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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, 2000
[_] 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).
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 16, 2001 was approximately $882,000,000. 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 16, 2001 was 88,029,645.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement (the "Proxy
Statement") relating to its 2001 annual meeting of stockholders to be held on
May 15, 2001 are incorporated by reference into Part III of this Annual Report
on Form 10-K. Except as expressly incorporated by reference, the Registrant's
Proxy Statement shall not be deemed to be part of this report.
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LEGATO SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED
DECEMBER 31, 2000
Table of Contents
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 23
Item 3. Legal Proceedings.............................................. 23
Item 4. Submission of Matters to a Vote of Security Holders............ 24
PART II
Market for Registrant's Common Stock and Related Stockholder
Item 5. Matters........................................................ 26
Item 6. Selected Consolidated Financial Data........................... 26
Management's Discussion and Analysis of Financial Condition and
Item 7. Results of Operations.......................................... 27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..... 34
Item 8. Consolidated Financial Statements and Supplementary Data....... 34
Changes in and Disagreements with Accountants on Accounting and
Item 9. Financial Disclosure........................................... 34
PART III
Item 10. Directors and Executive Officers of the Registrant............. 35
Item 11. Executive Compensation......................................... 35
Security Ownership of Certain Beneficial Owners and
Item 12. Management..................................................... 35
Item 13. Certain Relationships and Related Transactions................. 35
PART IV
Exhibits, Financial Statement Schedules, and Reports on Form 8-
Item 14. K.............................................................. 36
Signatures............................................................... 60
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PART I
ITEM 1. BUSINESS
The discussion in this report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, including
statements on our expectations, beliefs, intentions or strategies regarding the
future, including without limitation, our financial outlook, successful
introduction of new products and expansion of operation. All forward-looking
statements included in this document are based on information available to us
on the date hereof. We assume no obligation to update any such forward-looking
statements. Our actual results could differ materially from those indicated in
such forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, fluctuations in quarterly
operating results, uncertainty in future operating results, litigation,
competition, product concentration, technological changes, reliance on
enterprise license transactions, modifications in the application of accounting
policies, reliance on indirect sales channels, changes in marketing strategies,
dependence on international revenue, management of our growth and expansion,
the ability to attract and retain qualified personnel, and other risks
discussed in this item under the heading "Risk Factors" and the risks discussed
in our other Securities and Exchange Commission filings.
We develop, market and support software products and services for
heterogeneous client/server computing environments in mid- to large-scale
enterprises. We are a technology leader in the network storage management
software market through our commitment to open, standards-based software
development. Our software delivers to customers a solution that is scalable,
high-performance and manageable and ensures high data and application
availability on a wide range of servers, clients, applications, databases and
storage devices. Our data protection products, primarily the NetWorker family
of products, and our data availability products, primarily our Legato Cluster
and wanCluster products, support many server platforms and accommodate a
variety of clients, applications, databases and storage devices. Our long-term
strategy is to create an integrated set of solutions centered on information
protection, availability and storage management that enhance and simplify
network computing as a whole.
The Legato Solution
Our information protection, availability and management software products
and services have been designed to address the requirements of information
technology, or IT, professionals as they expand their enterprise and build
their e-business computing environments. Based on open standards, our
information protection solutions employ a client/server architecture to enable
customers with flexibility and choice in their decisions regarding computing
systems. We offer a consistent operating approach for our information
availability solutions which improves our customers' ability to deploy one
solution across a broad range of operating systems. Coupled with our
professional services offerings, we offer 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 key advantages of our
solution include:
. Scalability;
. Heterogeneity;
. Performance;
. Ease of use; and
. Data availability.
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Scalability. Our solution architecture is designed to enable scalable growth
within a company's computing environment. For our customers, this means that
they can be confident that their information protection strategy is resilient
to changes in servers, clients, storage sub-systems, and storage devices. Our
solutions can be configured or expanded to meet the needs of a changing and
dynamic network thereby extending a customer's investment protection. 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 can be 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.
Our family of storage management server products operates on the following
operating systems:
. Linux;
. NetWare;
. Windows NT;
. Windows 2000;
. UNIX systems (AIX, Dynix/ptx, HP-UX, Irix Solaris, and Tru64); and
. UNIX systems and Windows NT and Windows 2000 offered by our OEMs.
Our products support server and desktop computer clients including:
. Macintosh;
. Mac OS;
. NetWare;
. Network Appliance
. UNIX;
. MPE/iX;
. Windows;
. Windows NT; and
. Windows 2000.
Our NetWorker Applications Modules support applications and databases
including:
. DB2;
. Informix;
. Lotus Notes;
. Microsoft Exchange;
. Microsoft SQL;
. Oracle;
. SAP R/3; and
. Sybase.
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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 data volumes 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 Legato Cluster,
CoStandByServer and Legato Mirroring Extension, enable 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
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. 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. Our Global Enterprise Management Systems, or G.E.M.S.,
product allows information system organizations the ability to globally manage
thousands of NetWorker storage servers.
Data availability. Our data availability products, including our CoStandBy
Server, Octopus, 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, Legato Cluster products can promptly select 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.
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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.
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 of expensive on-site 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 retrieve a
particular piece of removable storage media, thereby eliminating the need for
human intervention.
Products
Our NetWorker family of storage management server software 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
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network. Our server software is available for NetWare, Windows NT, Windows
2000, Linux, several UNIX platforms, including Compaq (Digital), HP, IBM,
Silicon Graphics, Sequent and Sun versions of UNIX. A number of applications
and enhancement 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, our customers must purchase the client software
for dissimilar platforms. 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, Sequent and Sun;
. ClientPak for PC Desktops, 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;
. ClientPak for Network Appliance, which supports Network Appliance filers
via TCP/IP Ethernet connections;
. ClientPak for Linux;
. ClientPak for NetWare, which supports NetWare; and
. ClientPak for Macintosh, which supports MacOS.
The base NetWorker server product for Windows NT and Windows 2000, Linux,
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, which provides support for up to eight client
connections and two storage devices;
. Network Edition--an enterprise-strength storage management solution for
distributed networks, which is packaged with support for up to ten
clients and supports 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,
which features enhanced architecture to increase throughput while
minimizing use of system resources and supports all standard NetWorker
options.
NetWorker for Linux and 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;
. Application Modules--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;
. Hierarchical Storage Management (HSM)--the ability to automatically
migrate rarely-used files from primary to secondary storage (Solaris
only);
. High Speed Device Support--the ability to utilize high speed devices;
. NDMP Support--the ability to provide local and remote data protection
services for Network Attached Storage (NAS) devices, via the Network Data
Management Protocol (NDMP);
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. Recovery Manager--the ability to provide automated "bare-metal" disaster
recovery for Solaris systems;
. 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 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;
. Application Modules--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;
. Hierarchical Storage Management (HSM)--the ability to automatically
migrate rarely-used files from primary to secondary storage;
. 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.
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 data availability products, including our CoStandBy Server, Octopus 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 wanCluster product complements the NetWorker family of products by
providing users with management of the EMC SRDF replication technology, and
automation of the disaster recovery activities necessary to bring a remote site
on-line.
Our Celestra products allow users the ability to move data 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.
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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-sales technical support to business partners and
end-user customers in North America from our corporate offices and from
regional offices in the following metropolitan areas:
. Atlanta . Los Angeles
. Boston . Montreal
. Chicago . New York
. Dallas . Seattle
. Denver . Toronto
. Houston . Washington, D.C.
We reach the market through multiple distribution channels including:
. Direct sales;
. Resellers;
. Distributors; 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 and distributors. 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 license our products to large regional and national
distributors who distribute 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 Tech Data.
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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 . Poland
. Belgium . Singapore
. Canada . South Korea
. China . Spain
. France . Sweden
. Germany . Switzerland
. Italy . Taiwan
. Japan . United Kingdom
. Netherlands
International product sales were $75.7 million in 2000, $65.8 million in
1999 and $45.5 million in 1998, representing 33% of total revenue in 2000, 29%
of total revenue in 1999 and 27% of total revenue in 1998. The majority of
international sales during these periods were made in Europe and Canada. We
believe that international markets present an attractive growth opportunity and
are expanding the scope of our international operations. We have engaged, and
will continue to engage, international resellers and distributors in targeted
countries and are developing cooperative 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.
OEMs.
Source Code OEM Program. Our source code OEM program generates royalty
revenue for our business. Under this program, we license our software products,
in source code form, to leading computer system and software suppliers from
which we typically receive an initial license fee and ongoing royalty revenue.
The OEM partner is then responsible for porting our software to its unique
operating system environment, testing it, licensing it through the OEM
partner's direct sales force and distribution channels and providing the
primary customer support after installation. OEM partners 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 such as personnel, facilities and infrastructure.
We currently have source code OEM agreements in place with several computer
system and software suppliers, including:
. Amdahl;
. ePresence (formerly Banyan Systems);
. Groupe Bull;
. EMC;
. Fujitsu-ICL;
. NEC;
. Siemens Nixdorf; and
. WumpusWare
Strategic Alliance Program. The Strategic Alliance 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
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investment in porting the source code to their platforms. For example, Sun
Microsystems, a private label reseller, licenses the object code for the
standard Legato products and licenses and supports the products under their
logo as described above for the source code OEM program. We also have
established strategic alliances with Hewlett-Packard, Informix and Oracle.
No one customer accounted for more than 10% of our total revenue for 2000,
1999 or 1998.
Corporate Marketing
We support our multi-tiered distribution efforts with marketing programs
designed to establish our image in key markets, differentiate our products, and
to generate end-user demand. Marketing programs include channel marketing,
product marketing, as well as programs specifically targeted to the North
American, European and other intercontinental markets. We participate in
industry forums and events, trade shows and advertise in key trade publications
and on the Internet. We work directly with industry analysts to update them on
our products. Leads are qualified by our inside sales staff and provided to our
channel partners. Additionally, resellers and distributors are provided with
promotional and educational materials and can qualify for market development
funding for specific promotional activities tailored for their solutions and
geography.
Service & Support
We employ systems engineers, educators and storage consultants who work
closely with our direct sales, resellers and our customers to resolve issues
and provide solutions during pre-sales and post-sales.
Support services. We offer maintenance, which consists of product updates
and technical support services. Product updates are included for the first year
with our software, and technical support may be purchased separately. Customers
may renew maintenance services annually or purchase future product updates.
Maintenance customers receive updates, enhancements and improvements to
supported software, such as support for new operating systems. Annual fees for
maintenance are calculated as a percentage of the customer's installed base of
products. The percentage is based upon the level of technical support selected
by the customer and is currently priced from 18% to 24% of product license list
price.
Generally, customers covered by the Basic Maintenance offering receive
telephone or electronic support from 8 a.m. to 5 p.m. in the customer's local
time zone, Monday through Friday. Response times for open cases are based on
service level objectives and the severity level that the customer sets at the
time the case is opened. The Extended Maintenance offering provides the same
level of service while expanding the hours of coverage to 24 hours a day, 7
days a week. The Premier Maintenance offering provides 24-hour technical
support coverage, enhanced service level objectives, priority escalation
management and a designated premium support account manager, or PSAM. The PSAM
facilitates the resolution of issues, conducts monthly conference calls, and
maintains familiarity with their technological and operational environment.
Customers that do not have technical support or want service outside their
coverage hours can request support for an additional fee. The pricing for this
support ranges from $500 to $2,500 for each technical support service incident.
Additionally, we offer customers the opportunity to purchase either a six-month
or one-year on-site PSAM, for $150,000 and $200,000, respectively.
Our support organization consists of an experienced staff of technical
support engineers providing telephone and electronic support via electronic
mail from our offices in California, Utah and Ontario, Canada. Our sales and
technical support organizations work closely together to ensure high levels of
overall customer satisfaction.
In recent years, our installed base of customers has significantly
increased, as have the number of customers purchasing software maintenance
contracts. This dramatic growth caused a period of depressed customer
satisfaction. As a result of increased staffing and operational improvements,
we have successfully improved customer satisfaction. Continued investments in
people, technology and operational infrastructure are
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intended to further improve customer satisfaction through decreased time to
resolution, easier access to relevant knowledge and efficiencies in our
operational workflows.
Education services. Our educational services organization offers education
and training to end-users, resellers and partners. Education and training
classes cover theory, installation, operations, configuration and planning on
information protection, information availability and information management.
Training classes are offered through in-house facilities at our offices in
North America and Europe as well as at off-site locations. We also have several
highly qualified authorized training center providers, or ATCs, around the
world. Our authorized training center providers are required to pass a
certification program to be able to teach our customers and resellers. We are
pursuing an aggressive plan to expand our educational offerings through a well-
recognized training company on a worldwide basis. This plan is expected to
substantially increase the number of individuals and companies trained on our
products and to expand the delivery of training through live and on-demand
webcasts. We also provide on-site training services upon request by customers.
Fees for education and training services are charged separately from our
software products
Consulting services. Our consultants are available to work closely with
customers' information systems organizations to assist our customers in
efficiently designing and building their complex storage environments,
tailoring our software products to achieve higher performance, and increasing
the degree of automation. We offer a wide range of tailored consulting services
targeted at solving our clients' complex storage issues. Some of these services
include initial assessments, architecture and design, installation,
configuration, deployment and management. We also offer a number of consulting
packages that provide customers with more specific topics, such as enterprise
analysis, storage network health check, replication and tape conversion. Fees
for consulting services are charged separately from our software products.
Research and Development
Our investment in research and development was $56.6 million in 2000, $40.1
million in 1999 and $25.6 million in 1998. We anticipate that we will continue
to commit substantial resources to research and development in the future. To
date, our development efforts have not resulted in any capitalized software
development costs. In addition, we receive the benefits of additional testing
and product enhancements from each source code OEM's development group. Our
future success will depend upon our ability to develop and introduce new
software products, including new releases, applications and enhancements, 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 and integrate our other technologies into
solutions to meet the ongoing storage management requirements of our customers.
We cannot guarantee that we will be successful in developing and marketing new
products that respond to technological change or evolving industry standards,
that we will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these new products, or
that our new products will adequately meet the requirements of the marketplace
and achieve market acceptance. If we 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.
As part of our ongoing development process, we released several new versions
of NetWorker and our Availability products during 2000 and intend to release
additional versions of NetWorker and Availability products in the future. In
addition, we released several new products, including, but not limited to:
. wanCluster--disaster recovery automation through the integration of our
Legato Cluster technology and EMC's SRDF product for remote data
replication;
. NetWorker 6.0--a major release of our NetWorker product that includes
scalability enhancements as well as support for Networked Attached
Storage ("NAS") via Network Data Management Protocol ("NDMP"); and
. Celestra 1.5--a new release of our serverless backup solution for
NetWorker.
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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, Ontario, Canada;
. Dublin, California;
. Eden Prairie, Minnesota;
. Marlborough, Massachusetts;
. New Delhi, India;
. Orem, Utah;
. Palo Alto, California; and
. Seattle, Washington.
Competition
We operate in the enterprise storage management market, which is intensely
competitive, highly fragmented and characterized by rapidly changing technology
and evolving standards. Competitors vary in size and in the scope and breadth
of the products and services offered. Our major competitors include:
Windows NT and Windows 2000 platforms:
Computer Associates and
Veritas.
Unix platforms:
Computer Associates;
EMC (Epoch);
Hewlett Packard;
IBM (Tivoli); and
Veritas.
Employees
As of December 31, 2000, we had a total of 1,270 employees. Of the total,
454 were in sales and marketing, 364 in research and development, 298 in
service and support and 154 in general and administration. 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.
Risk Factors
The following risk factors and other information included in this Annual
Report on Form 10-K should be carefully considered. The risks and uncertainties
described below are not the only ones we face. Additional
13
risks and uncertainties not presently known to us or that we currently deem
less significant also may impair our business operations. If any of the
following risks actually occur, our business, operating results and financial
condition could be materially negatively affected.
Our quarterly operating results are volatile.
Our quarterly operating results have varied in the past and may vary in the
future. Our quarterly operating results may vary depending on a number of
factors, many of which are outside of our control, including:
. The size and timing of orders;
. Intense competition;
. Macroeconomic uncertainty in the markets in which we operate;
. 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;
. 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 the
application of 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;
. Our ability to effectively manage and reduce our tax liabilities;
. Acquisition costs or other non-recurring charges in connection with the
acquisition of companies, products or technologies;
. Personnel changes; and
. General economic factors.
Our future operating results are uncertain.
Our historical results of operations are not necessarily indicative of our
results for any future period. Expectations, forecasts, and projections by
others or us are by nature forward-looking statements, and it is likely that
future results will vary. Forward-looking statements that were reasonable at
the time made may ultimately prove to be incorrect or false. It is our general
policy and practice not to update our forward-looking
14
statements. Some investors in our securities inevitably will experience gains
while others will experience losses, depending on the prices at which they
purchase and sell securities. Prospective and existing investors are strongly
urged to carefully consider the various cautionary statements and risks set
forth in this report.
We cannot predict our future revenue with any significant degree of
certainty for several reasons including:
. 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.
. 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;
. Macroeconomic factors may affect our customers' decision to license our
products or procure services;
. 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 the
application of revenue recognition policies; 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
may not be meaningful and should not be relied upon as indications of future
performance. Our operating results could be below the expectations of public
market analysts and investors in some future quarter or quarters. Our failure
to meet such expectations would likely cause the market price of our common
stock to decline.
We are currently subject to litigation.
Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against certain of our directors and officers and us. On May 1,
2000, the court consolidated all of the pending cases and, on May 10, 2000,
appointed a lead plaintiff, who filed a consolidated amended complaint on
August 7, 2000. Defendants filed motions to dismiss. On January 17, 2001, the
Court entered an Order granting the motions to dismiss with leave to amend. On
February 13, 2001, plaintiffs filed a second amended complaint, which generally
alleges that, between April 22, 1999 and May 17, 2000, defendants made false or
misleading statements of material fact about the Company's prospects and failed
to follow generally accepted accounting principles in violation of the federal
securities laws. The complaint seeks an unspecified amount in damages.
Defendants will file an answer to the complaint in April 2001 denying all
allegations that they violated the federal securities laws.
15
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 derivative case
has been related to the securities class action. Plaintiff moved to stay the
derivative case. On January 17, 2001, the Court denied plaintiffs' motion to
stay. Plaintiffs filed an amended complaint on February 9, 2001, which
generally alleges the same conduct as the shareholder class action, and claims
that defendants breached their fiduciary duties and engaged in improper insider
trading. The derivative complaint seeks unspecified damages and injunctive
relief. Defendants will move to dismiss the derivative complaint.
On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as a nominal defendant. On May 23, 2000, a shareholder
derivative action was filed in the Superior Court of California, County of San
Mateo, against certain of our officers and directors. We are named as a nominal
defendant. Both state derivative complaints generally allege the same conduct
as the derivative action filed in federal court, claim that our officers and
directors breached their fiduciary duties for the period October 21, 1999
through April 3, 2000, and seek unspecified damages and injunctive relief. The
Santa Clara derivative case was transferred to San Mateo County and
consolidated with the San Mateo derivative case.
The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second, and third quarters of 1999, and our revision of financial results for
the fourth quarter and fiscal 1999. We have been voluntarily cooperating with
the Staff of the Commission in its investigation.
The Company and the individual defendants intend to defend all of these
actions vigorously. However, there can be no assurance that any of the
complaints discussed above will be resolved without costly litigation, or in a
manner that is not materially adverse to our financial position, results of
operations or cash flows. 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:
Windows NT and Windows 2000 platforms:
Computer Associates and
Veritas.
Unix platforms:
Computer Associates;
EMC (Epoch);
Hewlett Packard;
IBM (Tivoli); and
Veritas.
We expect to encounter new competitors as we enter new markets. In addition,
many of our existing competitors are broadening their platform coverage. We
also expect increased competition from systems and network management
companies, especially those that have historically focused on the mainframe
market and are broadening their focus to include the client/server computer
market. In addition, since there are relatively low barriers to entry in the
software market, we expect additional competition from other established and
emerging companies. We also expect that competition will increase as a result
of future software industry consolidations. Increased competition could harm us
by causing, among other things, price reductions, reduced gross margins and
loss of market share.
16
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.
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. In addition, we need to
continue to integrate into our product lines the technologies of products we
acquired through the acquisitions of Intelliguard Software, Inc., Qualix Group,
Inc. (dba FullTime Software Inc.) and Vinca Corporation in 1999. 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.
17
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.
We have developed strategies to pursue larger enterprise license
transactions with corporate customers. However, we may not continue to
successfully market our products through larger enterprise license
transactions. Such failure would seriously harm our business, operating results
and financial condition. 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;
. Enterprise license transactions often include multiple elements such as
product licenses and service and support;
. Recognition of revenue from enterprise license transactions may vary from
transaction to transaction;
. 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.
Many of the large organizations that we target as customers have lowered
their rate of spending on enterprise software. Due to the large size of
enterprise transactions, if orders forecasted for a specific transaction for a
particular quarter are not realized in that quarter, our operating results for
that quarter may be seriously harmed.
We have changed certain of our licensing practices and modified the
application of our accounting policies, which results in delaying revenue
recognition.
During the past year, we have worked closely with our outside financial
auditors to ensure that our revenue recognition practices are consistent with
both our existing revenue recognition policies and the evolving guidance of the
AICPA on the treatment of certain software license transactions. Based upon our
recent experience with certain distributors and resellers, we began recognizing
revenue on transactions with certain channel members only upon receipt of
payment from those channel members. Further, we have modified our licensing
practices in negotiating certain of our enterprise software licenses. The
consequence of those changes is that the revenue from those licenses is
recognized ratably over the deployment term of those licenses rather than being
recognized all upon execution of the license. These are not changes in our
accounting policies; rather, they reflect a modification of our practices in
conformity with our long-standing policies and with generally accepted
accounting principles.
The accumulated results of these changes could affect quarterly results by
shifting revenue out to future quarters that previously was recognized upon
acceptance of a purchase order from a channel member or upon execution of an
end-user license. Customer acceptance of the new enterprise license structure,
which was intended to build greater visibility into our longer-term revenue
stream, could also affect our quarterly results. For instance, if in a
particular quarter, more customers negotiate a license structure that mandated
revenue recognition upon license execution, revenue for that quarter would be
greater; if, however, those customers
18
accept a license structure that required ratable recognition of license
revenue, the same amount of revenue would be spread over several quarters. We
do not yet have sufficient experience to accurately predict what the balance
will be between up-front and ratable recognition of license revenues in a given
quarter on larger enterprise transactions.
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 will continue to invest, resources to develop this channel. Such
investments could seriously harm our operating margins. We depend on our OEMs'
abilities to develop new products, applications and product enhancements on a
timely and cost-effective basis that will meet changing customer needs and
respond to emerging industry standards and other technological changes. Our
OEMs may not effectively meet these technological challenges. These OEMs are
not within our control, may incorporate the technologies of other companies in
addition to, or to the exclusion of, our technologies, and are not obligated to
purchase products from us. Our OEMs may not continue to carry our products. The
inability to recruit, or the loss of, important OEMs could seriously harm our
business, operating results and financial condition.
We are modifying some of our marketing strategies.
As noted above, we rely significantly upon resellers as part of our overall
marketing strategy. We are currently realigning our approach to working with
our strategic allies and other resellers. The objective of our new approach is
to form stronger ties with specific companies with whom we have global
alliances. We are also restructuring our reseller networks in order to create
greater rewards for distributors and resellers that demonstrate a greater
commitment to Legato, as measured in net sales, technical certification and
other factors. As a result of these changes, we may negatively affect the
volume of sales through our strategic alliances or our resellers. If a
significant number of resellers were to cease doing business with us as a
result of these changes, and sales through the remaining resellers failed to
compensate for the lost resellers, this strategic change could seriously harm
our business, operating results and financial condition.
We depend on international revenue.
Our continued growth and profitability will require further expansion of our
international operations. To successfully expand international operations, we
must establish additional foreign operations, hire additional personnel and
recruit additional international resellers. This will require significant
management attention and financial resources and could seriously harm our
operating margins. If we fail to further expand our international operations in
a timely manner, our business, operating results and financial condition could
be seriously harmed. In addition, we may fail to maintain or increase
international market demand for our products. Our international sales are
currently denominated in U.S. dollars. An increase in the value of the
U.S. dollar relative to foreign currencies could make our products more
expensive and, therefore, potentially less competitive in those markets. In
some markets, localization of our products and license documents is essential
to achieve or increase market penetration. We may incur substantial costs and
experience delays in localizing our products and license language. We may fail
to generate significant revenue from localized products.
19
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 and hire and retain qualified
personnel.
We have recently hired a significant number of new senior executives as well
as other employees throughout the Company. We plan to further increase our
total headcount in order to more effectively seek out new customers and to
better serve our existing customers. 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 in
hiring and retaining 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 continue to improve our financial and management controls,
reporting systems and procedures on a timely basis, and to expand, train and
manage our employees in all areas of the business. Our failure to do so would
seriously harm our business, operating results and financial condition.
Our investment in goodwill and intangibles resulting from our acquisitions
could become impaired.
As a result of our acquisitions in 1999, we recorded goodwill and
intangibles of $167.2 million, which is being amortized over a period of two to
five years. We will amortize $31.8 million in 2001, $29.5 million in 2002,
$28.6 million in 2003 and $14.0 million in 2004. To the extent we do not
generate sufficient cash flows to recover the net amount of the investment
recorded, the investment could be considered impaired and could be subject to
earlier write-off. In such event, our results of operations in any given period
could be negatively impacted, and the market price of our stock could decline.
We rely on our key personnel.
Our future performance depends on the continued service of our key
technical, sales and senior management personnel. Most of our technical, sales
or senior management personnel are not bound by employment agreements. The loss
of the services of one or more of our officers or other key employees could
seriously harm our business, operating results and financial condition.
We recently experienced a period of high employee turnover and have hired a
number of new executives at the levels of director, vice president and above.
Our future success also depends on our continuing ability to
20
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.
Our revenue recognition could be impacted by the actions of our sales
personnel.
The recognition of our revenue depends on, among other things, the terms
negotiated in our contracts with our customers. Our sales personnel may act
outside of their authority and negotiate additional terms without our
knowledge. To the extent that our sales personnel have negotiated terms that
are extraneous to the contract and of which we are unaware, whether the
additional terms are written or verbal, could prevent us from recognizing
revenue in accordance with our plans.
We rely on our sales personnel.
We experienced a number of voluntary resignations in our sales force during
the past year, including some of our senior level sales employees. 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 disruption to our
sales force could seriously harm our business, operating results and financial
condition.
We depend on growth in the enterprise storage management market.
All of our business is in the enterprise storage management market. The
enterprise storage management market is still an emerging market. Our future
financial performance will depend in large part on continued growth in the
number of organizations adopting company-wide storage and management solutions
for their client/server computing environments. The market for enterprise
storage management may not continue to grow at historic rates or at all. If
this market fails to grow or grows more slowly than we currently anticipate and
we are unable to capture market share from our competitors, our business,
operating results and financial condition would be seriously harmed.
We are affected by general economic and market conditions.
Segments of the computer industry have recently experienced significant
economic downturns characterized by decreased product demand, product
overcapacity, price erosion, work slowdowns, and layoffs. Our operations may
experience substantial fluctuations from period-to-period as a consequence of
such industry trends, general economic conditions affecting the timing of
orders from major customers, and other factors affecting capital spending. The
occurrence of such factors could seriously harm our business, operating results
or financial condition.
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.
21
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 licensing and support of products we offer may entail the risk of
product liability claims. Although we generally include provisions in our
license agreements that are intended to limit our liability, a successful
product liability claim brought against us could seriously harm our business,
operating results and financial condition.
Our trading price is volatile.
The trading of our common stock historically has been highly volatile, and
we expect that the price of our common stock will continue to fluctuate
significantly in the future. An investment in our common stock is subject to a
variety of significant risks, including, but not limited to the following:
. Quarterly fluctuations in financial results or results of other software
companies;
. Changes in our revenue growth rates or our competitors' growth rates;
. Announcements that our revenue or income are below analysts'
expectations;
. Changes in analysts' estimates of our performance or industry
performance;
. Announcements of new products by our competitors or by us;
. Announcements of disappointing financial results from our competitors,
strategic allies or major end users;
. Developments with respect to our patents, copyrights, or proprietary
rights or those of our competitors;
. Sales of large blocks of our common stock;
. Conditions in the financial markets in general;
. Litigation; and
. General business conditions and trends in the distributed computing
environment and software industry.
In addition, the stock market may experience extreme price and volume
fluctuations, which may affect the market price for the securities of
technology companies without regard to their operating performance or any of
the factors listed above. These broad market fluctuations may seriously harm
the market price of our common stock.
22
ITEM 2. PROPERTIES
Our principal headquarters is located in approximately 105,000 square feet
of space in Mountain View, California. This facility is leased through December
2009. Our principal research and development facility is located in
approximately 96,000 square feet of space in Palo Alto, California. This
facility is leased through September 2006. Our principal sales and marketing
office is located in approximately 52,500 square feet of space in Sunnyvale,
California. This facility is leased through February 2007. Our principal
technical support facility is located in approximately 97,600 square feet of
space in Burlington, Ontario. This facility is leased through October 2010. We
also currently lease other domestic offices throughout the United States, as
well as international offices throughout the world.
ITEM 3. LEGAL PROCEEDINGS
Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against certain of our directors and officers and us. On May 1,
2000, the court consolidated all of the pending cases and, on May 10, 2000,
appointed a lead plaintiff, who filed a consolidated amended complaint on
August 7, 2000. Defendants filed motions to dismiss. On January 17, 2001, the
Court entered an Order granting the motions to dismiss with leave to amend. On
February 13, 2001, plaintiffs filed a second amended complaint, which generally
alleges that, between April 22, 1999 and May 17, 2000, defendants made false or
misleading statements of material fact about the Company's prospects and failed
to follow generally accepted accounting principles in violation of the federal
securities laws. The complaint seeks an unspecified amount in damages.
Defendants will file an answer to the complaint in April 2001 denying all
allegations that they violated the federal securities laws.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our
officers and directors. We are named as nominal defendant. The derivative case
has been related to the securities class action. Plaintiff moved to stay the
derivative case. On January 17, 2001, the Court denied plaintiffs' motion to
stay. Plaintiffs filed an amended complaint on February 9, 2001, which
generally alleges the same conduct as the shareholder class action, and claims
that defendants breached their fiduciary duties and engaged in improper insider
trading. The derivative complaint seeks unspecified damages and injunctive
relief. Defendants will move to dismiss the derivative complaint.
On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as a nominal defendant. On May 23, 2000, a shareholder
derivative action was filed in the Superior Court of California, County of San
Mateo, against certain of our officers and directors. We are named as a nominal
defendant. Both state derivative complaints generally allege the same conduct
as the derivative action filed in federal court, claim that our officers and
directors breached their fiduciary duties for the period October 21, 1999
through April 3, 2000, and seek unspecified damages and injunctive relief. The
Santa Clara derivative case was transferred to San Mateo County and
consolidated with the San Mateo derivative case.
The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second, and third quarters of 1999, and our revision of financial results for
the fourth quarter and fiscal 1999. We have been voluntarily cooperating with
the Staff of the Commission in its investigation.
We 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 materially 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.
23
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, 2000.
Executive Officers
The following table sets forth information with respect to persons who
served as our executive officers as of March 23, 2001:
Name Age Positions
---- --- ---------
David B. Wright......... 51 Chairman, President and Chief Executive Officer
David L. Beamer......... 58 Executive Vice President, Worldwide Sales and Marketing
Andrew J. Brown......... 41 Senior Vice President and Chief Financial Officer
Thomas L. Panozzo....... 53 Senior Vice President, Service and Support
James Chappell.......... 40 Senior Vice President, Business Process and Development
Charles Fonner.......... 57 Vice President, Worldwide Marketing
George J. Symons........ 41 Vice President, Product Management and Development
Jack Landers............ 57 Vice President, Human Resources
Cory J. Sindelar........ 32 Vice President and Corporate Controller
David B. Wright has served as President and Chief Executive Officer of
Legato since October 2000 and Chairman of the Board of Directors since March
2001. Mr. Wright joined Legato following a thirteen-year career with Amdahl
Corporation, an integrated computing solutions company, where he served as
President and Chief Executive Officer since 1997. Before joining Amdahl, Mr.
Wright spent 11 years with IBM, an advanced information technology company,
serving in variety of staff and management positions. Mr. Wright holds a B.S.
in Physics and Mathematics from Xavier University in Cincinnati, Ohio and a
M.B.A. from Babson College. Mr. Wright serves on the Board of Directors of
Aspect Communications Corp., Insurance Services Office, Inc., INRANGE
Technologies Corp. and is the Chairman of the Silicon Valley Manufacturing
Group, a non-profit organization.
David L. Beamer serves as the Executive Vice President, Worldwide Sales and
Marketing and is responsible for all corporate and service provider marketing,
worldwide sales and international market development. Mr. Beamer joined Legato
in January of 2001 as the Executive Vice President of Worldwide Sales. Before
joining Legato, Mr. Beamer was the President and Chief Operating Officer of
FileTek Corporation of Rockville, Maryland, a privately held software and
systems integration company. Prior to FileTek, Mr. Beamer was with Amdahl
Corporation for sixteen years, where he was a corporate officer for six years
and served in various sales, marketing, and senior management roles. Before
joining Amdahl, he was with IBM Corporation for eight years. Mr. Beamer holds a
B.S. in electrical engineering and a M.B.A. in Marketing and Finance from Ohio
State University.
Andrew J. Brown joined Legato in October 2000 as the Senior Vice President
and Chief Financial Officer. Before joining Legato, Mr. Brown served as Vice
President, Finance and Chief Financial Officer of Adaptec, a data storage
access solution company, since August 1998. From July 1988 to August 1998, he
served in various financial roles within Adaptec including Vice President,
Corporate Controller and Principal Accounting Officer. Mr. Brown earned his
Bachelors degree in Accounting from Eastern Illinois University.
Thomas L. Panozzo joined Legato in July 1999 as Senior Vice President,
Service and Support. Before joining Legato, Mr. Panozzo 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.
24
James Chappell joined Legato in June 1992. In February 2001, Mr. Chappell
became Senior Vice President, Business Process and Development. From April 2000
to February 2001, he served as Vice President of Plans and Controls. From
October 1999 to 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. Before 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 in San Luis Obispo, California.
Charles Fonner joined Legato in February 2001 as Vice President, Worldwide
Marketing. Before joining Legato, Mr. Fonner served as President and Chief
Executive Officer of Npoint Corporation of Los Gatos, California, a privately
held software company. Prior to Npoint, Mr. Fonner was the Chief Operating
Officer of Tyecin Systems of Los Altos, California, a privately held software
company (acquired by Manugistics, Inc.). Prior to Tyecin, Mr. Fonner was with
Amdahl Corporation for 18 years, where he was a corporate officer for six
years. He served in various sales, marketing and senior management roles at
Amdahl. Before joining Amdahl, he was with IBM Corporation for ten years. Mr.
Fonner holds a degree in marketing from Bradley University.
George J. Symons currently serves as Vice President, Product Management and
Development and is responsible for all engineering, product management, product
marketing and quality assurance activities. He joined Legato in April 1999 as
Vice President, Product Marketing and Management after FullTime was acquired by
Legato. Mr. Symons was Vice President of Engineering at FullTime Software since
April 1996. Mr. Symons holds a B.A. in Management Science and Computer Science
from the University of California, San Diego, and a M.B.A. from the University
of California, Los Angeles.
Jack Landers joined Legato in August 2000 as Vice President, Human
Resources. Before joining Legato, Mr. Landers served as Vice President, Human
Resources for Pacific Gateway Exchange, Inc., an international long distance
telecommunications services provider. Additionally, Mr. Landers has held a
number of Senior Human Resources Management positions with Symantec Corp., Bay
Networks (now Nortel Networks) and Digital Equipment Corp. (now Compaq
Computers) Mr. Landers holds a B.A. in English Literature and a M.A in Teaching
from Boston College.
Cory J. Sindelar joined Legato in December 2000 as Vice President and
Corporate Controller. Prior to joining Legato, Mr. Sindelar served as Corporate
Controller at iBEAM Broadcasting Corporation, a provider of an Internet
broadcast network and web casting services, from April 2000 to December 2000.
Mr. Sindelar also served as Senior Manager at PricewaterhouseCoopers LLP, a
global assurance and business advisory firm, based in the firm's San Jose
office from July 1998 to April 2000. Additionally, Mr. Sindelar has held
various accounting, auditing and controller positions with Arthur Andersen LLP
and C-Cube Microsystems. Mr. Sindelar holds a degree in accounting from
Georgetown University.
25
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. The following table sets forth the high and low closing sales prices of
our common stock for each quarter in the two-year period ended December 31,
2000. Such prices represent prices between dealers, do not include retail mark-
ups, markdowns or commissions and may not represent actual transactions.
1999 2000
------------- -------------
High Low High Low
------ ------ ------ ------
First Quarter.................................... $32.75 $20.75 $67.75 $25.19
Second Quarter................................... $29.75 $15.25 $22.00 $ 9.88
Third Quarter.................................... $49.13 $28.31 $15.25 $ 8.31
Fourth Quarter................................... $79.25 $41.09 $12.81 $ 6.69
As of March 16, 2001, we had approximately 319 registered stockholders and
estimate that we had approximately 53,000 beneficial owners of our common
stock.
We have never declared or paid a cash dividend on our common stock and do
not intend to pay cash dividends on our common stock in the foreseeable future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Five-Year Summary
December 31,
--------------------------------------------
2000 1999 1998(2) 1997(2) 1996(3)
-------- -------- -------- -------- -------
(in thousands, except per share amounts)
Revenue.......................... $231,395 $228,567 $167,907 $118,499 $88,920
Gross profit..................... 185,563 196,790 143,114 97,812 70,457
Income (loss) from operations.... (51,413) 2,991 27,815 21,589 15,747
Net income (loss)................ (35,249) 2,704 19,869 15,066 10,814
Basic net income (loss) per
share(1)........................ (0.41) 0.03 0.26 0.21 0.16
Diluted net income (loss) per
share(1)........................ (0.41) 0.03 0.24 0.19 0.14
Cash, cash equivalents and
investments..................... 165,145 169,928 125,972 87,433 76,945
Total assets..................... 414,864 422,894 207,224 141,908 111,704
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements.
(2) Selected financial data for the year-ended December 31, 1998 and 1997 was
derived by combining Legato's selected financial data for the year-ended
December 31, 1998 and 1997 with FullTime's financial data for the twelve-
months ended December 31, 1998 and 1997, respectively.
(3) Selected financial data for the year-ended December 31, 1996 was derived by
combining Legato's selected financial data for the year-ended December 31,
1996 with FullTime's financial data for the fiscal year-ended June 30, 1997
and 1996, respectively.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in this report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, including
statements on our expectations, beliefs, intentions or strategies regarding the
future, including without limitation, our financial outlook, successful
introduction of new products and expansion of operation. All forward-looking
statements included in this document are based on information available to us
on the date hereof. We assume no obligation to update any such forward-looking
statements. Our actual results could differ materially from those indicated in
such forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, fluctuations in quarterly
operating results, uncertainty in future operating results, litigation,
competition, product concentration, technological changes, reliance on
enterprise license transactions, modifications in the application of accounting
policies, reliance on indirect sales channels, changes in marketing strategies,
dependence on international revenue, management of our growth and expansion,
the ability to attract and retain qualified personnel, and other risks
discussed in this item under the heading "Risk Factors" and the risks discussed
in our other Securities and Exchange Commission filings.
Overview
Legato Systems, Inc. was incorporated in Delaware in September 1988. We
develop, market and support software products and services for heterogeneous
client/server computing environments in mid- to large-scale enterprises. We are
a technology leader in the network storage management software market through
our commitment to open, standards-based software development. Our software
delivers to customers a solution that is scalable, high-performance and
manageable and ensures high data and application availability on a wide range
of servers, clients, applications, databases and storage devices. Our data
protection products, primarily the NetWorker family of products, and our data
availability products, primarily our Legato Cluster and wanCluster products,
support many server platforms and accommodate a variety of clients,
applications, databases and storage devices. Our long-term strategy is to
create an integrated set of solutions centered on information protection,
availability and storage management that enhance and simplify network computing
as a whole.
On August 6, 1998, we acquired Software Moguls, Inc., a developer of
advanced backup-retrieval products for the Windows NT and UNIX environments,
for 498,998 shares of our common stock. The acquisition had a total purchase
price of $10.9 million and was accounted for as a pooling of interests.
On April 1, 1999, we acquired Intelliguard Software, Inc. and O.R.P., Inc.,
developers of standards-based storage management solutions of the storage area
networks, for 1,440,000 shares of our common stock and $9.0 million in cash.
The acquisition had a total purchase price of $55.4 million and was accounted
for as a purchase.
On April 19, 1999, we acquired Qualix Group, Inc. (dba FullTime Software,
Inc.), a developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions than enable customers to proactively manage application
service level availability, for 3,442,000 shares of our common stock. The
acquisition had a total purchase price of $52.5 million and was accounted for
as a pooling of interests.
On July 30, 1999, we acquired Vinca Corporation, a developer of high
availability and data protection software, for 1,531,000 shares of our common
stock, $18.8 million in cash and the assumption of options to purchase 590,000
share of our common stock. The acquisition had a total purchase price of $91.7
million and was accounted for as a purchase.
27
For the acquisitions accounted for as pooling of interests, we restated our
financial statements to represent the combined financial results of previously
separate entities for all periods presented. For the acquisitions accounted for
as purchase business combinations, we recorded the results of operations of the
acquired companies with our results of operations as of the date of
acquisition.
Results of Operations
Revenue. Revenue is derived from primarily two sources: (i) product license
revenue, derived from the sale of product licenses to resellers and end users,
including large-scale enterprises, and royalty revenue, derived from initial
license fees and ongoing royalties from product licenses of source code to
OEMs; and (ii) service and support revenue, derived from providing software
updates, support and education and consulting services to end users.
Product license revenue is generally recognized when a signed contract or
other persuasive evidence of an arrangement exists, the software has been
shipped or electronically delivered, the license fee is fixed and determinable
and collection of resulting receivables is probable. For sales to domestic
distributors, product license revenue is recognized upon sale by the
distributor to the end user, since these distributors generally 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 sales to certain value-added resellers in the fiscal years ended December
31, 1999 and 2000, product license revenue is recognized upon receipt of cash
from these value-added resellers since the arrangements with these resellers
may include extended payment terms, which in some cases, are contingent upon
them receiving payment from their end-user customer. Estimated product returns
are recorded upon recognition of revenue from customers having rights of
return, including exchange rights for unsold products and product upgrades.
Provisions for estimated warranty costs and anticipated retroactive price
adjustments are recorded at the time products are shipped. Product license
revenue from royalty payments is recognized upon receipt of royalty reports
from OEMs related to their product sales. Revenue from subscription license
agreements, which include software, rights to future products and maintenance,
is recognized ratably over the term of the subscription period.
Service and support revenue consists primarily of revenue received for
providing maintenance (i.e., software updates and technical support), on-site
support, consulting and training. Revenue from maintenance is recognized
ratably over the term of the agreements. Revenue allocated to education and
consulting services, or derived from the separate sales of these services, is
recognized as the related services are provided.
When contracts contain multiple obligations (e.g. products, updates,
technical support and other services) wherein vendor specific objective
evidence exists for all undelivered elements, the Company accounts for the
delivered elements in accordance with the "Residual Method" prescribed by
Statement of Position 98-9. Any revenue related to updates or technical support
in these arrangements is recognized ratably over the term of the maintenance
arrangement.
% Change
------------
2000 1999 1998 00/99 99/98
------ ------ ------ ----- -----
(in millions)
Product license......................... $145.6 $161.1 $129.1 (10)% 25%
Service and support..................... 85.8 67.5 38.8 27 74
------ ------ ------
Total revenue......................... $231.4 $228.6 $167.9 1 36
====== ====== ======
Sources of Revenue as a Percent of Total Revenue.
2000 1999 1998
------ ------ ------
Product license......................... 63% 70% 77%
Service and support..................... 37 30 23
28
Product license revenue decreased for 2000, when compared to 1999, primarily
due to the implementation of our new software subscription licensing model
during the second quarter of 2000 and, to a lesser extent, a decrease in sales
volume of our software products resulting from the headcount turnover within
the sales force. The increase in product license for 1999, when compared to
1998, is primarily as a result of the continued acceptance of our NetWorker
family of products, particularly to large-scale enterprises, as well as
increased royalty revenue. The increase of sales and marketing personnel as
well as sales and marketing programs helped to increase the market acceptance
of our products and product sales.
Service and support revenue increased for 2000, when compared to 1999,
primarily as a result of increased maintenance renewals over a larger installed
base and, to a lesser extent, growth in our consulting and education services.
The increase in service and support revenue for 1999, when compared to 1998, is
primarily attributable to 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. We expect that service and support will increase in absolute
dollars in 2001, but at a growth rate less than in 2000.
Revenue by Geography.
% Change
------------
2000 1999 1998 00/99 99/98
------ ------ ------ ----- -----
(in millions)
Domestic................................ $155.7 $162.8 $122.4 (4)% 33%
International........................... 75.7 65.8 45.5 15 45
------ ------ ------
Total revenue......................... $231.4 $228.6 $167.9 1 36
====== ====== ======
Revenue by Geography as a Percent of Total Revenue.
2000 1999 1998
------ ------ ------
Domestic................................ 67% 71% 73%
International........................... 33 29 27
Domestic revenue decreased for 2000, when compared to 1999, primarily due to
a decrease in sales volume of our products given the turnover in the headcount
of the domestic sales force and the implementation of our new software
subscription licensing model during the second quarter of 2000. International
revenue increased primarily as a result of the continued market acceptance of
our products overseas as we continue to invest in international sales offices
and to sign international distributors and resellers. The majority of
international sales during these periods were made in Europe and Canada. We
intend to grow sales by increasing productivity of the domestic sales force and
further expanding our international operations. In order to successfully expand
international sales, we must continue to establish additional foreign
operations, hire additional personnel for these operations and recruit
additional international resellers.
Cost of Revenue.
% Change
------------
2000 1999 1998 00/99 99/98
------ ------ ------ ----- -----
(in millions)
Product license......................... $ 6.0 $ 5.9 $ 9.7 2% (39)%
Service and support..................... 39.8 25.9 15.1 54 71
Cost of Revenue as a Percent of Related Revenue.
2000 1999 1998
------ ------ ------
Product license......................... 4% 4% 8%
Service and support..................... 46 38 39
29
Cost of product license revenue includes costs of production personnel,
packaging and documentation, freight and royalties. Product gross margin
remained constant at 96% in 2000, when compared in 1999. Product gross margin
increased to 96% in 1999, when compared to 92% in 1998, primarily due to the
phase out of reselling third-party products through Qualix Direct telesales
organization prior to our acquisition in April 1999.
Cost of service and support revenue includes costs associated with providing
customers with services, such as consulting and education, telephonic and on-
site support and product updates. Costs include primarily salaries and costs to
recruit, develop and retain personnel, packaging, documentation and delivery of
product updates and costs to maintain the infrastructure necessary to manage a
services organization. Cost of service and support revenue increased $13.9
million in 2000, when compared to 1999, and was driven by increases in the
support function and expansion of our consulting and education services.
Service and support headcount increased to 298 in 2000 from 238 in 1999. Cost
of service and support revenue increased $10.8 million in 1999, when compared
to 1998, primarily due to supporting a larger installed base of products as
well as providing higher support levels to customers. Service and support
headcount increased to 238 in 1999 from 141 in 1998. Service and support gross
margin decreased to 54% in 2000, when compared to 62% in 1999 and 61% in 1998,
primarily due to the increased staffing to support as discussed above and
outsourcing certain of our consulting arrangements.
Total gross profit was $185.6 million in 2000, $196.8 million in 1999 and
$143.1 million in 1998, representing gross margin of 80% in 2000, 86% in 1999
and 85% in 1998. The decrease in total gross margin for 2000, when compared to
1999, relates primarily to the decrease in service and support gross margin
during 2000.
Operating Expenses.
% Change
-----------
2000 1999 1998 00/99 99/98
------ ----- ----- ----- -----
(in millions)
Sales and marketing........................ $106.7 $93.8 $72.0 14% 30%
Research and development................... 56.6 40.1 25.6 41 56
General and administrative................. 35.6 20.5 15.9 74 29
Operating Expenses as a Percent of Total Revenue.
2000 1999 1998
------ ----- -----
Sales and marketing........................ 46% 41% 43%
Research and development................... 24 18 15
General and administrative................. 15 9 9
Sales and marketing expenses consist primarily of employee-related costs
such as salaries, benefits, commissions and promotional and advertising
expenses. The increase in sales and marketing expenses of $12.9 million for
2000, when compared to 1999, was primarily attributable to increased recruiting
costs, air travel and facilities expenses and, to a lesser extent, an increase
in our headcount to 454 employees in 2000 from 449 employees in 1999. The
increase in sales and marketing expenses of $21.8 million in 1999, when
compared to 1998, was primarily attributable to an increase in employee-related
expenses resulting from increased headcount to 449 from 243 in 1998 and as a
result of additional marketing and promotional activities to increase awareness
of our products. We believe that sales and marketing expenses will increase in
2001 in absolute dollars, but decrease as a percentage of total revenue, as we
continue to moderately expand our sales and marketing staff.
Research and development expenses consist primarily of employee-related
costs such as salaries, benefits and facilities and equipment costs. The
increase in research and development expenses of $16.5 million for
30
2000, when compared to 1999, was primarily attributable to increases in
salaries and benefits as headcount ramped significantly in 1999 as a result of
our acquisitions of Intelliguard in April 1999 and Vinca in July 1999. Under
purchase accounting, the results of operations of these companies were added to
our results of operations from the date of acquisition. Accordingly, we have a
full year of salary and benefits costs in 2000. The increase in research and
development expenses of $14.5 million for 1999, when compared to 1998, was
primarily attributable to the increased staffing and associated support for
engineers necessary to expand and enhance our product line. The number of
research and development personnel increased from 193 in 1998 to 384 employees
in 1999 and decreased to 364 employees in 2000. We believe that research and
development expenses will continue to increase slightly in absolute dollars,
but decrease as a percentage of total revenue, as we continue to invest in
developing new products and enhancing existing products.
General and administrative expenses primarily include employee-related costs
of our finance, human resources, facilities, information systems and other
administrative departments. The increase in general and administrative expenses
of $15.1 million for 2000, when compared to 1999, was primarily attributable to
increases in salaries and other compensation, recruiting costs, legal and other
professional services and bad debt expense. The increase in general and
administrative expenses of $4.6 million for 1999, when compared to 1998, was
primarily attributable to increased staffing and related costs required to
manage and support our expansion. General and administrative personnel
increased from 83 employees in 1998 to 165 employees in 1999 and decreased to
154 employees in 2000. We expect that general and administrative expenses will
increase in absolute dollars, but decrease as a percentage of revenue, as we
make certain investments in infrastructure in the first half of 2001and
continue to expand our operations internationally.
Amortization of intangibles was $38.1 million in 2000, $21.8 million in 1999
and $1.1 million in 1998. During 1999, we recorded additional intangibles
related to the acquisitions of Intelliguard totaling $58.7 million and Vinca
totaling $102.7 million. (See Note 7 to the Notes to the Consolidated Financial
Statements.) We are amortizing these intangibles on a straight-line basis over
periods ranging from seventeen months to five years from the dates of
acquisition. We expect to amortize intangibles of $31.8 million in 2001, $29.5
million in 2002, $28.6 million in 2003 and $14.0 million in 2004.
We incurred acquisition-related expenses of $5.0 million related to FullTime
in 1999 and $0.6 million related to Software Moguls in 1998. Such expenses
consisted primarily of investment banking, accounting and other professional
fees and costs relating to the closure of duplicative facilities and severance
costs. In addition, we incurred professional fees of $1.3 million in connection
with our proposed acquisition of Ontrack Data International, Inc. during the
fourth quarter of 1999. In January 2000, we entered into a Mutual Termination
Agreement with Ontrack to immediately terminate the proposed acquisition. (See
Note 7 to the Notes to the Consolidated Financial Statements.) In connection
with our acquisitions of Intelliguard during the second quarter of 1999 and
Vinca during the third quarter of 1999, we purchased in-process research and
development of $3.2 million and $8.3 million, respectively. During 2000 and
1998, we did not acquire any purchased in-process research and development
projects.
The fair value of Intelliguard's and Vinca's core technologies, existing
products, as well as the technology currently under development were determined
by independent appraisers using the income approach, which discounts expected
future cash flows to present value. The discount rates used in the present
value calculations were derived from a weighted average cost of capital
analysis, adjusted upward by a premium of 5% for the in-process projects from
the Intelliguard acquisition and 8.5% to 26% for the in-process projects from
Vinca acquisition to reflect additional risks inherent in the development life
cycle. We expect that the pricing models related to these acquisitions will be
considered standard within the high-technology industry. However, we have not
and do not expect to achieve a material amount of expense reductions or
synergies as a result of integrating the acquired in-process technology.
Therefore, the valuation assumptions do not include anticipated cost savings.
31
The Intelliguard projects included in in-process research and development
and the percent complete, the estimated cost to complete and the value assigned
to each project follows (in thousands):
Estimate Percent Estimated Cost Value
Project Completion To Complete Assigned
------- ---------------- -------------- --------
A................................ 9% $340 $ 780
B................................ 50% $680 1,660
C................................ 17% $170 730
-------
$ 3,170