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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number: 0-26130
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LEGATO SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3077394
(State of incorporation) (I.R.S. Employer
Identification No.)
2350 West El Camino Real
Mountain View, California 94040
(Address of principal executive offices)
(650) 210-7000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Preferred Share Purchase Rights
Common Stock, $.0001 par value
(Title of each class).
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 31, 2000 was approximately $1,080,000,000. Shares
of Common Stock held by each officer and director have been excluded in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
The number of shares outstanding of the registrant's common stock as of
March 31, 2000 was 86,774,992.
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LEGATO SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1999
Table of Contents
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 26
Item 3. Legal Proceedings.............................................. 26
Item 4. Submission of Matters to a Vote of Security Holders............ 26
Item 4a. Executive Officers of the Registrant........................... 26
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder 28
Matters........................................................
Item 6. Selected Consolidated Financial Data........................... 29
Item 7. Management's Discussion and Analysis of Financial Condition and 30
Results of Operations..........................................
Item 8. Consolidated Financial Statements and Supplementary Data....... 40
Item 9. Changes in and Disagreements with Accountants on Accounting and 40
Financial Disclosure...........................................
PART III
Item 10. Directors and Executive Officers of the Registrant............. 68
Item 11. Executive Compensation......................................... 69
Item 12. Security Ownership of Certain Beneficial Owners and 75
Management.....................................................
Item 13. Certain Relationships and Related Transactions................. 76
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8- 77
K..............................................................
Schedule II--Valuation and Qualifying Accounts........................... 80
Signatures............................................................... 81
PART I
ITEM 1. BUSINESS
The discussion in this report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, including
statements on our expectations, beliefs, intentions or strategies regarding the
future. All forward-looking statements included in this document are based on
information available to us on the date hereof. We assume no obligation to
update any such forward-looking statements. Our actual results could differ
materially from those indicated in such forward-looking statements. Factors
that could cause or contribute to such differences include, but are not limited
to, fluctuations in quarterly operating results, uncertainty in future
operating results, litigation, product concentration, competition,technological
changes, reliance on enterprise license transactions, reliance on indirect
sales channels, dependence on international revenue, management of our growth
and expansion, integration of recent acquisitions and other risks discussed in
this item under the heading "Risk Factors" and the risks discussed in our other
Securities and Exchange Commission filings.
Legato Systems, Inc. was incorporated in Delaware in September 1988. We
develop, market and support network storage management software products for
heterogeneous client/server computing environments and large scale enterprises.
We believe we are currently a technology leader in the network storage
management software market because of the scalability, heterogeneity,
performance, ease of use, central administration and data availability of our
software products. Our data protection products, primarily the NetWorker family
of products, and our data availability products, primarily our HA+, Octopus,
Replication and Cluster products, support many storage management server
platforms and accommodate a variety of clients, servers, applications,
databases and storage devices. Our long term strategy is to create an
integrated set of solutions centered around storage management that enhance and
simplify network computing as a whole.
In the third quarter of 1998, we acquired Software Moguls, Inc, a developer
of advanced backup-retrieval products for Window NT and UNIX environments. In
the second quarter of 1999, we acquired Intelliguard Software, Inc., or
Intelliguard, a developer of standards-based storage management solutions for
storage area networks and Qualix Group, Inc. (dba FullTime Software, Inc.), or
FullTime, a developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions. On July 30, 1999, we acquired Vinca Corporation, or Vinca,
a developer of high availability and data protection software. These
acquisitions are intended to enable us to continue to provide customers with
storage management technologies to protect their data with ease and confidence.
The research and development resources and product lines from these
acquisitions potentially provide us with opportunities to enhance the core
elements of our enterprise storage management solution.
We utilize multiple distribution channels, including direct sales, resellers
and original equipment manufacturers, or OEMs, as a part of our strategy to
achieve comprehensive coverage in the market. We license our source code to
leading computer system and software suppliers, including:
. Amdahl;
. Banyan;
. Compaq (Digital);
. Compaq (Tandem);
. EMC (Data General);
. Fujitsu-ICL;
. Nihon-Unisys;
. NEC;
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. Siemens Nixdorf;
. Silicon Graphics;
. Sony;
. Sun Microsystems; and
. Unisys.
These leading computer system and software suppliers port our products to
their proprietary platforms, sell the products through their direct and
indirect distribution channels and provide primary support for the products
after installation. These relationships enable us to reach a broad customer
base, while reducing development, support and product costs. We have also
established strategic partnerships with EMC Corporation, Hewlett-Packard,
Network Appliance and Oracle.
The Legato Solution
Our data protection and data availability software products have been
designed to address the emerging requirements of storage management in
client/server computing environments. These products employ a client/server
architecture in which a server centralizes storage management services,
including failover and recovery management as well as replication capabilities,
for a wide variety of clients, including servers and desktop computers. We
believe our products provide a cost-effective storage management solution that
scales to support large networks, supports heterogeneous client/server
computing environments, accomplishes storage management tasks within stringent
time constraints, reduces the cost of network administration and employs an
easy-to-use graphical user interface. The core elements of the our solution
include:
. Scalability;
. Heterogeneity;
. Performance;
. Ease of use;
. Central administration; and
. Data availability.
Scalability. Our storage management architecture, also referred to as
Enterprise Storage Management Architecture, or ESMA, is designed to be scalable
so that it can grow with an expanding network and accommodate a wide range of
storage management needs. Our storage server family can be configured or
expanded to meet the storage requirement needs of a changing and dynamic
network. Our architecture is modular, so that clients, servers and storage
devices can be upgraded or added without requiring redesign of the entire
system. An existing server can be quickly upgraded to a more powerful server
with minimal modification. Furthermore, our architecture can adapt to growing
networks with its ability to easily add clients to a given storage management
server. For example, a single NetWorker storage management server has been
employed to manage data located on hundreds of clients ranging from desktop
computers to large file servers.
Heterogeneity. Our storage management solutions are designed to support a
wide range of servers, clients, applications, databases and storage devices.
Servers, clients, applications, databases and storage devices supported by our
BusinesSuite products include:
. DB2;
. Informix;
. Lotus Notes;
. Microsoft Exchange;
. Microsoft SQL;
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. Oracle;
. SAP R/3; and
. Sybase.
Our family of storage management server products operates on the following
platforms:
. Compaq Tru64;
. Linux;
. NetWare;
. Windows NT;
. Windows 2000;
. UNIX systems (AIX, Dynix/ptx, HP-UX, Irix, SGI and Solaris); and
. UNIX systems and Windows NT and Windows 2000 offered by our OEMs.
Server and desktop computer clients supported include:
. DOS;
. Macintosh;
. Mac OS'
. NetWare;
. Network Appliance;
. OS/2;
. UNIX;
. MPE/iX;
. Windows;
. Windows NT; and
. Windows 2000.
Storage devices supported include most popular tape drives, and optical and
tape robotic storage devices. All NetWorker server platforms inter-operate with
all supported clients. As a result, customers can mix and match clients and
servers as necessary to meet their specific requirements. In addition,
NetWorker's interoperability enables the flexibility to change storage
management server platforms, without disrupting any client systems.
Performance. Organizations usually need to accomplish storage management
functions (which tend to consume network bandwidth as large amounts of data are
transferred over the network) during a network's off-peak hours. Our NetWorker
storage management server can process data from many clients in parallel,
allowing high volumes of network data to be managed within stringent time
constraints. NetWorker is designed to take advantage of improvements in the
physical environment to deliver higher performance. As networks employ higher-
speed computers, faster and increased capacity storage devices and higher
bandwidth networking technologies, NetWorker is designed to exploit these
capabilities to move data quickly. Our data availability products, including
Replication, Cluster, HA+ and Octopus, provide for real-time replication for
data exchange and synchronization for local applications, data exchange among
remote sites and disaster recovery without significant downtime and create
collaborative clusters of server resources across platforms, networks and
applications to ensure resource availability.
Ease of Use. Our storage management solutions have been designed to be easy
to use for both network administrators and end users. Our architecture permits
a network administrator to perform the storage management function for the
entire network either from the storage server or a client. The network
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administrator can access our products through a number of graphical user
interfaces, including Windows, Windows NT and Windows 2000 and Motif. Network
administrators can also automate their storage operations by adding robotic
storage libraries, further reducing the need for human intervention. Finally,
our architecture supports a simple user interface that permits end users to
access or recover copies of their files without the need for intervention by
the network administrator.
Central Administration. Our Global Enterprise Management Systems, or
G.E.M.S., product allows information system organizations the ability to
globally manage hundreds and even thousands of NetWorker storage servers.
G.E.M.S. provides services such as policy management, software distribution,
universal licensing and advanced media management and can be integrated with
management frameworks including CA Unicenter, HP Openview, and Tivoli TME.
Data Availability. Our data availability products, including our HA+,
Octupus, Replication and Cluster products, help to minimize the impact of
failures caused by system malfunction, human error, sabotage or natural
disasters. These data availability products are designed to monitor, replicate
and support a variety of UNIX-based and Windows NT and Windows 2000 operating
systems, hardware platforms, disk configurations, networks, applications and
databases. For example, if a server goes down, or for any reason stops
providing service to an application, HA+ can promptly elect another server to
carry on service and allow users to continually access their data and
applications.
Architecture
The most basic function of a storage management system is data protection.
The process of data protection involves making backup copies of data stored on
hard disks onto low-cost, high capacity removable media such as tapes and
optical disks.
Our architecture provides reliable data protection services. Data may be
managed according to the application that produces it. For example, a
relational database may be frequently updated. To back up this kind of database
efficiently, it is necessary to understand how the database is constructed, so
that a consistent copy of the database can be made while it is undergoing
change and while the database is "on-line." Our architecture can accommodate
the data produced by different applications because of its Application Specific
Module, or ASM, technology. Each ASM can be tailored to the specific storage
management needs of a particular kind of application data, and all ASMs are
implemented using a modular architecture designed to permit new ASMs to be
easily integrated into our storage offerings.
Once data is read from the client's hard disk, it is transmitted to the
storage management software that resides on the storage server using industry-
standard communications protocols such as TCP/IP and SPX/IPX. A high-
performance, integrated database is fundamental to the storage management
server engine. This database has two roles: to keep track of where the storage
management server has stored the data, and to keep track of what data is
stored. Our architecture makes it possible for clients to query the database as
to what data is under management and for clients to access this data
themselves. This enables novice users to directly access the system, thereby
reducing the burden on network administrators.
One of the most critical ways our architecture achieves its ability to
accommodate an increasing number of clients while retaining high performance is
by implementing parallel data transfers from the clients to the storage
management server in the same way that adding more tellers to serve customers
allows a bank to process more transactions in the same amount of time. When an
additional client's data is managed, it may be scheduled for processing by the
storage management server at the same time as the data from other clients.
Thus, one slow client need not slow down the entire storage management process.
Our architecture achieves this parallelism by writing multiple client data
streams to the tape simultaneously. This allows the full bandwidth of the tape
drive to be used as the data from many clients can be delivered to the tape
drive in the same amount of time as the data from one client. As a result, one
high-capacity tape drive can be shared effectively by more than one client on
the network, and, therefore, it may not be necessary to purchase several tape
drives to accomplish data protection in the required amount of time.
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An increasingly important function of the architecture to some end users is
to facilitate the management of data according to its criticality. As an
example, a set of quarterly reports may be grouped together and filed away.
This data may not need to be accessed on a regular basis, but may need to be
retrievable for a period of years because of certain regulatory requirements.
This class of data is termed "archive" data, because it may be filed away for
future reference and need not be kept on-line. When archived data is needed, it
must be explicitly retrieved, typically from offsite storage. It is also
possible to archive data in such a way that it appears to be on-line, when it
in reality is stored elsewhere. This process is referred to as "hierarchical
storage management." The indexing technology embedded within our storage
products is designed to support the management of protected, archived, and
hierarchically managed data.
In addition to data protection, an important function of the architecture is
data availability, which provides end users access to the computing power, data
and applications they need, when and where they need them, including times when
data protection actually takes place. As organizations migrate or consider
migrating business-critical applications to distributed computing environments,
they frequently need to ensure that such applications are fully operational
around the clock. In order to facilitate data availability without significant
downtime, open application interfaces take place so that other applications can
share data. Open application interfaces layer over existing computing
environments, including data, systems, standard TCP/IP networks and
applications, without requiring additional programming or changes to the
existing applications. Therefore, the data protection process, as well as the
implementation of system and software upgrades, can occur without the
traditional downtime.
To reduce the burden on expensive administrative staff, our architecture
allows the storage management server to be managed remotely, from an easy-to-
use, graphical user interface familiar to the administrator. The use of a
common administrative protocol developed by us greatly facilitates the
development of diverse user interfaces that support remote administration. Our
family of storage management products can also automate a wide range of storage
management functions and can employ robotic storage devices to remove the need
for human intervention to retrieve a particular piece of removable storage
media.
Products
Our family of storage management server software--NetWorker--provides
network storage management services for a wide variety of platforms. NetWorker
consists of two basic components: a client module that accesses the data being
managed, and a server module that performs the protection, management and
control of network data. Typically, the server module is selected to run on the
platform most familiar to the administrative staff in an organization; the
client modules are selected according to the type of computers installed on the
network. Our server software is available for NetWare, Windows NT, Windows
2000, several UNIX platforms, including Compaq (Digital), HP, IBM, Silicon
Graphics, Sequent and Sun versions of UNIX. A number of applications and
enhancements options are available for the storage server.
The base NetWorker server product provides data protection services for
clients and includes client software for the same platform as the NetWorker
server, as well as support for a set of popular non-robotic storage devices. In
multiple platform environments, client software for dissimilar platforms must
be purchased. The following client packages are currently available:
. ClientPak for UNIX, which supports a diverse set of UNIX clients,
including Linux, Hewlett-Packard, Compaq (Digital), IBM and Sequent;
. ClientPak for PC Desktops, which supports OS/2, Windows 95, Windows 98,
Windows NT and Windows 2000;
. ClientPak for Windows NT and Windows 2000, which supports Window NT and
Windows 2000 workstations and Windows NT and Windows 2000 Servers;
. ClientPak for MPE/iX, which supports HP3000 MPE/iX systems;
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. ClientPak for Network Appliance, which supports Network Appliance filers
via TCP/IP ethernet connections;
. ClientPak for NetWare, which supports NetWare; and
. ClientPak for Macintosh, which supports MacOS.
The base NetWorker server product for Windows NT and Windows 2000 , UNIX and
NetWare is also available through the following offerings, which support a
variety of NetWorker options:
. Workgroup Edition--a storage management solution for small networks in
corporate environments. Workgroup Edition provides support for up to four
client connections and two storage devices;
. Network Edition--an enterprise-strength storage management solution for
distributed networks. Network Edition supports up to ten clients, as well
as options that add client connections, expand client platform coverage,
and deliver advanced data management services; and
. Power Edition--a storage management solution for customers with very
large servers, clusters, or the requirement to drive high-speed devices.
Power Edition features enhanced architecture to increase throughput while
minimizing use of system resources and supports all standard NetWorker
options.
NetWorker for UNIX is licensed by the number of clients to be supported and
has the following storage management server options available:
. Archive--the ability to archive data;
. Autochanger--the ability to employ tape and optical jukeboxes of varying
capacities;
. BusinesSuite--the ability to utilize a family of add-on modules tailored
for databases and business applications;
. Client Connections--the ability to increase the number of clients of the
storage management server beyond the ten supported by the base product;
. High Speed Device Support--the ability to utilize high speed devices;
. Silo Support--the ability to leverage mainframe-class storage silos;
. SNMP Modules--the ability to integrate with leading system management
offerings; and
. Storage Nodes--the ability to perform very high-speed backup locally
which is managed centrally.
NetWorker for Windows NT and Windows 2000 is Microsoft BackOffice certified
and licensed by the number of clients to be supported and it has the following
storage management server options available:
. Archive--the ability to archive data;
. Autochanger--the ability to employ tape and optical jukeboxes of varying
capacities;
. BusinesSuite--the ability to utilize a family of add-on modules tailored
for databases and business applications such as SQL Server and Exchange
Server;
. Client Connections--the ability to increase the number of clients of the
storage management server beyond the ten supported by the base product;
. Open File Manager--the ability to protect open files;
. Silo Support--the ability to leverage mainframe-class storage silos;
. SNMP Module--the ability to integrate with leading system management
offerings; and
. Storage Nodes--the ability to perform very high-speed backup locally
which is managed centrally.
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NetWorker for NetWare is licensed by the number of clients to be supported
and has the following storage management server options available:
. Archive--the ability to archive data;
. Autochanger--the ability to employ tape and optical jukeboxes of varying
capacities; and
. Client Connections--the ability to increase the number of clients of the
storage management server beyond the ten supported by the base product.
NetWorker server software has an entry end user list price from $1,150 to
$22,425, while a fully configured NetWorker system can have an end user list
price of over $100,000.
Our G.E.M.S. product complements the NetWorker family of products by
providing an approach to managing enterprise-wide storage from Java-enabled Web
browsers via a central console. G.E.M.S allows systems administrators to
centrally configure, control, and manage storage in geographically dispersed
areas. The main features of G.E.M.S. include policy-based administration,
software management and flexible software licensing across the enterprise.
G.E.M.S. provides system administrators the ability to control multiple data
zones managed by NetWorker servers.
Our data availability products, including our HA+, Octopus, Replication and
Cluster products, complement the NetWorker family of products by providing
users with continual real-time access to data and applications and allow
systems to be backed up without the traditional downtime. Resources can be
transparently relocated to continue to provide services to users while system
changes are applied.
Our Celestra products allow users the ability to move data directly from
disk to disk or disk to tape without interrupting the server that owns the
data. The capability of our Celestra products may be useful for companies'
electronic commerce environments, where servers require accessibility 24 hours
a day, 7 days a week.
Our SmartMedia products allow customers to share tape libraries between
applications, which may be useful in storage area network environments, where
several servers share a single tape library.
Sales and Marketing
Our strategy is to deploy a comprehensive sales, marketing and support
infrastructure to meet the storage management needs of users of complex
client/server networks worldwide. We use a multi-tier distribution model to
reach end user customers, which range in size from individual corporate
departments or small businesses to large multinational corporations. Network
storage management software is an application that may be utilized across many
industries segments.
We provide sales and pre-sale technical support to business partners and end
user customers from our Palo Alto office and from regional offices in the
following metropolitan areas:
. Atlanta;
. Boston;
. Chicago;
. Dallas;
. Denver;
. Los Angeles;
. New York;
. Seattle;
. Toronto; and
. Washington, D.C.
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The range of distribution channels includes:
. Direct sales;
. Resellers; and
. OEMs.
Direct Sales
We have established a dedicated sales force to penetrate large enterprise-
wide opportunities. As storage requirements increase, storage management
applications increase in strategic importance to major enterprises. We have
recognized the need to establish even closer relationships with our largest
corporate clients. Customers participating in our enterprise sales program have
an assigned salesperson and an executive contact, participate in our technical
exchange program and work closely with us to develop large projects for
installations over a period of time. An enterprise sales representative
coordinates business partner activities across the customer's enterprise and
closely monitors customer satisfaction.
Resellers
We have established regional sales offices to increase the effectiveness of
and support to our channel partners.
North America Enterprise Solution Partners. Our North America Enterprise
Solution Partners program provides a significant source of revenue in North
America. The Enterprise Solution Partners program enables third-party
integrators specializing in storage management and client/server network
solutions to provide end user customers with complete solutions, including
systems and storage hardware, complementary software and our software. The
reseller is responsible for managing the sales and installation process in each
customer situation. In large, complex opportunities, our support personnel work
with the reseller to provide technical support. This approach enables us to
cost effectively achieve broader market coverage, while maintaining close
contact with end user customers in order to obtain input on product direction
and to monitor customer satisfaction.
North America Distributor Program. To further expand coverage in the
marketplace, we sell our products to large regional and national distributors
who sell the products to resellers with expertise in storage management and
integrating network solutions for end users. We provide support to these
network solutions resellers. We currently have relationships with various major
distributors, including Access Graphics, Gates/Arrow, Ingram Micro and
TechData.
International Reseller and Distributor Programs. We have similar reseller
and distributor programs internationally. We currently operate sales offices in
the following countries to support resellers and distributors throughout
various regions of the world, including, but not limited to:
. Australia;
. Belgium;
. Canada;
. China;
. France;
. Germany;
. Japan;
. Italy;
. Netherlands;
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. Poland;
. Singapore;
. Sweden;
. Switzerland; and
. United Kingdom.
International product sales were $65.8 million in 1999, $45.5 million in
1998 and $27.7 million in 1997, representing 29 percent of total revenue in
1999, 27% in 1998 and 23 percent in 1997. The majority of international sales
during these periods were made in Europe and Asia. We believe that
international markets present an attractive growth opportunity and are
expanding the scope of our international operations. We have engaged, and
intend to add international resellers and distributors in targeted countries
and are developing joint marketing programs with certain resellers and
distributors. In order to facilitate penetration in certain markets, we, along
with cooperation from certain international distributors, are in the process of
localizing certain products to certain targeted languages.
We also rely significantly on our resellers for the marketing and
distribution of our products. Our agreements with resellers are generally not
exclusive and in many cases may be terminated by either party without cause.
Many of our resellers carry our competitors' product lines. We cannot guarantee
that these resellers will give a high priority to the marketing of our products
or that they will continue to carry our products. Events or occurrences of this
nature could seriously harm our business, operating results and financial
condition.
OEMs
Source Code OEM Program. Our source code OEM program generates significant
royalty revenue. Under this program, we license our software products, in
source code form, to leading computer system and software suppliers from which
we receive an initial license fee and ongoing royalty revenue. The OEM partner
is then responsible for porting our software to its unique operating system
environment, testing it, selling it through the OEM partner's direct sales
force and distribution channels and providing the primary customer support
after installation. The OEM partners generally have exclusive rights to the
products on their proprietary platforms (subject to certain minimum royalty
obligations), but, in certain cases, work cooperatively to incorporate their
enhancements into our storage products on an ongoing basis. The benefit of this
approach for end users is that they can acquire our family of storage
management products as part of a complete systems solution from a single
vendor, with such vendor providing a single point of contact for customer
support. The benefit to us has been access to our OEM partners' customer bases,
both in North America and overseas, without a commensurate investment in fixed
expense. We currently have source code OEM agreements in place with several
computer system and software suppliers, including:
. Amdahl;
. Banyan;
. Compaq (Digital);
. Compaq (Tandem);
. EMC (Data General);
. Fujitsu-ICL;
. Nihon-Unisys;
. NEC;
. Siemens Nixdorf;
. Silicon Graphics;
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. Sony;
. Sun Microsystems; and
. Unisys.
Strategic Partner Program. The Strategic Partner program is an alternative
to the source code OEM program for major system providers who wish to offer our
products along with theirs, but prefer not to make an investment in enhancing
the base Legato product. For example, SunSoft, a private label reseller,
licenses the object code for the standard Legato products and sells and
supports the products under the SunSoft logo as described above for the source
code OEM program. We also have established strategic partnerships with Hewlett-
Packard, Informix, Netscape and Oracle.
The source code OEMs and strategic partner programs accounted for
approximately $23.3 million in 1999, $19.2 million in 1998 and $16.7 million in
1997. We are currently investing, and intend to continue to invest resources to
develop this channel, which could seriously harm our operating margins if such
efforts are not successful. We cannot guarantee that we will be successful in
our efforts to increase the revenue represented by this channel. We are
dependent upon our OEMs' ability to develop new products, applications and
product enhancements on a timely and cost-effective basis that will meet
changing customer needs and respond to emerging industry standards and other
technological changes. We cannot guarantee that our OEMs will effectively meet
these technological challenges. These OEMs are not within our control, may
incorporate into their products the technologies of other companies in addition
to those of ours and are not obligated to purchase products from us. We cannot
guarantee that any OEM will continue to carry our products, and the inability
to recruit, or the loss of, important OEMs could seriously harm our business,
operating results and financial condition.
No one customer accounted for more than 10 percent of our total revenue for
1999, 1998 and 1997.
Corporate Marketing
We support our multi-tiered distribution efforts with extensive marketing
programs designed to establish our image in key markets, differentiate our
products, and to generate end user demand. Marketing programs include channel
marketing, product marketing, as well as programs specifically targeted to the
North American, Asian and other intercontinental markets. We participate in
industry forums and events, trade shows and advertise in key network systems
publications and on the Internet. We work directly with industry analysts to
update them on our products. Leads are qualified by our inside sales staff and
provided to our channel partners. Additionally, resellers and distributors are
provided with promotional and educational materials and can qualify for market
development funding for specific promotional activities tailored for their
solutions and geography.
Customer Support and Professional Services
We employ systems engineers who work closely with our direct sales personnel
to assist resellers and end users with pre-sales and post-sales support
matters. In addition, we employ a centralized support organization, which
provides customers with technical support and professional services including
education, training and consulting.
Customer Support. We offer product update services and help desk services.
Product updates services may be purchased pre-bundled with our software
products or separately after the products are registered. Customers may renew
product update services annually or purchase future updates on an as-needed
basis. Product update service customers receive updates, enhancements and
improvements to supported software, including support for new operating systems
once available. Annual fees for product update services are generally
equivalent to 15 percent of the price of the products under license paid by
customers.
Generally, basic help desk service customers may receive telephone or
electronic support from 8 a.m. to 5 p.m. in the customer's local time zone,
Monday through Friday. Response times for open cases are based on service level
objectives and the severity level that the customer sets at the time the case
is opened. We also
12
offer premium help-desk service, which includes a one year contract covering
seven-day, 24-hour technical support, enhanced service level objectives,
priority escalation management and a designated premium support account
manager, or PSAM. The PSAM conducts monthly conference calls with the
customers, maintains familiarity with their environment, and facilitates
communication between the customer and us. Depending on the type of help desk
service desired, the pricing ranges from $500 to $2,500 for per-incident help
desk service and from $1,000 to more than $30,000 for annual support
agreements. Premium help-desk service customers can purchase PSAM visits on an
annual, quarterly, or monthly interval with prices from $2,000 to $20,000. For
our highest level of support, we offer customers the opportunity to purchase
either a six-month or one-year onsite PSAM contract, for $150,000 and $200,000,
respectively.
The customer service and support organization consists of an experienced
staff of technical support engineers providing telephone and electronic support
via electronic mail from our offices in Palo Alto, California and Toronto,
Canada. Our sales and customer support organizations work closely together to
ensure overall customer satisfaction.
In recent years, our installed base of customers has significantly
increased, as have the number of customers purchasing software support
contracts. From time to time, we receive customer complaints about the
timeliness and accuracy of customer support. Although we plan to add customer
support personnel in order to address current customer support needs and intend
to closely monitor progress in this area, we cannot guarantee that these
efforts will be successful.
Education and Training. Our professional services organization offers
education and training to end users and resellers. Education and training
classes include covering theory, installation, operations, configuration, and
planning on information protection, information availability and information
management. Training classes are offered through in-house facilities at our
offices in Palo Alto, as well as at off-site locations. We also provide on-site
training services upon request by customers. Fees for education and training
services are charged separately from our software products. Although we intend
to add education and training personnel in order to meet customer needs, we
cannot guarantee that these efforts will be successful. If our efforts are not
successful, it could seriously harm our business, operating results and
financial condition.
Consulting. Our consultants are available to work closely with customers'
information systems organizations. These consulting services generally consist
of assisting customers in setting up more complex installations or tailoring
our software products to achieve higher performance or a higher degree of
automation. We also offer a number of consulting packages that provide
customers with more specific topics, such as enterprise analysis, storage
network health check, replication and tape conversion. Fees for consulting
services are charged separately from our software products. While we continue
to allocate resources in order to provide customers with additional value-added
services, we cannot guarantee that these efforts will be successful. Although
we intend to add consulting personnel in order to meet customer needs, we
cannot guarantee that these efforts will be successful. If our efforts are not
successful, it could seriously harm our business, operating results and
financial condition.
Research and Development
Since our inception, we have made substantial investments in product
development. In addition, we receive the benefits of additional testing and
product enhancements from each source code OEM's development group. Our future
success will depend upon our ability to develop and introduce new software
products, including new releases, applications and enhancements, on a timely
basis that keep pace with technological developments and emerging industry
standards and address the increasingly sophisticated needs of our customers. In
particular, our strategy is to continue to leverage the NetWorker architecture
to enhance the functionality of the product through new releases, applications
and product enhancements to meet the ongoing storage management requirements of
our customers. We cannot guarantee that we will be successful in developing and
marketing new products that respond to technological change or evolving
industry standards, that we will not experience difficulties that could delay
or prevent the successful development, introduction and marketing of these new
products, or that our new products will adequately meet the requirements of the
13
marketplace and achieve market acceptance. If we are unable, for technological
or other reasons, to develop and introduce new products in a timely manner in
response to changing market conditions or customer requirements, our business,
operating results and financial condition will be seriously harmed.
Also, some of our competitors currently offer certain of these potential new
products. Due to the complexity of client/server software and the difficulty in
gauging the engineering effort required to produce these potential new
products, such potential new products are subject to significant technical
risks. We cannot guarantee that such potential new products will be introduced
on a timely basis or at all.
As part of our ongoing development process, we released several new versions
of NetWorker during 1999, and intend to release additional versions of
NetWorker. In addition, we released several new products that support the base
NetWorker software, including, but not limited to:
. Cluster 4.3--server-based software solution for high availability
clustering on Windows NT, Windows 2000, Solaris, HP-UX and AIX;
. G.E.M.S. Reporter--designed to deliver essential Legato NetWorker Server
monitoring and reporting, including information about back-up times,
amounts of data saved and backup success or failure for individual files
and databases; and
. NetApp ClientPak--provides a solution for backing up UNIX and NT file
systems hosted on Network Appliance filers.
We cannot guarantee that these and future new products will achieve market
acceptance. The lack of market acceptance for these and future new products
will seriously harm our business, operating results and financial condition.
We have research and development centers in the following locations:
. Boulder, Colorado;
. Burlington, Canada;
. Dublin, California;
. Eden Prairie, Minnesota;
. Marlborough, Massachusetts;
. New Dehli, India;
. Orem, Utah;
. Palo Alto, California; and
. Seattle, Washington.
Total expenses for research and development were $40.1 million in 1999, $25.6
million in 1998 and $17.8 million in 1997. We anticipate that we will continue
to commit substantial resources to research and development in the future. To
date, our development efforts have not resulted in any capitalized software
development costs.
Competition
We operate in the enterprise storage management market, which is intensely
competitive, highly fragmented and characterized by rapidly changing technology
and evolving standards. Competitors vary in size and in the scope and breadth
of the products and services offered. Our major competitors include:
Novell NetWare and Windows NT and Windows 2000 platforms:
Computer Associates (Cheyenne Software); and
Veritas (Seagate, Palindrome and Arcada).
14
Sun Solaris/SunOS platform:
Computer Associates (Legent/Lachman);
EMC2 (Epoch);
Peripheral Devices (Delta Microsystems);
Spectra Logic; and
Veritas.
AIX platform and the HP-UX platform:
IBM; and
Hewlett Packard.
We expect to encounter new competitors as we enter new markets. In addition,
many of our existing competitors are broadening their platform coverage. We
also expect increased competition from systems and network management
companies, especially those that have historically focused on the mainframe
market and are broadening their focus to include the client/server market. In
addition, since there are relatively low barriers to entry in the software
market, we expect additional competition from other established and emerging
companies. We also expect that competition will increase as a result of future
software industry consolidations. Increased competition could harm us by
causing, among other things:
. Price reductions;
. Reduced gross margins; and
. Loss of market share.
Many of our current and potential competitors have longer operating
histories and have substantially greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger customer
base, than we have. As a result, certain current and potential competitors can
respond more quickly to new or emerging technologies and changes in customer
requirements. They can also devote greater resources to the development,
promotion, sale and support of their products. In addition, current and
potential competitors may establish cooperative relationships among themselves
or with third parties. If so, new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. In addition, network
operating system vendors could introduce new or upgrade existing operating
systems or environments that include functionality offered by our products. If
so, our products could be rendered obsolete and unmarketable. For all the
foregoing reasons, we may not be able to compete successfully, which would
seriously harm our business, operating results and financial condition.
Employees
As of March 31, 2000, we had a total of 1,265 employees. Of the total, 453
were in sales and marketing, 400 in research and development, 183 in technical
support, 169 in finance, administration and operations and 60 in consulting and
education services. Our future success depends, in significant part, upon the
continued service of our key technical and senior management personnel and our
continuing ability to attract and retain highly qualified technical, sales and
managerial personnel. Competition for such personnel is intense, and we cannot
guarantee that we can retain our key technical and managerial employees or that
we can attract, assimilate or retain other highly qualified technical, sales
and managerial personnel in the future. None of our employees are represented
by a labor union. We have not experienced any work stoppages and consider our
relations with our employees to be good.
15
Risk Factors
In addition to the other information in this Report, the following risk
factors should be considered carefully in evaluating our business and us:
Our Quarterly Operating Results Are Volatile.
Our quarterly operating results have varied in the past and may vary in the
future. Our quarterly operating results may vary depending on a number of
factors, many of which are outside of our control, including:
. The size and timing of orders;
. Increased competition;
. Market acceptance of our new products, applications and product
enhancements or our competitors;
. Changes in pricing policies or those of our competitors;
. Our ability to develop, introduce and market new products, applications
and product enhancements;
. Ability to integrate acquired businesses;
. Our ability to control costs;
. Quality control of products sold;
. Lengthy sales cycles, particularly with enterprise license transactions;
. Delay in the recognition of revenue from enterprise license and
application service provider transactions;
. Modification in reseller relationships resulting in changes to revenue
recognition policies;
. Success in expanding sales and marketing programs;
. Technological changes in our markets;
. The mix of sales among our channels;
. Deferrals of customer orders in anticipation of new products,
applications or product enhancements;
. Market readiness to deploy our products for distributed computing
environments;
. Changes in our strategy or that of our competitors;
. Customer budget cycles and changes in these budget cycles;
. Foreign currency and exchange rates;
. Acquisition costs or other non-recurring charges in connection with the
acquisition of companies, products or technologies;
. Costs and expenses related to class action litigation;
. Personnel changes; and
. General economic factors.
Our Future Operating Results Are Uncertain.
Our historical results of operations are not necessarily indicative of our
results for any future period. Expectations, forecasts, and projections by us
or others are by nature forward-looking statements, and future results cannot
be guaranteed. Forward-looking statements that were true at the time may
ultimately prove to be incorrect or false. We will not update our forward-
looking statements. Some investors in our securities inevitably will experience
gains while others will experience losses, depending on the prices at which
they purchase and sell securities. Prospective and existing investors are
strongly urged to carefully consider the various cautionary statements and
risks set forth in this report.
16
We cannot predict our future revenue with any significant degree of
certainty for several reasons including:
. Product revenue in any quarter is substantially dependent on orders
booked and shipped in that quarter, since we operate with virtually no
order backlog;
. We do not recognize revenue on sales to domestic distributors until the
products are sold through to end-users;
. The storage management market is rapidly evolving;
. Our sales cycles vary substantially from customer to customer, in large
part because we are becoming increasingly dependent upon larger company-
wide enterprise license transactions to corporate customers. Such
transactions include product license, service and support components and
take a long time to complete;
. The timing of large orders can significantly affect revenue within a
quarter;
. The timing of recognition of revenue from enterprise license and
application service provider transactions can significantly affect
revenue within a quarter;
. Modification in reseller relationships resulting in changes to revenue
recognition policies;
. License and royalty revenue are difficult to forecast. Our royalty
revenue is dependent upon product license sales by OEMs of their products
that incorporate our software. Accordingly, this royalty revenue is
subject to OEMs' product cycles, which are also difficult to predict.
Fluctuations in licensing activity from quarter to quarter further impact
royalty revenue, because initial license fees generally are non-recurring
and recognized upon the signing of a license agreement; and
Our expense levels are relatively fixed and are based, in part, on our
expectations of our future revenue. Consequently, if revenue levels fall below
our expectations, our net income will decrease because only a small portion of
our expenses varies with our revenue.
We believe that period-to-period comparisons of our results of operations
are not meaningful and should not be relied upon as indications of future
performance. Our operating results will be below the expectations of public
market analysts and investors in some future quarter or quarters. Our failure
to meet such expectations would likely seriously harm the market price of our
common stock.
Litigation.
On January 20, 2000, a shareholder securities class action complaint was
filed in the U.S. District Court, Northern District of California, against
Legato and certain of its directors and officers. Other similar class actions
involving the same defendants and substantially similar allegations were filed
soon thereafter. The complaints generally allege that, between October 21, 1999
and January 19, 2000, the defendants made false or misleading statements of
material fact about our prospects and failed to follow generally accepted
accounting principles; one amended complaint alleges that the wrongdoing
occurred between October 21, 1999 and March 31, 2000. The complaints assert
claims under the federal securities laws. The complaints seek an unspecified
amount in damages. The court has determined that all of the cases are related
and assigned them to one federal judge. Two plaintiffs filed motions to be
appointed as lead plaintiff. On May 1, 2000, the court held a hearing and
consolidated all of the pending cases; the court took under submission the lead
plaintiff motions. The lead plaintiff will file a consolidated amended
complaint.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our
officers and directors. We are named as nominal defendant. The complaint
generally alleges the same conduct as the shareholder class actions filed in
U.S. District Court. The complaint asserts that as a result of this conduct
certain of our officers and directors breached their fiduciary duties to us and
engaged in improper insider trading. The complaint seeks an unspecified amount
in damages and injunctive
17
relief on our behalf. The court determined that the derivative action is
related to the class actions and has assigned it to the same federal judge.
On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as nominal defendant. The complaint generally alleges
the same conduct as the shareholder class actions filed in U.S. District Court.
The complaint asserts that as a result of this conduct certain of our officers
and directors breached their fiduciary duties to us and engaged in improper
insider trading. The complaint seeks an unspecified amount in damages and
injunctive relief on our behalf.
The Company and the individual defendants intend to defend all of these
actions vigorously. There can be no assurance that any of the complaints
discussed above will be resolved without costly litigation, or in a manner that
is not adverse to our financial position, results of operations or cash flows.
No estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies.
Our Market is Highly Competitive.
We operate in the enterprise storage management market, which is intensely
competitive, highly fragmented and characterized by rapidly changing technology
and evolving standards. Competitors vary in size and in the scope and breadth
of the products and services offered. Our major competitors include:
Novell NetWare and Windows NT and Windows 2000 platforms:
Computer Associates (Cheyenne Software); and
Seagate (Palindrome and Arcada).
Sun Solaris/SunOS platform:
Computer Associates (Legent/Lachman);
EMC2 (Epoch);
Peripheral Devices (Delta Microsystems);
Spectra Logic; and
Veritas.
AIX platform and the HP-UX platform:
IBM; and
Hewlett Packard.
We expect to encounter new competitors as we enter new markets. In addition,
many of our existing competitors are broadening their platform coverage. We
also expect increased competition from systems and network management
companies, especially those that have historically focused on the mainframe
market and are broadening their focus to include the client/server computer
market. In addition, since there are relatively low barriers to entry in the
software market, we expect additional competition from other established and
emerging companies. We also expect that competition will increase as a result
of future software industry consolidations. Increased competition could harm us
by causing, among other things:
. Price reductions;
. Reduced gross margins; and
. Loss of market share.
18
Many of our current and potential competitors have longer operating
histories and have substantially greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger customer
base, than we have. As a result, certain current and potential competitors can
respond more quickly to new or emerging technologies and changes in customer
requirements. They can also devote greater resources to the development,
promotion, sale and support of their products. In addition, current and
potential competitors may establish cooperative relationships among themselves
or with third parties. If so, new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. In addition, network
operating system vendors could introduce new or upgrade existing operating
systems or environments that include functionality offered by our products. If
so, our products could be rendered obsolete and unmarketable. For all the
foregoing reasons, we may not be able to compete successfully, which would
seriously harm our business, operating results and financial condition.
In addition, our public announcement of a review of 1999 transactions,
delays in filing our Annual Report on Form 10-K for 1999 and in reporting
operating results for the first quarter of 2000 while this review was being
completed, commencement of de-listing of our common stock from the Nasdaq
National Market as a result of our failure to satisfy our public reporting
obligations in a timely manner and resulting customer uncertainty regarding our
financial condition may adversely affect our ability to sell our products.
We Depend on Our NetWorker Product Line.
We currently derive, and expect to continue to derive, a substantial
majority of our revenue from our NetWorker software products and related
services. A decline in the price of or demand for NetWorker, or failure to
achieve broad market acceptance of NetWorker, would seriously harm our
business, operating results and financial condition. We cannot reasonably
predict NetWorker's remaining life for several reasons, including:
. The recent emergence of our market;
. The effect of new products, applications or product enhancements;
. Technological changes in the network storage management environment in
which NetWorker operates; and
. Future competition.
We Must Respond to Rapid Technological Changes with New Product Offerings.
The markets for our products are characterized by:
. Rapid technological change;
. Changing customer needs;
. Frequent new software product introductions; and
. Evolving industry standards.
The introduction of products embodying new technologies and the emergence of
new industry standards could render our existing products obsolete and
unmarketable.
To be successful, we need to develop and introduce new software products on
a timely basis that:
. Keep pace with technological developments and emerging industry
standards; and
. Address the increasingly sophisticated needs of our customers.
19
We may:
. Fail to develop and market new products that respond to technological
changes or evolving industry standards;
. Experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new products; or
. Fail to develop new products that adequately meet the requirements of the
marketplace or achieve market acceptance
If so, our business, operating results and financial condition would be
seriously harmed.
We currently plan to introduce and market several potential new products in
the next twelve months. Some of our competitors currently offer certain of
these potential new products. Such potential new products are subject to
significant technical risks. We may fail to introduce such potential new
products on a timely basis or at all. In the past, we have experienced delays
in the commencement of commercial shipments of our new products. Such delays
caused customer frustrations and delay or loss of product revenue. If potential
new products are delayed or do not achieve market acceptance, our business,
operating results and financial condition would be seriously harmed. In the
past, we have also experienced delays in purchases of our products by customers
anticipating our launch of new products. Our business, operating results and
financial condition would be seriously harmed if customers defer material
orders in anticipation of new product introductions.
Software products as complex as those we offer may contain undetected errors
or failures when first introduced or as new versions are released. We have in
the past discovered software errors in certain of our new products after their
introduction. We experienced delays or lost revenue during the period required
to correct these shipments, despite testing by us and by our current and
potential customers. This may result in loss of or delay in market acceptance
of our products, which could seriously harm our business, operating results and
financial condition.
We Rely on Enterprise License Transactions.
In the past, we marketed our products at the department level of corporate
customers. Within the last few years, we developed strategies to pursue larger
enterprise license transactions with corporate customers. We may fail to
successfully market our products in larger enterprise license transactions.
Such failure would seriously harm our business, operating results and financial
condition. Our operating results are sensitive to the timing of such orders.
Such orders are difficult to manage and predict, because:
. The sales cycle is typically lengthy, generally lasting three to six
months, and varies substantially from transaction to transaction;
. They often include muliple elements such as product licenses and service
and support;
. Recognition of revenue from enterprise license transactions may vary from
transaction to transaction;
. They typically involve significant technical evaluation and commitment of
capital and other resources; and
. Customers' internal procedures frequently cause delays in orders. Such
internal procedures include approval of large capital expenditures,
implementation of new technologies within their networks, and testing new
technologies that affect key operations.
Due to the large size of enterprise transactions, if orders forecasted for a
specific transaction for a particular quarter are not realized in that quarter,
our operating results for that quarter may be seriously harmed.
Historically, we have not had a separate large enterprise or national
accounts sales force and only within the last few years have we begun to
develop direct sales groups focused on these larger accounts. To succeed in the
national accounts market, we will be required to continue to transition our
existing sales forces into
20
enterprise level sales groups, and attract and retain qualified personnel. New
personnel will require training to obtain knowledge of the attributes of our
products. We may not be successful in creating the necessary sales organization
or in attracting, retaining or training these individuals. To succeed in the
enterprise and national accounts market will require, among other things,
establishing and continuing to develop relationships and contacts with senior
technology officers at these accounts. Our business, financial condition and
results of operations would be seriously harmed if our sales force is not
successful in these efforts.
We Rely on Indirect Sales Channels.
We rely significantly on our distributors, systems integrators and value
added resellers, or collectively, resellers, for the marketing and distribution
of our products. Our agreements with resellers are generally not exclusive and
in many cases may be terminated by either party without cause. Many of our
resellers carry product lines that are competitive with ours. These resellers
may not give a high priority to the marketing of our products. Rather, they may
give a higher priority to other products, including the products of
competitors, or may not continue to carry our products. Events or occurrences
of this nature could seriously harm our business, operating results and
financial condition. In addition, we may not be able to retain any of our
current resellers or successfully recruit new resellers. Any such changes in
our distribution channels could seriously harm our business, operating results
and financial condition.
Our strategy is also to increase the proportion of our customers licensed
through OEMs. We may fail to achieve this strategy. We are currently investing,
and intend to continue to invest resources to develop this channel. Such
investments could seriously harm our operating margins. We depend on our OEMs'
abilities to develop new products, applications and product enhancements on a
timely and cost-effective basis that will meet changing customer needs and
respond to emerging industry standards and other technological changes. Our
OEMs may not effectively meet these technological challenges. These OEMs:
. Are not within our control;
. May incorporate the technologies of other companies in addition to, or to
the exclusion of, our technologies, and
. Are not obligated to purchase products from us. In addition, our OEMs
generally have exclusive rights to our technology on their platforms,
subject to certain minimum royalty obligations.
Our OEMs may not continue to carry our products. The inability to recruit,
or the loss of, important OEMs could seriously harm our business, operating
results and financial condition.
We Depend on International Revenue.
Our continued growth and profitability will require further expansion of our
international operations. To successfully expand international operations, we
must:
. Establish additional foreign operations;
. Hire addition personnel; and
. Recruit additional international resellers.
This will require significant management attention and financial resources
and could seriously harm our operating margins. If we fail to further expand
our international operations in a timely manner, our business, operating
results and financial condition could be seriously harmed. In addition, we may
fail to maintain or increase international market demand for our products. Our
international sales are currently denominated in U.S. dollars. An increase in
the value of the U.S. dollar relative to foreign currencies could make our
products more expensive and, therefore, potentially less competitive in those
markets. In some markets, localization of our products is essential to achieve
market penetration. We may incur substantial costs and experience delays in
localizing our products. We may fail to generate significant revenue from
localized products.
21
Additional risks inherent in our international business activities generally
include:
. Significant reliance on our distributors and other resellers who do not
offer our products exclusively;
. Unexpected changes in regulatory requirements;
. Tariffs and other trade barriers;
. Lack of acceptance of localized products, if any, in foreign countries;
. Longer accounts receivable payment cycles;
. Difficulties in managing international operations;
. Potentially adverse tax consequences, including restrictions on the
repatriation of earnings;
. The burdens of complying with a wide variety of foreign laws; and
. The risks related to the global economic turbulence.
The occurrence of such factors could seriously harm our international sales
and, consequently, our business, operating results and financial condition.
We Must Manage Our Growth and Expansion.
We have recently experienced a period of significant expansion of our
operations that has placed a significant strain upon our management systems and
resources. In addition, we have recently hired a significant number of
employees, and plan to further increase our total headcount. We also plan to
expand the geographic scope of our customer base. This expansion has resulted
and will continue to result in substantial demands on our management resources.
From time to time, we receive customer complaints about the timeliness and
accuracy of customer support. We plan to add customer support personnel in
order to address current customer support needs. If we are not successful
hiring such personnel, our business, operating results and financial condition
could be seriously harmed. Our ability to compete effectively and to manage
future expansion of our operations, if any, will require us to (a) continue to
improve our financial and management controls, reporting systems and procedures
on a timely basis, and (b) expand, train and manage our employees. Our failure
to do so would seriously harm our business, operating results and financial
condition.
We Must Integrate Recent Acquisitions.
On August 6, 1998, we acquired Software Moguls, Inc. a developer of advanced
backup-retrieval products for the Windows NT and UNIX environments. On April 1,
1999, we acquired Intelliguard, a developer of standards-based storage
management solutions for storage area networks. On April 19, 1999, we acquired
FullTime, a developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions. On July 30, 1999, we acquired Vinca, a developer in high
availability and data protection software. We may make additional acquisitions
in the future. Acquisitions of companies, products or technologies entail
numerous risks, including:
. An inability to successfully assimilate acquired operations and products;
. Diversion of management's attention;
. Loss of key employees of acquired companies;
. Substantial transaction costs; and
. Substantial additional costs charged to operations as a result of the
failure to consummate acquisitions.
22
Some of the products we acquired may require significant additional
development before they can be marketed and may not generate revenue at levels
we anticipate. Moreover, our future acquisitions may result in dilutive
issuances of our equity securities, the incurrence of debt, large one-time
write-offs and the creation of goodwill or other intangible assets that could
result in amortization expense. We cannot guarantee that our efforts to
consummate acquisitions or integrate acquisitions will be successful. If our
efforts are not successful, it could seriously harm our business, financial
condition and results of operations.
We Rely on Our Key Personnel.
Our future performance depends on the continued service of our key
technical, sales and senior management personnel. Most of our technical, sales
or senior management personnel are not bound by an employment agreements. The
loss of the services of one or more of our officers or other key employees
could seriously harm our business, operating results and financial condition.
Our future success also depends on our continuing ability to attract and
retain highly qualified technical, sales and managerial personnel. Competition
for such personnel is intense, and we may fail to retain our key technical,
sales and managerial employees or attract, assimilate or retain other highly
qualified technical, sales and managerial personnel in the future.
We Rely on Our Sales Personnel
We have recently experienced a number of voluntary resignations in our sales
force and may have further attrition or disruption in the sales force following
our recent announcements. Our future success depends on our continuing ability
to attract and retain highly qualified sales personnel. Competition for such
personnel is intense, and we may fail to retain our sales personnel or attract,
assimilate or retain other highly qualified sales personnel in the future. Any
further attrition or disruptions to our sales force could seriously harm our
business, operating results and financial condition.
We Depend on Growth in the Enterprise Storage Management Market.
All of our business is in the enterprise storage management market. The
enterprise storage management market is still an emerging market. Our future
financial performance will depend in large part on continued growth in the
number of organizations adopting company-wide storage and management solutions
for their client/server computing environments. The market for enterprise
storage management may not continue to grow. If this market fails to grow or
grows more slowly than we currently anticipate, our business, operating results
and financial condition would be seriously harmed.
We Are Affected by General Economic and Market Conditions.
During recent years, segments of the computer industry have experienced
significant economic downturns characterized by:
. Decreased product demand;
. Product overcapacity;
. Price erosion;
. Work slowdowns; and
. Layoffs.
23
Our operations may experience substantial fluctuations from period-to-period
as a consequence of such industry patterns, general economic conditions
affecting the timing of orders from major customers, and other factors
affecting capital spending. The occurrence of such factors could seriously harm
our business, operating results or financial condition.
Protection of Our Intellectual Property is Limited.
Our success depends significantly upon proprietary technology. To protect
our proprietary rights, we rely on a combination of:
. Patents;
. Copyright and trademark laws;
. Trade secrets;
. Confidentiality procedures; and
. Contractual provisions.
We seek to protect our software, documentation and other written materials
under patent, trade secret and copyright laws, which afford only limited
protection. However,
. We may not develop proprietary products or technologies that are
patentable;
. Any issued patent may not provide us with any competitive advantages or
may be challenged by third parties; or
. The patents of others may seriously impede our ability to do business.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult, and software piracy can be expected to be a persistent problem. In
licensing our products, other than in enterprise license transactions, we rely
on "shrink wrap" licenses that are not signed by licensees. Such licenses may
be unenforceable under the laws of certain jurisdictions. In addition, the laws
of some foreign countries do not protect our proprietary rights to as great an
extent as do the laws of the United States. Our means of protecting our
proprietary rights may not be adequate. Our competitors may independently
develop similar technology, duplicate our products or design around patents
issued to us or other intellectual property rights of ours.
From time to time, we have received claims that we are infringing third
parties' intellectual property rights. In the future, we may be subject to
claims of infringement by third parties with respect to current or future
products, trademarks or other proprietary rights. We expect that software
product developers will increasingly be subject to infringement claims as the
number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation, cause product shipment delays or require us to enter into royalty
or licensing agreements with third parties. If such royalty or licensing
agreements, if required, are not available on terms acceptable to us, our
business, operating results and financial condition could be seriously harmed.
Defects in Our Products Would Harm Our Business.
Our products can be used to manage data critical to organizations. As a
result, the sale and support of products we offer may entail the risk of
product liability claims. A successful product liability claim brought against
us could seriously harm our business, operating results and financial
condition.
24
Year 2000 Issues Could Affect Our Business.
Many currently installed computer systems and software products include
coding to accept only two digit entries in the date code field. These date code
fields need to accept four digit entries to distinguish 21st century dates from
20th century dates. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail. Some uncertainty
existed in the software industry concerning the potential effects associated
with such problems, although much of that uncertainty has now been allayed
following the roll-over to the Year 2000.
The risks posed by Year 2000 issues could still adversely affect our
business in a number of significant ways. We believe after examining and
testing our products that our internally developed technology, as well as the
third-party technology incorporated into our products, is Year 2000 compliant.
Moreover, to date, we have not detected any disruptions in our software
applications or in the applications of our vendors arising from the roll-over
to the Year 2000. Nonetheless, our products could experience unexpected Year
2000 issues that we have failed to uncover to date, which could cause our
products to be impaired. We also use third party financial and other systems in
our internal business operations. To our knowledge, these products have not
experienced Year 2000 disruptions following the roll-over to the Year 2000.
Nonetheless these systems could suffer from unexpected Year 2000 issues. Any
such Year 2000 issues could materially adversely affect our business. Moreover,
we may in the future be required to defend our products or services in
litigation or arbitration proceedings involving our products or services
related to Year 2000 compliance issues, or to negotiate resolutions of claims
based on Year 2000 issues. Defending or resolving Year 2000 related disputes,
regardless of the merits of such disputes, and any liability we have for Year
2000 related damages, including consequential damages, could be expensive.
Our Trading Price is Volatile.
The trading of our common stock is highly volatile, closing as high as
$79.25 and as low as $10.625 since December 1, 1999, and the price of our
common stock will fluctuate in the future. An investment in our common stock is
subject to a variety of significant risks, including, but not limited to the
following:
. Quarterly fluctuations in financial results or results of other software
companies;
. Changes in our revenue growth rates or our competitors' growth rates;
. Announcements that our revenue or income are below analysts'
expectations;
. Changes in analysts' estimates of our performance or industry
performance;
. Announcements of new products by our competitors or by us;
. Developments with respect to our patents, copyrights, or proprietary
rights or those of our competitors;
. Sales of large blocks of our common stock;
. Conditions in the financial markets in general;
. Litigation;
. General business conditions and trends in the distributed computing
environment and software industry; and
. Costs and resources required to address potential Year 2000 problems
relating to our products or our internal use software and hardware.
In addition, the stock market may experience extreme price and volume
fluctuations, which may affect the market price for the securities of
technology companies without regard to their operating performance or any of
the factors listed above. These broad market fluctuations may seriously harm
the market price of our common stock.
25
ITEM 2. PROPERTIES
Our principal headquarters, beginning in March 2000, is located in
approximately 105,000 square feet of space in Mountain View, California. This
facility is leased through December 2009. Our principal research and
development facility is located in approximately 96,000 square feet of space in
Palo Alto, California. This facility is leased through September 2006. Our
principal sales and marketing office is located in approximately 52,500 square
feet of space in Sunnyvale, California. This office is leased through February
2007. We also currently lease other domestic offices throughout the United
States, as well as international offices throughout the world.
ITEM 3. LEGAL PROCEEDINGS
On January 20, 2000, a shareholder securities class action complaint was
filed in the U.S. District Court, Northern District of California, against
Legato and certain of its directors and officers. Other similar class actions
involving the same defendants and substantially similar allegations were filed
soon thereafter. The complaints generally allege that, between October 21, 1999
and January 19, 2000, the defendants made false or misleading statements of
material fact about our prospects and failed to follow generally accepted
accounting principles; one amended complaint alleges that the wrongdoing
occurred between October 21, 1999 and March 31, 2000. The complaints assert
claims under the federal securities laws. The complaints seek an unspecified
amount in damages. The court has determined that all of the cases are related
and assigned them to one federal judge. Two plaintiffs filed motions to be
appointed as lead plaintiff. On May 1, 2000, the court held a hearing and
consolidated all of the pending cases; the court took under submission the lead
plaintiff motions. The lead plaintiff will file a consolidated amended
complaint.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our
officers and directors. We are named as nominal defendant. The complaint
generally alleges the same conduct as the shareholder class actions filed in
U.S. District Court. The complaint asserts that as a result of this conduct
certain of our officers and directors breached their fiduciary duties to us and
engaged in improper insider trading. The complaint seeks an unspecified amount
in damages and injunctive relief on our behalf. The court determined that the
derivative action is related to the class actions and has assigned it to the
same federal judge.
On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as nominal defendant. The complaint generally alleges
the same conduct as the shareholder class actions filed in U.S. District Court.
The complaint asserts that as a result of this conduct certain of our officers
and directors breached their fiduciary duties to us and engaged in improper
insider trading. The complaint seeks an unspecified amount in damages and
injunctive relief on our behalf.
The Company and the individual defendants intend to defend all of these
actions vigorously. There can be no assurance that any of the complaints
discussed above will be resolved without costly litigation, or in a manner that
is not adverse to our financial position, results of operations or cash flows.
No estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 1999.
ITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are biographical summaries of our executive officers as of
April 3, 2000:
Louis C. Cole, 56, joined Legato, as President, Chief Executive Officer and
a Director in June 1989. Since April 1995, Mr. Cole has also served as Chairman
of the Board. Before joining Legato, from March 1987 until
26
July 1988, Mr. Cole served as Executive Vice President responsible for all
operating divisions of Novell, Inc., or Novell, a manufacturer of computer
networking and software products. Mr. Cole serves as a director of Inference
Corp., Rogue Wave Software and NetIQ, all publicly held software companies. Mr.
Cole holds a B.S. in mathematics and education from Pennsylvania State
University at Edinboro.
Kent D. Smith, 51, has served as Executive Vice President of Strategic
Alliances of Legato since October 1999. In April 2000, Mr. Smith also assumed
responsibilities as Executive Vice President of Worldwide Sales, Support and
Corporate Marketing. He served as Executive Vice President and Chief Operating
Officer from May 1996 until October 1999. He served as Executive Vice President
of Customer Operations from March 1995 to May 1996. Before joining Legato, from
March 1994 until March 1995, Mr. Smith served as Vice President of Emerging
Markets at VeriFone, Inc., or VeriFone, a transaction automation company. Prior
to joining VeriFone, Mr. Smith held a range of sales and marketing positions in
the United States and overseas with IBM Corporation, or IBM, a publicly held
manufacturer of computers and related products, from 1974 to 1994. Mr. Smith
holds a B.A. in German from California State University at Fullerton and an
M.B.A. from the University of Southern California.
Nora M. Denzel, 37, has served as Senior Vice President and General Manager
of the Data Protection and Management Division since October 1999. In April
2000, Ms. Denzel also assumed responsibilities as General Manager of the Data
Availability Management Division. She served as Senior Vice President of
Product Operations from January 1997 to October 1999. Before joining Legato,
Ms. Denzel served as the director of IBM's storage management software products
and held a range of operations, engineering and marketing positions with IBM
from 1984 to 1996. She serves on the boards of a private software company,
Women in Technology International and the University of Santa Clara Business
School. Ms. Denzel holds a B.S. in Computer Science from the State University
of New York and an M.B.A. from Santa Clara University.
Thomas L. Panozzo, 52, joined Legato in July 1999 as Senior Vice President
of Worldwide Customer Support, Prior to joining Legato, Mr. Panazzo served as
Vice President, Customer Support, of Candle Corporation, a systems management
software company, from January 1997 to June 1999. From June 1966 to January
1997, he served in various positions at IBM, including Senior Project
Executive, Manager and Regional Manager. Mr. Panozzo holds a B.S. from the
Illinois Institute of Technology and a M.B.A. from Pepperdine University.
Stephen C. Wise, 45, joined Legato Systems, Inc., in September 1996 as
Senior Vice President of Finance and Administration and Chief Financial
Officer. Before joining Legato, Mr. Wise served as Senior Vice President,
Finance of Novell from December 1994 to September 1996. He was Vice President
and Corporate Controller of Novell from January 1991 to December 1994 and was
Vice President, Accounting and Planning from January 1990 to January 1991. Mr.
Wise holds a B.S. in Accounting from San Jose State University and an M.B.A.
from Santa Clara University.
James Chappell, 39, joined Legato Systems, in June 1992. In April 2000, Mr.
Chappell became the Vice President of Plans and Controls. From October 1999
until April 2000, he served as Vice President and General Manager of the Data
Availability Division. From August 1998 to October 1999, he served as our Vice
President of Business Development. From June 1992 to July 1998, Mr. Chappell
held various sales and marketing management positions with Legato, including
general manager, manager of strategic businesses and director of worldwide
channel marketing. Prior to joining Legato, Mr. Chappell served as President of
The Connectivity Lab, a data communications consulting firm, from March 1989 to
March 1991. Mr. Chappell holds a B.S. in Computer Science from Cal Poly
University, San Luis Obispo, California.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol
LGTO. Since April 20, 2000, an "E" has been appended to our trading symbol,
indicating that we have become subject to Nasdaq delisting procedures as a
result of our delay in filing our Form 10-K for fiscal 1999. The following
table sets forth the high and low closing sales prices of our common stock from
January 1, 1997 through December 31, 1999. Such prices represent prices between
dealers, do not include retail mark-ups, mark-downs or commissions and may not
represent actual transactions.
Share prices have been adjusted to reflect the two-for-one splits of our
common stock, which were effected July 5, 1996, April 17, 1998 and August 13,
1999.
High Low
------ ------
Fiscal 1997
-----------
First Quarter.................................................. $ 8.22 $ 4.04
Second Quarter................................................. $ 6.22 $ 2.75
Third Quarter.................................................. $ 8.94 $ 4.35
Fourth Quarter................................................. $11.66 $ 8.07
Fiscal 1998
-----------
First Quarter.................................................. $14.97 $10.03
Second Quarter................................................. $19.75 $12.88
Third Quarter.................................................. $27.37 $17.57
Fourth Quarter................................................. $32.97 $15.13
Fiscal 1999
-----------
First Quarter.................................................. $32.75 $20.75
Second Quarter................................................. $29.75 $15.25
Third Quarter.................................................. $49.13 $28.31
Fourth Quarter................................................. $79.25 $41.09
As of April 30, 2000, there were approximately 200 holders of record of our
common stock. We believe that a significant number of beneficial owners of our
common stock hold shares in street name.
We have never paid a cash dividend on our common stock and do not intend to
pay cash dividends on our common stock in the foreseeable future.
28
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Five Year Summary
December 31,
-------------------------------------------
1999 1998(3) 1997(3) 1996(2) 1995(2)
-------- -------- -------- -------- -------
(in thousands, except per share amounts)
Revenue.......................... $228,567 $167,907 $118,499 $ 88,920 $49,066
Gross profit..................... 196,790 143,114 97,812 70,457 36,591
Income from operations........... 2,991 27,815 21,589 15,747 7,288
Net income....................... 2,704 19,869 15,066 10,814 8,628
Basic earnings per share(1)...... 0.03 0.26 0.21 0.16 0.21
Shares used in basic earnings per
share calculations.............. 82,420 76,762 72,849 68,565 41,100
Diluted earnings per share(1).... 0.03 0.24 0.19 0.14 0.14
Shares used in diluted earnings
per share
calculations(1)................. 89,351 83,074 78,886 78,215 63,246
Cash, cash equivalents and
investments..................... 169,928 125,972 87,433 76,945 53,805
Working capital.................. 152,514 119,717 87,848 71,427 41,156
Total assets..................... 422,894 207,224 141,908 111,704 69,946
Retained earnings (accumulated
deficit)........................ 46,068 43,364 23,495 9,741 (1,073)
Total stockholders' equity....... 337,745 158,529 114,737 90,813 56,229
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements
(2) Selected financial data for the year-ended December 31, 1996 and 1995 was
derived by combining Legato's selected financial data for the year-ended
December 31, 1996 and 1995 with FullTime's financial data for the fiscal
year-ended June 30, 1997 and 1996, respectively.
(3) Selected financial data for the year-ended December 31, 1998 and 1997 was
derived by combining Legato's selected financial data for the year-ended
December 31, 1998 and 1997 with FullTime's financial data for the twelve-
months ended December 31, 1998 and 1997, respectively.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in this report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding our expectations, beliefs, intentions or strategies
regarding the future. All forward-looking statements included in this document
are based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. Our actual results
could differ materially from those discussed. Factors that could cause or
contribute to such differences include, but are not limited to, fluctuations in
quarterly operating results, uncertainty in future operating results,
litigation, product concentration, competition, technological changes, reliance
on enterprise license transactions, reliance on indirect sales channels,
dependence on international revenue, management of our growth and expansion,
integration of recent acquisitions and other risks discussed in this item under
the heading "Risk Factors" and the risks discussed in our other Securities and
Exchange Commission filings.
Results of Operations
Overview
On January 19, 2000, we announced that we would be restating results for the
third quarter of 1999 to reflect an adjustment concerning one contract that
decreased revenue in the third quarter from $71.7 million to $65.9 million;
this agreement has been subsequently terminated. On March 31, 2000, we filed a
Form 12b-25 with the Securities and Exchange Commission stating that we were
unable to file our Form 10-K within the prescribed period because, as a result
of our regular first quarter review that included a review of past due accounts
receivables, including certain fourth quarter transactions for which payment
was due, we discovered additional information that related to such transactions
and requested our independent auditors to evaluate such transactions in light
of this additional information. On April 3, 2000, we announced that we
discovered that a number of our sales representatives, acting outside their
authority, had entered into side agreements affecting contracts signed with
resellers in the fourth quarter. These side agreements supplemented the
contractual arrangements for sales transactions with these resellers by making
payment to us contingent on sale by the reseller. As a result, we delayed
filing of our 10-K pending conclusion of our review of these matters. We also
announced that we believed our revenue for the first quarter ended March 31,
2000 would be in the range of $54 million to $56 million, and that we expected
to release complete financial results and provide additional information
relating to the first quarter on April 19, 2000.
On April 5, 2000, our Board of Directors appointed a special investigation
committee of the board composed of two outside directors, Messrs. Bingham and
Strohm, to investigate, with the assistance of outside counsel, the nature and
extent of the side agreements and our revenue recognition practices. On April
17, 2000, we announced that although we had previously anticipated that we
would file our Form 10-K by April 14, we would be delaying the filing of our
Form 10-K pending completion of the evaluation of transactions throughout
fiscal 1999. We also announced that, as a result of our ongoing investigation,
we would delay the release of our financial results for the first quarter of
fiscal 2000 until we had filed our Form 10-K. During its investigation, the
committee discovered certain facts indicating that a number of our sales
representatives, acting outside their authority, had entered into additional
unauthorized written and oral agreements outside our standard contractual terms
with certain of our resellers. These side agreements allowed the resellers to
pay us only when they were paid by end users, to return product in the event
that a sale to an end user was not consummated, or to pay us on extended terms.
If the existence of these side agreements had been known at the time that the
transactions were signed, we would not have recognized revenue on these
transactions in the period in which they were initially recorded as the fees
involved would not have been deemed to be fixed or determinable. Accordingly,
we have revised the revenue recognition for all transactions with these
resellers during fiscal 1999 to reflect the point in time when these fees were
considered fixed or determinable which coincided with the receipt of
30
payments from these resellers. The results of our review of the transactions in
1999 were such that we concluded that the problems surrounding unauthorized
written and oral agreements did not extend into earlier years.
As a result of the revisions discussed above, we will restate our revenues
and results of operations for the quarters ended September 30, 1999, June 30,
1999 and March 31, 1999 and will revise our results for the quarter ended
December 31, 1999 previously announced on January 19, 2000. The effect of these
adjustments is a decrease in revenue of $23.0 million and a decrease in net
income of $12.3 million for the year ended December 31, 1999.
We develop, market and support network storage management software products
for heterogeneous client/server computing environments and large scale
enterprises. Our data protection products, primarily the NetWorker family of
software products, from which we derive a substantial majority of our revenue,
and our data availability products primarily our HA+, Octopus, Replication and
Cluster products, support many storage management server platforms and can
accommodate a variety of servers, clients, applications, databases and storage
devices. We license our products through resellers and directly to end users
primarily located in North America, Europe and Asia Pacific. We also license
our source code to original equipment manufacturers, or OEMs, in exchange for
initial licensing fees and receive ongoing royalties from the OEMs' product
sales. Substantially all of the OEMs are large computer system and software
suppliers located in the United States, Europe and Asia Pacific.
We acquired Software Moguls, Inc. in August 1998 and FullTime in April 1999,
primarily for their product offerings and research and development teams. We
accounted for the acquisitions as poolings-of-interests. Accordingly, we
restated the financial statements to represent the combined financial results
of previously separate entities for all periods presented.
31
Selected elements of our consolidated financial statements are shown below
for the last three years as a percentage of total revenue and as a percentage
change from year to year.
% Increase
% of Total Revenue (Decrease)
for Years ------------------
Ended December 31, 1999 1998
------------------------ Compared Compared
1999 1998 1997 to 1998 to 1997
------ ------ ------ -------- --------
Revenue:
Product license............... 60% 62% 58% 32% 51%
Service and support........... 30 23 20 74 68
Royalty....................... 10 11 14 22 15
Other products................ -- 4 8 (93) (39)
------ ------ ------
Total revenue............... 100 100 100 36 42
Cost of revenue:
Product license............... 3 3 4 5 14
Service and support........... 11 9 7 71 71
Other products................ -- 3 6 (93) (39)
------ ------ ------
Total cost of revenue....... 14 15 17 28 20
------ ------ ------
Gross profit.................... 86 85 83 38 46
Operating expenses:
Research and development...... 17 15 15 56 44
Sales and marketing........... 41 43 38 30 58
General and administrative.... 9 10 10 29 36
Amortization of intangibles... 10 1 1 1,849 --
Merger-related expenses....... 3 -- -- 867 --
In-process research and
development.................. 5 -- -- -- --
------ ------ ------
Total operating expenses.... 85 69 64 68 51
------ ------ ------
Income from operations.......... 1 16 19 (89) 29
Interest income, net............ 3 3 3 14 38
------ ------ ------
Income before provision for
income taxes................... 4 19 22 (74) 30
Provision for income taxes...... 3 8 8 (57) 27
------ ------ ------
Net income...................... 1% 11% 14% (86)% 32%
====== ====== ======
Revenue
Total revenue was $228.6 million in 1999, $167.9 million in 1998 and $118.5
million in 1997. Total revenue increased 36 percent from 1998 to 1999 and 42
percent from 1997 to 1998. Total revenue increased primarily as a result of the
continued acceptance of our Networker family of products, increased sales of
service and support contracts, as well as increased royalty revenue.
Product License Revenue. Product license revenue was $137.4 million in 1999,
$103.8 million in 1998 and $68.8 million in 1997. Product license revenue
increased 32 percent from 1998 to 1999 and 51 percent from 1997 to 1998.
Product license revenue increased primarily as a result of the continued market
acceptance of our products. Product license revenue also increased as a result
of increased product sales to large-scale enterprises. The increase in our
number of sales and marketing personnel, as well as sales and marketing
programs helped to increase the market acceptance of our products and product
sales. Our sales and marketing personnel increased from 266 employees in 1997
to 449 employees in 1999. We recognize product revenue upon shipment if a
signed contract exists, the fee is fixed or determinable, collection of
resulting receivables is probable and product returns are reasonably estimable,
except for sales to domestic distributors and certain value-added resellers for
1999. We recognize revenue from domestic distributors upon sale by the
distributor
32
since these distributors have unlimited rights of return and we historically
have not been able to make reasonable estimates of product returns for these
distributors. We also incur additional internal costs to assist our
distributors in selling our products to end users. For transactions entered
into 1999 with those resellers where we have determined that fees were not
fixed or determinable due to circumstances involving unauthorized written and
oral agreements outside our normal contractual terms, as discussed in Note 1,
we recognize revenue upon receipt of cash. A total of $7.1 million has been
billed to those resellers for transactions entered into in 1999 and for which
products have been delivered but for which the receivable and revenue has not
been recognized. For certain sales where the licensing fee is not due until the
customer deploys the software, revenue is recognized when the customer reports
to us that the software has been deployed. Prior growth rates of our product
license revenue are not indicative of future product license revenue growth
rates and may not be sustainable in the future.
Service and Support Revenue. Service and support revenue was $67.5 million
in 1999, $38.8 million in 1998 and $23.1 million in 1997. Service and support
revenue increased 74 percent from 1998 to 1999 and 68 percent from 1997 to
1998. Service and support revenue increased primarily as a result of the growth
in the number of registered customers electing to subscribe to support
contracts and to renew software support contracts after the initial one-year
term. Our increase in internal staffing for software support helped to increase
new sales and renewals of our software support contracts. Our increase in
internal staffing for education and consulting services resulted in increased
sales of the education and consulting services we offer. Our technical support
personnel increased from 80 employees in 1997 to 183 employees in 1999. Our
consulting and education services personnel increased from 19 employees in 1997
to 55 employees in 1999. We collect fees for ongoing customer support and
product updates in advance and recognize this support revenue ratably over the
period of the contract. For education and consulting services, we recognize
revenue as such services are performed. Prior growth rates of our software
service and support revenue are not indicative of future software service and
support revenue growth rates and may not be sustainable in the future.
Royalty Revenue. Royalty revenue was $23.3 million in 1999, $19.2 million in
1998 and $16.7 million in 1997. Royalty revenue increased 22 percent from 1998
to 1999 and 15 percent from 1997 to 1998. The increase in royalty revenue is
attributed to increased product sales by OEMs, including new OEM partners from
our acquisition of Vinca in July 1999. Royalty revenues are recognized upon
receipt of quarterly royalty reports from OEMs related to their product sales
for the previous quarter. Prior growth rates of our royalty revenue are not
indicative of future royalty revenue growth rates and may not be sustainable in
the future.
Other Product Revenue. Revenue from sales of other products was $0.5 million
in 1999, $6.2 million in 1998 and $10.0 million in 1997. Other product revenue
decreased 93 percent from 1998 to 1999 and 39 percent from 1997 to 1998. Other
product revenue represented less than 1 percent of total revenue in 1999, 4
percent in 1998 and 8 percent in 1997. Other product revenue consists primarily
of third-party ancillary hardware and software products for distributed
computing systems that are resold by Qualix Direct, the telesales organization
of FullTime, acquired in April 1999. The decrease in other revenue is primarily
attributable to the continued focus on sales of internally developed software
products rather than third party products sold through Qualix Direct.
International product license revenue accounted for 41 percent of total
revenue in 1999 and 1998 and 37 percent in 1997. International license revenue
in absolute dollars increased primarily as a result of the continued market
acceptance of our products overseas. An increase in the number of international
sales offices and international distributors and resellers marketing our
products helped increase the market acceptance of our products overseas. The
majority of international sales during these periods were made in Europe and
Canada. To date, we have established foreign offices in the following
countries:
. Australia;
. Belgium;
. Canada;
33
. China;
. France;
. Germany;
. Japan;
. Italy;
. Netherlands;
. Poland;
. Singapore;
. Sweden;
. Switzerland; and
. United Kingdom.
We believe that our continued growth and profitability will require further
expansion of our international operations. In order to successfully expand
international sales in 2000 and subsequent periods, we must continue to
establish additional foreign operations, hire additional personnel for these
operations and recruit additional international resellers. Expansion and
management of our international operations will require significant management
attention and financial resources and could seriously harm certain operating
results if such efforts are not successful. To the extent that we are unable to
effect these additions in a timely manner, our growth, if any, in international
revenue will be limited, and our business, operating results and financial
condition could be seriously harmed. In addition, we cannot guarantee that we
will be able to maintain or increase international market demand for our
products. Our international sales are currently denominated in U.S. dollars. An
increase in the value of the U.S. dollar relative to foreign currencies could
make our products more expensive and, therefore, potentially less competitive
in those markets. In some markets, localization of our products is essential to
achieve market penetration. We may incur substantial costs and experience
delays in localizing our products, and we cannot guarantee that any localized
product will ever generate significant revenue.
Gross Profit
Gross profit was $196.8 million in 1999, $143.1 million in 1998 and $97.8
million in 1997, representing 86 percent of total revenue in 1999, 85 percent
in 1998 and 83 percent in 1997. Gross profit consists of product license,
service and support and other product revenue less related costs.
Gross profit from product license revenue was $131.8 million in 1999, $98.5
million in 1998 and $64.1 million in 1997, representing 96 percent of product
license revenue in 1999, 95 percent in 1998 and 93 percent in 1997. Gross
profit from product license revenue increased 34 percent from 1998 to 1999 and
54 percent from 1997 to 1998. Gross profit from product license revenue
consists of product license revenue less the related costs. Related costs of
revenue consist primarily of product media, documentation and packaging. Gross
profit from product license revenue as a percentage of product license revenue
increased primarily as a result leveraging the costs of sales over a higher
product license revenue base.
Gross profit from service and support revenue was $41.6 million in 1999,
$23.7 million in 1998 and $14.2 million in 1997, representing 62 percent of the
service and support revenue in 1999, 61 percent in 1998 and 62 percent in 1997.
Gross profit from service and support revenue increased 76 percent from 1998 to
1999 and 66 percent from 1997 to 1998. The continued investment consists of
additional costs associated with supporting a larger installed base of
products, as well as costs to provide higher support levels to customers. Costs
of service and support revenue consist primarily of personnel-related costs
incurred in providing telephone support, consulting services, and training to
customers, costs of providing software updates and costs of education and
consulting materials.
Gross profit from other product revenue was $0.1 million in 1999, $1.8
million in 1998 and $2.8 million in 1997, representing 29 percent of other
product revenue in 1999 and 1998 and 28 percent in 1997. Gross
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profit from other product revenue decreased 93 percent from 1998 to 1999 and 39
percent from 1997 to 1998. Gross profit from other product revenue decreased in
absolute dollars primarily as a result of FullTime's continued focus on sales
of internally developed software products rather than third party products sold
through Qualix Direct telesales organization prior to our acquisition in April
1999.
Operating E