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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission File Number: 0-26130
LEGATO SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
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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)
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(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
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Securities registered pursuant to Section 12(g) of the Act:
Preferred Share Purchase Rights
Common Stock, $0.0001 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 4, 2002 was approximately $991 million. 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 4, 2002 was 90,443,311.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement (the "Proxy
Statement") relating to its annual meeting of stockholders to be held in 2002
are incorporated by reference into Part III of this Annual Report on Form 10-K.
Except as expressly incorporated by reference, the registrant's Proxy Statement
shall not be deemed to be part of this report.
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LEGATO SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED
DECEMBER 31, 2001
Table of Contents
PART I
Item 1. Business................................................................................. 1
Item 2. Properties............................................................................... 25
Item 3. Legal Proceedings........................................................................ 26
Item 4. Submission of Matters to a Vote of Security Holders...................................... 26
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters..................... 27
Item 6. Selected Consolidated Financial Data..................................................... 27
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................... 36
Item 8. Consolidated Financial Statements and Supplementary Data................................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..... 36
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 37
Item 11. Executive Compensation................................................................... 37
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 37
Item 13. Certain Relationships and Related Transactions........................................... 37
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 38
Signatures......................................................................................... 59
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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, including without limitation, our financial outlook, successful
introduction of new products and expansion of operation. 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,
competition, product concentration, technological changes, reliance on
enterprise license transactions, reliance on indirect sales channels, changes
in marketing strategies, dependence on international revenue, management of our
growth and expansion, the ability to attract and retain qualified personnel and
other risks discussed in this item under the heading "Risk Factors" and the
risks discussed in our other Securities and Exchange Commission filings.
Overview
We develop, market and support software products and services for
information management of distributed, open systems environments. Information
management includes the protection, recovery and avoidance of failures of data
and applications so that business users can gain access to the information that
they need when they need it. Distributed, open systems are generally understood
to include UNIX, Windows NT, Windows 2000 and Linux server computer systems. We
offer software products for backup, recovery and archive of data; for managing
the performance and operation of application services; and for optimizing the
use of storage devices and media including disk and tape. Our customers use our
products and services to safeguard and manage their information assets and
associated applications so that their businesses can continue to operate, and
do so in a more cost-effective manner.
Recent Development
On February 20, 2002, we entered into a definitive agreement to acquire OTG
Software, Inc. ("OTG"). OTG provides data management and collaboration
solutions that virtualize storage for any type of data, including files,
messages and databases, while providing easy and transparent access. The merger
agreement provides that each share of OTG common stock will be exchanged for
0.6876 of a share of Legato common stock and $2.50 per share of cash. We will
also assume all outstanding options to purchase OTG common shares. The closing
of the merger is subject to regulatory approval and Legato and OTG shareholder
approvals, and is expected to close in the second quarter of 2002. After the
transaction is completed, OTG's shareholders will own approximately 21% of the
combined entity's shares. This strategic acquisition will result in substantial
one-time charges along with ongoing substantial amortization of intangibles to
our results of operations.
The Key Challenges Faced by our Customers
Our customers are Global 2000 companies that typically use a combination of
UNIX, Windows and Linux server systems to support their business operations in
large centralized data centers, regional data centers, and remotely located
branch offices. Centralized and regional data centers manage data and
applications that support the business-critical functions of a company,
including financial records and reporting, customer support and service, human
resources and sales and marketing activities. Branch offices are frequently
connected to data centers by wide-area networks to exchange daily revenue
reports and other types of business-critical data. Increasingly, businesses are
also relying on Internet and Intranet capabilities to support communications and
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operations within a company, to support business-to-business operations among
partners and to support e-commerce business directly with customers.
Within this complex environment, converging business trends are combining to
put significant pressure on the information technology resources supporting the
business. The challenges facing our customers are severe:
. Many Global 2000 businesses are doubling their data every year.
. Many Global 2000 businesses are becoming more and more global in their
operations, which means that applications and data must be available all
of the time.
. Businesses cannot find, hire or train enough skilled administrators to
manage and protect all of the new storage devices, servers, network
connections, data and applications that are required each year.
As a result, information technology managers need to provide higher levels
of service to their business operations, which necessitates implementing more
complex information technology environments. But, these managers must somehow
manage the complex environments with the same resources that they have had in
the past. These competing requirements are creating a demand for storage
management software that enables customers to manage more data and applications
with less effort and expense.
The Causes of Data Growth. The rate of data growth is increasing, because
companies are now using information to maintain and improve the competitive
position of their businesses. The need for more and better access to
information is causing companies to deploy many new types of applications. New
applications generate new data. Newer applications generally include media-rich
formats, which means that they generate larger quantities of data than ever
before. The amount of data in business environments has doubled each year for
the last several years. This is according to International Data Corporation
(IDC), a leading independent analyst that reports on the storage industry. IDC
and other analysts expect this trend to continue at least for the next several
years.
Information Technology Environments Are Becoming More Complex. The need
for new applications and data creates an increased demand for more server
systems and greater capacity storage devices, all of which must be managed,
interconnected with networks, and kept available. Moreover, business operations
are becoming more and more global and taking advantage of Internet and Intranet
technologies to support company communications, business-to-business
operations, and e-commerce business. Global businesses require global
information technology infrastructures, and these global infrastructures need
to be managed around the clock in order to be available in a global economy.
These trends have been exacerbated and, in some cases, accelerated by the
tragic events of September 11, 2001. More businesses are now concerned not only
about ensuring business continuance within a data center or branch office, but
are also seeking solutions that can help them to continue business operations
even when entire sites are damaged or destroyed.
The Effect of Labor Shortage on Information Technology
Organizations. Gartner Group, IDC and other independent information technology
research firms report that a worldwide labor shortage continues to exist for
people who are experienced and skilled in information technology disciplines.
This includes the people required to manage and protect expanding data and
application resources that are critical to delivering information to business
users. IDC estimates that in order to keep up with the growth in data alone,
individual information technologists will need to increase their efficiency by
over 60% per year between now and 2004.
What Businesses Need from Storage Management Solutions
Our storage management solutions can help to address key challenges facing
our customers by:
. Automating, or partially automating, management tasks for applications and
data, reducing administration time and human error.
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. Optimizing use of existing networks and storage devices such as tape
libraries, slowing the rate at which new bandwidth and devices must be
introduced and ensuring higher returns on investment of the new devices as
they are added.
. Enabling information protection to occur without interrupting application
service levels.
. Providing methods for restoring data and applications quickly,
efficiently, and with minimal risk to the business operation.
Our software solutions are fully backed by support services, consulting
services, and educational services.
Gartner Group, an independent information technology research firm,
estimates that customer demand will increase the size of the storage software
market from $6.6 billion in 2001 to $16.7 billion in 2005, with a
year-over-year growth rate ranging from 27% in 2002 to 25% in 2005.
Critical Requirements for Networked Storage Management
In a traditional deployment, a storage device, whether it be a disk or tape
library, is connected directly to a single server system; this is called Direct
Attached Storage, or DAS. DAS deployments accounted for nearly 74% of the
market in 2001 as reported by Gartner Group. However, DAS is expected to retain
only 41% of the market by 2004, and drop to only 30% of the market by 2005
according to Gartner Group. Gartner Group expects DAS to be replaced by various
types of networked storage architectures including Storage Area Network, or
SAN, and Network Attached Storage, or NAS.
SAN provides a separate network on which all storage devices are located,
for common access by all applications. SAN networks are usually connected by
Fibre Channel, which allows application servers and storage devices to be
located at farther distances from each other than conventional network
connections, and thus offers more flexibility to support wider parts of a
business. NAS provides a central storage device that can be added to an
existing network for common access by all applications. NAS devices have
started to introduce support for Fibre Channel networks in addition to
conventional networks, which means that businesses have the ability to combine
the use of SAN with NAS.
The key benefit of any networked data storage architecture is that it
provides data consolidation. With appropriate storage management software,
consolidated storage can cost less to manage and can be managed more
efficiently and with fewer people than traditional DAS.
By definition, consolidated storage also supports a wider segment of a
customer's business operation, because more servers are connected to it. This
means that SAN and NAS failures and performance problems have wider impacts on
the business, since they affect more applications and more business users than
a failure of a stand-alone DAS device. Therefore, deployment of SAN and NAS is
further increasing the demand for storage management software.
Our Software Products
Our software products are designed to help Global 2000 companies manage and
safeguard their applications and data more efficiently and effectively in
enterprise-wide storage networks, from data centers to branch offices. Because
our products are designed to work with mixed deployments of market-leading
server systems, applications, databases, networks, storage devices and
architectures, our products also give our customers the maximum choice to
create the storage network that they need to support their business while also
being able to safeguard it. Our goal for our customers is to increase the
overall recoverability and reliability of their complex computing
infrastructures, while also reducing apparent complexity and cost to manage.
Our products provide our customers with three types of benefits: information
protection, application availability and management. Our solutions for
information protection feature the Legato NetWorker(R) family of
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products, and provide capabilities to backup, restore and archive data. Our
solutions for application availability feature the Automated Availability
Manager, or AAM, family of products and provide capabilities to manage,
automate and recover the operation of applications. Our solutions for
management feature AlphaStor(TM) media and device management and provide
capabilities to share storage devices among servers and applications and to
track the location of removable media to ensure recoverability of data.
Legato Information Protection Products: A Strong Foundation
The foundation of any storage management solution is information protection.
Data must be protected so that it can be recovered in the event that the
original copy of the data is corrupted or otherwise destroyed or made
unavailable for use. The process of protecting information involves making
backup copies of data onto low-cost, high-capacity media such as tapes and
optical disks. Once data is lost, the user's ability to recover or restore the
data in a timely fashion becomes important. To ensure a more timely recovery of
data, companies are more frequently creating multiple non-removable disk copies
of data, including snapshots of data in combination with tape and optical
media. Our solutions for information protection range in price from $2,000 per
server up to $400,000 or more for a fully-deployed solution environment,
depending on the customer's infrastructure and business requirements.
Our products for information protection include:
Product Description
Legato NetWorker(R)......... Legato NetWorker protects data through backup,
recovery and archival processes. NetWorker is
supported on a wide range of popular server
systems, including: Windows NT, Windows 2000,
Linux, NetWare and UNIX (including UNIX from
Compaq (Digital), Hewlett Packard, IBM, Silicon
Graphics, Sequent and Sun Microsystems).
We provide the following options for NetWorker,
which enable customers to obtain specialized
configurations depending on the storage equipment
that they are using:
. Capabilities integrated with NAS devices
using Network Data Management Protocol, or
NDMP, for faster recovery of data;
. Snapshot Modules for use with market-leading
third-party snapshot solutions that create
volumes for backup and recovery, managed
through NetWorker for simplification and
ultra-fast performance;
. Application Modules for use with
market-leading databases and applications,
which are added to NetWorker to minimize
interruption to application service levels
as much as possible during the backup
process;
. Celestra(R) Power, which provides a
serverless technology that transfers data
directly between disk and tape without
having to go through the application server,
thereby ensuring that application
performance is not impacted by backup and
recovery;
. Hierarchical Storage Management, or HSM,
capabilities to automate the migration of
rarely-used files from primary to secondary
storage to optimize the use of disk storage;
. Open File Manager for Windows, which enables
NetWorker to backup files that business
users have open with their applications;
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. NetWorker Recovery Manager that provides
bare-metal recovery protection for NetWorker
servers to enable fast and simple
replacement of an entire NetWorker server so
that our customers can more quickly get to
the point of being able to recover data; and
. NetWorker Autochanger that enables NetWorker
to control the robotic arms built into
popular storage libraries and silos to
manage tape autochanger activities in
support of data backup, recovery and archive.
We provide Legato NetWorker in several editions
with various levels of functionality that scale
from the largest data centers to the smallest
branch office environments. NetWorker editions
include Workgroup Edition, Network Edition and
Power Edition.
Legato NetWorker(R) Laptop.. Legato NetWorker Laptop provides information
protection of desktop and mobile laptop computer
systems.
Legato GEMS Console......... Legato Global Enterprise Management Systems, or
GEMS, Console provides centralized management of
Legato NetWorker capabilities, to enable our
customers to use a single team of administrators
to monitor and manage their enterprise-wide
storage management network supported by Legato
Networker.
Legato NetWorker
Operations Console.......... Legato NetWorker Operations Console provides
centralized management of NetWorker capabilities
for the backup operator. This gives the operator
the functionality necessary to get the job done
without adding all of the administrative
functions that are not necessary. Reports are
also provided to quickly understand the status of
backup jobs.
Legato Application Availability Products: Ensuring Information Availability
Just as data must be protected so that it can be recovered, applications
must be safeguarded to ensure that business users, partners and customers can
continue to communicate and support key business activities. Applications need
to continue to operate and be available even when server systems stop
operating, when networks fail, when multiple users try to use them at the same
time and when administrators need to upgrade and maintain the applications.
Moreover, when the operation of an entire data center or branch office is
threatened due to a disaster, including power outage, fire, hurricane, tornado,
earthquake or other event, the business must have a means to relocate and
recover its key applications to another location. Our application availability
products enable our customers to proactively manage and protect their
applications, just as our information protection products enable them to manage
and protect their data. Our solutions for application availability range in
price from $799 for a single Linux server up to $200,000 or more for a
fully-deployed wide-area solution, protecting the largest UNIX servers.
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Our products for application availability include:
Product Description
Legato Automated
Availability Manager........ Legato Automated Availability Manager, or AAM,
enables our customers to proactively manage their
applications across mixed varieties of server
systems, at local and remote distances, and for
the purpose of avoiding application downtime and
optimizing application performance. AAM is
supported on a wide range of market-leading
server systems, including: Windows NT, Windows
2000, Linux and UNIX (including UNIX from Hewlett
Packard, IBM and Sun Microsystems).
We provide the following options for AAM that
enable customers to obtain specialized
configurations depending on the applications that
they are using:
. Application Modules for use with
market-leading databases and business
applications, which are added to AAM to
monitor, manage and automate the unique
operations of these applications.
Ultimately, these modules raise the overall
level of availability and quality of service
that our customers can achieve for their
business operations.
. Replication Modules for use with popular
disk-to-disk data replication products,
which are added to AAM to monitor and
automate the replication products to
simplify their operation and reduce the
total cost of ownership. These Replication
Modules also enable AAM to manage recovery
of applications in coordination with
recovery of data at a remote site for
comprehensive automated recovery of data
center operations from site-to-site in the
event of a disaster.
Legato Co-StandbyServer..... Legato Co-StandbyServer provides synchronous data
mirroring from disk-to-disk combined with
application protection on Windows NT and Windows
2000 for high availability of Windows-based
applications and transparent recovery of
operations when disks fail.
Legato Mirroring Extension.. Legato Mirroring Extension, or LME, provides
synchronous data mirroring from disk-to-disk for
the data used by Microsoft Cluster Service. LME
helps our customers to use the disks within
Windows server systems to support Microsoft
clusters, rather than having to purchase and
manage an external shared disk device. Having two
copies of the data also ensures that Microsoft
clusters can continue to operate through disk
failures.
Legato RepliStor(TM)........ Legato RepliStor provides asynchronous
replication of data from any disk attached to a
Windows NT or Windows 2000 server to any other
disk attached to that server. Legato RepliStor
can replicate data over local- and wide-area
network connections, with no limitations in
distance. Data replication is used by our
customers to support a variety of business
requirements including off-line tape backup of
data in centralized locations, transfer of data
from site-to-site, web content publication and
the safeguarding of business operations from
disaster.
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Product Description
Legato StandbyServer for
NetWare..................... Legato StandbyServer provides mirroring
protection of data combined with application
protection on NetWare for high availability of
NetWare-based applications and transparent
recovery of operations when disks fail.
Legato SnapshotServer for
NetWare..................... Legato SnapshotServer for NetWare creates
snapshot copies of data to enable faster recovery
of business operations.
Legato Management Products: Maximizing Storage Investments
Our management products enable customers to reduce costs by reducing
administrative time and by optimizing the use of existing storage devices. Our
management products optimize the use of tape storage devices by automatically
allocating them among backup servers. Our management products create an
"operator-less" capability by dynamically allocating existing storage devices
and managing a data storage library. This "operator-less" capability reduces
administrative time and human error for our customers. Additionally, our
products provide full lifecycle management for removable storage media through
all stages of the media's use, from when the media first enters the pool to
when it is finally retired. This includes rotation management, which allows our
customers to track and manage their media through the process of moving it from
data centers to off-site storage locations. Without this capability, customers
often manage offsite-tape inventory using an error-prone manual process of
recording this information on paper or in spreadsheets, which is not integrated
with the backup application itself. Managing the location of tapes on paper
also makes the process of locating tapes time consuming and even impossible
when the paper record is misplaced. Our solutions for management range in price
from $15,000 up to $350,000 for a fully-deployed networked storage environment.
Our products for management include:
Product Description
Legato AlphaStor............ Legato AlphaStor reduces the cost of information
protection by enabling more than one backup
server to share tape drives and libraries. This
is done by dynamically re-assigning storage
devices according to which servers need them at
any given time. Without AlphaStor, customers must
purchase and deploy individual devices for each
backup server. This is an inefficient system that
causes customers to have to purchase more devices
than they actually need to protect their data.
AlphaStor also simplifies management of devices,
not only by reducing the number required but also
by providing an easy-to-use central management
console that our customers can rely on to monitor
and manage all of their storage devices and
libraries from a single location.
Legato AlphaStor also automates the management
and tracking of removable storage media through
their entire lifecycles, by policy, for maximum
media handling efficiency and protection. Our
customers use AlphaStor to automate their
corporate media rotation policies, to ensure that
media get sent to offsite storage locations or
vaults in compliance with data protection
policies and to ensure the appropriate retirement
of worn media. AlphaStor currently supports
Legato NetWorker backup servers, with plans to
support the management and tracking of media
created by other applications, including tapes
created by Veritas, IBM, Computer Associates and
other backup vendors.
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Product Description
Legato AlphaStor supports backup servers running
on Windows NT, Windows 2000 and UNIX (including
UNIX from Hewlett Packard, IBM, Sun Microsystems
and Compaq (Digital)).
Legato Storage Resource
Management.................. Legato Storage Resource Management, or SRM,
monitors the use of disk devices to enable our
customers to maximize disk usage and
efficiencies. SRM does this by providing trend
data that our customers need to store data more
efficiently and to anticipate requirements for
additional disk space.
Sales and Marketing
We market and sell our products and services through a variety of sales
channels, including direct sales, value-added resellers, system integrators,
distributors and original equipment manufacturers, or OEMs.
Our principal strategy is to work with market-leading storage vendors and
reseller organizations as partners. We provide the technology, and our partners
sell, deliver and support Legato-based solutions. This provides us with an
effectively larger penetration in the market than we could achieve on our own.
Moreover, our customers obtain more effective solutions, because they are
integrated with market-leading storage solutions, and supported and maintained
in a coordinated fashion, rather than piece-meal. In selecting a strategy that
relies upon partners, we obtain competitive advantage for ourselves, for our
partners and for our customers. Our long-term target model is to obtain 75% of
our revenue from our partner channels and 25% of our revenue from our direct
sales.
We provide sales and pre-sales technical support to business partners and
end-user customers worldwide from our corporate offices and from regional
offices in the following metropolitan areas:
. Atlanta . Milan .Sidney
. Boston . Montreal .Singapore
. Brussels . Munich .Stockholm
. Chicago . New York .Tokyo
. Dallas . Oslo .Toronto
. Denver . Paris .Vienna
. Houston . San Jose .Washington, D.C.
. London . San Francisco .Warsaw
. Los Angeles . Seattle .Zurich
. Madrid . Seoul
Direct sales. Our direct sales force works on large enterprise-wide
projects to ensure close 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 business initiatives and satisfaction.
Resellers and distributors. We have deployed a regional sales force
dedicated to working with our partners to increase their effectiveness in
supporting our mutual customers. Our long-term model is to obtain 50% of our
revenue from this channel.
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Enterprise Solution Partners. Our North America Enterprise Solution
Partners program enables third-party integrators specializing in storage
management and open systems network solutions to provide customers with
complete solutions. These complete solutions include 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 storage environments, our support personnel work with the
reseller to provide technical support. This approach enables us to achieve
broader market coverage, while maintaining close contact with customers in
order to obtain input on product direction and to monitor customer satisfaction.
Distributor Program. To further expand coverage in the marketplace, we
license our products to large regional and national distributors who distribute
the products to resellers with expertise in storage management and the
integration of network solutions for end-users. We provide support to these
network solutions resellers. We currently have relationships with various major
distributors, including Gates/Arrow, GE Access, Ingram Micro, Nissho
Electronics and Tech Data.
Our international product sales were $121.7 million in 2001, $75.7 million
in 2000 and $65.8 million in 1999, representing 50% of total revenue in 2001,
33% of total revenue in 2000 and 29% of total revenue in 1999. The majority of
our international sales during these periods were made in Europe. We believe
that international markets present an attractive growth opportunity, and we are
expanding the scope of our international operations. We have engaged, and will
continue to engage, international resellers and distributors in targeted
countries. In order to facilitate penetration in certain markets, we are
working in conjunction with certain international distributors to localize
certain products to certain targeted languages.
OEMs and Strategic Alliances. Our OEM and strategic alliances program
generates royalty and reseller revenue for our business, and our model is to
generate 25% of our revenue from this channel. Under this program, we can
license our software products, in source or object code form, to leading
computer system and software suppliers from which we typically receive an
initial license fee and ongoing royalty revenue. The OEM partner is then
generally responsible for porting our software to its unique operating system
environment, testing it, licensing it through the OEM partner's direct sales
force and distribution channels and providing the primary customer support
after installation. Under this program, we can also support reseller sales,
joint sales initiatives, co-support and co-marketing agreements. Our customers
benefit from our relationships with OEM and strategic alliance partners,
because, as a result, our customers can acquire our family of storage
management products as part of a complete system solution from a single vendor,
with simplified implementation of the entire set of technology, and with a
single point of contact for customer support or coordinated support. We have
benefited from these relationships as they have allowed us to gain access to
our OEM and strategic partners' customer bases, both in the United States and
internationally, without a commensurate investment in fixed expenses such as
personnel, facilities and infrastructure.
Our principal strategic alliance and OEM relationships include Compaq, Dell,
EMC, Fujitsu, Fujitsu-Siemens Computers, Hewlett Packard, Hitachi, IBM, Maxtor,
Microsoft, NEC, Network Appliance, Oracle, Siemens, Silicon Graphics, Storage
Networks, StorageTek, and Sun Microsystems.
Highlights of Our Strategic Alliances Activities
The following highlights reflect some of our current partner activities:
Compaq. We are supporting Compaq's initiative of delivering a complete
solution for information protection to its customers. Compaq is engaged with us
in the following joint activities:
. Compaq resells our products;
. Compaq provides first-level support for our products; and
. Compaq offers Compaq Care Paqs for services to install our products.
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Compaq's Care Paqs include Legato services as we are the first information
protection vendor that Compaq has selected to participate in its Care Paq
program.
EMC. We are supporting EMC's initiative of providing world-class business
continuance. We do this by offering integrated solutions that add value to
EMC's software and hardware products. For example, we offer Legato Automated
Availability Manager for WANs for EMC SRDF, which adds value to EMC's
market-leading solution for data replication on Symmetrix. We also offer
NetWorker modules for EMC software.
Fujitsu. We are supporting Fujitsu's initiative of offering their
PRIMECLUSTER for linking Fujitsu's PRIMEPOWER and other servers
cost-effectively and with maximum power, availability and scalability. We
accomplish this through an OEM relationship under which our NetWorker and
SmartMedia products are integrated as components of Fujitsu's offerings. This
solution targets the Japanese market.
Fujitsu-Siemens Computers (FSC). We are supporting FSC's initiative of
offering customers world-class solutions for data protection and high
availability. Our joint activities with FSC include:
. An OEM relationship with FSC under which FSC incorporates our NetWorker
product within its products; and
. FSC develops their own value-added modules to compliment NetWorker.
We announced our worldwide OEM agreement with FSC in the fourth quarter of
2001, covering our NetWorker, Celestra and SmartMedia products. This OEM
agreement targets the European market.
IBM. We are supporting IBM's initiative to offer TotalStorage solution
bundles and to offer Linux solutions. We accomplish this by:
. Participating in joint design and co-marketing activities, as reflected in
our marketing agreement;
. Providing a version of NetWorker for IBM Informix to bundle;
. Supporting IBM network attached storage;
. Providing a version of NetWorker that IBM bundles with its LTO tape
libraries and DB2; and
. Offering NetWorker modules for key IBM middleware solutions on Linux,
including Notes, DB2 and Informix.
Microsoft. We are supporting Microsoft's initiative to penetrate and
dominate enterprise data center environments. We do this by:
. Certifying our products for use with Microsoft Windows NT and Windows
2000; and
. Focusing our Automated Recovery Manager, or ARM, initiative on Microsoft
Exchange.
Network Appliance. We are supporting Network Appliance's initiative to
provide global solutions for application and data availability. We accomplish
this by:
. Continuing to offer market-leading solutions integrated with Network
Appliance's embedded software capabilities through open standards that
provide ultra-fast backup and recovery of data on Network Appliance
devices;
. Expanding our customers' options for media and device management within a
NAS or SAN networked storage configuration; and
. Qualifying our solutions for Network Appliance's NearStore R100
introduction to provide rapid recovery and backup, including Legato
RepliStor for disk-to-disk data replication and Legato NetWorker for data
backup and recovery.
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Oracle. We provide information protection for Oracle. We do this by:
. Continuing to provide a version of Legato NetWorker to Oracle, which
Oracle ships to its customers with every Oracle database that it delivers;
and
. Providing support for Oracle9i, Oracle's latest version of its database
solution.
Sun Microsystems. We are assisting Sun to provide complete storage
solutions that include best-of-breed components. We do this by:
. Participating in Sun's Vendor Integration Program as the only storage
management vendor;
. Being included as part of Sun's Integrateable Stack via Sun Solstice
Backup, an OEM version of Legato NetWorker, which reduces total cost of
ownership through its scalability, open architecture and superior
performance; and
. Providing support for Sun Cluster 3.0 with our Legato NetWorker.
Concentration of Customers
No single customer accounted for more than 10% of our total revenue for
2001, 2000 or 1999.
Corporate Marketing
We support our multi-tiered distribution efforts with 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, European and other intercontinental markets. We participate in
industry forums, events and trade shows and advertise in key trade 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.
Service & Support
We employ systems engineers, educators and storage consultants who work
closely with our direct sales, resellers and our customers to resolve issues
and provide solutions during pre-sales and post-sales.
Support services. We offer maintenance, which consists of product updates
and technical support services. Product updates are included for the first year
with our software, and technical support may be purchased separately. Customers
may renew maintenance services annually or purchase future product updates.
Maintenance customers receive updates, enhancements and improvements to
supported software, such as support for new operating systems. Annual fees for
maintenance are calculated as a percentage of the customer's installed base of
products. The percentage is based upon the level of technical support selected
by the customer and is currently priced from 18% to 24% of product license list
price.
Generally, customers covered by the Basic Maintenance offering 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. The Extended Maintenance offering provides the same
level of service while expanding the hours of coverage to 24 hours a day, 7
days a week. The Premier Maintenance offering provides 24-hour technical
support coverage, enhanced service level objectives, priority escalation
management and a designated premium support account manager, or PSAM. The PSAM
facilitates the resolution of issues, conducts monthly conference calls and
maintains familiarity with a business' technological and operational
environment. Customers that do not have
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technical support or want service outside their coverage hours can request
support for an additional fee. The pricing for this support ranges from $500 to
$2,500 for each technical support service incident. Additionally, we offer
customers the opportunity to purchase either a six-month or one-year on-site
PSAM, for $150,000 and $200,000, respectively.
Our support organization consists of an experienced staff of technical
support engineers providing telephone and electronic support via electronic
mail from our offices in California, Utah and Ontario, Canada. Our sales and
technical support organizations work closely together to ensure high levels of
overall customer satisfaction.
In recent years, our installed base of customers has significantly
increased, as have the number of customers purchasing software maintenance
contracts. This dramatic growth caused a period of depressed customer
satisfaction. As a result of increased staffing and operational improvements,
we have successfully improved customer satisfaction. Continued investments in
people, technology and operational infrastructure are intended to further
improve customer satisfaction through decreased time to resolution, easier
access to relevant knowledge and efficiencies in our operational workflows.
Education services. Our educational services organization offers education
and training to end-users, resellers and partners. Education and training
classes cover theory, installation, operations, configuration and planning on
information protection, information availability and information management.
Training classes are offered through our reseller's in-house facilities at
their offices in North America and Europe as well as at off-site locations. Our
authorized training provider is required to pass a product certification
program as well as qualification experience to be able to teach our customers
and resellers. We have implemented an aggressive plan to expand our educational
offerings through a well-recognized training company on a worldwide basis,
Global Knowledge. This plan is expected to substantially increase the number of
individuals and companies trained on our products and to expand the delivery of
training through live and on-demand webcasts. This has allowed us to pursue a
significant worldwide product certification exam program through 3,200
Prometric sites. We also provide on-site training services upon request by
customers. Fees for education and training services are charged separately from
our software products.
Consulting services. Our consultants are available to work closely with
customers' information systems organizations to assist our customers in
efficiently designing and building their complex storage environments,
tailoring our software products to achieve higher performance and increasing
the degree of automation. We offer a wide range of tailored consulting services
targeted at solving our clients' complex storage issues. Some of these services
include initial assessments, architecture and design, installation,
configuration, deployment and management of storage devices. 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.
Research and Development
Our investment in research and development was $64.3 million in 2001, $59.6
million in 2000 and $41.7 million in 1999. 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. 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, in 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 and integrate our other technologies into
solutions 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
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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 marketplace and achieve market
acceptance. If we were 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 would be seriously harmed.
In 2001, we released a significant number of new products in support of our
strategy for providing products for information protection, application
availability and management. The new products we released include:
. Legato NetWorker 6.1, introducing Direct Access Recovery capabilities for
NAS devices using NDMP;
. Legato NetWorker 4.2 for NetWare, supporting NetWare 6.0;
. Legato NetWorker Recovery Manager 1.0, for Windows NT;
. Legato NetWorker Laptop 5.0;
. Legato NetWorker HSM 5.2 for Windows;
. Legato GEMS Console, for centralized management of one or more NetWorker
servers;
. Legato NetWorker Module 2.1 for Lotus Notes & Domino, including support
for Linux;
. Legato Open File Manager 8.0;
. Legato Automated Availability Manager 4.8, with heartbeats over Fibre
Channel for avoidance of "split-brain" problems in which different servers
can try to take action on the same resources at the same time;
. Legato Octopus 4.2, introducing Direct Naming Service protection;
. Legato StandbyServer 5.4 and SnapshotServer 4.0;
. Legato Co-StandbyServer 2000, for Windows 2000; and
. Legato AlphaStor 2.0, introducing foreign tape support and multi-path
rotation management.
We cannot guarantee that these and future new products will achieve market
acceptance. The lack of market acceptance for these and future new products
would seriously harm our business, operating results and financial condition.
We have research and development centers in the following locations:
. Ann Arbor, Michigan; . Dublin, California;
. Louisville, Colorado; . Marlborough, Massachusetts;
. Burlington, Ontario, Canada; . Palo Alto, California; and
. Cincinnati, Ohio; . Bellevue, Washington.
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 Commvault,
Computer Associates and Veritas on the Windows platforms; and include Computer
Associates, EMC (Epoch), Hewlett Packard, IBM (Tivoli), and Veritas on the UNIX
platforms. We currently have no major competitor on the Linux platform, though
we expect Veritas, among others, to enter the Linux market segment in 2002.
Gartner Group covers our market, and reported in December 2001 that Legato
remains among the top market leaders for enterprise backup, along with Hewlett
Packard, IBM (Tivoli) and Veritas.
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Some potential customers may elect to develop their own capabilities
internally that may be similar to our software products, and decide not to
purchase storage management software from any outside vendor. Furthermore,
storage companies with whom we have OEM and strategic alliance relationships
could decide to compete with us by offering their own storage management
solutions that exclude our software. Many competitors and partners have
significantly more financial and technical resources than we do, and may cause
us to lose sales and may limit the growth of our revenue and business.
Key Technology Differentiators
We are a technology leader in the networked storage management software
market through our commitment to open, standards-based software development.
Our customers have come to depend on the following key characteristics that
commonly define all of our solutions:
. Scalability;
. Serviceability;
. Interoperability;
. Performance; and
. Management.
Scalability. Our solution architecture is designed to enable scalable
growth within a company's computing environment, from the smallest
single-server implementation, to a remote branch office, to the largest data
center environment. For our customers, this means that they can scale their
infrastructure up or down as their business requires, and continue to protect
their information and applications with a continuity that ensures no gaps in
protection and with no retraining. This also preserves our customers'
investment in their existing storage infrastructure, by supporting flexible
options for sharing storage across larger and larger deployments of application
servers.
Our solutions can be configured or expanded as required, to support our
customers' dynamically changing environments. Our solutions architecture is
modular, allowing customers to add clients, servers, storage nodes and support
for added networked storage without requiring redesign or redeployment of their
storage management software. An existing server can be quickly upgraded with
more powerful capabilities for information protection, application
availability, or both, in some cases just by changing a license key.
Serviceability. Our solutions enable serviceability by providing tracing
features built into our software that can be turned on when errors occur and
can assist technical support teams in diagnosing and fixing problems. We also
do this by providing commands that can be used to obtain information about the
status of software components, again to assist technical support teams in
diagnosing and fixing problems. Our error codes are fully documented in the
user documentation that we provide with our products, and this can assist
customers and technical personnel by helping them to understand what may be
causing problems with their solutions.
Our solutions are also built to enable easy upgrades and migration to newer
versions by being built by policy to support previous configuration data for
the same product whenever possible. This means that customers moving from one
version of our products to another have minimal disruption to their business
operation. We also provide defined and tested migration procedures when
required.
Interoperability. Our solutions are designed to support and protect
market-leading open system servers, applications, databases, networks and
storage devices to preserve our customers' ability to select the combination of
technologies that best support their business.
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Our top-tier operating systems which are supported by both our NetWorker
family and AAM family of solutions, are:
. Linux;
. Windows NT;
. Windows 2000; and
. UNIX systems (AIX, HP-UX, Sun Solaris).
Our second-tier operating systems are supported only by our NetWorker family
of solutions, as follows:
. NetWare;
. UNIX systems (Dynix/ptx, Irix and Tru64); and
. Mac OS.
We provide Modules for NetWorker and AAM, for managing and protecting the
following applications and databases:
. DB2;
. Informix;
. Lotus Notes;
. Microsoft Exchange;
. Microsoft SQL;
. Oracle;
. SAP R/3; and
. Sybase.
We provide integration to support software embedded within leading storage
devices, including:
. EMC Symmetrix;
. EMC CLARiiON;
. EMC Celerra;
. Network Appliance filers; and
. Maxtor MaxAttach.
We provide certified support of popular networked storage configurations,
including:
. SAN, including most popular switch, HBA and bridge vendors;
. NAS, including most market-leading devices;
. TAN, including most popular tape drives, optical and tape robotic storage
devices; and
. DAS, including most popular disk devices.
We provide support of market-leading library devices, including those from
market-leading storage vendors.
Performance. Enterprise organizations continue to deal with expanding data
volumes and increasing service levels for applications. These trends are in
conflict with the need to control costs and preserve
15
manageability. Moreover, what continues to drive expanding data volumes is the
need to deploy strategic applications to keep organizations competitive in the
market. To enable this type of growth to continue, businesses need options for
eliminating the impact of backup on their application performance, for
continuing to reduce the time-to-recovery and for proactively maintaining and
optimizing the service levels that their applications layer delivers to support
their business.
We provide market-leading capabilities for optimized backup performance,
including options for backing up clients in parallel, multi-streamed, in
LAN-free configurations to free up business networks and even in serverless
configurations to ensure application performance. These options enable backup
to occur during business operations, while minimizing impact to those
operations. Similarly, we provide solutions that continually reduce
time-to-recovery by utilizing best-in-class technology, such as using disk for
backup and integrating our products with market-leading snapshot technology.
Our AAM family of solutions is designed to monitor and proactively manage
applications to ensure the highest service levels that can be achieved by the
computing infrastructure and to avoid downtime caused by failures. AAM
solutions are also tuned for fast recovery restart of application components
and interdependent resources, including IP addresses, application services and
connections to data.
Management. Legato solutions provide centralized capabilities for managing
heterogeneous infrastructures at local and remote distances. This creates a
single-point-of-control management interface across the most critical
applications and data that support the business. In this way, we allow our
customers to utilize their highly-skilled system administration staff to best
advantage since they can manage and protect information and applications across
all parts of their wide-scale infrastructure. Moreover, we provide separate
consoles for operators and administrators to enable less expensive staff to
take over less critical and complicated tasks, and reduce the overall cost of
storage management for our customers. We also enable multiple
points-of-operation within a customer's environment, to ensure maximum division
of workload.
To enable maximum flexibility and to lower training requirements, we also
provide cross-platform manageability: our solutions provide a single management
console that can be run on the platform of customer choice, whether it be
Windows, UNIX or Linux, and can be used to operate information and application
protection and recovery across all other platforms within the customer's
environment.
Our solutions also deliver capabilities to automate repetitive tasks,
freeing up expensive system administrator time that can be applied to other
activities. This is achieved by designing our solutions to enable easy
automation, by supporting standard event reporting, including SNMP event
trapping to enable integration with leading systems management solutions, and
by providing our own solution for automating these capabilities. SNMP stands
for Simple Network Management Protocol, and is the commonly accepted standard
used in the industry for software event reporting and tracking.
Employees
As of December 31, 2001, we had 1,338 employees. Of the total, 486 were in
sales and marketing, 348 in research and development, 310 in service and
support and 194 in general and administration. Of our 1,338 employees, 1,092
were located in the United States and Canada, 195 were located in Europe and 51
were located in the rest of the world. None of our employees are represented by
a labor union, and we believe our relationship with our employees is good.
Risk Factors
The following risk factors and other information included in this Annual
Report on Form 10-K should be carefully considered. The risks and uncertainties
described below are not the only ones we face. Additional risks and
uncertainties not presently known to us or that we currently deem less
significant also may impair our
16
business operations. If any of the following risks actually occur, our
business, operating results and financial condition could be materially
negatively affected.
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 dollar value of orders and the timing of when orders are received;
. Intense competition;
. Macroeconomic uncertainty and weakness;
. Market acceptance of our new products, applications and product
enhancements of our competitors;
. Changes in pricing policies or those of our competitors;
. The current challenging spending environment in our customers' IT
departments;
. Our ability to develop, introduce and market new products, applications
and product enhancements;
. 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;
. Success in expanding sales and marketing programs;
. Technological changes in our customers' environments;
. 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;
. Our ability to effectively manage and reduce our tax liabilities;
. Our ability to integrate recently acquired businesses;
. Acquisition costs or other non-recurring charges in connection with the
acquisition of companies, products or technologies;
. Loss of our information technology infrastructure for a significant period
of time;
. 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
others or us are by nature forward-looking statements, and it is likely that
future results will vary. Forward-looking statements that were reasonable at
the time made may ultimately
17
prove to be incorrect or false. It is our general policy and practice not to
update our forward-looking statements. Some investors in our securities
inevitably will experience gains while others will experience losses, depending
on the prices at which they purchase and sell securities. Prospective and
existing investors are strongly urged to carefully consider the various
cautionary statements and risks set forth in this report.
We cannot predict our future revenue with any significant degree of
certainty for several reasons including:
. Our sales cycles vary substantially from customer to customer, in large
part because we depend upon large enterprise license transactions with
corporate customers. Furthermore, such transactions may include extended
payment terms, escalating discounts, acceptance provisions or other terms
that would preclude immediate revenue recognition of some or all of the
license component;
. 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;
. Due to general economic factors that currently affect our end-user
customers' businesses, those customers are being more deliberate in the
manner in which they make information technology spending decisions;
. OEM 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 and the general health of their
businesses; these trends are also difficult for us to predict.
Fluctuations in licensing activity from quarter to quarter further impact
royalty revenue, because initial license fees generally are non-recurring
and generally recognized upon the signing of a license agreement;
. 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; 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 losses will increase because only a small
portion of our expenses varies with our revenue.
We believe that period-to-period comparisons of our results of operations
may not be meaningful and should not be relied upon as indications of future
performance. Our operating results could be below the expectations of public
market analysts and investors in some future quarter or quarters. Our failure
to meet such expectations would likely cause the market price of our common
stock to decline.
We are currently subject to litigation.
Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against us and certain of our directors and officers. On May 1,
2000, the court consolidated the pending cases and, on May 10, 2000, appointed
a lead plaintiff, who filed a consolidated amended complaint on August 7, 2000.
Defendants moved to dismiss. On January 17, 2001, the court granted the motions
to dismiss with leave to amend. On February 13, 2001, plaintiffs filed a second
amended complaint, which generally alleges that, between April 22, 1999 and May
17, 2000, defendants made false or misleading statements of material fact about
our prospects and failed to follow generally accepted accounting principles in
violation of the federal securities laws. The complaint seeks an unspecified
amount in damages. Defendants answered the complaint in April 2001 denying all
allegations that they violated the federal securities laws.
18
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 a nominal defendant. The derivative
case has been related to the securities class action. Plaintiffs filed an
amended complaint on February 9, 2001, which generally alleges the same conduct
as the shareholder class action, and claims that defendants breached their
fiduciary duties and engaged in improper insider trading. The derivative
complaint sought unspecified damages and injunctive relief. Defendants moved to
dismiss the derivative complaint. On July 10, 2001, the court granted
defendants' motion to dismiss with leave to amend. Plaintiffs filed an amended
complaint on August 23, 2001; plaintiffs then moved to voluntarily dismiss the
amended complaint with the right to refile the complaint at a later date if
they choose to do so, and the Court granted plaintiffs' motion in November 2001.
On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as a nominal defendant. On May 23, 2000, a shareholder
derivative action was filed in the Superior Court of California, County of San
Mateo, against certain of our officers and directors. We are named as a nominal
defendant. Both state derivative complaints generally allege the same conduct
as the derivative action filed in federal court, claiming that our officers and
directors breached their fiduciary duties for the same period, and seek
unspecified damages and injunctive relief. The state derivative cases have been
consolidated in San Mateo County. Plaintiffs filed a consolidated amended
complaint. Defendants filed a demurrer, which was denied on July 20, 2001.
The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second and third quarters of 1999, and our revision of financial results for
the fourth quarter of 1999. We have been voluntarily cooperating with the Staff
of the Commission in its investigation.
We intend to defend all of these actions vigorously. However, 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 materially adverse to our
financial position, results of operations or cash flows.
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: Computer
Associates; EMC (Epoch); Hewlett Packard; IBM (Tivoli); and Veritas. We expect
to encounter new competitors as we enter new markets. In addition, many of our
existing competitors are broadening their platform coverage. We also expect
increased competition from systems and network management companies, especially
those that have historically focused on the mainframe market and are broadening
their focus to include the client/server computer market. In addition, since
there are relatively low barriers to entry in the software market, we expect
additional competition from other established and emerging companies. We also
expect that competition will increase as a result of future software industry
consolidations. Increased competition could harm us by causing, among other
things, price reductions, reduced gross margins and loss of market share.
Many of our current and potential competitors have longer operating
histories and have substantially greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger customer
base than we have. As a result, certain current and potential competitors can
respond more quickly to new or emerging technologies and changes in customer
requirements. They can also devote greater resources to the development,
promotion, sale and support of their products. In addition, current and
potential competitors may establish cooperative relationships among themselves
or with third parties. If so, new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. In addition, network
operating system vendors could introduce new or upgraded operating systems or
environments that include functionality offered by our products. If so, our
products could be rendered obsolete and unmarketable. For all
19
the foregoing reasons, we may not be able to compete successfully, which would
seriously harm our business, operating results and financial condition.
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
build and sustain 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 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. In addition, we need to
continue to integrate into our product lines the technologies of products we
acquired through the acquisitions completed in 1999, and to develop the
technologies we acquired from Software Clearing House, Inc. in July 2001. 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 have introduced several new products during 2001, and currently plan to
introduce and market several more potential new products in the next twelve
months. Some of our competitors currently offer products analogous to 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 of, or loss of, 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.
Our products may contain undetected errors.
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. As a result of those errors, 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. In addition, customers have
in the past brought to our attention "bugs" in our software created by the
customers' unique operating environments. Although we have been able to fix
such software bugs in the past, we may not always be able to do so. These types
of circumstances may result in the loss of, or delay in, market acceptance of
20
our products or increase the need for additional customer support personnel,
which could seriously harm our business, operating results and financial
condition.
Defects in our products would harm our business.
Our products can be used to manage data critical to organizations. As a
result, the licensing and support of products we offer may entail the risk of
product liability claims. Although we generally include provisions in our
license agreements that are intended to limit our liability, a successful
product liability claim brought against us could seriously harm our business,
operating results and financial condition.
We rely on enterprise license transactions.
We have developed strategies to pursue larger enterprise license
transactions with corporate customers. However, we may not continue to
successfully market our products through larger enterprise license
transactions. Such failure would seriously harm our business, operating results
and financial condition. In addition, many of the large organizations that we
target as customers have lowered their rate of spending on enterprise software.
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 nine
months, and varies substantially from transaction to transaction;
. Enterprise license transactions often include multiple elements such as
product licenses and service and support;
. Recognition of revenue from enterprise license transactions may vary from
transaction to transaction;
. These transactions typically involve significant technical evaluation and
commitment of capital and other resources;
. A growing number of our direct-license customers are located outside the
United States, where the sales cycle can be lengthier than transactions
negotiated within the United States;
. Our customers are being more deliberate about information technology
spending decisions due to the current state of the overall economy; and
. Customers' internal procedures frequently cause delays in orders. Such
internal procedures include approval of large capital expenditures,
implementation of new technologies within their networks and testing new
technologies that affect key operations.
Due to the large size of enterprise transactions, if orders forecasted for a
specific transaction for a particular quarter are not realized in that quarter,
our operating results for that quarter may be seriously harmed.
We rely on indirect sales channels.
We rely significantly on our distributors, systems integrators and
value-added resellers, or collectively, resellers, for the marketing and
distribution of our products. Our agreements with resellers are generally not
exclusive and in many cases may be terminated by either party without cause.
Many of our resellers carry product lines that are competitive with ours. These
resellers may not give a high priority to the marketing of our products.
Rather, they may give a higher priority to other products, including the
products of competitors, or may not continue to carry our products. Events or
occurrences of this nature could seriously harm our business, operating results
and financial condition. In addition, we may not be able to retain any of our
current resellers or successfully recruit new resellers. Any such changes in
our distribution channels could seriously harm our business, operating results
and financial condition.
21
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 will 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. 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 are modifying some of our marketing strategies.
As noted above, we rely significantly upon resellers as part of our overall
marketing strategy. We are currently realigning our approach to work with our
strategic alliances and other resellers. The objective of our new approach is
to form stronger ties with specific companies with whom we have global
alliances. We are also restructuring our reseller networks in order to create
greater rewards for distributors and resellers that demonstrate a greater
commitment to us, as measured in net sales, technical certification and other
factors. As a result of these changes, we may negatively affect the volume of
sales through our strategic alliances or our resellers. If a significant number
of resellers were to cease doing business with us as a result of these changes,
and sales through the remaining resellers failed to compensate for the lost
resellers, this strategic change 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 expand international operations successfully, we
must establish additional foreign operations, hire additional 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. Most 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, potentially less competitive in those markets. In some markets,
localization of our products and license documents is essential to achieve or
increase market penetration. We may incur substantial costs and experience
delays in localizing our products and license language. We also may fail to
generate significant revenue from localized products.
Additional risks inherent in our international business activities generally
include:
. Significant reliance on our distributors and other resellers who do not
offer our products exclusively;
. Unexpected changes in regulatory requirements;
. Tariffs and other trade barriers;
. Lack of acceptance of localized products, if any, in foreign countries;
. Longer negotiation and 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 multiple local, country
and regional laws; and
. The risks related to the current weakness in some regions, including,
without limitation, Europe and Asia.
The occurrence of such factors could seriously harm our international sales
and, consequently, our business, operating results and financial condition.
22
We depend on growth in the enterprise data storage market.
The overwhelming majority of our business is in the enterprise data storage
market. The enterprise data storage management market is still a maturing and
dynamic 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 at historic
rates, or at all. If this market fails to grow, or grows more slowly than we
currently anticipate, and we are unable to capture market share from our
competitors, our business, operating results and financial condition would be
seriously harmed.
We are affected by general economic and market conditions.
Segments of the computer industry have recently experienced significant
economic downturns characterized by decreased product demand, product
overcapacity, price erosion, work slowdowns and layoffs. These downturns appear
to coincide with the widely-reported weakness in the overall economy. Our
operations may experience substantial fluctuations from period-to-period as a
consequence of such industry trends, 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.
Our revenue recognition could be impacted by the unauthorized actions of our
personnel.
The recognition of our revenue depends on, among other things, the terms
negotiated in our contracts with our customers. Our personnel may act outside
of their authority and negotiate additional terms without our knowledge. In the
event that our sales personnel have negotiated terms that do not appear in the
contract and of which we are unaware, whether the additional terms are written
or verbal, we could be prevented from recognizing revenue in accordance with
our plans. Furthermore, depending on when we learn of unauthorized actions and
the size of transactions involved, we may have to restate revenue for a
previously reported period, which would seriously harm our business, operating
results and financial condition.
We rely on our sales personnel.
In the past, we have experienced significant voluntary resignations in our
sales force, including some of our senior level sales employees, and may
experience such turnover again. Our future success depends on our continuing
ability to attract and retain highly qualified sales personnel. Competition for
such personnel remains 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 disruption to our sales force could seriously harm our
business, operating results and financial condition.
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 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.
Approximately one third of our employees joined the Company since the
beginning of 2001. Our future success also depends on our continuing ability to
attract and retain highly qualified technical, sales and managerial personnel.
Despite recent weakness in the economy, competition for such highly qualified
personnel remains 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.
23
Our investment in goodwill and intangibles resulting from our acquisitions
could become impaired.
As a result of our acquisitions in 1999 and in 2001, we recorded goodwill
and intangibles of $177.0 million of which $48.9 million was written-off in the
fourth quarter of 2001 due to an impairment. As of December 31, 2001, we had
goodwill of $17.3 million and acquired intangibles of $14.3 million on our
Consolidated Balance Sheet. With our adoption of Statement of Financial
Accounting Standard No. 142, "Goodwill and Other Intangible Assets" in the
first quarter of 2002, goodwill will no longer be amortized. We expect to
amortize intangibles of $5.7 million in 2002, $5.7 million in 2003 and $2.9
million in 2004. To the extent we do not generate sufficient cash flows to
recover the net amount of the intangibles recorded, the intangibles could be
subsequently written-off. In such event, our results of operations in any given
period could be negatively impacted, and the market price of our stock could
decline.
If we make unprofitable acquisitions or are unable to successfully integrate
any acquisition, our business would suffer.
We have in the past, and may in the future, acquire businesses, products or
technologies that we believe compliment or expand our existing business. In
furtherance of this strategy, we announced our agreement to acquire OTG
Software, Inc, a data storage software company based in Rockville, Maryland, in
February 2002. In July 2001, we acquired Software Clearing House, Inc., a
software developer, reseller and consulting organization based in Cincinnati,
Ohio. Our ability to achieve favorable results in 2002 and beyond will be
dependent in part upon our ability to successfully integrate the people,
products and business lines of our acquisitions. In addition, we will need to
work with our acquired companies' customers and business partners to establish
new relationships based upon the broader range of products and services
available from us. Further, we must accomplish the synergies identified during
the acquisition process. Failure to execute on any of these elements of the
integration process could seriously harm our business, operating results or
financial condition.
We cannot ensure that any acquisitions or acquired businesses, products or
technologies associated therewith will generate sufficient revenue to offset
the associated costs of the acquisitions or will not result in other adverse
effects. Moreover, from time to time, we may enter into negotiations for the
acquisition of businesses, products or technologies but be unable or unwilling
to consummate the acquisitions under consideration. This could cause
significant diversion of managerial attention and out of pocket expenses to us.
We could also be exposed to litigation as a result of an acquisition, including
claims that we failed to negotiate in good faith, misappropriated confidential
information or other claims.
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. Despite this limited protection, 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. We may also develop proprietary products or technologies that cannot
be protected by patent law.
Despite our efforts to protect our proprietary rights, we are aware that
unauthorized parties have attempted to transfer licenses to third parties, copy
aspects of our products or to obtain and use information that we regard as
proprietary. Policing unauthorized use and transfer 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, in whole or in part, 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.
24
From time to time, we have received claims that we are infringing on 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 are not available on terms acceptable to us, our business, operating
results and financial condition could be seriously harmed.
Our trading price is volatile.
The trading of our common stock historically has been highly volatile, and
we expect that the price of our common stock will continue to fluctuate
significantly 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;
. Announcements of disappointing financial results from our competitors,
strategic allies or major end users;
. Developments with respect to our patents, copyrights or proprietary rights
or those of our competitors;
. Sales of large blocks of our common stock;
. Acquisitions or dispositions of our common stock by corporate officers or
members of the Board of Directors;
. Conditions in the financial markets in general;
. Litigation; and
. General business conditions and trends in the distributed computing
environment and software industry.
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.
ITEM 2. PROPERTIES
Our principal headquarters 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 August 2006. Our principal technical support
facility is located in approximately 97,600 square feet of space in Burlington,
Ontario. This facility is leased through September 2010. We also currently
lease other domestic offices throughout the United States, as well as
international offices throughout the world.
25
ITEM 3. LEGAL PROCEEDINGS
Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against us and certain of our directors and officers. On May 1,
2000, the court consolidated the pending cases and, on May 10, 2000, appointed
a lead plaintiff, who filed a consolidated amended complaint on August 7, 2000.
Defendants moved to dismiss. On January 17, 2001, the court granted the motions
to dismiss with leave to amend. On February 13, 2001, plaintiffs filed a second
amended complaint, which generally alleges that, between April 22, 1999 and May
17, 2000, defendants made false or misleading statements of material fact about
our prospects and failed to follow generally accepted accounting principles in
violation of the federal securities laws. The complaint seeks an unspecified
amount in damages. Defendants answered the complaint in April 2001 denying all
allegations that they violated the federal securities laws.
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 a nominal defendant. The derivative
case has been related to the securities class action. Plaintiffs filed an
amended complaint on February 9, 2001, which generally alleges the same conduct
as the shareholder class action, and claims that defendants breached their
fiduciary duties and engaged in improper insider trading. The derivative
complaint sought unspecified damages and injunctive relief. Defendants moved to
dismiss the derivative complaint. On July 10, 2001, the court granted
defendants' motion to dismiss with leave to amend. Plaintiffs filed an amended
complaint on August 23, 2001; plaintiffs then moved to voluntarily dismiss the
amended complaint with the right to refile the complaint at a later date if
they choose to do so, and the Court granted plaintiffs' motion in November 2001.
On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as a nominal defendant. On May 23, 2000, a shareholder
derivative action was filed in the Superior Court of California, County of San
Mateo, against certain of our officers and directors. We are named as a nominal
defendant. Both state derivative complaints generally allege the same conduct
as the derivative action filed in federal court, claiming that our officers and
directors breached their fiduciary duties for the same period, and seek
unspecified damages and injunctive relief. The state derivative cases have been
consolidated in San Mateo County. Plaintiffs filed a consolidated amended
complaint. Defendants filed a demurrer, which was denied on July 20, 2001.
The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second and third quarters of 1999, and our revision of financial results for
the fourth quarter of 1999. We have been voluntarily cooperating with the Staff
of the Commission in its investigation.
We intend to defend all of these actions vigorously. However, 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 materially adverse to our
financial position, results of operations or cash flows.
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, 2001.
26
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. As of February 28, 2002, there were approximately 350 record holders of
our common stock. We have never declared or paid a cash dividend on our common
stock and do not intend to pay cash dividends on our common stock in the
foreseeable future. The following table sets forth the high and low closing
sales prices of our common stock for each quarter in the two-year period ended
December 31, 2001.
2001 2000
------------ -------------
High Low High Low
------ ----- ------ ------
First Quarter.................................... $18.38 $6.94 $67.75 $25.19
Second Quarter................................... $17.99 $8.00 $22.00 $ 9.88
Third Quarter.................................... $16.01 $4.76 $15.25 $ 8.31
Fourth Quarter................................... $15.05 $5.01 $12.81 $ 6.69
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Five-Year Summary
December 31,
-----------------------------------------------
2001 2000 1999 1998(2) 1997(2)
--------- -------- -------- -------- --------
(in thousands, except per share amounts)
Revenue..................................... $ 242,601 $231,395 $228,567 $167,907 $118,499
Gross profit................................ 188,168 183,784 195,789 142,657 97,470
Income (loss) from operations............... (124,713) (51,413) 2,991 27,815 21,589
Net income (loss)........................... (81,495) (35,249) 2,704 19,869 15,066
Basic net income (loss) per share(1)........ (0.92) (0.41) 0.03 0.26 0.21
Diluted net income (loss) per share(1)...... (0.92) (0.41) 0.03 0.24 0.19
Cash, cash equivalents and investments...... 145,695 165,145 169,928 125,972 87,433
Total assets............................. 355,261 414,864 422,894 207,224 141,908
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements.
(2) 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.
27
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 on our expectations, beliefs, intentions or strategies regarding the
future, including without limitation, our financial outlook, successful
introduction of new products and expansion of operation. 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,
competition, product concentration, technological changes, reliance on
enterprise license transactions, reliance on indirect sales channels, changes
in marketing strategies, dependence on international revenue, management of our
growth and expansion, the ability to attract and retain qualified personnel and
other risks discussed in this item under the heading "Risk Factors" and the
risks discussed in our other Securities and Exchange Commission filings.
Overview
Legato Systems, Inc. was incorporated in Delaware in September 1988. We
develop, market and support software products and services for information
management of distributed, open systems environments. Information management
includes the protection, recovery and avoidance of failures of data and
applications so that business users can gain access to the information that
they need when they need it. Distributed, open systems are generally understood
to include UNIX, Windows NT, Windows 2000 and Linux server computer systems. We
offer software products for backup, recovery and archive of data; for managing
the performance and operation of application services; and for optimizing the
use of storage devices and media including disk and tape. Our customers use our
products and services to safeguard and manage their information assets and
associated applications so that their businesses can continue to operate, and
do so in a more cost-effective manner.
On February 20, 2002, we entered into a definitive agreement to acquire OTG
Software, Inc. ("OTG"). OTG provides data management and collaboration
solutions that virtualize storage for any type of data, including files,
messages and databases, while providing easy and transparent access. The merger
agreement provides that each share of OTG common stock will be exchanged for
0.6876 of a share of Legato common stock and $2.50 per share of cash. We will
also assume all outstanding options to purchase OTG common shares. The closing
of the merger is subject to regulatory approval and Legato and OTG shareholder
approvals, and is expected to close in the second quarter of 2002. After the
transaction is completed, OTG's shareholders will own approximately 21% of the
combined entity's shares. This strategic acquisition will result in substantial
one-time charges along with ongoing substantial amortization of intangibles to
our results of operations.
Critical Accounting Policies
In preparing our financial statements, we must make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue
and expenses during the reporting period. The areas that require significant
judgment are as follows:
Revenue recognition and allowances for doubtful accounts and product
returns. An assessment of our customers' ability to pay is one of the
considerations that affect revenue recognition. In some cases, we sell to
undercapitalized resellers in emerging markets. As such, we defer revenue
recognition until cash is received, the reseller has established a history of
making timely payments or the reseller's financial condition has improved.
Furthermore, once we have recognized revenue, we must evaluate our accounts
receivable at each period end for amounts that we believe are no longer
collectible. This evaluation is largely done based on comments received
28
from the customer and/or our sales personnel, a review of financial condition
via credit agencies and our historical experience with the customer. The
unexpected filing of a bankruptcy petition by a customer or reseller may impact
our evaluation of accounts receivable in any given period. However, this risk
is mitigated by the fact that our accounts receivable is dispersed among a
large number of customers. As of December 31, 2001, no customer accounted for
more than 10% of our accounts receivable. For each reporting period, we must
also estimate the amount of product that will be returned for reasons,
including, without limitation, wrong product ordered, duplicate orders and
excessive quantities. Our estimates are computed using our historical return
experience. Product returns over the past several years have not deviated
significantly from our historical experience.
Accounting for income taxes. As part of the process of preparing our
consolidated financial statements, we are required to estimate our income taxes
in each of the jurisdictions in which we operate. This process involves us
estimating our actual current tax exposure together with assessing the
temporary differences resulting from differing treatment of items, such as
deferred revenue or deductibility of certain intangible assets, for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included within our consolidated balance sheet. We must
then assess the likelihood that our deferred tax assets will be recovered from
future taxable income. To the extent we believe the recovery is not likely, we
must establish a valuation allowance, which will result in a tax provision in
the consolidated statement of operations.
Valuation of long-lived and intangible assets and goodwill. We assess the
impairment of long-lived assets, identifiable intangibles and related goodwill
and enterprise level goodwill whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors we consider
important that could trigger an impairment review include the following:
. Significant underperformance relative to expected historical or projected
future operating results;
. Significant changes in the manner of our use of the acquired assets or the
strategy for our overall business;
. Significant negative industry or economic trends; or
. Significant decline in our market capitalization relative to net book
value for a sustained period.
When we determine that the carrying value may not be recovered based upon
the existence of one or more of the above indicators, we measure any impairment
based on a projected discounted cash flow method using a discount rate
determined by our management to be commensurate with the risk inherent in our
current business model.
Results of Operations
Revenue. Revenue is derived from primarily two sources: (i) license
revenue, derived from the sale of software licenses to resellers and end users,
including large-scale enterprises, and royalty revenue, derived from initial
license fees and ongoing royalties from licenses of source code to OEMs; and
(ii) service and support revenue, derived from providing software updates,
support and education and consulting services to end users.
License revenue is generally recognized when a signed contract or other
persuasive evidence of an arrangement exists, the software has been shipped or
electronically delivered, the license fee is fixed or determinable and
collection of resulting receivables is probable. 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. For sales to domestic distributors,
license revenue is recognized upon sale by the distributor to the end-user.
License revenue from royalty payments is recognized upon receipt of royalty
reports from OEMs related to their product sales. Revenue from subscription
license agreements (which
29
include software, rights to future products and maintenance) is recognized
ratably over the term of the subscription period.
Service and support revenue consists primarily of revenue received for
providing software updates, technical support for software products, on-site
support, consulting and training. Revenue from updates and support is
recognized ratably over the term of the agreements. Revenue allocated to
education and consulting services, or derived from the separate sales of these
services, is recognized as the related services are provided.
When contracts contain multiple obligations (e.g., products, updates,
technical support and other services) wherein vendor specific objective
evidence exists for all undelivered elements, we account for the delivered
elements in accordance with the "Residual Method" prescribed by Statement of
Position 98-9. Any revenue related to updates or technical support in these
arrangements is recognized ratably over the term of the maintenance arrangement.
% Change
----------
2001 2000 1999 01/00 00/99
------ ------ ------ ----- -----
(in millions)
License................................ $147.5 $145.6 $161.1 1% (10)%
Service and support.................... 95.1 85.8 67.5 11 27
------ ------ ------
Total revenue....................... $242.6 $231.4 $228.6
====== ====== ======
Sources of Revenue as a Percent of Total Revenue
2001 2000 1999
---- ---- ----
License................................ 61% 63% 70%
Service and support.................... 39 37 30
While license revenue increased in 2001 over the previous year, license
revenue decreased as a percentage of total revenue in 2001, when compared to
2000, primarily as a result of the economic recession and the reduced spending
by customers. In prior years, our customers were willing to forecast expected
demand for the next couple of years and purchase that quantity of licenses
upfront in exchange for a greater discount. In 2001, our customers were more
conservative with their estimates or were unwilling to make these large
purchases. License revenue decreased for 2000, when compared to 1999, primarily
due to the implementation of our new software subscription licensing model
during the second quarter of 2000 and, to a lesser extent, a decrease in sales
volume of our software products resulting from the headcount turnover within
the sales force.
Service and support revenue increased for 2001, when compared to 2000, as a
result of our improvement in the number of customers renewing their support
contracts to over 90% and the increased rates we charge for such services. Our
increase in staffing for software support helped to increase new sales and
renewals of our software support contracts. Even though overall service and
support revenue increased in 2001, our revenue from consulting and educational
services decreased by $5.2 million. The decrease in consulting services revenue
was due to productivity issues caused by the re-organization of our field sales
force, which typically sells consulting engagements. The decrease in
educational services revenue was a result of our outsourcing of this function
to Global Knowledge Networks, Inc., an international information technology
education integrator, in the second quarter of 2001. Service and support
revenue increased for 2000, when compared to 1999, primarily as a result of
increased maintenance renewals over a larger installed base and, to a lesser
extent, growth in our consulting and education services. We expect that service
and support revenue will increase in absolute dollars in 2002, but at a growth
rate less than in 2001.
30
Revenue by Geography
% Change
----------
2001 2000 1999 01/00 00/99
------ ------ ------ ----- -----
(in millions)
Domestic............................... $120.9 $155.7 $162.8 (22)% (4)%
International.......................... 121.7 75.7 65.8 61 15
------ ------ ------
Total revenue....................... $242.6 $231.4 $228.6
====== ====== ======
Revenue by Geography as a Percent of Total Revenue
2001 2000 1999
---- ---- ----
Domestic............................... 50% 67% 71%
International.......................... 50 33 29
Domestic revenue decreased for 2001, when compared to 2000, primarily due
the economic recession in the United States. Revenue from our OEM partners
decreased significantly as their businesses suffered in the poor economic
climate; and our customers in the United States have reduced their information
technology spending in order to better align their expenses with their deflated
revenue trends. Further, a large part of our sales force in the United States
is new to Legato, and they have not reached the level of productivity of which
we believe they are capable. Domestic revenue decreased for 2000, when compared
to 1999, primarily due to a decrease in sales volume of our products given the
turnover in the headcount of the domestic sales force and the implementation of
our new software subscription licensing model during the second quarter of
2000. International revenue increased primarily as a result of the continued
market acceptance of our products overseas. The majority of international sales
during these periods were made in Europe. We intend to increase sales by
continuing to develop and broaden our OEM relationships, increasing the
productivity of our domestic sales force and cautiously expanding our
international operations.
Cost of Revenue
% Change
----------
2001 2000 1999 01/00 00/99
----- ----- ----- ----- -----
(in millions)
License................................ $ 5.5 $ 6.0 $ 5.9 (8)% 2%
Service and support.................... 48.9 41.6 26.9 18 55
----- ----- -----
Total cost of revenue............... $54.4 $47.6 $32.8
===== ===== =====
Cost of Revenue as a Percent of the Related Revenue
2001 2000 1999
---- ---- ----
License................................ 4% 4% 4%
Service and support.................... 51 48 40
Cost of license revenue includes costs of production personnel, packaging
and documentation, freight and royalties. Product gross margin remained
constant at 96% in 2001 when compared to 2000 and 1999. Cost of service and
support revenue includes costs associated with providing customers with
services, such as consulting and education, telephonic and on-site support and
product updates. Costs of service and support include primarily salaries,
packaging, documentation and delivery of product updates and costs to maintain
the infrastructure necessary to manage a services organization. Cost of service
and support revenue increased by $7.3 million in 2001, when compared to 2000,
and by $14.7 million in 2000, when compared to 1999, and was driven by
increases in the support function as we delivered better support and increased
our customer satisfaction as measured by periodic surveys. Service and support
headcount increased to 310 in 2001 from 298 in 2000 and 238
31
in 1999. Service and support gross margin decreased slightly to 49% in 2001
from 52% in 2000 and 60% in 1999. The decrease of 8% in 2000 was primarily due
to the increased staffing to support as discussed above and outsourcing certain
of our consulting arrangements.
Total gross profit was $188.2 million in 2001, $183.8 million in 2000 and
$195.8 million in 1999, representing gross margin of 78% in 2001, 79% in 2000
and 86% in 1999. The decrease in total gross margin for 2000, when compared to
1999, relates primarily to the decrease in service and support gross margin
during 2000.
Operating Expenses
% Change
----------
2001 2000 1999 01/00 00/99
------ ------ ----- ----- -----
(in millions)
Sales and marketing.................... $125.8 $109.2 $95.2 15% 15%
Research and development............... 64.3 59.6 41.7 8 43
General and administrative............. 30.8 28.3 16.4 9 73
Operating Expenses as a Percent of Total Revenue
2001 2000 1999
---- ---- ----
Sales and marketing.................... 52% 47% 42%
Research and development............... 27 26 18
General and administrative............. 13 12 7
Sales and marketing expenses. Sales and marketing expenses consist
primarily of employee-related costs such as salaries, benefits, commissions and
promotional and advertising expenses. The increase in sales and marketing
expenses of $16.6 million for 2001, when compared to 2000, was, for the most
part, a result of an increase in salaries and other compensation. Our sales and
marketing personal increased to 486 from 454 in 2000 and 449 in 1999. The
increase in sales and marketing expenses of $14.1 million for 2000, when
compared to 1999, was primarily attributable to increased recruiting costs, air
travel and facilities expenses and, to a lesser extent, an increase in our
headcount. We believe that sales and marketing expenses will increase in
absolute dollars in 2002, but decrease as a percentage of total revenue, as we
focus our efforts on improving the efficiency and productivity of our current
personnel.
Research and development expenses. Research and development expenses
consist primarily of employee-related costs such as salaries, benefits and
facilities and equipment costs. The increase in research and development
expenses of $4.7 million for 2001, when compared to 2000, resulted from
increased depreciation expense, facilities expenses and salaries and other
compensation. Salary and other compensation increased even though overall
headcount decreased as of December 31, 2001, because the majority of the
headcount reductions associated with the development laboratory restructuring
occurred in the fourth quarter of 2001. The number of research and development
personnel decreased to 348 in 2001 from 364 in 2000 and 384 in 1999. The
increase in research and development expenses of $17.8 million for 2000, when
compared to 1999, was primarily attributable to increases in salaries and
benefits as headcount increased significantly in 1999 as a result of our
acquisitions of Intelliguard in April 1999 and Vinca in July 1999. Under
purchase accounting, the results of operations of these companies were added to
our results of operations from the date of acquisition. Accordingly, we
recorded a full year of salary and benefits costs in 2000. We believe that
research and development expenses will continue to increase slightly in
absolute dollars in 2002, but decrease as a percentage of total revenue, as we
invest in developing new products and integrating our existing technologies.
General and administrative expenses. General and administrative expenses
primarily include employee-related costs of our finance, human resources and
other administrative departments and an allocated amount of facilities,
information technology and education costs. The increase in general and
administrative costs of $2.5 million in 2001, when compared to 2000, related to
increases in salaries, other compensation, travel and
32
entertainment, partially offset by a reduction in recruiting costs. The
increase in general and administrative expenses of $11.9 million for 2000, when
compared to 1999, was attributable to increases in salaries and other
compensation, recruiting costs, legal and other professional services and bad
debt expense. General and administrative personnel increased to 194 in 2001
from 154 in 2000 and 165 employees in 1999. We expect that general and
administrative expenses will increase in absolute dollars in 2002, but decrease
as a percentage of revenue, as headcount will not fluctuate significantly from
its current level.
Restructuring charges. During 2001, we incurred $9.4 million in charges as
we restructured our development operations to reduce our cost structure and to
integrate and reduce selling and marketing activities. In connection with these
activities, we reduced our workforce by approximately 215 employees and closed
our development facilities in Sunnyvale, California; Eden Prairie, Minnesota;
Orem, Utah; and New Delhi, India. As of December 31, 2001, accrued
restructuring charges related primarily to future lease commitments, which will
be paid through 2004, and some severance and benefit costs, which will be paid
in 2002. We continue to search for subtenants for these excess facilities. But
given the short duration of the remaining lease terms and the current market
for commercial real estate, our ability to find subtenants at reasonable rates
is unlikely. The following table summarizes the restructuring activity during
2001 (in thousands):
Severance
and Excess
Benefits Facilities Assets Total
--------- ---------- ------- -------
Balance, December 31, 2000............. $ -- $ -- $ -- $ --
Restructuring charges............... 3,148 2,398 3,827 9,373
Cash payments....................... (2,512) (1,177) -- (3,689)
Non-cash write-off.................. -- -- (3,827) (3,827)
------- ------- ------- -------
Balance, December 31, 2001............. $ 636 $ 1,221 $ -- $ 1,857
======= ======= ======= =======
Impairment of intangibles. In connection with the restructuring actions
taken in the fourth quarter of 2001, we made certain decisions related to our
various technologies, which resulted in the impairment of some of the acquired
intangibles. With regard to the Intelliguard acquired intangibles, we chose to
pursue an alternative technology, which resulted in writing-off all related
intangibles of $20.3 million. With regards to the Vinca acquired intangibles,
we chose to cease development of certain Vinca technology, impairing the
related intangible assets by $28.5 million.
Amortization of acquired intangibles. Amortization of acquired intangibles
was $33.8 million in 2001, $38.1 million in 2000 and $21.8 million in 1999. The
intangible assets resulted from our acquisitions of Software Clearing House, or
SCH, in July 2001, Vinca in July 1999 and Intelliguard in April 1999. (See Note
5 to the Notes to the Consolidated Financial Statements for further details.)
As of December 31, 2001, we had goodwill of $17.3 million and acquired
intangibles of $14.3 million on our Consolidated Balance Sheet. With our
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" in the first
quarter of 2002, goodwill will no longer be amortized. As such, we expect to
amortize intangibles of $5.7 million in 2002, $5.7 million in 2003 and
$2.9 million in 2004.
In the acquisition of SCH, all issued and outstanding shares of SCH were
purchased for $10.3 million. We also paid $1.9 million to current and former
employees as a transactional bonus, assumed net liabilities of $0.3 million and
incurred $1.6 million in acquisition related expenses, which consisted
primarily of professional fees, severance expenses and facility abandonment
costs. Excluding SCH's cash balance of $4.0 million, the aggregate purchase
price was $10.1 million and was allocated as follows (in thousands):
Tangible assets received................................... $ 2,522
Developed technology....................................... 989
Goodwill................................................... 9,377
Liabilities assumed........................................ (2,792)
-------
$10,096
=======
33
The purchase price of SCH was allocated to the assets acquired, including
tangible and intangible assets, and liabilities assumed based upon the fair
value of such assets and liabilities on the date of acquisition and was based
on our estimates of fair value with the excess purchase price over the net
assets acquired allocated to goodwill. The tangible assets consisted primarily
of accounts receivable, deferred tax assets and property and equipment. The
liabilities assumed consisted primarily of accounts payable. Developed
technology was identified and valued through analysis of data provided by SCH
concerning development projects, their stage of development, the time and
resources needed to complete them, if applicable, their expected income
generating ability and the associated risks. The income approach, which
includes an analysis of the cash flows and risks associated with achieving such
cash flows, was the primary technique utilized in valuing the developed
technology. Since SCH had recently completed its latest product, AlphaStor,
there were no research and development projects that were in-process as of the
date of acquisition.
Acquisition-related expenses. In 1999, we incurred acquisition-related
expenses of $5.0 million related to FullTime. Such expenses consisted primarily
of investment banking, accounting and other professional fees and costs
relating to the closure of duplicative facilities and severance costs. In
addition, we incurred professional fees of $1.2 million in connection with our
proposed acquisition of Ontrack Data International, Inc. during 1999, which was
subsequently terminated. In connection with our acquisitions of Intelliguard
and Vinca, we purchased in-process research and development of $3.2 million and
$8.3 million, respectively.
Interest and Other Income, Net. Interest and other income, net was $7.7
million in 2001, $6.6 million in 2000 and $5.4 million in 1999. The increase in
interest and other income, net in 2001 relates primarily to a $2.0 million gain
on the sale of an equity investment during the second quarter of 2001.
Excluding this gain, interest and other income, net decreased by $0.9 million,
which reflects a decrease in interest rates during 2001 partially offset by
higher yielding cash investments in taxable and longer duration instruments.
The increase in interest and other income, net of $1.2 million in 2000, when
compared to 1999, related to higher interest rates in 2000.
Provision for (Benefit from) Income Taxes. The benefit from income taxes
was $35.5 million in 2001 as compared to $9.5 million in 2000 and a provision
for income taxes of $5.7 million in 1999, with an effective tax rate of 30% in
2001, 21% in 2000 and 68% in 1999. The difference in the effective tax rate for
2001, when compared to 2000, is primarily attributable to a decrease in the
amount of non-deductible goodwill amortization and a decrease in foreign tax
expense related to foreign income. The difference in the effective tax rate for
2000, when compared to 1999, is primarily attributable to our net loss in 2000
versus net income in 1999 and the effect of non-deductible amortization and
foreign tax expense related to foreign income. (See Note 7 to the Notes to the
Consolidated Financial Statements for further details.)
Liquidity and Capital Resources
Our cash, cash equivalents and investments totaled $145.7 million as of
December 31, 2001 as compared to $165.1 million as of December 31, 2000. As of
December 31, 2001, we had working capital of $167.3 million, no long-term debt
and stockholders' equity of $260.0 million. To date, we have financed our
operations primarily by cash from operations and sales of our common stock.
Net cash provided by operating activities was $0.3 million in 2001, $11.8
million in 2000 and $51.9 million in 1999. Net cash provided by operating
activities in 2001 consisted primarily of depreciation and amortization of
$52.7 million, impairment of intangibles of $48.9 million and the tax benefit
from stock option exercises of $4.1 million. This was offset by the net loss of
$81.5 million, an increase in the deferred tax assets of $45.3 million and the
net change in operating assets and liabilities of $16.6 million. Net cash
provided by operating activities in 2000 consisted primarily of increases to
accrued liabilities and deferred revenue of $14.9 million, depreciation and
amortization of $52.8 million, the tax benefit from stock option exercises of
$4.6 million and a provision for doubtful accounts and sales returns of $7.0
million, which were partially offset by the net loss of $35.2 million and
increases in deferred tax assets of $19.9 million and other assets of
$10.4 million. Net cash provided by operating activities in 1999 consisted
primarily of net income of $2.7 million plus the tax benefit from stock option
exercises of $36.4 million, depreciation and amortization of $32.9 million,
34
the write-off of purchased in-process research and development costs of $11.5
million, a provision for doubtful accounts and product returns of $9.8 million
offset by a change in operating assets and liabilities of $12.9 million and a
change in deferred taxes of $28.5 million.
Net cash used in investing activities was $61.7 million in 2001, $25.1
million in 2000 and $52.6 million in 1999. Purchases of property and equipment
increased to $26.1 million in 2001 from $25.0 million in 2000 and from $14.6
million in 1999. In 2001, we spent $11.6 million to replace and upgrade our
core information technology infrastructure. In 2002, we expect our capital
investment in property and equipment to return to 1999 levels. Investing
activities also consisted of net payments of $8.7 million related to the
purchase Software Clearing House in 2001 and $24.3 million related to the
purchases of Intelliguard and Vinca in 1999.
Net cash provided by financing activities was $14.4 million in 2001, $8.3
million in 2000 and $32.7 million in 1999. Net cash provided by financing
activities for these years consisted primarily of proceeds received from the
issuance of our common stock. During 1999, we also received $6.8 million in
connection with the sale of one qualifying accounts receivable on a
non-recourse basis. However, in 2000, 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. The short-term
loan was repaid in 2000.
As of December 31, 2001, the only significant contractual obligations or
commercial commitments consisted of our facility lease commitments totaling
$82.6 million, of which $15.1 million will be paid out in 2002, $13.6 million
in 2003 and $53.9 million thereafter. (See Note 4 to the Notes to the
Consolidated Financial Statements for further details.) We do not have any
other off-balance sheet arrangement that could significantly reduce our
liquidity. Further, a significant portion of our cash inflows has been
generated by our operations. Because our operating results may fluctuate
significantly as a result of decrease in customer demand or decrease in the
acceptance of our future products, our ability to generate positive cash flow
operations may not be achieved. Based on our current operating plan, we believe
our current cash and investment balances and cash flow from operations will be
sufficient to meet our working capital and capital expenditure requirements for
at least the next twelve months.
Disclosures About Market Risk
Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. While we are exposed with
respect to interest rate fluctuations in many countries, our interest income is
most sensitive to fluctuations in the general level of U.S. interest rates. In
this regard, changes in the U.S. interest rates affect the interest earned on
our cash, cash equivalents and investments. We invest in high quality credit
issuers and, by policy, limit the amount of our credit exposure to any one
issuer. As stated in our policy, our first priority is to reduce the risk of
principal loss. Consequently, we seek to preserve our invested funds by
limiting default risk, market risk and reinvestment risk. We mitigate default
risk by investing in only high quality credit securities that we believe to be
low risk and by positioning our portfolio to respond appropriately to a
significant reduction in a credit rating of any investment issuer or guarantor.
The portfolio includes only marketable securities with active secondary or
resale markets to ensure portfolio liquidity.
Cash equivalents are highly liquid debt instruments with maturities of three
months or less as of the date of purchase. As of December 31, 2001, the
carrying value approximated fair value. The table below presents the carrying
value and related weighted average interest rates for our investments in
marketable securities as of December 31, 2001 (dollars in millions).
Carrying Interest
Value Rate
-------- --------
Investments--fixed rate.......................... $ 82.4 3.8%
Cash equivalents:
Fixed rate.................................... 32.5 2.6
Variable rate................................. 18.9 1.8
------
$133.8 3.4
======
35
Foreign Currency Risk. As a global concern, we face exposure to adverse
movements in foreign currency exchange rates. This exposure 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.
Recent Accounting Pronouncements. In June 2001, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations." SFAS No. 141 requires the use of the
purchase method of accounting for business combinations initiated after June
30, 2001, and eliminates the pooling-of-interests method. SFAS No. 141 did not
have an impact on our financial position and results of operations.
In June 2001, the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which requires the discontinuance of goodwill amortization.
In addition, the standard includes provisions upon adoption for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the testing for impairment of existing goodwill and other intangibles. We will
adopt SFAS No. 142 beginning with our first quarter of 2002 and will cease to
amortize $17.3 million of goodwill. Goodwill amortization would have been $6.9
million in 2002 and compares to goodwill amortization of $19.0 million in 2001.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed." We will adopt SFAS No. 144 beginning with our first quarter of 2002
and expect the adoption will not have a significant impact on our financial
position and results of operations.
In November 2001, the Emerging Issues Task Force finalized Issue No. 01-09,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)," which states, among other provisions, that
cash consideration (including a sales incentive) given by a vendor to a
customer is presumed to be a reduction of the selling price and, therefore,
should be characterized as a reduction of revenue. That presumption may be
overcome upon meeting certain conditions, in which case the consideration
should be characterized as a cost. We adopted the provisions of Issue No. 01-09
during the fourth quarter of 2001, and the adoption did not have a significant
impact on our financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 7A is incorporated by reference from the
section entitled "Disclosures About Market Risk" found in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by Item 8 are submitted as a separate
section of this Annual Report on Form 10-K. See Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors is incorporated by
reference from the sections entitled "Election of Directors" and "Compliance
with Reporting Requirements of Section 16(a)" in our definitive Proxy Statement
for our annual stockholders' meeting to be held in 2002.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the
section entitled "Director and Executive Compensation and Related Information"
in our definitive Proxy Statement for our annual stockholders' meeting to be
held in 2002.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by Item 12 is incorporated by reference from the
section entitled "Security Ownership of Certain Beneficial Owners and
Management" in our definitive Proxy Statement for our annual stockholders'
meeting to be held in 2002.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from the
section entitled "Certain Relationships and Related Transactions" in our
definitive Proxy Statement for our annual stockholders' meeting to be held in
2002.
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 Financial Statements
Index to Consolidated Financial Statements
Report of Independent Accountants......................................... 40
Consolidated Balance Sheets as of December 31, 2001 and 2000.............. 41
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 2001.......................................... 42
Consolidated Statement of Stockholders' Equity for each of the three years
in the period ended December 31, 2001................................... 43
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2001.......................................... 44
Notes to the Consolidated Financial Statements............................ 45
(a) 2 Financial Statement Schedules
All schedules have been omitted because they are not required or the
required information is shown in the financial statements or notes thereto.
(a) 3 Exhibits
The following exhibits are filed with this Annual Report on Form 10-K:
Exhibit
Number Exhibit Title
- ------ -------------
2.1 (9) Agreement and Plan of Merger, dated as of February 20, 2002, by and among the Registrant,
Orion Acquisition Sub Corp. and OTG Software, Inc.
3.1(3) Amended and Restated Certificate of Incorporation of the Registrant, as amended to date.
3.2(5) Amended and Restated Bylaws of the Registrant adopted on May 23, 1997.
3.3(6) Form of Certificate of Designation filed in connection with Rights Agreement, dated May 23,
1997.
4.1(6) Rights Agreement, dated March 23, 1997 between the Registrant and Harris Trust and Savings
Bank.
10.1(1) # Form of Indemnification Agreement entered into between the Registrant and it directors and
officers.
10.2(1) # The Registrant's 1995 Stock Option/Stock Issuance Plan, as amended to date.
10.3(1) # The Registrant's Employee Stock Purchase Plan.
10.4 (2) # The Registrant's International Employee Stock Purchase Plan.
10.5(7) # The Registrant's 2001 Employee Stock Purchase Plan and 2001 International Employee Stock
Purchase Plan.
10.6(4) Lease Agreement dated March 14, 1996, between the Registrant and Coherent, Inc., regarding
the space located at 3210 Porter Drive, Palo Alto, California.
10.7 Lease Agreement dated July 6, 1999, between the Registrant and Sobrato Interests III, regarding
the space located at 2350 West El Camino Real, Mountain View, California.
38
Exhibit
Number Exhibit Title
- ------ -------------
10.8 Lease Agreement dated December 14, 1999, between the Registrant and Westbury International
(1991) Corporation, regarding the space located at 1000 International Blvd., Burlington,
Ontario, Canada.
10.9(8) # Separation Agreement, dated July 28, 2000, between the Registrant and Stephen C. Wise.
10.10 (8) # Offer Letter from Registrant to David B. Wright, dated September 25, 2000; Amendment to
Employment Agreement between Registrant and David B. Wright, dated December 4, 2000; and
Promissory Note between Registrant and David B. Wright, dated December 6, 2000.
21.1 Subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants.
24.1 Power of Attorney (included at pages 59-60)
- --------
# Compensatory plan or arrangements.
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-1, filed May 9, 1995 (File No. 33-92072).
(2) Incorporated by reference to the Registrant's Registration Statement on
Form S-8, filed March 14, 1996 (File No. 333-02378).
(3) Incorporated by reference to the Registrant's Form 14A, filed April 6, 1998.
(4) Incorporated by reference to the Registrant's Form 10-Q, filed August 13,
1996.
(5) Incorporated by reference to the Registrant's Current Report on Form 8-K,
dated June 6, 1997.
(6) Incorporated by reference to the Registrant's Form 8-A, dated May 30, 1997.
(7) Incorporated by reference to the Registrant's Registration Statement on
Form S-8, filed May 16, 2001 (File No. 333-61022).
(8) Incorporated by reference to the Registrant's Form 10-K, filed March 29,
2001.
(9) Incorporated by reference to the Registrant's Form 8-K, filed February 21,
2002.
(b) Reports on Form 8-K
None.
(c) Exhibits
See (a) 3 above.
(d) Financial Statement Schedule
See 14. (a) 2 above.
39
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Legato Systems, Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index on page 38 present fairly, in all material respects, the
financial position of Legato Systems, Inc and its subsidiaries as of
December 31, 2001 and 2000, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America 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 our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
January 25, 2002,
except as to Note 10, which is
as of February 20, 2002
40
LEGATO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amount)
December 31,
------------------
2001 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 63,281 $110,274
Short-term investments....................................................... 82,414 40,626
Accounts receivable, net..................................................... 39,581 47,655
Other current assets......................................................... 12,373 20,465
Deferred tax assets.......................................................... 61,136 35,272
-------- --------
Total current assets..................................................... 258,785 254,292
Long-term investments........................................................... -- 14,245
Property and equipment, net..................................................... 42,884 37,328
Other assets.................................................................... 2,196 2,311
Long-term deferred tax assets................................................... 19,754 2,788
Intangible assets, net.......................................................... 31,642 103,900
-------- --------
$355,261 $414,864
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................. $ 8,316 $ 5,126
Accrued liabilities.......................................................... 41,440 33,551
Deferred revenue............................................................. 41,748 53,853
-------- --------
Total current liabilities................................................ 91,504 92,530
Deferred revenue--net of current portion........................................ 3,798 --
-------- --------
Total liabilities........................................................ 95,302 92,530
-------- --------
Commitments and contingencies (Note 4)
Stockholders' Equity:
Common stock and capital in excess of par, $0.0001 par value: 200,000 shares
authorized; 89,613 and 87,389 issued and outstanding, respectively......... 329,951 311,802
Notes receivable from sale of stock.......................................... -- (341)
Accumulated other comprehensive income....................................... 684 54
Retained earnings (accumulated deficit)...................................... (70,676) 10,819
-------- --------
Total stockholders' equity............................................... 259,959 322,334
-------- --------
$355,261 $414,864
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
41
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amount)
Year Ended December 31,
-----------------------------
2001 2000 1999
--------- -------- --------
Revenue:
License........................................................... $ 147,528 $145,612 $161,094
Service and support............................................... 95,073 85,783 67,473
--------- -------- --------
Total revenue................................................. 242,601 231,395 228,567
--------- -------- --------
Cost of revenue:
License........................................................... 5,517 6,020 5,907
Service and support............................................... 48,916 41,591 26,871
--------- -------- --------
Total cost of revenue......................................... 54,433 47,611 32,778
--------- -------- --------
Gross profit......................................................... 188,168 183,784 195,789
--------- -------- --------
Operating expenses:
Sales and marketing............................................... 125,824 109,247 95,174
Research and development.......................................... 64,292 59,570 41,740
General and administrative........................................ 30,768 28,292 16,390
Restructuring charges............................................. 9,373 -- --
Impairment of intangibles......................................... 48,869 -- --
Amortization of acquired intangibles.............................. 33,755 38,088 21,785
Acquisition-related expenses...................................... -- -- 6,239
In-process research and development............................... -- -- 11,470
--------- -------- --------
Total operating expenses...................................... 312,881 235,197 192,798
--------- -------- --------
Income (loss) from operations........................................ (124,713) (51,413) 2,991
Interest and other income, net....................................... 7,675 6,631 5,448
--------- -------- --------
Income (loss) before provision for (benefit from) income taxes....... (117,038) (44,782) 8,439
Provision for (benefit from) income taxes............................ (35,543) (9,533) 5,735
--------- -------- --------
Net income (loss).................................................... $ (81,495) $(35,249) $ 2,704
========= ======== ========
Basic net income (loss) per share.................................... $ (0.92) $ (0.41) $ 0.03
========= ======== ========
Diluted net income (loss) per share.................................. $ (0.92) $ (0.41) $ 0.03
========= ======== ========
Shares used in basic net income (loss) per share..................... 88,842 86,727 82,420
========= ======== ========
Shares used in diluted net income (loss) per share................... 88,842 86,727 89,351
========= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements
42
LEGATO SYSTEMS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock
------------------
Par Value Notes Accumulated Retained
and Capital Receivable Other Earnings Total
Comprehensive in Excess From Sale Comprehensive (Accumulated Stockholders'
Income (Loss) Shares of Par of Stock Income (Loss) Deficit) Equity
------------- ------ ----------- ---------- ------------- ------------ -------------
Balance, December 31, 1998................. 78,696 $115,439 $(345) $ 71 $ 43,364 $158,529
Stock issued under option plans............ 3,483 21,300 -- -- -- 21,300
Stock issued under employee stock purchase
plan...................................... 561 4,524 -- -- -- 4,524
Stock issued for acquisitions.............. 2,642 114,344 -- -- -- 114,344
Tax benefit from stock option exercises.... -- 36,446 -- -- -- 36,446
Unrealized loss on investments............. $ (102) -- -- -- (102) -- (102)
Net income................................. 2,704 -- -- -- -- 2,704 2,704
-------- ------ -------- ----- ----- -------- --------
$ 2,602
========
Balance, December 31, 1999................. 85,382 292,053 (345) (31) 46,068 337,745
Payment on notes receivable................ -- -- 4 -- -- 4
Stock issued under option plans............ 1,547 9,251 -- -- -- 9,251
Stock issued under employee stock purchase
plan...................................... 460 5,777 -- -- -- 5,777
Tax benefit from stock option exercises.... -- 4,620 -- -- -- 4,620
Stock-based compensation................... -- 101 -- -- -- 101
Unrealized gain on investments............. $ 85 -- -- -- 85 -- 85
Net loss................................... (35,249) -- -- -- -- (35,249) (35,249)
-------- ------ -------- ----- ----- -------- --------
$(35,164)
========
Balance, December 31, 2000................. 87,389 311,802 (341) 54 10,819 322,334
Settlement of notes receivable............. (3) (135) 341 -- -- 206
Stock issued under option plans............ 1,421 7,954 -- -- -- 7,954
Stock issued under employee stock purchase
plan...................................... 806 6,249 -- -- -- 6,249
Tax benefit from stock option exercises.... -- 4,081 -- -- -- 4,081
Unrealized gain on investments............. $ 630 -- -- -- 630 -- 630
Net loss................................... (81,495) -- -- -- -- (81,495) (81,495)
-------- ------ -------- ----- ----- -------- --------
$(80,865)
========
Balance, December 31, 2001................. 89,613 $329,951 $ -- $ 684 $(70,676) $259,959
====== ======== ===== ===== ======== ========
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,
------------------------------
2001 2000 1999
--------- -------- ---------
Cash flows from operating activities:
Net income (loss)..................................................... $ (81,495) $(35,249) $ 2,704
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Deferred taxes (net of effect of acquisitions)..................... (45,258) (19,925) (28,514)
Depreciation and amortization...................................... 50,792 52,848 32,930
Impairment of intangibles.......................................... 48,869 -- --
In-process research and development................................ -- -- 11,470
Write-off of property and equipment................................ 3,827 -- --
Provision for doubtful accounts and product returns................ 2,961 6,995 9,837
Tax benefit from stock option exercises............................ 4,081 4,620 36,446
Changes in operating assets and liabilities:
Accounts receivable............................................ 6,670 (1,263) (19,116)
Other assets................................................... 11,305 (10,410) (3,493)
Accounts payable............................................... 1,468 (631) 502
Accrued liabilities............................................ 5,650 7,444 (10,105)
Deferred revenue............................................... (8,538) 7,415 19,268
--------- -------- ---------
Net cash provided by operating activities................... 332 11,844 51,929
--------- -------- ---------
Cash flows from investing activities:
Purchase of available-for-sale securities............................. (523,541) (63,417) (103,886)
Maturities and sales of available-for-sale securities................. 496,628 63,337 96,873
Acquisition of property and equipment................................. (26,124) (24,998) (14,618)
Purchase of acquired companies, net of cash assumed................... (8,697) -- (24,252)
Investment in other securities........................................ -- -- (5,000)
Other................................................................. -- -- (1,672)
--------- -------- ---------
Net cash used in investing activities....................... (61,734) (25,078) (52,555)
--------- -------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock................................ 14,203 15,028 25,820
Proceeds from (repayment of) short-term loan.......................... -- (6,847) 6,847
Other................................................................. 206 105 4
--------- -------- ---------
Net cash provided by financing activities................... 14,409 8,286 32,671
--------- -------- ---------
Net increase (decrease) in cash and cash equivalents........ (46,993) (4,948) 32,045
Cash and cash equivalents at beginning of year........................ 110,274 115,222 83,177
--------- -------- ---------
Cash and cash equivalents at end of year.............................. $ 63,281 $110,274 $ 115,222
========= ======== =========
Supplemental cash flow information:
Cash paid for income taxes......................................... $ 3,036 $ 2,247 $ 3,702
Non-cash investing and financing activities:
Issuance of common stock and stock options exchanged in purchase
business combinations............................................ -- -- 114,344
Deferred tax liability recorded in business combinations........... -- -- 22,740
Unrealized gain (loss) on investments.............................. 630 85 (102)
Common stock exchanged for notes receivable........................ 135 -- --
The accompanying notes are an integral part of these consolidated financial
statements.
44
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company
Legato Systems, Inc. was incorporated in Delaware in September 1988. We
develop, market and support software products and services for information
management of distributed, open systems environments. Information management
includes the protection, recovery and avoidance of failures of data and
applications so that business users can gain access to the information that
they need when they need it. Distributed, open systems are generally understood
to include UNIX, Windows NT, Windows 2000 and Linux server computer systems. We
offer software products for backup, recovery and archive of data; for managing
the performance and operation of application services; and for optimizing the
use of storage devices and media including disk and tape. Our customers use our
products and services to safeguard and manage their information assets and
associated applications so that their businesses can continue to operate, and
do so in a more cost-effective manner.
2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation. The consolidated
financial statements include the Company's accounts and the accounts of its
wholly owned subsidiaries and branch offices. All significant intercompany
balances and transactions have been eliminated. Certain prior year consolidated
financial statement balances have been reclassified to conform to the 2001
presentation.
Foreign Currency Translation. Assets and liabilities of foreign
subsidiaries, where the functional currency is the local currency, are
translated using exchange rates in effect at the end of the period, and revenue
and costs are translated using average exchange rates for the period. Gains and
losses on the translation into U.S. dollars of amounts denominated in foreign
currencies are included in the results of operations for those operations whose
functional currency is the U.S. dollar, and as a separate component of
stockholders' equity for those operations whose functional currency is the
local currency.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires us
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.
Concentration of Credit Risk. Financial instruments that potentially
subject us to concentrations of credit risk consist principally of investments
and accounts receivable. Our investment policy limits investments to
shorter-term, low-risk instruments. Financial instruments are executed with
financial institutions with strong credit ratings, which minimizes risk of loss
due to non-payment. We have not experienced any losses due to credit impairment
related to our financial instruments. Concentration of credit risk related to
accounts receivable is limited as our customers are dispersed across
geographies. As of December 31, 2000 and 2001, no single customer accounted for
more than 10% of accounts receivable.
Cash, Cash Equivalents and Investments. Cash equivalents are highly liquid
debt instruments with maturities of three months or less as of the date of
purchase. Investments are equity securities or debt instruments with original
maturities greater than three months. The appropriate classification of
investments in marketable securities is determined at the time of purchase.
Marketable securities classified as available-for-sale are carried at fair
value, with the unrealized gains or losses (net of tax), reported as a separate
component of stockholders' equity until realized. Realized gains and losses are
recognized based on the specific identification method and were not significant
in 1999 and 2000. In 2001, we recognized a gain of $2.0 million related to the
sale of an equity investment, which was recorded in other income on our
consolidated statement of operations. As of December 31, 2001 and 2000, all
marketable securities were classified as available-for-sale.
45
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of our investments in marketable securities follows (in thousands):
December 31,
------------------
2001 2000
-------- --------
Corporate debt securities........................ $ 91,284 $ --
U.S. government notes............................ 18,130 1,120
Money market funds............................... 17,353 93,919
Asset backed securities.......................... 4,142 --
Auction rate securities.......................... 1,450 19,991
State and local municipality notes............... 909 32,690
Equity securities................................ 499 5,000
-------- --------
Total marketable securities................... 133,767 152,720
Less: cash equivalents........................... (51,353) (97,849)
-------- --------
Total investments............................. $ 82,414 $ 54,871
======== ========
As of December 31, 2001, investments with contractual maturities of one year
or less and one year through three years were $14.7 million and $67.2 million,
respectively.
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 two to five 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.
Capitalized Software Development Costs. Capitalization of software
development costs begins upon the establishment of technological feasibility of
the product and ends when the product is available for general release to
customers. Capitalized costs are then amortized on a straight-line basis over
the estimated product life, or on the ratio of current revenue to the total
projected product revenue, whichever is greater. To date, the period between
achieving technological feasibility, which we have defined as the establishment
of a working model and typically occurs when beta testing commences, and the
general availability of such software has been short. As such, software
development costs qualifying for capitalization have been insignificant.
Long-lived Assets. Long-lived assets, certain identifiable intangible
assets and goodwill related to these assets are reviewed for impairment. For
assets to be held and used, including acquired intangibles, we initiate a
review whenever events or changes in circumstances indicate that the carrying
value of a long-lived asset may not be recoverable. Recoverability of an asset
is measured by comparison of its carrying value to the future undiscounted cash
flows that the asset is expected to generate. Any impairment is measured by the
amount by which the carrying value exceeds the projected discounted future
operating cash flows. Assets to be disposed of and for which we have committed
a plan to dispose of the assets, whether through sale or abandonment, are
reported at the lower of carrying value or fair value less costs to sell.
Revenue Recognition. Revenue is derived from primarily two sources: (i)
license revenue, derived from the sale of software licenses to resellers and
end users, including large-scale enterprises, and royalty revenue, derived from
initial license fees and ongoing royalties from licenses of source code to
OEMs; and (ii) service and support revenue, derived from providing software
updates, support and education and consulting services to end users.
License revenue is generally recognized when a signed contract or other
persuasive evidence of an arrangement exists, the software has been shipped or
electronically delivered, the license fee is fixed or
46
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
determinable and collection of resulting receivables is probable. 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. For sales to
domestic distributors, license revenue is recognized upon sale by the
distributor to the end-user. License revenue from royalty payments is
recognized upon receipt of royalty reports from OEMs related to their product
sales. Revenue from subscription license agreements, which include software,
rights to future products and maintenance, is recognized ratably over the term
of the subscription period.
Service and support revenue consists primarily of revenue received for
providing software updates, technical support for software products, on-site
support, consulting and training. Revenue from updates and support is
recognized ratably over the term of the agreements. Revenue allocated to
education and consulting services, or derived from the separate sales of these
services, is recognized as the related services are provided.
When contracts contain multiple obligations (e.g., products, updates,
technical support and other services) wherein vendor specific objective
evidence exists for all undelivered elements, we account for the delivered
elements in accordance with the "Residual Method" prescribed by Statement of
Position 98-9. Any revenue related to updates or technical support in these
arrangements is recognized ratably over the term of the maintenance arrangement.
The following summarizes the activity related to the allowance for doubtful
accounts and product returns (in thousands):
Balance at Charged Balance
Beginning Against Charged to at End
of Year Revenue Expenses Deductions of Year
---------- ------- ---------- ---------- -------
Year ended December 31, 2001........... $7,731 $1,208 $ 801 $(1,872) $7,868
Year ended December 31, 2000........... 3,734 5,138 1,857 (2,998) 7,731
Year ended December 31, 1999........... 3,896 9,531 306 (9,999) 3,734
Advertising Expenses. Advertising costs are expensed as incurred and
totaled $2.0 million in 2001, $2.0 million in 2000 and $3.7 million in 1999.
Comprehensive Income (Loss). Comprehensive income (loss) includes
unrealized gains and losses on investments that are available for sale, the
impact of which has been excluded from net income (loss) and reflected as
equity. The components of comprehensive income (loss) are reported on our
consolidated statement of stockholders' equity.
47
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Net Income (Loss) Per Share. Basic net income (loss) per share is computed
by dividing net income (loss) by the weighted average shares of common stock
outstanding during the year. Diluted net income per share is computed by
dividing net income by the weighted average shares of common stock and
potential common shares outstanding during the year. Potential common shares
outstanding consist of dilutive shares issuable upon the exercise of
outstanding options to purchase common stock as computed using the treasury
stock method. For the years in which we have a loss, potential common shares
outstanding are excluded from the computation of diluted net loss per share as
their effect is anti-dilutive. A reconciliation of the shares used to calculate
basic net income (loss) per share and diluted net income (loss) per share
follows (in thousands):
Year Ended December 31,
-----------------------
2001 2000 1999
------ ------ ------
Shares used to calculate basic net income (loss) per share........... 88,842 86,727 82,420
Effect of dilutive securities--common stock options............... -- -- 6,931
------ ------ ------
Shares used to calculate diluted net income (loss) per share......... 88,842 86,727 89,351
====== ====== ======
As of December 31, 2001, there were potential common shares outstanding of
11.7 million shares with a weighted average price of $8.56 per share. These
shares were not considered in calculating diluted net loss per share, because
their effect was anti-dilutive.
Recent Accounting Pronouncements. In June 2001, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations." SFAS No. 141 requires the use of the
purchase method of accounting for business combinations initiated after June
30, 2001, and eliminates the pooling-of-interests method. SFAS No. 141 did not
have an impact on our financial position and results of operations.
In June 2001, the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which requires the discontinuance of goodwill amortization.
In addition, the standard includes provisions upon adoption for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the testing for impairment of existing goodwill and other intangibles. We will
adopt SFAS No. 142 beginning with our first quarter of 2002 and will cease to
amortize $17.3 million of goodwill. Goodwill amortization would have been $6.9
million in 2002 and compares to goodwill amortization of $19.0 million in 2001.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed." We will adopt SFAS No. 144 beginning with our first quarter of 2002
and expect the adoption will not have a significant impact on our financial
position and results of operations.
In November 2001, the Emerging Issues Task Force finalized Issue No. 01-09,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)," which states, among other provisions, that
cash consideration (including a sales incentive) given by a vendor to a
customer is presumed to be a reduction of the selling price and, therefore,
should be characterized as a reduction of revenue. That presumption may be
overcome upon meeting certain conditions, in which case the consideration
should be characterized as a cost. We adopted the provisions of Issue No. 01-09
during the fourth quarter of 2001, and the adoption did not have a significant
impact on our financial position or results of operations.
48
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Consolidated Balance Sheet Detail
December 31,
------------------
2001 2000
-------- --------
(in thousands)
Accounts receivable:
Trade accounts receivable......................................... $ 47,449 $ 55,386
Allowances for doubtful accounts and product returns.............. (7,868) (7,731)
-------- --------
$ 39,581 $ 47,655
======== ========
Property and equipment:
Computer hardware................................................. $ 43,801 $ 37,959
Computer software................................................. 18,978 8,155
Office equipment, furniture and fixtures.......................... 16,193 14,612
Leasehold improvements............................................ 13,344 11,676
-------- --------
92,316 72,402
Accumulated depreciation.......................................... (49,432) (35,074)
-------- --------
$ 42,884 $ 37,328
======== ========
Intangible assets:
Goodwill.......................................................... $ 48,998 $ 87,257
Patents and core technology (estimated useful life of 3 years).... 24,589 23,600
Distribution channel (estimated useful life of 3 years)........... 22,500 22,500
Purchased technology.............................................. -- 20,430
Trademarks........................................................ -- 7,300
Assembled workforce (estimated useful life of 3 years)............ 4,500 5,360
Other intangible assets........................................... -- 690
-------- --------
100,587 167,137
Accumulated amortization............................................. (68,945) (63,237)
-------- --------
$ 31,642 $103,900
======== ========
Accrued liabilities:
Accrued compensation and benefits................................. $ 19,202 $ 14,806
Income tax payable................................................ 7,354 9,284
Other accrued liabilities......................................... 14,884 9,461
-------- --------
$ 41,440 $ 33,551
======== ========
49
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Commitments and Contingencies
Operating Leases. We lease our operating facilities under non-cancelable
operating leases that expire at various dates through 2010. Certain of these
leases contain renewal options. Rent expense was $13.6 million in 2001, $12.1
million in 2000 and $8.5 million in 1999. We also entered into non-cancelable
sub-leases that expire at various dates through 2007 and recognized sub-lease
income of $2.9 million in 2001, $1.7 million in 2000 and $0.3 million in 1999,
which was offset against rent expense. As of December 31, 2001, future minimum
lease commitments and sub-lease income were as follows (in thousands):
Operating Sub-lease
Year ending December 31, Leases Income
------------------------ --------- ---------
2002............................................. $15,137 $2,692
2003............................................. 13,556 1,616
2004............................................. 12,106 1,451
2005............................................. 11,353 1,495
2006............................................. 10,059 1,540
Thereafter....................................... 20,373 196
------- ------
$82,584 $8,990
======= ======
Litigation. Beginning on January 20, 2000, a number of shareholder
securities class action complaints were filed in the U.S. District Court,
Northern District of California, against us and certain of our directors and
officers. On May 1, 2000, the court consolidated the pending cases and, on May
10, 2000, appointed a lead plaintiff, who filed a consolidated amended
complaint on August 7, 2000. Defendants moved to dismiss. On January 17, 2001,
the court granted the motions to dismiss with leave to amend. On February 13,
2001, plaintiffs filed a second amended complaint, which generally alleges
that, between April 22, 1999 and May 17, 2000, defendants made false or
misleading statements of material fact about our prospects and failed to follow
generally accepted accounting principles in violation of the federal securities
laws. The complaint seeks an unspecified amount in damages. Defendants answered
the complaint in April 2001 denying all allegations that they violated the
federal securities laws.
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 a nominal defendant. The derivative
case has been related to the securities class action. Plaintiffs filed an
amended complaint on February 9, 2001, which generally alleges the same conduct
as the shareholder class action, and claims that defendants breached their
fiduciary duties and engaged in improper insider trading. The derivative
complaint sought unspecified damages and injunctive relief. Defendants moved to
dismiss the derivative complaint. On July 10, 2001, the court granted
defendants' motion to dismiss with leave to amend. Plaintiffs filed an amended
complaint on August 23, 2001; plaintiffs then moved to voluntarily dismiss the
amended complaint with the right to refile the complaint at a later date if
they choose to do so, and the Court granted plaintiffs' motion in November 2001.
On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as a nominal defendant. On May 23, 2000, a shareholder
derivative action was filed in the Superior Court of California, County of San
Mateo, against certain of our officers and directors. We are named as a nominal
defendant. Both state derivative complaints generally allege the same conduct
as the derivative action filed in federal court, claiming that our officers and
directors breached their fiduciary duties for the same period, and seek
unspecified damages and injunctive relief. The state derivative cases have been
consolidated in San Mateo County. Plaintiffs filed a consolidated amended
complaint. Defendants filed a demurrer, which was denied on July 20, 2001.
50
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second and third quarters of 1999, and our revision of financial results for
the fourth quarter of 1999. We have been voluntarily cooperating with the Staff
of the Commission in its investigation.
We intend to defend all of these actions vigorously. However, 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 materially adverse to our
financial position, results of operations or cash flows.
Restructuring Charges. During 2001, we incurred $9.4 million in charges as
we restructured our development operations to reduce our cost structure and to
integrate and reduce selling and marketing activities. In connection with these
activities, we reduced our workforce by approximately 215 employees and closed
our development facilities in Sunnyvale, California, Eden Prairie, Minnesota,
Orem, Utah and New Delhi, India. As of December 31, 2001, accrued restructuring
charges related primarily to future lease commitments, which will be paid
through 2004, and some severance and benefits, which will be paid in 2002. The
following table summarizes the restructuring activity during 2001 (in
thousands):
Severance
and Excess
Benefits Facilities Assets Total
--------- ---------- ------- -------
Balance, December 31, 2000............. $ -- $ -- $ -- $ --
Restructuring charges............... 3,148 2,398 3,827 9,373
Cash payments....................... (2,512) (1,177) -- (3,689)
Non-cash write-off.................. -- -- (3,827) (3,827)
------- ------- ------- -------
Balance, December 31, 2001............. $ 636 $ 1,221 $ -- $ 1,857
======= ======= ======= =======
5. Acquisitions
FullTime. On April 19, 1999, we completed our acquisition of Qualix Group,
Inc. (dba FullTime Software, Inc.), a developer of distributed,
enterprise-wide, cross-platform, adaptive computing solutions that enable
customers to proactively manage application service level availability. We
issued 3.4 million shares of common stock in exchange for all the common stock
and options of FullTime and accounted for the acquisition as a pooling of
interests. In connection with the acquisition of FullTime, we incurred
acquisition related expenses of $5.0 million, consisting primarily of charges
for transaction fees, involuntary termination benefits, non-cancelable
obligations and write-offs of leasehold improvements for sales and
administrative offices that were duplicative and vacated. We presented the 1999
financial statements and related data to represent the combined financial
results of the previously separate entities.
Intelliguard. 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. We (i) issued
approximately 1.4 million shares of common stock with a fair market value of
$42.5 million, (ii) provided cash consideration of $9.0 million for all of the
outstanding stock of Intelliguard and (iii) 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 the date of acquisition. In
the fourth quarter of 2001, we decided to pursue alternative technology and
closed the development laboratories associated with this acquisition, which
resulted in the write-off of all related intangibles of $20.4 million.
51
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Vinca. On July 30, 1999, we completed our acquisition of Vinca Corporation,
a developer of high availability and data protection software. We (i) issued
approximately 1.5 million shares of common stock with a fair market value of
$54.3 million, (ii) exchanged options to purchase approximately 0.6 million
shares of common stock with a approximate value of $17.6 million and (iii)
provided cash consideration of $18.8 million for all of the outstanding stock
and options of Vinca and (iv) incurred transaction costs 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 the date of
acquisition. In the fourth quarter of 2001, we decided to consolidate certain
features of the Vinca technology into our existing availability products and
ceased development of other Vinca technology. As a result, we recorded an
impairment charge of $28.5 million against certain of the identified intangible
assets and related goodwill. As of December 31, 2001, the remaining intangibles
consisted of patents and core technology of $12.5 million, distribution channel
of $1.7 million, assembled workforce of $1.3 million and goodwill of $14.5
million.
The following unaudited pro forma information combines the results of
operations as if the acquisitions of Intelliguard and Vinca were consummated at
the beginning of the period presented (in thousands, except per share amounts):
Year Ended
December 31, 1999
-----------------
Revenue.......................................... $237,766
Net loss......................................... (3,604)
Basic and diluted net loss per share............. (0.04)
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.
SCH. On July 17, 2001, we acquired Software Clearing House, Inc. (d/b/a SCH
Technologies), a developer of media management for the open systems market. All
issued and outstanding shares of SCH were purchased for $10.3 million. We also
paid $1.9 million to current and former employees as a transactional bonus,
assumed net liabilities of $0.3 million and incurred $1.6 million in
acquisition related expenses, which consisted primarily of professional fees,
severance expense and facility abandonment costs. Excluding SCH's cash balance
of $4.0 million, the aggregate purchase price was $10.1 million and was
allocated as follows (in thousands):
Tangible assets received................................... $ 2,522
Developed technology....................................... 989
Goodwill................................................... 9,377
Liabilities assumed........................................ (2,792)
-------
$10,096
=======
The purchase price was allocated to the assets acquired, including tangible
and intangible assets, and liabilities assumed based upon the fair value of
such assets and liabilities on the date of acquisition and was based on our
estimates of fair value with the excess purchase price over the net assets
acquired allocated to goodwill. The tangible assets consist primarily of
accounts receivable, deferred tax assets and property and equipment. The
liabilities assumed consist primarily of accounts payable. Developed technology
was identified and valued through analysis of data provided by SCH concerning
development projects, their stage of development, the time and resources needed
to complete them, if applicable, their expected income generating ability and
the associated risks. The income approach, which includes an analysis of the
cash flows and risks
52
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
associated with achieving such cash flows, was the primary technique utilized
in valuing the developed technology. Since SCH had recently completed its
latest product, AlphaStor, there were no research and development projects that
were in-process as of the date of acquisition.
The following unaudited pro forma information combines the results of
operations as if the acquisition of SCH was consummated at the beginning of the
periods presented (in thousands, except for per share data):
Year Ended December 31,
----------------------
2001 2000
-------- --------
Revenue.......................................... $256,468 $249,884
Net loss......................................... (83,108) (38,669)
Basic and diluted net loss per share............. (0.94) (0.45)
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.
6. Stockholders' Equity
Preferred Stock. We are authorized to issue 5.0 million shares of preferred
stock, none of which are issued or outstanding. The Board of Directors has the
authority to issue the preferred stock in one or more series and to fix rights,
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.
1995 Stock Option/Stock Issuance Plan. As of December 31, 2001, under the
1995 Stock Option/Stock Issuance Plan (the "1995 Plan"), 32.8 million shares of
common stock have been authorized for issuance, of which 6.3 million shares
were available for future grant. The share reserve automatically increases on
the first trading day in each calendar year by the lesser of (i) the number of
shares equal to 3% of the total number of shares of our common stock
outstanding on December 31 of the immediately preceding calendar year or
(ii) 3.0 million shares. 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, whereby 25% of the shares become exercisable one year after the
grant date and monthly thereafter over 36 months, and terminate ten years after
their original grant date.
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% 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
53
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 employment.
A summary of option activity follows (in thousands, except per share
amounts):
Year Ended December 31,
--------------------------------------------------
2001 2000 1999
---------------- ---------------- ----------------
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Outstanding at beginning of year..................................... 14,892 $15.43 12,114 $16.98 10,719 $ 7.49
Options granted and assumed....................................... 10,509 8.76 9,453 15.42 6,422 27.41
Options exercised................................................. (1,421) 5.60 (1,547) 5.98 (3,483) 6.01
Options forfeited................................................. (2,984) 19.26 (5,128) 21.92 (1,544) 15.58
------ ------ ------
Outstanding at end of year........................................... 20,996 12.24 14,892 15.43 12,114 16.98
====== ====== ======
Options exercisable at end of year................................... 7,321 14.20 4,820 11.29 4,143 6.49
Weighted average fair value of options granted during the year....... 6.30 12.10 15.14
As of December 31, 2001, the options outstanding and exercisable by exercise
price are as follows (in thousands, except per share amounts):
Options
Options Outstanding Exercisable
--------------------------- ---------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Contractual Exercise Exercise
Exercise Prices Shares Life Price Shares Price
--------------- ------ ----------- -------- ------ --------
$ 0.19-$ 2.96................ 531 3.14 $ 1.54 531 $ 1.54
3.37- 4.76................ 3,923 9.65 4.75 60 4.33
4.87- 8.00................ 2,146 8.28 7.08 473 6.07
8.05- 9.69................ 1,055 8.85 9.14 254 9.15
9.69- 9.75................ 3,361 8.86 9.75 1,289 9.75
9.98- 11.27................ 2,525 7.75 10.78 1,670 10.92
11.30- 14.25................ 2,964 8.98 13.09 606 12.72
14.50- 20.75................ 2,311 7.89 18.07 1,296 19.03
21.09- 68.81................ 2,103 7.78 31.55 1,126 29.66
70.87- 77.00................ 79 7.93 73.06 15 71.29
------ -----
20,996 8.47 12.24 7,321 14.20
====== =====
Employee Stock Purchase Plans. In 2001, the 2001 Employee Stock Purchase
Plan and the 2001 International Employee Stock Purchase Plan (collectively, the
"ESP Plan") was approved by the stockholders and replaced the previous plan.
The purchase period under the old plan will be allowed to continue until it
expires in July 2002, after which the plan will be terminated. The ESP Plan has
reserved for issuance 3.0 million shares of common stock and is administered
over offering periods of 24 months each, with each offering period divided into
four consecutive six-month purchase periods beginning May 1 and November 1 of
each year. Eligible employees may designate not more than 10% of their cash
compensation (up to $25,000 per employee per annum) to be deducted each pay
period for the purchase of common stock under the ESP Plan, and participants
54
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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% 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.
As of December 31, 2001, there were 2.9 million shares of common stock reserved
for future issuance under the ESP Plan.
Fair Value Disclosures. Had compensation expense for our fixed stock option
and employee stock purchase plans been based on the fair value at the date of
grant for the awards under a method prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation," our net income (loss) and net income (loss) per
share would have been adjusted to the following pro forma amounts (in
thousands, except per share amounts):
Year Ended December 31,
----------------------------
2001 2000 1999
--------- -------- -------
Net income (loss)--as reported........................ $ (81,495) $(35,249) $ 2,704
Net income (loss)--pro forma.......................... (151,083) (79,616) (9,752)
Basic net income (loss) per share--as reported........ (0.92) (0.41) 0.03
Basic net income (loss) per share--pro forma.......... (1.70) (0.92) (0.12)
Diluted net income (loss) per share--as reported...... (0.92) (0.41) 0.03
Diluted net income (loss) per share--pro forma........ (1.70) (0.92) (0.12)
The fair value of options granted and shares purchased under the 1995 Plan
and ESP Plan was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted average assumptions assuming a
dividend yield of zero for all periods:
Year Ended December 31,
-----------------------------
2001 2000 1999
--------- --------- ---------
Stock options:
Expected volatility........................... 106% 100% 79%
Risk-free interest rate....................... 4.6% 6.2% 4.8%
Expected life................................. 4 years 4 years 4 years
Employee stock purchase plan:
Expected volatility........................... 106% 100% 79%
Risk-free interest rate....................... 4.6% 6.1% 4.8%
Expected life................................. 0.5 years 0.5 years 0.5 years
These pro forma amounts may not be representative of the effects on reported
net loss for future years as options vest over several years and additional
awards are generally made each year.
Stockholder Rights Plan. In May 1997, we adopted a stockholder rights plan
(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 Legato without offering a fair price in the event we are confronted
in the future with coercive or unfair takeover tactics. The rights expire on
May 23, 2007.
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% of their eligible compensation, subject to
certain limitations. We may make contributions to the Plan at the discretion of
the Board of Directors and have contributed $0.8 million in 2001, $0.8 million
in 2000 and $1.1 million in 1999.
55
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Income Taxes
The provision for (benefit from) income taxes consists of the following (in
thousands):
Year Ended December 31,
----------------------------
2001 2000 1999
-------- -------- --------
Current:
Federal............................. $ 781 $ 3,079 $ 15,881
State............................... 3 541 2,389
Foreign............................. 2,559 3,761 1,642
-------- -------- --------
3,343 7,381 19,912
-------- -------- --------
Deferred:
Federal............................. (35,749) (14,808) (11,474)
State............................... (3,137) (1,793) (2,389)
Foreign............................. -- (313) (314)
-------- -------- --------
(38,886) (16,914) (14,177)
-------- -------- --------
$(35,543) $ (9,533) $ 5,735
======== ======== ========
In 2001, loss before benefit from income taxes consisted of a loss from U.S.
operations of $119.3 million and income from foreign operations of $2.3
million. In 2000, loss before benefit from income taxes consisted of a loss
from U.S. operations of $47.6 million and income from foreign operations of
$2.8 million. In 1999, income before provision for income taxes consisted of
income from U.S. operations of $5.9 million and income from foreign operations
of $2.5 million. The tax benefit associated with dispositions from employee
stock plans for 2001, 2000, and 1999 was $4.1 million, $4.6 million and $36.4
million, respectively. Such benefit was recorded to common stock and capital in
excess of par and a reduction to taxes payable or an increase to deferred tax
assets. The effective tax rate differs from the statutory federal income tax
rate as follows:
Year Ended December 31,
----------------------
2001 2000 1999
----- ----- -----
Statutory federal income tax rate................ (35.0)% (35.0)% 35.0%
State income taxes, net of federal benefit....... (2.7) (2.1) (8.0)
Tax exempt interest income....................... (0.1) (1.8) (6.6)
Research and experimental credit................. (1.1) (3.1) (21.6)
Losses not benefited............................. -- 2.2 --
Non-deductible merger costs...................... 6.4 8.9 8.8
In-process research and development.............. -- -- 54.4
Foreign taxes.................................... 1.5 6.9 2.0
Other............................................ 0.6 2.7 4.0
----- ----- -----
(30.4)% (21.3)% 68.0%
===== ===== =====
As of December 31, 2001, we have federal and California net operating loss
carryforwards of $78.7 million and $12.0 million available to reduce future
federal and California taxable income, respectively. These federal and
California carryforwards begin to expire in 2019 and 2004, respectively. In
addition to these carryforwards, as a result of our acquisition of FullTime and
Vinca in 1999, we also have federal and state net operating loss carryforwards
of $20.4 million and $3.7 million available to offset future federal and state
taxable income, respectively. These federal and state carryforwards begin to
expire in 2010 and 2003, respectively. The extent to
56
LEGATO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
which the FullTime and Vinca loss carryforwards can be used to offset future
taxable income are limited under Section 382 of the Internal Revenue Code and
applicable state tax law.
As of December 31, 2001, we have federal and California research and
experimentation tax credit carryforwards of $8.5 million and $4.0 million,
respectively. These federal tax credit carryforwards begin to expire in 2019,
and the California tax credit carryforwards do not expire. In addition to these
tax credit carryforwards, as a result of our acquisition of FullTime in 1999,
we have federal research and experimentation tax credit carryforwards of $0.7
million, which begin to expire in 2012. The extent to which the FullTime tax
credit carryforwards can be used to offset future taxes are limited under
Section 383 of the Internal Revenue Code.
As of December 31, 2001, we have federal alternative minimum tax credit
carryforwards of $0.9 million, which do not expire. In addition, we have
foreign tax credit carryforwards of $3.0 million, which begin to expire in 2003.
Significant components of our deferred tax assets and liabilities are as
follows (in thousands):
December 31,
-----------------
2001 2000
------- --------
Deferred tax assets:
Allowances, accrued liabilities and other.......... $ 8,461 $ 7,180
Accrued compensation and benefits.................. 1,478 1,359
Net operating loss and credit carryforwards........ 49,857 31,597
Intangible asset--purchased technology............. 18,137 8,630
Deferred revenue................................... 3,520 4,425
Other.............................................. 4,887 2,759
------- --------
86,340 55,950
Deferred tax liabilities:
Goodwill--Vinca acquisition........................ (5,450) (17,890)
------- --------
$80,890 $ 38,060
======= ========
8. Industry and Geographic Segment Information
We use one measurement of profitability for our business. Our software
products and related services are developed and marketed to support
heterogeneous client/server computing environments and mid- to large-scale
enterprises. Revenue information on a product basis is as follows (in
thousands):
Year Ended December 31,
--------------------------
2001 2000 1999
-------- -------- --------
License:
NetWorker and related NetWorker products...... $133,263 $117,806 $142,067
Other products................................ 14,265 27,806 19,027
Service and support.............................. 95,073 85,783 67,473
-------- -------- --------
$242,601 $231,395 $228,567
======== ======== ========
57
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 (in thousands):
Year Ended December 31,
--------------------------
2001 2000 1999
-------- -------- --------
Revenue:
United States....................... $120,871 $155,654 $162,790
Europe.............................. 81,177 51,873 48,041
Other countries..................... 40,553 23,868 17,736
-------- -------- --------
$242,601 $231,395 $228,567
======== ======== ========
Long-lived assets:
United States....................... $ 49,470 $ 83,203 $ 89,735
Europe.............................. 2,205 2,427 2,206
Other countries..................... 5,532 4,564 3,536
-------- -------- --------
$ 57,207 $ 90,194 $ 95,477
======== ======== ========
The revenue information by geographical area is based on the country of
destination. Other than the United States, no country accounted for more than
10% of our total revenue for 2001, 2000 and 1999, except for Germany accounted
for 12% of total revenue for 2001. No single customer accounted for more than
10% of our total revenue for 2001, 2000 and 1999.
9. Selected Quarterly Financial Data--(Unaudited)
Year Ended December 31, 2001 Year Ended December 31, 2000
------------------------------------- -----------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
-------- -------- ------- -------- -------- ------- ------- -------
(in thousands, except per share data)
Total revenue.......................... $ 62,030 $ 57,013 $62,511 $ 61,047 $ 58,424 $54,170 $58,281 $60,520
Gross profit........................ 48,598 43,661 48,562 47,347 44,765 42,625 46,455 49,939
Net loss............................ (47,934) (12,984) (9,976) (10,601) (13,937) (3,744) (7,581) (9,987)
Basic and diluted net loss per share... (0.54) (0.15) (0.11) (0.12) (0.16) (0.04) (0.09) (0.12)
10. Subsequent Event
On February 20, 2002, we entered into a definitive agreement to acquire OTG
Software, Inc. ("OTG") for cash and stock at a value of approximately $373
million. OTG, based in Rockville, Maryland, provides data management and
collaboration solutions that virtualize storage for any type of data, including
files, messages and databases, while providing easy and transparent access. The
merger agreement provides that each share of OTG common stock will be exchanged
for 0.6876 of a share of Legato common stock and $2.50 per share of cash. We
will also assume all outstanding options to purchase OTG common shares. The
closing of the merger is subject to regulatory approval and Legato and OTG
stockholder approvals and is expected to close in the second quarter of 2002.
After the transaction is completed, OTG's stockholders will own approximately
20% of the combined entity's shares.
58
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/ DAVID B. WRIGHT
Date: March 14, 2002 By: _______________________________
David B. Wright
Chairman of the Board, President
and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints David B. Wright and Andrew J. Brown, and each of
them, as his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments (including
post-effective amendments) to this Annual Report on Form 10-K, and to file the
same, with exhibits thereto and other documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact
and agents, and each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, or their or his substitutes, may lawfully do or cause
to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated have signed this report below.
Signature Title Date
--------- ----- ----
/s/ DAVID B. WRIGHT Chairman, President and Chief March 14, 2002
- ----------------------------- Executive Officer
David B. Wright (Principal Executive
Officer)
/s/ ANDREW J. BROWN Senior Vice President and March 14, 2002
- ----------------------------- Chief Financial Officer
Andrew J. Brown (Principal Financial
Officer)
/s/ CORY J. SINDELAR Vice President and Corporate March 14, 2002
- ----------------------------- Controller (Principal
Cory J. Sindelar Accounting Officer)
/s/ ERIC A. BENHAMOU Director March 14, 2002
- -----------------------------
Eric A. Benhamou
/s/ H. RAYMOND BINGHAM Director March 14, 2002
- -----------------------------
H. Raymond Bingham
/s/ BRENDAN J. DAWSON Director March 14, 2002
- -----------------------------
Brendan J. Dawson
59
Signature Title Date
--------- ----- ----
/s/ KENNETH A. GOLDMAN Director March 14, 2002
- -----------------------------
Kenneth A. Goldman
/s/ CHRISTOPHER B. PAISLEY Director March 14, 2002
- -----------------------------
Christopher B. Paisley
/s/ DAVID N. STROHM Director March 14, 2002
- -----------------------------
David N. Strohm
60