire at various dates through February 2007. Minimum lease commitments at
December 31, 1999 were as follows (in thousands):
2000................................................................ $11,768
2001................................................................ 11,331
2002................................................................ 11,122
2003................................................................ 11,115
2004 and thereafter................................................. 43,523
-------
Total minimum lease commitments..................................... $88,859
=======
Rent expense for 1999, 1998 and 1997 was $8,535,000, $5,650,000 and
$3,519,000, respectively.
We are engaged in certain legal and administrative proceedings incidental to
our normal business activities. While it is not possible to determine the
ultimate outcome of these actions at this time, we believe that any liabilities
resulting from such proceedings, or claims which are pending or known to be
threatened, will not have a material adverse effect on our financial position
or results of operations. (See Note 12 to the Notes to Consolidated Financial
Statements).
6. Acquisitions
For acquisitions accounted for under the pooling-of-interests method, we
restated the accompanying financial statements and financial data to represent
the combined financial results of the previously separate entities for all
periods presented. No significant adjustments were required to conform the
accounting policies of the acquired companies. For acquisitions accounted for
under the purchase method, our consolidated results of operations include the
operating results of the acquired companies from their acquisition dates.
Acquired
53
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
assets and liabilities were recorded at their estimated fair values at the
dates of acquisition, and the aggregate purchase price plus costs directly
attributable to the completion of acquisitions have been allocated to the
assets and liabilities acquired.
Qualix Group, Inc. On April 19, 1999, we completed the merger with Qualix
Group, Inc. (dba FullTime Software, Inc.), or FullTime, a developer of
distributed, enterprise-wide, cross-platform, adaptive computing solutions that
enable customers to proactively manage application service level availability.
We issued 3,442,000 shares of our common stock in exchange for all the common
stock and options of FullTime. We accounted for the acquisition as a pooling of
interests.
Software Moguls, Inc. In August 1998, we issued 498,998 shares of common
stock in exchange for all the outstanding shares of Software Moguls, Inc., a
developer of advanced backup-retrieval products for the Windows NT and UNIX
environments. We accounted for the acquisition as a pooling of interests.
The table below presents the separate results of operations for Software
Moguls and FullTime for the periods prior to the combination. Our results of
operations include Software Moguls and FullTime since the date the mergers were
completed:
Year Ended December 31,
----------------------------
1999 1998 1997
-------- -------- --------
(in thousands)
Revenue:
Legato Systems, Inc........................ $223,477 $142,233 $ 81,834
FullTime................................... 5,090 24,729 34,614
Software Moguls............................ -- 945 2,051
-------- -------- --------
Total.................................... $228,567 $167,907 $118,499
======== ======== ========
Net income (loss):
Legato Systems, Inc........................ $ 5,334 $ 28,111 $ 15,739
FullTime................................... (4,012) (11,643) 1,376
Software Moguls............................ -- (403) (1,646)
-------- -------- --------
Total.................................... 1,322 16,065 15,469
Adjustment to reflect elimination of
valuation allowance..................... 1,382 3,804 (403)
-------- -------- --------
Net income............................... $ 2,704 $ 19,869 $ 15,066
======== ======== ========
Intelliguard Software, Inc. On April 1, 1999, we completed the acquisition
of Intelliguard Software, Inc. and O.R.P., Inc., developers of standards-based
storage management solutions for storage area networks, collectively referred
to as Intelliguard. We (i) issued 1,440,000 shares of our common stock with a
fair market value of $42.5 million, calculated based on the average of the
share price three days prior to the announcement of the acquisition on January
28, 1999 and three days after this date, and (ii) provided cash consideration
of $9.0 million for all of the outstanding stock of Intelliguard and incurred
transaction costs consisting primarily of professional fees of $3.9 million,
resulting in a total purchase price of $55.4 million. The results of operations
of Intelliguard have been included with our results of operations since April
1, 1999, the date of acquisition.
Vinca Corporation. On July 30, 1999, we completed the acquisition of Vinca
Corporation, or Vinca, a developer of high availability and data protection
software. We (i) issued approximately 1,531,000 shares of our common stock with
an estimated value of $54.3 million, calculated based on the average of the
share price
54
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for the ten days preceding three days prior to the closing date, the date the
number of shares was fixed, and (ii) exchanged options to purchase
approximately 590,000 shares of our common stock with a estimated value of
$17.6 million and provided cash consideration of $18.8 million for all of the
outstanding stock and options of Vinca. The fair market value of the exchanged
options to purchase 590,000 shares of our common stock was calculated using the
Black-scholes option-pricing model with the following assumptions: 1) expected
volatility of 80.59%, 2) weighted-average risk-free interest rate of 5.68%, 3)
expected term of approximately five years and 4) no expected dividends. In
connection with the acquisition, we incurred transaction costs consisting
primarily of professional fees of $1.0 million, resulting in a total purchase
price of $91.7 million. The results of operations of Vinca have been included
with our results of operations since July 30, 1999, the date of acquisition.
The acquisitions were accounted for as a purchase business combinations,
which means that the purchase price was allocated to the assets acquired and
liabilities assumed based on the estimated fair values at the date of
acquisition.
The fair value of the assets of Intelliguard, which was determined through
established valuation techniques used in the software industry, and a summary
of the consideration exchanged for these assets follows (in thousands):
Total purchase price.............................................. $55,355
=======
Assets acquired:
Tangible assets, primarily cash, accounts receivable and
property and equipment......................................... 1,919
Purchased software products..................................... 11,930
Purchased in-process research and development................... 3,170
Assembled workforce............................................. 860
Non-compete agreements.......................................... 690
Goodwill........................................................ 45,215
Liabilities assumed............................................. (8,429)
-------
$55,355
=======
The Intelliguard projects included in in-process research and development
and the percent complete, the estimated cost to complete and the value assigned
to each project are as follows (in thousands):
Estimate of Percent Estimated Cost To Value
Project Completion Complete Assigned
------- ------------------- ----------------- --------
A 9% $340 $ 780
B 50% $680 1,660
C 17% $170 730
-------
Total purchased in-process research and development $3,170
======
55
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of the assets of Vinca which was determined through
established valuation techniques used in the software industry, and a summary
of the consideration exchanged for these assets follows (in thousands):
Total purchase price............................................. $ 91,705
Deferred taxes................................................... 22,740
--------
$114,445
========
Assets acquired:
Tangible assets, primarily cash, accounts receivable and
property and equipment........................................ $ 10,858
Patents and core technology.................................... 23,600
Distribution channel........................................... 22,500
Completed products............................................. 5,200
Purchased in-process research and development.................. 8,300
Assembled workforce............................................ 4,500
Trademarks..................................................... 7,300
Goodwill....................................................... 39,621
Liabilities assumed............................................ (7,434)
--------
$114,445
========
The Vinca projects included in in-process research and development and the
percent complete, the estimated cost to complete and the value assigned to each
project are as follows (in thousands):
Estimate of Percent Estimated Cost To
Project Completion Complete Value Assigned
------- ------------------- ----------------- --------------
A 60% $ 800 $ 700
B 60% 180 600
C 90% 175 2,200
D 90% 150 2,200
E 90% 300 1,000
F 30% 1,035 300
G 80% 2,065 800
H 40% 5,471 200
I 20% 2,450 300
------
Total purchased in-process research and development $ 8,300
=======
The amounts allocated to the purchased in-process technology were determined
based on appraisals completed by independent third parties using established
valuation techniques and was expensed upon acquisition, because technological
feasibility had not been established and no future alternative uses existed.
The value of these projects was determined by estimating the costs to develop
the purchased in-process technology into commercially viable products,
estimating the resulting net cash flows from the sale of the products resulting
from the completion of the projects reduced by the portion of the revenue
attributable to core technology, and discounting the net cash flows back to
their present value. Amounts allocated to intangible assets and goodwill
resulting from the above acquisitions are amortized over periods ranging from
seventeen months to five years from the date of acquisition.
Summarized below are our unaudited pro forma results of operations as though
Intelliguard and Vinca had been acquired at the beginning of the periods
presented. Adjustments have been made for estimated increases in
56
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
amortization for purchased software products, assembled work force and non-
compete agreements and related income tax effects. (in thousands, except per
share amounts):
December 31,
------------------
1999 1998
-------- --------
Revenue................................................. $237,766 $196,410
======== ========
Net loss................................................ $ (3,604) $ (9,376)
======== ========
Basic and diluted loss per share........................ $ (0.04) $ (0.12)
======== ========
The above amounts are based upon certain assumptions and estimates which we
believe are reasonable and do not reflect any benefit from economies of scale
which might be achieved from combined operations. The pro forma financial
information presented above is not necessarily indicative of either the results
of operations that would have occurred had the acquisitions taken place at the
beginning of the periods presented or of future results of operations of the
combined companies. The charges for in-process research and development and
merger-related expenses have not been included in the unaudited pro forma
results because it is nonrecurring and directly related to the acquisition.
Merger and acquisition-related expenses. In connection with the merger with
FullTime, we incurred merger related expenses of $4,968,000, consisting
primarily of charges for transaction fees, involuntary termination benefits,
non-cancellable obligations and write-offs of leasehold improvements for sales
and administrative offices that were duplicative and vacated. On November 18,
1999, we signed a definitive agreement to acquire Ontrack Data International,
Inc. (Ontrack), a provider of data recovery software and service solutions. On
January 24, 2000, we entered into a Mutual Termination Agreement with Ontrack
Data International, Inc. to immediately terminate the proposed acquisition. In
connection with the proposed and terminated acquisition, we incurred expenses
of $1,271,000 consisting primarily of attorneys', bankers' and accountants'
fees.
A summary of these expenses follows:
FullTime Ontrack Total
-------- ------- ------
Professional fees.................................. $1,782 $1,133 $2,915
Printing and filing fees........................... 318 138 456
Involuntary termination costs...................... 757 -- 757
Write-off of leasehold improvements for vacated
facilities........................................ 1,419 -- 1,419
Non-cancellable obligations........................ 692 -- 692
------ ------ ------
Total............................................ $4,968 $1,271 $6,239
====== ====== ======
At December 31, 1999, substantially all charges from the merger with
FullTime had been paid.
7. Stockholders' Equity
Stock Splits
We effected two-for-one splits of our common stock (in the form of stock
dividends) on July 5, 1996, April 17, 1998 and August 13, 1999. These stock
splits have been retroactively reflected in our consolidated financial
statements.
Preferred Stock
We are authorized to issue 5,000,000 shares of preferred stock, none of
which is issued or outstanding. The Board of Directors has the authority to
issue the preferred stock in one or more series and to fix rights,
57
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
preferences, privileges and restrictions, and the number of shares constituting
any series and the designation of such series, without any further vote or
action by the stockholders.
Stockholder Rights Plan
In May 1997, we adopted a stockholder rights plan, or the Rights Plan, in
which preferred stock rights were distributed as a rights dividend at a rate of
one right for each share of common stock held as of the close of business on
June 23, 1997. The Rights Plan is designed to deter coercive or unfair takeover
tactics and to prevent an acquirer from gaining control of us without offering
a fair price in the event we are confronted in the future with coercive or
unfair takeover tactics. The rights expire May 23, 2007.
Stock Option/Stock Issuance Plan
Under our 1995 Stock Option/Stock Issuance Plan, or the 1995 Plan,
approximately 17,051,000 shares of common stock have been authorized for
issuance. The share reserve automatically increases on the first trading day in
each calendar year by the number of shares equal to three percent of the total
number of shares of our common stock outstanding on December 31 of the
immediately preceding calendar year. Options to purchase shares may be granted
and shares may be issued directly under the 1995 Plan. Options must have an
exercise price not less than 100% and 85% of fair market value of the common
stock on the date of grant for incentive stock options and non-statutory stock
options, respectively. The purchase price for shares issued directly may not be
less than 85% of fair market value on the date of grant. Options generally vest
over four years and terminate ten years after their original grant dates.
The 1995 Plan is divided into three separate components: (i) the
Discretionary Option Grant Program, under which employees, non-employee Board
members who are not serving on our Compensation Committee and consultants may,
at the discretion of the Compensation Committee, be granted options to purchase
shares of common stock, (ii) the Stock Issuance Program, under which such
persons may, at the Compensation Committee's discretion, be issued shares of
common stock directly, through the purchase of such shares or in consideration
of the past performance of services, and (iii) the Automatic Option Grant
Program, under which option grants will automatically be made at periodic
intervals to eligible non-employee Board members to purchase shares of common
stock at an exercise price equal to 100 percent of their fair market value on
the grant date. Each individual who first becomes a non-employee Board member
will receive a 96,000 share option grant on the date such individual joins the
Board, provided such individual has not been previously employed by us. In
addition, at each Annual Stockholders Meeting, each individual who has served
as a non-employee Board member for at least six months prior to such Annual
Meeting and who is to continue to serve as a non-employee Board member after
the meeting will receive an additional option grant to purchase 24,000 shares
of common stock, whether or not such individual has been in our prior employ.
Options granted under the 1995 plan generally become exercisable over a four
year period, whereby 25 percent of the shares become exercisable one year after
the grant date and ratably thereafter over 36 months. Options granted prior to
July 5, 1995 contain provisions allowing for early exercise of unvested
options. Shares issued upon such early exercise are subject to vesting and
repurchase rights by Legato. At December 31, 1999, 1998 and 1997, none of the
shares outstanding was subject to repurchase by us. Upon exercise,
approximately 13,000, 373,000 and 1,989,000 option shares under grant are
subject to repurchase by us at December 31, 1999, 1998 and 1997, respectively.
58
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is a summary of option activity:
Weighted
Number of Average Price Options Price
Shares Per Share Per Share
-------------- ------------- -------------
(in thousands)
Outstanding at December 31,
1996.......................... 10,644 $ 1.92 $ 0.03-$11.13
Options granted and assumed.. 5,221 $ 6.72 $ 3.04-$11.66
Options exercised............ (2,901) $ 0.82 $ 0.03-$ 6.00
Options canceled............. (1,881) $ 5.32 $ 0.19-$11.66
-------
Outstanding at December 31,
1997.......................... 11,083 $ 3.87 $ 0.03-$11.66
Options granted and assumed.. 4,039 $12.86 $10.28-$28.57
Options exercised............ (3,345) $ 2.55 $ 0.03-$10.25
Options canceled............. (1,058) $ 5.88 $ 0.44-$26.22
-------
Outstanding at December 31,
1998.......................... 10,719 $ 7.49 $ 0.03-$28.57
Options granted and assumed.. 6,422 $27.41 $13.03-$77.00
Options exercised............ (3,483) $ 6.01 $ 0.03-$35.45
Options canceled............. (1,544) $15.58 $ 0.03-$68.81
-------
Outstanding at December 31,
1999.......................... 12,114 $16.98 $ 0.03-$77.00
=======
At December 31, 1999, 1998 and 1997, approximately 6,613,000, 4,702,000 and
1,504,000 shares of common stock remained available for grant under our stock
option plans. At December 31, 1999, 1998 and 1997, approximately 4,143,000,
3,947,000 and 3,484,000 options were exercisable at weighted average exercise
prices per share of $6.49, $3.42 and $1.43, respectively.
The options outstanding and currently exercisable by exercise price at
December 31, 1999 are as follows:
Options Outstanding Options Exercisable
------------------------------------- -----------------------
Weighted
Average
Exercise Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
-------- ----------- ----------- -------- ----------- --------
(in thousands, except per share amounts)
$ 0.03-$ 0.44 281 4.05 $ 0.32 281 $ 0.32
$ 0.71-$ 2.38 1,131 5.23 $ 1.30 1,130 $ 1.30
$ 2.96-$ 4.69 575 6.48 $ 3.51 501 $ 3.45
$ 4.77-$ 8.22 1,521 7.06 $ 6.27 741 $ 6.04
$ 8.31-$13.03 2,332 7.92 $11.01 1,180 $11.10
$13.63-$22.00 3,946 9.09 $19.47 225 $16.88
$22.22-$39.99 1,742 9.36 $31.91 85 $26.33
$41.69-$54.34 320 9.76 $48.17 -- $ --
$67.50-$77.00 266 9.92 $71.73 -- $ --
------ -----
12,114 4,143
====== =====
We have elected to continue to follow the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, for
financial reporting purposes and have adopted the disclosure-only provisions
of Statement of Financial Accounting Standards No. 123, or SFAS 123,
Accounting for Stock-Based Compensation. Accordingly, no compensation cost has
been recognized for the options granted under the
59
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1995 Plan. The fair value of our stock options was estimated using a Black-
Scholes option pricing model. The fair value of each option grant is estimated
on the date of grant using a type of Black-Scholes option pricing model using
the multiple options approach with the following assumptions used for grants:
1999 1998 1997
------ ------ ------
Expected volatility.................................. 0.794 0.848 0.724
Weighted-average risk-free interest rate............. 4.81% 5.22% 6.14%
Expected life (from vesting date).................... 1 year 1 year 1 year
Expected dividends................................... -- -- --
Based on the above assumptions, the aggregate fair value and weighted
average fair value per share of options granted in 1999, 1998 and 1997 were
$93,397,000, $30,464,000 and $18,475,000, and $15.14, $7.32 and $3.48,
respectively.
Employee Stock Purchase Plan
We maintain an Employee Stock Purchase Plan, or the Purchase Plan, under
which 5,200,000 shares of common stock are reserved for issuance. The Purchase
Plan is administered over offering periods of 24 months each, with each
offering period divided into four consecutive six-month purchase periods
beginning August 1 and February 1 of each year. Eligible employees may
designate not more than 10 percent of their cash compensation to be deducted
each pay period for the purchase of common stock under the Purchase Plan, and
participants may not purchase more than 4,000 shares of stock in any one six-
month purchase period. On the last business day of each purchase period, shares
of common stock are purchased with the employee's payroll deductions
accumulated during the six months, generally at a price per share of 85 percent
of the market price of the common stock on the employee's entry date into the
applicable offering period or the last day of the applicable purchase period,
whichever is lower. For 1999, 1998 and 1997, 561,000, 434,000 and 538,000
shares were issued under the plan at weighted average purchase price of $8.05,
$7.45 and $7.46, respectively. At December 31, 1999, 3,297,000 shares were
reserved for future issuance under the plan.
Under SFAS 123, the fair value of employee's purchase rights under the
Employee Stock Purchase Plan was estimated using the multiple options approach
with the following assumptions:
1999 1998 1997
-------- -------- --------
Expected volatility............................ 0.794 0.848 0.724
Weighted-average risk-free interest rate....... 4.75% 5.23% 5.88%
Expected life.................................. 6 months 6 months 6 months
Expected dividends............................. -- -- --
Based on the above assumptions, the aggregate fair value and weighted
average fair value per share of those purchase rights granted in 1999, 1998 and
1997 was $11,860,000, $2,099,000 and $2,557,000, and $14.00, $3.75 and $3.65,
respectively.
60
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro Forma Stock Compensation Cost
For pro forma purposes, had compensation cost for the 1995 Plan and the
Purchase Plan been determined based on the fair value at the grant date for
awards from 1995 through 1999 consistent with the provisions of SFAS No. 123,
our net income (loss), basic and diluted earnings (loss) per share for 1999,
1998 and 1997 would have been as follows:
1999 1998 1997
------- ------- -------
(in thousands, except
per share data)
Net income--as reported............................ $ 2,704 $19,869 $15,066
======= ======= =======
Net income (loss)--pro forma....................... $(9,752) $ 8,382 $10,751
======= ======= =======
Basic earnings per share--as reported.............. $ 0.03 $ 0.26 $ 0.21
======= ======= =======
Basic earnings (loss) per share--pro forma......... $ (0.12) $ 0.11 $ 0.15
======= ======= =======
Diluted earnings per share--as reported............ $ 0.03 $ 0.24 $ 0.19
======= ======= =======
Diluted earnings (loss) per share--pro forma....... $ (0.12) $ 0.10 $ 0.14
======= ======= =======
As the provisions of SFAS 123 are only applied to stock options granted
after January 1, 1995 in the above pro forma amounts, the impact of pro forma
stock compensation cost will likely continue to increase as the vesting period
for our options and the period over which the stock compensation is charged to
expense is generally four years.
8. Employee Benefit Plans
Profit Sharing Plan
We have a 401(k) Profit Sharing Plan (the Plan) covering all of our
employees. Under the Plan, participating employees may elect to contribute up
to 15 percent of their eligible compensation, subject to certain limitations.
We may make contributions to the Plan at the discretion of the Board of
Directors. We contributed $1,121,000, $662,000 and $260,000 to the Plan in
1999, 1998 and 1997, respectively.
9. Income Taxes
The provision for income taxes consists of the following:
1999 1998 1997
-------- ------- -------
(in thousands)
Current:
Federal........................................ $ 15,881 $16,026 $ 7,696
State.......................................... 2,389 4,111 2,041
Foreign........................................ 1,642 1,035 400
-------- ------- -------
19,912 21,172 10,137
Deferred:
Federal........................................ (11,474) (7,649) 154
State.......................................... (2,389) (464) 27
Foreign........................................ (314) (314) (314)
-------- ------- -------
(14,177) (8,427) (133)
-------- ------- -------
$ 5,735 $12,745 $10,004
======== ======= =======
61
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 1999, income before provision for income taxes consisted of $5,918,000 of
income from U.S. operations and $2,521,000 of income from foreign operations.
In 1998, income before provision for income taxes consisted of $31,220,000 of
income from U.S. operations and $1,394,000 of income from foreign operations.
In 1997, income before provision for income taxes consisted of $24,864,000 of
income from U.S. operations and $206,000 of income from foreign operations. The
tax benefit associated with dispositions from employee stock plans for 1999,
1998 and 1997 was $36,446,000, $12,814,000 and $4,970,000, respectively. Such
benefit was recorded to additional paid-in capital and a reduction to taxes
payable or an increase to deferred tax assets.
Our effective tax rate differs from the statutory federal income tax rate as
follows:
1999 1998 1997
----- ---- ----
Statutory federal income tax rate......................... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit................ (8.0) 6.8 5.2
Tax exempt interest income................................ (6.6) (1.8) (2.7)
Research and experimental credit.......................... (21.6) (1.1) (1.5)
Software Moguls, Inc. losses not benefited................ -- 0.1 2.4
Non-deductible merger costs............................... 8.8 -- --
In-process research and development....................... 54.4 -- --
Other..................................................... 6.0 0.1 1.6
----- ---- ----
Effective tax rate...................................... 68.0% 39.1% 40.0%
===== ==== ====
As a result of our acquisition of Software Moguls, Inc. in August 1998,
accounted for as a pooling-of-interests, additional tax provisions were not
required since Software Moguls, Inc. was a non-taxable S-corporation prior to
the acquisition. On a pro forma basis, the tax impact of the acquisition would
have increased our 1997 net income by approximately $609,000 as a result of a
net loss of $1.6 million for Software Moguls, Inc., assuming an effective tax
rate of 37 percent. The pro forma basic and diluted net income per share would
have been $0.21 and $0.20, respectively for 1997.
At December 31, 1998, as a result of our acquisition of FullTime, we had
federal and state net operating loss carryforwards of approximately $11,600,000
and $4,300,000 available to reduce future federal and state taxable income,
respectively. The federal and state carryforwards begin to expire in 2001 and
2003, respectively. We have federal research and experimentation credits of
$726,000 which expire beginning 2018, and minimum tax credit carryforwards of
$39,000 which do not expire. The extent to which the loss and credit
carryforwards can be used to offset future taxable income or taxes are limited
under Section 382 of the Internal Revenue Code and applicable state tax law. An
adjustment to recognize the benefit of FullTime's net operating loss in 1998
has been made to these consolidated financial statements resulting in a
decrease in the provision for income taxes of $3,804,000 for 1998. Adjustments
have been made to eliminate the recognition of the benefit of net operating
loss carryforwards in the consolidated financial statements resulting in
increases in the provision for income taxes of $403,000 for 1997.
Prior to the acquisition, FullTime provided a valuation allowance for its
net deferred tax assets related primarily to loss carryforwards generated since
inception in 1990. Upon acquisition of FullTime, we determined that estimated
combined taxable income is sufficient to conclude that such net deferred tax
assets of FullTime would be realized. Accordingly, the valuation allowance was
eliminated.
62
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant components of our deferred tax assets and liabilities are as
follows:
December 31,
-----------------
1999 1998
-------- -------
(in thousands)
Deferred tax assets:
Allowances, accrued liabilities and other............... $ 3,227 $ 3,247
Accrued compensation and benefits....................... 1,343 896
State taxes............................................. 360 356
Net operating loss and credit carryforwards............. 22,365 4,372
Intangible asset--purchased technology.................. 3,261 346
Deferred revenue........................................ 11,029 2,722
-------- -------
41,585 11,939
Deferred tax liabilities:
Goodwill--Vinca acquisition............................. (23,137) --
Intangible asset--purchased technology.................. (313) (626)
-------- -------
Net deferred tax asset................................ $ 18,135 $11,313
======== =======
The noncurrent portion of our deferred tax assets was $25,626,000 and
$4,372,000 at 1999 and 1998, respectively.
10. Industry and Geographic 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.
Revenue information on a product basis is as follows:
Year Ended December 31,
--------------------------
1999 1998 1997
-------- -------- --------
(in thousands)
Product license:
NetWorker and related NetWorker products...... $118,788 $ 91,322 $ 49,695
Other products................................ 18,577 12,506 19,057
Service and support............................. 67,473 38,774 23,085
Royalty......................................... 23,279 19,155 16,661
Other products, primarily third-party hardware
and software................................... 450 6,150 10,001
-------- -------- --------
Total....................................... $228,567 $167,907 $118,499
======== ======== ========
63
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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:
1999 1998
-------- --------
(in thousands)
Revenue:
United States............................................ $162,790 $122,424
Europe................................................... 48,041 37,212
Other countries.......................................... 17,736 8,271
-------- --------
Total.................................................. $228,567 $167,907
======== ========
Long-lived assets:
United States............................................ $163,335 $ 18,390
Europe................................................... 2,206 1,113
Other countries.......................................... 3,536 3,859
-------- --------
Total.................................................. $169,077 $ 23,362
======== ========
The revenue information by geographical area is based on the country of
destination. We did not maintain revenue information by geographical area in
1997. Other than the United States, no country accounted for more than 10
percent of our total revenue for 1999 and 1998.
No one customer accounted for more than 10 percent of our total revenue for
1999, 1998 and 1997.
11. Selected Quarterly Financial Data (unaudited)
On January 19, 2000, we announced that 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
receivable, 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 quarter of
fiscal 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
64
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
authority, had entered into additional unauthorized written and oral agreements
outside our standard contractual terms with certain of our resellers. These
side agreements allowed the resellers to pay us only when they were paid by end
users, to return product in the event that a sale to an end user was not
consummated, or to pay us on extended terms. If the existence of these side
agreements had been known at the time that the transactions were signed, we
would not have recognized revenue on these transactions in the period in which
they were initially recorded as the fees involved would not have been deemed to
be fixed or determinable. Accordingly, we have revised the revenue recognition
for all transactions with these resellers during fiscal 1999 to reflect the
point in time when these fees were considered fixed or determinable which
coincided with the receipt of payments from resellers. The results of our
review of the transactions in 1999 were such that we concluded that the
problems surrounding unauthorized written and oral agreements did not extend
into earlier years.
As a result of the revisions discussed above, we 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 year ended December 31, 1999.
First Quarter Second Quarter
----------------- -----------------
As As As As
Reported Restated Reported Restated
-------- -------- -------- --------
in thousands, except per share data
1999:
Total revenue.......................... $52,351 $43,945 $62,008 $51,564
Gross profit........................... 45,464 37,058 54,576 44,132
Net income (loss)...................... 8,197 2,760 4,438 (1,093)
Basic earnings (loss) per share........ $ 0.10 $ 0.04 $ 0.06 $ (0.01)
Diluted earnings (loss) per share...... $ 0.10 $ 0.03 $ 0.05 $ (0.01)
Third Quarter Fourth Quarter
----------------- --------------
As As
Reported Restated
-------- --------
(in thousands, except per share
data)
Total revenue............................... $71,688 $67,931 $65,127
Gross profit................................ 63,664 59,907 55,693
Net income (loss)........................... 3,438 1,396 (359)
Basic earnings (loss) per share............. $ 0.04 $ 0.02 $ (0.00)
Diluted earnings (loss) per share........... $ 0.04 $ 0.02 $ (0.00)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share
data)
1998:
Total revenue............................... $34,385 $39,257 $44,493 $49,772
Gross profit................................ 29,207 32,968 37,926 43,013
Net income.................................. 3,118 3,566 6,102 7,083
Basic earnings per share.................... $ 0.04 $ 0.05 $ 0.08 $ 0.09
Diluted earnings per share.................. $ 0.04 $ 0.04 $ 0.07 $ 0.08
65
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. Subsequent Events
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. Currently, no amounts
have been accrued for these matters.
66
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Legato Systems, Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Legato Systems, Inc and its subsidiaries at December 31, 1999 and
1998, and the results of their operations and their cash flows for each of the
three years in the period ended December 31,1999 in conformity with accounting
principles generally accepted in the United States. In addition, in our opinion
the financial statement schedule listed in the index appearing under Item
14(a)(2) on page 80 presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and the financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
May 12, 2000
67
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors
The Company's Board of Directors is comprised of six (6) members.
Mr. Cole joined the Company as President, Chief Executive Officer and a
Director in June 1989. Since April 1995, Mr. Cole has also served as Chairman
of the Board. Before joining the Company, from March 1987 until July 1988, Mr.
Cole served as Executive Vice President responsible for all operating divisions
of Novell, Inc., a publicly held manufacturer of computer networking and
software products. Mr. Cole currently serves as a director of Inference Corp.,
NetIQ Corporation and Rogue Wave Software, Inc. all publicly held software
companies. Mr. Cole holds a B.S. in mathematics and education from Pennsylvania
State University at Edinboro.
Mr. Benhamou has been a Director of the Company since March 1993. Mr.
Benhamou has been the Chief Executive Officer of 3Com Corporation ("3Com"), a
publicly held computer network products company, since September 1990, and has
been Chairman of the Board of 3Com since July 1994. He served as the President
of 3Com from April 1990 until August 1998. From April 1990 until September
1990, Mr. Benhamou served as Chief Operating Officer of 3Com. Mr. Benhamou
currently serves as a director of Cypress Semiconductor, a publicly held
semiconductor company. Mr. Benhamou holds a Diplome d'Ingenieur from Ecole
Nationale Superieure d'Arts et Metiers in Paris, France, and an M.S. in
electrical engineering from Stanford University.
Mr. Bingham has been a Director of the Company since December 1998. Mr.
Bingham has been President and Chief Executive Officer of Cadence Design
Systems ("Cadence"), a publicly held electronic design automation software
company, since April 1999 and a director of Cadence since November 1997. From
1993 to March 1999, he served as Executive Vice President and Chief Financial
Officer of Cadence. Prior to joining Cadence, Mr. Bingham served eight years as
Executive Vice President and Chief Financial Officer of Red Lion Hotels and
Inns, an owner and operator of a chain of hotels. Mr. Bingham currently serves
as a director of Onyx Software Corporation, Tenfold Corporation, and Integrated
Measurement Systems, Inc., all publicly held companies. Mr. Bingham holds a
B.A. in economics from Weber State University and an M.B.A. from Harvard
University.
Mr. Fong has been a Director of the Company since December 1988. Mr. Fong
joined Mayfield Fund ("Mayfield"), a venture capital firm, in 1988 and has been
a general partner of several venture capital funds affiliated with Mayfield
since 1990. Mr. Fong currently serves as a director of Interwave
Communications, a publicly held provider of communications infrastructure
equipment and software, and Vixel Corporation, a publicly held provider of
storage area network solutions. Mr. Fong holds a B.S. in electrical engineering
from the University of California at Berkeley, and an M.S. in electrical
engineering and an M.B.A. from Stanford University.
Mr. Strohm has been a Director of the Company since December 1988. Mr.
Strohm joined Greylock Management Corporation ("Greylock"), a venture capital
management company, in 1980 and is a general partner of several venture capital
funds affiliated with Greylock. Mr. Strohm currently serves as a director of
Switchboard, Inc., an Internet based local merchant networking company,
DoubleClick, Inc., a leading provider of comprehensive Internet advertising
solutions and ISS Group, Inc., a provider of Internet security software, all
publicly held, as well as several privately held technology companies. Mr.
Strohm holds a B.A. from Dartmouth College and an M.B.A. from Harvard
University.
Mr. White has been a Director of the Company since May 1995. Since August
1997, Mr. White has been providing marketing consulting services within the
high-tech industry. From January 1989 to August 1997, Mr. White served as
President, Chief Executive Officer and a director of Informix Corporation, a
publicly held database software company. From March 1986 to December 1988, Mr.
White served as President and Chief
68
Operating Officer of Wyse Technology, Inc., a publicly held personal computer
manufacturing company. Mr. White currently serves as a director of Adaptec,
Inc., a publicly held manufacturer and retailer of peripheral adapters, and
TibCo, a publicly held provider of internet infrastructure software. In
addition, Mr. White is a member of the Board of Trustees of Illinois Wesleyan
University. Mr. White holds a B.A. from Illinois Wesleyan University and an
M.B.A. from the University of Illinois, Urbana.
Executive Officers
The executive officers of the Company as of December 31, 1999 are set forth
in Part I, Item 4a of this document.
ITEM 11. EXECUTIVE COMPENSATION
Director Compensation
Except for grants of stock options, directors of the Company generally do
not receive compensation for services provided as a director. The Company also
does not pay compensation for committee participation or special assignments of
the Board of Directors.
Non-employee Board members are eligible for option grants pursuant to the
provisions of the Automatic Option Grant Program under the Company's 1995 Stock
Option/Stock Issuance Plan. Under the Automatic Option Grant Program, each
individual who first becomes a non-employee Board member after the date of the
Company's initial public offering will be granted an option to purchase 96,000
shares on the date such individual joins the Board, provided such individual
has not been in the prior employ of the Company. In addition, at each Annual
Meeting of Stockholders, each individual who has served as a non-employee Board
member for at least six months prior to such Annual Meeting will receive an
additional option grant to purchase 24,000 shares of Common Stock, whether or
not such individual has been in the prior employ of the Company. The option
price for each option grant under the Automatic Option Grant Program will be
equal to the fair market value per share of Common Stock on the automatic grant
date and each automatic option grant will be immediately exercisable for all of
the option shares. The shares purchasable under the option will be subject to
repurchase at the original exercise price in the event the optionee's Board
service should cease prior to vesting. With respect to each initial grant, the
repurchase right shall lapse and the optionee shall vest in four (4) equal
annual installments from the grant date. Each annual grant shall vest in two
equal and successive annual installments. Pursuant to the Automatic Option
Grant Program, Messrs. Benhamou, Fong, Strohm and White were each granted
options to purchase 96,000 shares of Common Stock on July 5, 1995 at an
exercise price of $2.38 per share, 24,000 shares on May 16, 1996 at an exercise
price of $5.47 per share, 24,000 shares on May 15, 1997 at an exercise price of
$4.47 per share, 24,000 shares on May 14, 1998 at an exercise price of $15.24,
and 24,000 shares on May 13, 1999 at an exercise price of $21.97. Mr. Bingham,
who joined the Board on December 18, 1998, was granted an option to purchase
96,000 shares of Common Stock at an exercise price of $27.53. Pursuant to the
Automatic Option Grant Program, each of Messrs. Benhamou, Bingham, Fong, Strohm
and White will be granted options to purchase 24,000 shares of Common Stock at
the 2000 Annual Meeting.
Directors who are also employees of the Company are eligible to receive
options and be issued shares of Common Stock directly under the 1995 Stock
Option/Stock Issuance Plan and are also eligible to participate in the
Company's Employee Stock Purchase Plan and, if an executive officer of the
Company, the Executive Bonus Plan.
Compensation of Executive Officers
The Compensation Committee of the Company's Board of Directors (the
"Compensation Committee" or the "Committee") has the exclusive authority to
establish the level of base salary payable to the Chief Executive Officer
("CEO") and certain other executive officers of the Company and to administer
the Company's 1995 Stock Option/Stock Issuance Plan and Employee Stock Purchase
Plan. In addition, the Committee has the responsibility for approving the
individual bonus programs to be in effect for the CEO and certain other
executive officers and other key employees each fiscal year.
69
For the 1999 fiscal year, the process utilized by the Committee in
determining executive officer compensation levels was based on the subjective
judgment of the Committee. Among the factors considered by the Committee were
the recommendations of the CEO with respect to the compensation of the
Company's key executive officers. However, the Committee made the final
compensation decisions concerning such officers.
General Compensation Policy. The Committee's fundamental policy is to offer
the Company's executive officers competitive compensation opportunities based
upon overall Company performance, their individual contribution to the
financial success of the Company and their personal performance. It is the
Committee's objective to have a substantial portion of each officer's
compensation contingent upon the Company's performance, as well as upon his or
her own level of performance. Accordingly, each executive officer's
compensation package consists of: (i) base salary, (ii) cash bonus awards and
(iii) long-term stock-based incentive awards.
Base Salary. The base salary for each executive officer is set on the basis
of general market levels and personal performance. Each individual's base pay
is positioned relative to the total compensation package, including cash
incentives and long-term incentives.
In preparing the performance graph for this Proxy Statement, the Company has
selected the Hambrecht & Quist Software Sector Index. The companies included in
the Company's informal survey are not necessarily those included in the
Hambrecht & Quist Software Sector Index, because they were determined not to be
competitive with the Company for executive talent or because compensation
information was not available.
Annual Cash Bonuses. Each executive officer has an established cash bonus
target. The annual pool of bonuses for executive officers is distributed on the
basis of the Company's achievement of the financial performance targets
established at the start of the fiscal year and personal objectives established
for each executive. Actual bonuses paid reflect an individual's accomplishment
of both corporate and functional objectives and are based on a percentage of
the individual's base salary. The corporate goals set for the 1999 bonuses are
based on the achievement of quarterly and annual revenue and income targets.
Long-Term Incentive Compensation. During fiscal 1999, the Committee, in its
discretion, made option grants to Messrs. Cole Chappell, Ferraro, Wise, and
Malmstedt and Ms. Denzel under the 1995 Stock Option/Stock Issuance Plan.
Generally, a significant grant is made in the year that an officer commences
employment and no grant is made in the second year. Thereafter, option grants
may be made at varying times and in varying amounts in the discretion of the
Committee. Generally, the size of each grant is set at a level that the
Committee deems appropriate to create a meaningful opportunity for stock
ownership based upon the individual's position with the Company, the
individual's potential for future responsibility and promotion, the
individual's performance in the recent period and the number of unvested
options held by the individual at the time of the new grant. The relative
weight given to each of these factors will vary from individual to individual
at the Committee's discretion. Applying these principles, a significant grant
was made to Mr. Malmstedt in connection with his commencement of employment
with the Company following the acquisition of Full-Time Software in 1999 and
smaller grants were made to Messrs. Cole Chappell and Wise and Ms. Denzel.
Each grant allows the officer to acquire shares of the Company's common
stock at a fixed price per share (the market price on the grant date) over a
specified period of time. The option vests in periodic installments over a two
to four year period, contingent upon the executive officer's continued
employment with the Company. The vesting schedule and the number of shares
granted are established to ensure a meaningful incentive in each year following
the year of grant. Accordingly, the option will provide a return to the
executive officer only if he or she remains in the Company's employ, and then
only if the market price of the Company's Common Stock appreciates over the
option term.
CEO Compensation. The annual base salary for Mr. Cole, the Company's
President and Chief Executive Officer, was increased by 6% by the Committee
effective February 1, 1999. The Committee's decision was made primarily on the
basis of Mr. Cole's performance of his duties.
70
The remaining components of the Chief Executive Officer's 1999 fiscal year
incentive compensation were entirely dependent upon the Company's financial
performance and provided no dollar guarantees. The bonus paid to the Chief
Executive Officer for the fiscal year was based on the same incentive plan for
all other officers. Specifically, a target incentive was established at the
beginning of the year using an agreed-upon formula based on Company revenue and
profit. Each year, the annual incentive plan is reevaluated with a new
achievement threshold and new targets for revenue and profit. The option grant
made to the Chief Executive Officer during the 1999 fiscal year was based on
the factors discussed above. The bonus award was intended to reflect his years
of service with the Company and to place a significant portion of Mr. Cole's
total compensation at risk, because the bonus will provide little or no
compensation unless Company performance achieves agreed-upon thresholds.
Tax Limitation. Under the Federal tax laws, a publicly-held company such as
the Company will not be allowed a federal income tax deduction for compensation
paid to certain executive officers to the extent that compensation exceeds $1
million per officer in any year. To qualify for an exemption from the $1
million deduction limitation, the stockholders approved a limitation under the
Company's 1995 Stock Option/Stock Issuance Plan on the maximum number of shares
of Common Stock for which any one participant may be granted stock options per
calendar year. Because this limitation was adopted, any compensation deemed
paid to an executive officer when he exercises an outstanding option under the
1995 Stock Option/Stock Issuance Plan with an exercise price equal to the fair
market value of the option shares on the grant date will qualify as
performance-based compensation that will not be subject to the $1 million
limitation. Since it is not expected that the cash compensation to be paid to
the Company's executive officers for the 2000 fiscal year will exceed the $1
million limit per officer, the Committee will defer any decision on whether to
limit the dollar amount of all other compensation payable to the Company's
executive officers to the $1 million cap.
Compensation Committee
Kevin A. Fong
David N. Strohm
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Company's Board of Directors was formed in
September 1992, and the current members of the Compensation Committee are
Messrs. Fong and Strohm. Neither of these individuals was at any time during
1999, or at any other time, an officer or employee of the Company. No executive
officer of the Company serves as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as a member of the Company's Board of Directors or Compensation
Committee.
71
EXECUTIVE COMPENSATION AND RELATED INFORMATION
The following Summary Compensation Table sets forth the compensation earned
by the Company's Chief Executive Officer and the four other most highly
compensated executive officers who were serving as such at the end of 1999
(collectively, the "Named Officers"), each of whose aggregate compensation for
1999 exceeded $100,000 for services rendered in all capacities to the Company
and its subsidiaries for that fiscal year.
Summary Compensation Table
Long-Term
Annual Compensation Compensation
----------------------- ------------
Number of
Securities
Name and Principal Underlying All Other
Position Year Salary(1) Bonus Options Compensation(2)
------------------ ---- --------- -------- ------------ ---------------
Louis C. Cole............. 1999 $255,314 $212,633 300,000 $1,410
Chairman of the Board,
President 1998 $240,170 $195,059 200,000 $ 626
and Chief Executive
Officer 1997 $218,334 $107,625 100,000 $1,440
Nora M. Denzel............ 1999 $202,718 $128,762 100,000 $1,368
Senior Vice President, 1998 $181,996 $115,249 -- $ 626
Product Operations 1997 $146,666 $ 84,000 300,000 $ 303
Kent D. Smith............. 1999 $211,680 $133,300 -- $1,381
Executive Vice President, 1998 $211,260 $154,077 100,000 $ 626
Worldwide Sales, Support
and Corporate Marketing 1997 $198,300 $ 86,721 50,000 $ 870
Stephen C. Wise........... 1999 $194,964 $123,944 80,000 $1,353
Senior Vice President,
Finance and 1998 $183,400 $102,375 -- $ 626
Administration, Chief
Financial Officer 1997 $165,831 $ 56,470 250,000 $ 558
David Malmstedt........... 1999 $209,022 $131,764 600,000 $1,405
Former Senior Vice
President 1998 -- -- -- --
of Field Sales Operations 1997 -- -- -- --
- --------
(1) Salary includes amounts deferred under the Company's 401(k) Plan.
(2) Represents life insurance premiums paid by the Company and Company
matching contributions of $1,000 to each Named Officer made to the
Company's 401(k) plan.
72
The following table contains information concerning the stock option grants
made to each of the Named Officers for 1999. No stock appreciation rights were
granted to these individuals during such year.
Option Grants in Last Fiscal Year
Potential Realizable
Value at Assumed
Annual Rates of
Stock Price
Appreciation for
Individual Grants(1) Option Term(2)
-------------------------------------------- --------------------
Number of % of Total
Securities Options
Underlying Granted to Exercise
Options Employees Price Per Expiration
Name Granted in 1999 Share Date 5% 10%
---- ---------- ---------- --------- ---------- --------- ----------
Louis C. Cole........... 300,000 5.56% $ 20.75 2/16/2009 3,914,869 9,921,047
Nora M. Denzel.......... 100,000 1.85% $ 20.75 2/16/2009 1,304,956 3,307,016
Kent D. Smith........... -- -- -- -- -- --
Stephen C. Wise......... 80,000 1.48% $ 20.75 2/16/2009 1,043,965 2,645,612
.42% $17.563 4/19/2009 251,479 637,297
David Malmstedt......... 600,000(3) 10.69% $17.563 4/19/2009 6,375,687 16,157,243
- --------
(1) The options disclosed in the table were granted on February 17, 1999,
except the options disclosed in the table for Mr. Malmstedt were granted
on April 20, 1999. The exercise price for each option may be paid in cash,
in shares of Common Stock valued at fair market value on the exercise date
or through a cashless exercise procedure involving a same-day sale of the
purchased shares. The Company may also finance the option exercise by
loaning the optionee sufficient funds to pay the exercise price for the
purchased shares, together with any federal and state income tax liability
incurred by the optionee in connection with such exercise. The plan
administrator has the discretionary authority to reprice the options
through the cancellation of those options and the grant of replacement
options with an exercise price based on the fair market value of the
option shares on the regrant date. The options have a maximum term of 10
years measured from the option grant date, subject to earlier termination
in the event of the optionee's cessation of service with the Company.
Except as otherwise noted, the options listed in the table become
exercisable for 50% of the shares after two years of service from the
designated vesting date and for the remaining 50% monthly over the one
year thereafter. Under each of the options, the option shares will vest
upon an acquisition of the Company by merger or asset sale, unless the
acquiring company assumes the options. Any options that are assumed or
replaced in the transaction and do not otherwise accelerate at that time
shall automatically accelerate (and any unvested option shares which do
not otherwise vest at that time shall automatically vest) in the event the
optionee's service terminates by reason of an involuntary or constructive
termination within 18 months following the transaction.
(2) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of
the Company's securities that the actual stock price appreciation over the
10-year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the Common Stock
appreciates over the option term, no value will be realized from the
option grants made to the executive officers.
(3) This grant to Mr. Malmstedt becomes exercisable for 20% of the shares
after one year of service from the designated grant date, for an
additional 20% after two years of service from the grant date and for the
remaining 60% vests monthly over the next twenty-four months.
73
The following table sets forth information concerning option exercises in
1999 and option holdings as of the end of the 1999 fiscal year with respect to
each of the Named Officers. No stock appreciation rights were outstanding at
the end of that year.
Aggregate Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Value Realized Underlying Unexercised In-the-Money Options
Shares (Market Price at Options at FY-End At FY-End(1)($)
Acquired Exercise Less ------------------------- -------------------------
Name on Exercise Exercise Price)($) Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------------ ----------- ------------- ----------- -------------
Louis C. Cole........... 375,000 14,996,585 606,706 358,334 36,124,585 18,099,055
Nora M. Denzel.......... 146,630 5,320,734 28,370 300,002 1,744,462 17,172,333
Kent D. Smith........... 124,600 5,154,924 693,648 28,752 44,546,472 1,812,745
Stephen C. Wisel........ 114,600 4,551,974 30,921 234,079 1,939,217 13,428,210
David Malmstedt......... 22,173 667,477 5,177 629,050 305,769 32,465,780
- --------
(1) Based on the fair market value of the Company's Common Stock at year-end
($68.813) per share less the exercise price payable for such shares.
Bonus Plan. In 1999, the Company instituted an executive bonus program
pursuant to which bonuses will be paid to executive officers based on
individual and Company performance targets. In addition, certain non-executive
employees will receive quarterly and annual bonuses if the Company meets its
performance targets. The Company's performance targets are based on meeting
revenue and income levels on a quarterly and annual basis.
EMPLOYMENT CONTRACTS AND CHANGE IN CONTROL ARRANGEMENTS
None of the Company's current executive officers have employment or
severance agreements with the Company, and their employment may be terminated
at any time at the discretion of the Board of Directors.
The Compensation Committee has the authority under the 1995 Stock
Option/Stock Issuance Plan to accelerate the exercisability of outstanding
options, or to accelerate the vesting of the shares of Common Stock subject to
outstanding options, held by the Chief Executive Officer and the Company's
other executive officers. Such acceleration may be conditioned on the
optionee's termination of employment (whether involuntarily or through a forced
resignation) and may be conditioned upon the occurrence of a merger,
reorganization or consolidation or upon a hostile take-over of the Company
effected through a tender offer or through a change in the majority of the
Board as a result of one or more contested elections for Board membership.
74
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (TABLE
TO BE UPDATED)
The following table sets forth, as of February 25, 2000, certain information
with respect to shares beneficially owned by (i) each person who is known by
the Company to be the beneficial owner of more than five percent of the
Company's outstanding shares of Common Stock, (ii) each of the Company's
directors and the executive officers named in the Summary Compensation Table
and (iii) all current directors and executive officers as a group. Beneficial
ownership has been determined in accordance with Rule 13d-3 under the Exchange
Act. Under this rule, certain shares may be deemed to be beneficially owned by
more than one person (if, for example, persons share the power to vote or the
power to dispose of the shares). In addition, shares are deemed to be
beneficially owned by a person if the person has the right to acquire shares
(for example, upon exercise of an option or warrant) within sixty (60) days of
the date as of which the information is provided; in computing the percentage
ownership of any person, the amount of shares is deemed to include the amount
of shares beneficially owned by such person (and only such person) by reason of
such acquisition rights. As a result, the percentage of outstanding shares of
any person as shown in the following table does not necessarily reflect the
person's actual voting power at any particular date.
Shares Beneficially Owned
as of February 25, 2000 (1) (2)
------------------------------------
Beneficial Owner Number of Shares Percentage of Class
---------------- ---------------- -------------------
Fidelity Management & Research........... 8,075,587 9.32%
One Post Office Square
Boston, MA 02109
Louis C. Cole (3)........................ 3,582,941 4.10%
Nora M. Denzel (4)....................... 95,914 *
James Chappell (5)....................... 164,402 *
David Malmstedt (6)...................... 163,784 *
Thomas Panozzo........................... 459 *
Kent D. Smith (7)........................ 769,065 *
Stephen C. Wise (8)...................... 66,901 *
Eric A. Benhamou (9)..................... 278,000 *
H. Raymond Bingham (10).................. 24,000 *
Kevin A. Fong (11)....................... 162,992 *
David N. Strohm.......................... 448,802 *
Phillip E. White (11).................... 106,000 *
All current directors and executive
officers as
a group (12 persons) (12)............... 5,863,260 6.60%
- --------
* Less than 1% of the outstanding shares of Common Stock.
(1) Except as indicated in the footnotes to this table and pursuant to
applicable community property laws, the persons named in the table have
sole voting and investment power with respect to all shares of Common
Stock. To the Company's knowledge, the entities named in the table have
sole voting and investment power with respect to all shares of Common
Stock shown as beneficially owned by them.
(2) The number of shares of Common Stock deemed outstanding for each
individual shareholder includes shares issuable pursuant to stock options
that may be exercised within sixty (60) days after February 25, 2000.
(3) Includes options exercisable into 623,373 shares of Common Stock and
2,957,984 shares held by The Louis and Jolene Cole 1988 Revocable Trust,
dated November 7, 1988 (the "Cole Trust"), of which Mr. Cole is a trustee.
(4) Includes options exercisable into 72,856 shares of Common Stock.
(5) Includes options exercisable into 85,199 shares of Common Stock.
(6) Includes options exercisable into 159,658 shares of Common Stock.
(7) Includes options exercisable into 701,565 shares of Common Stock.
(8) Includes options exercisable into 63,180 shares of Common Stock.
(9) Includes options exercisable into 246,000 shares of Common Stock.
(10) Includes options exercisable into 24,000 shares of Common Stock.
(11) Includes options exercisable into 96,000 shares of Common Stock.
(12) Includes options exercisable into 2,167,731 shares of Common Stock.
75
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company's Certificate of Incorporation limits the liability of its
directors for monetary damages arising from a breach of their fiduciary duty as
directors, except to the extent otherwise required by the Delaware General
Corporation Law. Such limitation of liability does not affect the availability
of equitable remedies such as injunctive relief or rescission.
The Company's Bylaws provide that the Company shall indemnify its directors
and officers to the fullest extent permitted by Delaware law, including in
circumstances in which indemnification is otherwise discretionary under
Delaware law. The Company has also entered into indemnification agreements with
its officers and directors containing provisions that may require the Company,
among other things, to indemnify such officers and directors against certain
liabilities that may arise by reason of their status or service as directors or
officers and to advance their expenses incurred as a result of any proceeding
against them as to which they could be indemnified.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The consolidated financial statements of the registrant as set forth under
Item 8 are filed as part of this Annual Report on Form 10-K.
(a) (2) Financial Statement Schedule
Schedule II--Valuation and Qualifying Accounts is filed on page 80 of
this Report on Form 10-K.
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are omitted
because they are not required under the related instructions or are
inapplicable.
The independent accountant's reports with respect to the above listed
financial statements and financial statement schedule listed in Items 14 (a)
(1) and 14 (a) (2), are filed on page 67 of this Report on Form 10-K.
(a) (3) Exhibits
2.1(3) Stock Purchase Agreement, dated as of January 5, 1996, among the
Registrant, Innovus, Inc., 815598 Ontario, Inc., the stockholders
of Innovus, Inc., and the stockholders of 815598 Ontario, Inc.
2.2(3) Stock Purchase Agreement, dated as of January 5, 1996, among the
Registrant, Innovus Technologies, Inc., and the stockholders of
Innovus Technologies, Inc.
2.3(6) Agreement and Plan of Reorganization, dated as of July 30, 1998, by
and among Legato Systems, Inc., Aspen Acquisition Corp., Software
Moguls, Inc., Sunil Khadilkar, Louis C. Cole and the Undersigned
Stockholders.
2.4(10) Agreement and Plan of Reorganization, dated October 25, 1998, by
and among Legato Systems, Inc., Hat Acquisition Corp. and Qualix
Group, Inc.
2.5(11) Amendment No. 1 to the Agreement and Plan of Reorganization , dated
October 25, 1998, by and among Legato Systems, Inc., Hat
Acquisition Corp. and Qualix Group, Inc., dated February 9, 1999.
2.6(12) Agreement and Plan of Reorganization By and Among Legato Systems,
Inc., Sundance Acquisition Corp., Vinca Corporation, the Canopy
Group, Inc. (as Stockholders' Representative), and the Undersigned
Stockholders of Vinca Corporation, dated June 7, 1999.
3.1(6)(9) Amended and Restated Certificate of Incorporation of the
Registrant, as amended to date
3.2(7) Amended and Restated Bylaws of the Registrant adopted on May 23,
1997.
3.3(8) Form of Certificate of Designation filed in connection with Rights
Agreement, dated May 23, 1997.
4.7(8) Rights Agreement, dated May 23, 1997 between the Company and Harris
Trust and Savings Bank, including the Certificate of Designation of
Series A Junior Participating Preferred Stock, Form of Right
Certificate and Summary of Rights to Purchase Preferred Shares
attached thereto as Exhibit A, B and C, respectively.
4.8(6) Registration Rights Agreement, dated July 30, 1998, by and between
Legato Systems, Inc., a Delaware corporation and the Stockholders
of Software Moguls, Inc.
4.9(6) Affiliates Agreement, dated July 30, 1998, between Legato Systems,
Inc. a Delaware corporation and the Stockholders of Software
Moguls, Inc.
10.1(1) Form of Indemnification Agreement entered into between the
Registrant and it directors and officers.
77
10.3(1) The Registrant's 1995 Stock Option/Stock Issuance Plan, as amended
to date.
10.4(1)(5) The Registrant's Employee Stock Purchase Plan.
10.6(1) Form of United States Reseller Terms and Conditions for Purchase
of Legato Products.
10.7(1) Form of International Authorized Systems Integrator Agreement.
10.8(1) Form of Shrinkwrap License Agreement.
10.9(1)(2) Technology License and Distribution agreement, dated January 20,
1995, between the Registrant and SunSoft, Inc.
10.10(1) Master Software License and Support Agreement between the
Registrant and Open Software Foundation.
10.11(1) License Agreement, dated February 24, 1989, between the Registrant
and The Regents of the University of California.
10.12(1) Software Agreement, dated January 20, 1989, between the Registrant
and AT&T Information Systems, Inc.
10.13(4)(5) The Registrant's International Employee Stock Purchase Plan.
10.14(6) Lease agreement dated March 14, 1996 between the Registrant and
Coherent, Inc., a Delaware corporation, and Legato Systems, Inc.,
a Delaware corporation, regarding the space located at 3210 Porter
Drive, Palo Alto, California
21.1 Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants
27.1 Financial Data Schedule
- --------
(1) Incorporated by reference to the registrant's Registration Statement on
Form S-1, filed May 9, 1995 (File No. 33-92072).
(2) Confidential treatment requested as to certain portions of this exhibit.
(3) Incorporated by reference to the registrant's Current Report on Form 8-K,
dated January 19, 1996.
(4) Incorporated by reference to the registrant's Registration Statement on
Form S-8, filed March 14, 1996 (File No. 333-2378).
(5) Compensatory plan or arrangement.
(6) Incorporated by reference to the registrant's Registration Statement on
Form S-3, filed December 15, 1998 (File No. 333-64693).
(7) Incorporated by reference to the registrant's Current Report on Form 8-K,
dated June 6, 1997.
(8) Incorporated by reference to the registrant's Form 8-A, dated May 30,
1997.
(9) Incorporated by reference to the registrant's Registration Statement on
Form S-8, filed November 10, 1998 (File No. 333-67031).
(10) Incorporated by reference to the registrant's Current Report on Form 8-K,
dated October 25, 1998.
(11) Incorporated by reference to the registrant's Registration Statement on
Form S-4, filed on March 15, 1999 (File No. 333-74433).
(12) Incorporation by reference to the registrant's Registration Statement on
Form S-4, filed on March 15, 1999 (File No.333-74433).
(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.
78
The Registrant filed a report on Form 8-K, dated November 18, 1999, in
connection with the Registrant's proposed acquisition of Ontrack Data
International, Inc.
The Registrant filed a report on Form 8-K/A, dated October 11, 1999, in
connection with the Registrant's acquisition of Vinca Corporation.
(c) Exhibits
See (a) (3) above.
(d) Financial Statement Schedule
See (a) (2) above.
79
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Charged to Balance at
Beginning of Costs and End of
Description Period Expenses Deductions Period
- ----------- ------------ ---------- ---------- ----------
Allowance for Doubtful Accounts:
Year ended December 31, 1997... $1,050 $ 628 $ 329 $1,349
Year ended December 31, 1998... 1,349 833 354 1,828
Year ended December 31, 1999... 1,828 306 1,218 916
Allowance for Sales Returns:
Year ended December 31, 1997... $ -- $2,135 $1,647 $ 488
Year ended December 31, 1998... 488 7,578 5,998 2,068
Year ended December 31, 1999... 2,068 9,531 8,781 2,818
80
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
/s/ Louis C. Cole May 17, 2000
By: _____________________________ _________
Louis C. Cole Date
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Louis C. Cole Chairman of the Board, President and May 17, 2000
_________________________________ Chief Executive Officer (Principal
Louis C. Cole Executive Officer)
/s/ Stephen C. Wise Senior Vice President, Finance and May 17, 2000
_________________________________ Administration and Chief Financial
Stephen C. Wise Officer (Principal Financial and
Accounting Officer)
/s/ Eric A. Benhamou Director May 17, 2000
_________________________________
Eric A. Benhamou
/s/ H. Raymond Bingham Director May 17, 2000
_________________________________
H. Raymond Bingham
/s/ Kevin A. Fong Director May 17, 2000
_________________________________
Kevin A. Fong
/s/ David N. Strohm Director May 17, 2000
_________________________________
David N. Strohm
/s/ Phillip E. White Director May 17, 2000
_________________________________
Phillip E. White
81