UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to ___________________
Commission File Number: 000-26130
___________________
LEGATO SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3077394
(State of Incorporation) (I.R.S. Employer
Identification No.)
2350 West El Camino Real, Mountain View, CA 94040
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 210-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the Registrant's Common Stock as of November
2, 2001 was 89,449,838.
1
LEGATO SYSTEMS, INC
INDEX
PART I - FINANCIAL INFORMATION
Page No.
--------
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31,
2000 - (unaudited) ................................................................ 3
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2001 and 2000 - (unaudited) ................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2001 and 2000 - (unaudited) ......................................... 5
Notes to Condensed Consolidated Financial Statements - (unaudited) ................ 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of
Operations ........................................................................ 11
Item 3 Quantitative and Qualitative Disclosures about Market Risk ........................ 23
PART II - OTHER INFORMATION
Item 1 Legal Proceedings ................................................................. 24
Item 2 Changes in Securities and Use of Proceeds ......................................... 24
Item 3 Defaults upon Senior Securities ................................................... 24
Item 4 Submission of Matters to a Vote of Security Holders ............................... 24
Item 5 Other Information ................................................................. 24
Item 6 Exhibits and Reports on Form 8-K .................................................. 24
Signatures ........................................................................ 24
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEGATO SYSTEMS, INC.
Condensed Consolidated Balance Sheets
(in thousands)
September 30, December 31,
2001 2000
------------- ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents..................................... $ 79,983 $110,274
Short-term investments........................................ 73,352 40,626
Accounts receivable, net...................................... 37,004 47,655
Deferred tax assets........................................... 63,623 35,272
Other current assets.......................................... 13,053 20,465
------------- ------------
Total current assets..................................... 267,015 254,292
Long-term investments.............................................. - 14,245
Property and equipment, net........................................ 40,282 37,328
Intangible assets, net............................................. 89,705 103,900
Other assets....................................................... 4,078 5,099
------------- ------------
$401,080 $414,864
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 10,137 $ 5,126
Accrued liabilities........................................... 38,991 33,551
Deferred revenue.............................................. 43,915 53,853
------------- ------------
Total current liabilities................................ 93,043 92,530
Stockholders' equity............................................... 308,037 322,334
------------- ------------
$401,080 $414,864
============= ============
See accompanying notes to condensed consolidated financial statements.
3
LEGATO SYSTEMS, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ---------------------
2001 2000 2001 2000
------ ------ ------ ------
(unaudited)
Revenue:
License........................................... $ 32,681 $ 32,936 $ 111,267 $ 110,307
Service and support............................... 24,332 21,234 69,304 62,664
-------- --------- --------- ---------
Total revenue................................. 57,013 54,170 180,571 172,971
-------- --------- --------- ---------
Cost of revenue:
License........................................... 2,055 1,387 3,986 4,531
Service and support............................... 11,297 10,158 37,015 29,421
-------- --------- --------- ---------
Cost of revenue............................... 13,352 11,545 41,001 33,952
-------- --------- --------- ---------
Gross profit.................................. 43,661 42,625 139,570 139,019
-------- --------- --------- ---------
Operating expenses:
Sales and marketing............................... 32,302 25,904 93,330 78,544
Research and development.......................... 17,055 14,229 48,285 45,360
General and administrative........................ 8,092 6,112 22,767 20,166
Amortization of acquired intangibles.............. 7,516 9,522 24,270 28,567
Restructuring charges............................. (1,329) - 4,758 -
-------- --------- --------- ---------
Total operating expenses..................... 63,636 55,767 193,410 172,637
-------- --------- --------- ---------
Loss from operations................................... (19,975) (13,142) (53,840) (33,618)
Interest and other income, net......................... 1,281 1,923 6,124 4,654
-------- --------- --------- ---------
Loss before benefit from income taxes.................. (18,694) (11,219) (47,716) (28,964)
-------- --------- --------- ---------
Benefit from income taxes.............................. (5,710) (7,475) (14,155) (7,652)
-------- --------- --------- ---------
Net loss............................................... $(12,984) $ (3,744) $ (33,561) $ (21,312)
======== ========= ========= =========
Net loss per share:
Basic and diluted................................. $ ( 0.15) $ (0.04) $ (0.38) $ (0.25)
======== ========= ========= =========
Weighted average common shares outstanding........ 89,288 86,956 88,624 86,527
======== ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
4
LEGATO SYSTEMS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
Nine Months Ended
September 30,
-----------------------------
2001 2000
----------- -----------
(unaudited)
Cash flows from operating activities:
Net loss......................................................................... $(33,561) $(21,312)
Adjustments to reconcile net loss to net cash provided by operating activities:
Deferred taxes............................................................... (27,991) (13,648)
Depreciation and amortization................................................ 39,105 39,428
Provision for doubtful accounts and product returns.......................... 1,562 1,917
Tax benefit from stock option exercises...................................... 5,434 2,197
Changes in assets and liabilities:
Accounts receivable...................................................... 10,646 12,892
Other assets............................................................. 8,743 (189)
Accounts payable......................................................... 3,289 (755)
Accrued liabilities...................................................... 3,492 (6,343)
Deferred revenue......................................................... (10,169) (1,818)
----------- -----------
Net cash provided by operating activities............................. 550 12,369
----------- -----------
Cash flows from investing activities:
Purchases of available-for-sale securities....................................... (391,614) (49,905)
Maturities and sales of available-for-sale securities............................ 373,760 50,111
Acquisition of Software Clearing House, Inc...................................... (8,697) -
Purchase of property and equipment............................................... (17,493) (21,105)
----------- -----------
Net cash used in investing activities................................. (44,044) (20,899)
----------- -----------
Cash flows from financing activities-
Proceeds from issuance of common stock........................................... 13,203 14,497
Payment of short-term loan payable............................................... - (6,847)
----------- -----------
Net cash provided by financing activities............................. 13,203 7,650
----------- -----------
Net change in cash and cash equivalents............................................. (30,291) (880)
Cash and cash equivalents at beginning of period.................................... 110,274 115,222
----------- -----------
Cash and cash equivalents at end of period.......................................... $ 79,983 $114,342
=========== ===========
See accompanying notes to condensed consolidated financial statements.
5
LEGATO SYSTEMS, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared by Legato Systems, Inc. (the "Company" or "Legato") in accordance
with the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in consolidated
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted in accordance with
such rules and regulations. In the opinion of management, the accompanying
unaudited condensed consolidated financial statements reflect all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
financial position, results of operations and cash flows of the Company and its
subsidiaries. The results of operations for the interim periods presented are
not necessarily indicative of the results that may be expected for any future
interim period or for the year ending December 31, 2001, and the Company makes
no representations related thereto. These financial statements should be read in
conjunction with the annual audited consolidated financial statements and notes
as of and for the year ended December 31, 2000, included in the Company's Form
10-K dated March 28, 2001.
Certain prior year consolidated financial statement balances have been
reclassified to conform to the 2001 presentation.
2. Balance Sheet Components
September 30, December 31,
2001 2000
------------- ------------
Accounts receivable:
Trade accounts receivable............................... $ 44,371 $ 55,386
Allowances for doubtful accounts and product returns.... (7,367) (7,731)
-------- --------
$ 37,004 $ 47,655
======== ========
Property and equipment:
Computer equipment and software......................... $ 58,585 $ 46,114
Furniture and fixtures.................................. 10,848 10,138
Office equipment........................................ 5,689 4,474
Leasehold improvements.................................. 11,404 11,676
-------- --------
86,526 72,402
Accumulated depreciation and amortization............... (46,244) (35,074)
-------- --------
$ 40,282 $ 37,328
======== ========
Accrued liabilities:
Accrued compensation and benefits....................... $ 13,949 $ 14,806
Income taxes payable.................................... 12,847 9,240
Other accrued liabilities............................... 12,195 9,505
-------- --------
$ 38,991 $ 33,551
======== ========
3. Revenue Recognition
Revenue is derived from primarily two sources: (i) 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 the licensing of source code to original equipment
manufacturers ("OEMs"); and (ii) service and support revenue, derived from
providing software updates, support and education and consulting services to end
users.
6
License revenue is generally recognized when a signed contract or other
persuasive evidence of an arrangement exists, the software has been shipped or
electronically delivered, the license fee is fixed or determinable and
collection of resulting receivables is probable. For sales to domestic
distributors, 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. For sales to customers having rights of return,
including exchange rights for unsold products and product upgrades, estimated
product returns are recorded upon recognition of revenue. Provisions for
estimated warranty costs and anticipated retroactive price adjustments are
recorded at the time products are shipped. 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. The Company also incurs additional internal costs to
assist certain of its resellers and distributors in selling its products to
end-users.
Service and support revenue consists primarily of revenue received for
providing software updates, technical support for software products, on-site
support, and consulting and education services. Revenue from updates and support
is recognized ratably over the term of the agreements. Revenue allocated to
consulting and education 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.
4. Comprehensive Income (Loss)
Comprehensive income (loss) includes unrealized gains (losses) on
investments. The impact of which is excluded from net income (loss) and is
included in stockholders' equity. A summary of comprehensive income (loss) is as
follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Net loss................................................. $(12,984) $(3,744) $(33,561) $(21,312)
Unrealized gain (loss) on investments (net of taxes) .... 606 33 627 37
-------- ------- -------- --------
$(12,378) $(3,711) $(32,934) $(21,275)
======== ======= ======== ========
5. Computation of Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss)
by the weighted average shares of common stock outstanding during the period.
Diluted net income per share is computed by dividing net income by the weighted
average shares of common stock and potential common shares outstanding during
the period. Potential common shares outstanding consist of dilutive shares
issuable upon the exercise of outstanding options to purchase common stock as
computed using the treasury stock method. For periods in which we incur a loss,
potential common shares outstanding are excluded from the computation of diluted
net loss per share as their effect is anti-dilutive. Options to purchase
approximately 21,650,000 shares and 12,251,000 shares of common stock at the
weighted average price of $12.51 per share and $17.56 per share were outstanding
as of September 30, 2001 and 2000, respectively, but were not included in the
computation of diluted net loss per share because their effect would be
anti-dilutive.
6. Legal Proceedings
Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against us and certain of our directors and officers. On May 1,
2000, the court consolidated the pending cases and, on May 10, 2000, appointed a
lead plaintiff, who filed a consolidated
7
amended complaint on August 7, 2000. Defendants moved to dismiss. On January 17,
2001, the court granted the motions to dismiss with leave to amend. On February
13, 2001, plaintiffs filed a second amended complaint, which generally alleges
that, between April 22, 1999 and May 17, 2000, defendants made false or
misleading statements of material fact about our prospects and failed to follow
generally accepted accounting principles in violation of the federal securities
laws. The complaint seeks an unspecified amount in damages. Defendants answered
the complaint in April 2001 denying all allegations that they violated the
federal securities laws.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our officers
and directors. We are named as a nominal defendant. The derivative case has been
related to the securities class action. Plaintiffs filed an amended complaint on
February 9, 2001, which generally alleges the same conduct as the shareholder
class action, and claims that defendants breached their fiduciary duties and
engaged in improper insider trading. The derivative complaint sought unspecified
damages and injunctive relief. Defendants moved to dismiss the derivative
complaint. On July 10, 2001, the court granted defendants' motion to dismiss
with leave to amend. Plaintiffs filed an amended complaint on August 23, 2001;
plaintiffs then moved to voluntarily dismiss the amended complaint with the
right to refile the complaint at a later date if they choose to do so.
Defendants have moved to permanently dismiss the amended 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, claiming that our
officers and directors breached their fiduciary duties for the same period, and
seek unspecified damages and injunctive relief. The state derivative cases have
been consolidated in San Mateo County. Plaintiffs filed a consolidated amended
complaint. Defendants filed a demurrer, which was denied on July 20, 2001.
Defendants have filed a writ petition with the California Court of Appeal and
California Supreme Court.
The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second and third quarters of 1999, and our revision of financial results for the
fourth quarter of 1999. We have been voluntarily cooperating with the Staff of
the Commission in its investigation.
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 losses associated with the resolution of these contingencies.
7. Restructuring Charges
During the second quarter of 2001, we incurred $6.1 million of charges
related primarily to the closure of our facilities in Sunnyvale, California and
Eden Prairie, Minnesota. During the third quarter of 2001, we subleased our
facility in Sunnyvale, which reduced our expected loss on future lease
commitments by $1.3 million and is reflected as a credit on the Statement of
Operations. During the quarter, we also paid approximately $1.0 million in lease
commitments and real estate broker's fees. As of September 30, 2001, accrued
restructuring charges totaled $0.9 million and related primarily to future lease
commitments related to the facilities in Eden Prairie and Paris, France.
8. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations." SFAS No. 141 requires the use of the purchase method of
accounting for business combinations initiated after June 30, 2001, and
eliminates the pooling-of-interests method. We are currently assessing, but have
not yet determined, the impact of SFAS No. 141 on our financial position and
results of operations.
8
In June 2001, the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which is effective for fiscal years beginning after December
15, 2001. SFAS No. 142 requires the discontinuance of goodwill amortization. In
addition, the standard includes provisions upon adoption for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the testing for impairment of existing goodwill and other intangibles. We are
currently assessing, but have not yet determined, the impact of SFAS No. 142 on
our financial position and results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which is effective for fiscal
years beginning after December 15, 2001. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed." We are currently assessing, but have not yet determined, the
impact of SFAS No. 144 on our financial position and results of operations.
9. Acquisition of Software Clearing House, Inc.
On July 17, 2001, the Company acquired Software Clearing House, Inc.
("SCH"), which develops and distributes advanced storage solutions for the open
systems market. Under the terms of the acquisition agreement, all issued and
outstanding shares of SCH were purchased for $10.3 million. The Company also
paid $1.9 million to current and former employees as a transactional bonus,
assumed net liabilities of $0.3 million and anticipates incurring approximately
$1.6 million in acquisition related expenses, which consist primarily of
professional fees, severance expense and facility abandonment costs.
The total aggregate purchase price was $10.1 million (excluding SCH's
opening cash balance of $4.0 million) and was allocated to the assets acquired,
including tangible and intangible assets, and liabilities assumed based upon the
fair value of such assets and liabilities on the date of acquisition. The
allocation of purchase price to assets and liabilities was based on management's
estimates of their fair value with the excess cost over the net assets acquired
allocated to goodwill. The purchase price was allocated as follows (in
thousands):
Tangible assets received ............... $ 2,522
Developed technology ................... 989
Goodwill ............................... 9,377
Liabilities assumed .................... (2,792)
--------
$ 10,096
========
The tangible assets consist primarily of accounts receivable, deferred tax
assets and property and equipment. The liabilities assumed consist primarily of
accounts payable. Developed technology was identified and valued through
analysis of data provided by SCH concerning development projects, their stage of
development, the time and resources needed to complete them, if applicable,
their expected income generating ability and the associated risks. The income
approach, which includes an analysis of the cash flows and risks associated with
achieving such cash flows, was the primary technique utilized in valuing the
developed technology. Since SCH had recently completed its latest product,
AlphaStor, there were no research and development projects that were in-process
as of the date of acquisition.
The following unaudited pro forma information combines the results of
operations as if the acquisition of SCH had been consummated as of the beginning
of the periods presented (in thousands, except for per share data):
Nine months Nine months
ended ended
September 30, September 30,
2001 2000
--------------- ---------------
Revenue .................................................................... $189,244 $186,838
Net loss.................................................................... (34,981) (22,157)
Basic and diluted net loss per share........................................ $ (0.39) $ (0.26)
9
The pro forma net loss includes the impact of adjustments related to a
conforming accounting change (the write-off of capitalized software development
costs) and the reduction of interest income. The pro forma information does not
purport to be indicative of the results that would have occurred had the
acquisition actually been in effect for these periods, or the results that may
occur in the future.
10. Subsequent Events
In October 2001, we initiated plans to reduce our operating costs across
the Company. These plans include, but are not limited to, facilities closures
and headcount reductions. On October 22, 2001, we closed our development
laboratories in Orem, Utah and New Delhi, India, in order to improvement
management effectiveness and to reduce our cost structure. Certain of the
engineers and developers from these locations will be transferred to other
research and development laboratories in the United States. We expect these
plans to be substantially complete by the end of the year and to result in a
restructuring charge not to exceed $6 million in the fourth quarter of 2001.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The discussion in this report on Form 10-Q contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements reflecting 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, the
current challenging information technology spending environment, continued
weakness in the economy, 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 sales and marketing strategies, dependence on
international revenue, management of our growth and expansion, the ability to
attract and retain qualified personnel, the ability to integrate
recently-acquired business lines and other risks discussed in this item under
the heading "Risk Factors" and the risks discussed in our other Securities and
Exchange Commission filings.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data as a percentage of total revenue:
Three Months Ended Nine Months
September 30, Ended September 30,
--------------------- ---------------------
2001 2000 2001 2000
-------- -------- -------- --------
Revenue:
License ........................................... 57% 61% 62% 64%
Service and support ............................... 43 39 38 36
--- --- --- ---
Total revenue ................................. 100 100 100 100
--- --- --- ---
Cost of revenue:
License ........................................... 3 2 2 3
Service and support ............................... 20 19 21 17
--- --- --- ---
Total cost of revenue ......................... 23 21 23 20
--- --- --- ---
Gross profit .................................. 77 79 77 80
--- --- --- ---
Operating expenses:
Sales and marketing ............................... 57 48 52 45
Research and development .......................... 30 26 27 26
General and administrative ........................ 14 11 12 12
Amortization of acquired intangibles .............. 13 18 13 17
Restructuring charges ............................. (2) - 3 -
--- --- --- ---
Total operating expenses ................. 112 103 107 100
--- --- --- ---
Loss from operations ................................... (35) (24) (30) (20)
Interest and other income, net ......................... 2 3 3 3
--- --- --- ---
Loss before benefit from income taxes .................. (33) (21) (27) (17)
Benefit from income taxes .............................. (10) (14) (8) (5)
--- --- --- ---
Net loss ............................................... (23)% (7)% (19)% (12)%
=== === === ===
Overview
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
11
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 Automated Availability Manager , 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 provide back-up, availability and management of mission-critical
business information in the enterprise network environment. With the addition of
AlphaStor, a media management product we acquired through our acquisition of
SCH, we have strengthened our management product offerings.
Revenue
Total revenue increased $2.8 million, or 5%, to $57.0 million in the third
quarter of 2001 from $54.2 million for the third quarter of 2000. For the first
nine months of 2001, total revenue increased $7.6 million, or 4%, to $180.6
million from $173.0 million for the same period in 2000.
License revenue. License revenue decreased $0.3 million, or 1%, to $32.7
million in the third quarter of 2001 from $32.9 million in the third quarter of
2000. The decrease was primarily due to smaller size of license transactions and
a slow down in shrink-wrap sales immediately following the terrorist events that
occurred in the United States on September 11, 2001. For the first nine months
of 2001, license revenue increased $1.0 million, or 1%, to $111.3 million from
$110.3 million for the same period in 2000.
International license revenue for the third quarter of 2001 increased
slightly over the same period in 2000, and the percentage of total license
revenue by geographic region for the third quarter of 2001 was 50% in North
America, 34% in Europe and 16% in Asia, which compares to 52% in North America,
34% in Europe and 14% in Asia for the third quarter of 2000.
For the third quarter of 2001, license revenue by channel consisted of 41%
from direct customers, 15% from OEMs and 44% from resellers, which compares to
30% from direct customers, 20% from OEMs and 50% from resellers for the third
quarter of 2000. The increase in the percentage of license revenue from direct
customers reflects a decrease in the number of multi-year arrangements in 2001
whereby a significant portion of the license revenue is being recognized over
the deployment term. The decrease in the percentage of license revenue from OEMs
and resellers reflects the decrease in economy and reduced growth rates
experienced in the storage industry.
Service and Support Revenue. Service and support revenue increased $3.1
million, or 15%, to $24.3 million in the third quarter of 2001 from $21.2
million in the third quarter of 2000. The increase was primarily a result of the
growth in the number of registered customers electing to subscribe to support
contracts and the renewals of software support contracts after the initial
one-year term concluded. This increase was partially offset by a decrease in
revenue from education and consulting services. During the second quarter of
2001, we transitioned our education services to Global Knowledge Networks, Inc.,
an international information technology education integrator. For the first nine
months of 2001, service and support revenue increased $6.6 million, or 11%, to
$69.3 million from $62.7 million for the same period a year ago. Our increase in
internal staffing for software support helped to increase new sales and renewals
of our software support contracts.
Gross Profit
Gross profit increased $1.1 million, or 2%, to $43.7 million, representing
77% of total revenue, in the third quarter of 2001 from $42.6 million,
representing 79% of total revenue, in the third quarter of 2000. For the first
nine months of 2001, gross profit increased $0.6 million, or less than 1%, to
$139.6 million, representing 77% of total revenue, from $139.0 million,
representing 80% of total revenue, for the same period in 2000.
Gross profit from license revenue consists of license revenue less the
related costs of product media, documentation, third-party royalties and
packaging. Gross profit from license revenue decreased $0.9 million, or 3%, to
$30.6 million, representing 94% of license revenue, in the third quarter of 2001
from $31.5 million, representing 96% of license revenue, in the third quarter of
2000. For the first nine months of 2001, gross profit
12
from license revenue increased $1.5 million, or 1%, to $107.3 million,
representing 96% of license revenue, from $105.8 million, representing 96% of
license revenue, for the same period in 2000.
Costs of service and support revenue consist primarily of personnel-related
costs incurred in providing telephone support, consulting services, training to
customers and costs of providing software updates, education and consulting
materials. Gross profit from service and support revenue increased $1.9 million,
or 18%, to $13.0 million, representing 54% of service and support revenue, in
the third quarter of 2001 from $11.1 million, representing 52% of service and
support revenue, in the third quarter of 2000. For the first nine months of
2001, gross profit from service and support revenue decreased $0.9 million, or
3%, to $32.3 million, representing 47% of service and support revenue, from
$33.2 million, representing 53% of service and support revenue, for the same
period in 2000. The decrease relates primarily to a smaller number of consulting
services billings during 2001. The reduction in gross margin of service and
support revenue relates primarily to the under utilization of our consulting
organization and the increase in support personal to enhance customers
satisfaction. Service and support personnel have increased to 332 during 2001
from 286 in 2000.
Operating Expenses
Sales and marketing. Sales and marketing expenses consist primarily of
salaries and commissions for sales and marketing personnel and promotional
expenses. Sales and marketing expenses increased $6.4 million, or 25%, to $32.3
million in the third quarter of 2001 from $25.9 million in the third quarter of
2000. For the first nine months of 2001, sales and marketing expenses increased
$14.8 million, or 19%, to $93.3 million from $78.5 million for the same period
in 2000. The increase in sales and marketing expenses was primarily attributable
to the replacement of headcount after sales headcount was reduced by 12% in the
second quarter of 2000. Sales and marketing personnel have increased to 515
during 2001 from 422 in 2000. We believe that sales and marketing expenses,
excluding commissions, will decrease in absolute dollars as the sales force
becomes more productive and as we reduce certain marketing programs.
Research and development. Research and development expenses consist
primarily of personnel-related costs. Research and development expenses
increased $2.9 million, or 20%, to $17.1 million in the third quarter of 2001
from $14.2 million in the third quarter of 2000. For the first nine months of
2001, research and development expenses increased $2.9 million, or 6%, to $48.3
million from $45.4 million for the same period in 2000. The increase in research
and development expenses was primarily attributable to an increase in headcount
and a bonus of $0.6 million related to a retention plan established over a year
ago. Research and development personnel have increased to 416 during 2001 from
379 in 2000. We expect research and development expenses to decrease slightly in
absolute dollars.
General and administrative. General and administrative expenses include
personnel and other costs of our finance, human resources, facilities,
information systems and other administrative departments. General and
administrative expenses increased $2.0 million, or 32%, to $8.1 million in the
third quarter of 2001 from $6.1 million in the third quarter of 2000. For the
first nine months of 2001, general and administrative expenses increased $2.6
million, or 13%, to $22.8 million from $20.2 million for the same period in
2000. Excluding non-recurring professional fees of $1.3 million in 2000, general
and administrative expenses increased $3.9 million, or 21% during the first nine
months of 2001. The increase in general and administrative expenses was
primarily attributable to increased staffing and professional fees. General and
administrative personnel have increased to 204 during 2001 from 162 in 2000. We
believe that general and administrative expenses will decrease in absolute
dollars and as a percentage of revenue.
Amortization of intangibles. Amortization of intangibles decreased $2.0
million to $7.5 million in the third quarter of 2001 from $9.5 million in the
third quarter of 2000. For the first nine months of 2001, amortization of
intangibles decreased $4.3 million to $24.3 million from $28.6 million in 2000.
We are amortizing these intangibles on a straight-line basis over periods
ranging from seventeen months to five years from the respective dates of
acquisition.
Restructuring Charges. During the second quarter of 2001, we incurred $6.1
million of charges related primarily to the closure of our facilities in
Sunnyvale, California and Eden Prairie, Minnesota. During the third
13
quarter of 2001, we subleased our facility in Sunnyvale, which reduced our
expected loss on future lease commitments by $1.3 million and is reflected as a
credit on our Condensed Consolidated Statements of Operations.
Interest and other income, net. Interest and other income primarily
represents interest income from funds available for investment. Interest and
other income, net decreased $0.6 million to $1.3 million in the third quarter of
2001 from $1.9 million in the third quarter of 2000 due to a decline in interest
rates throughout 2001. Interest and other income, net increased $1.4 million to
$6.1 million in the first nine months in 2001 from $4.7 million for the same
period in 2000 due to a gain of $2.0 million on the sale of our equity
investment in HighGround Systems, Inc. after HighGround was acquired by Sun
Microsystems in April 2001.
Benefit from income taxes. The benefit from income taxes for the third
quarter of 2001 was $5.7 million compared to $7.5 million for the third quarter
of 2000. For the first nine months of 2001, the benefit from income taxes was
$14.2 million compared to $7.7 million for the same period in 2000. The
effective tax rate was 30% for the first nine months of 2001 and 26% for the
same period in 2000. The increase in the benefit for income taxes primarily
relates to a decrease in the amount of non-deductible goodwill amortization.
LIQUIDITY AND CAPITAL RESOURCES
Our cash, cash equivalents and investments totaled $153.3 million as of
September 30, 2001, and represented 38% of total assets as compared to $165.1
million as of December 31, 2000. As of September 30, 2001, we had no long-term
debt and stockholders' equity was $308.0 million.
We have financed our operations to date primarily by generating cash from
operations and selling our common stock. Net cash provided by operating
activities was $0.6 million for the nine months ended September 30, 2001 and
consisted primarily of a net change in assets and liabilities of $13.2 million
and depreciation and amortization of $39.1 million, partially offset by the net
loss of $33.6 million and deferred taxes of $25.2 million. For the nine months
ended September 30, 2000, net cash provided by operating activities was $12.3
million and consisted primarily of a net change in assets and liabilities of
$3.8 million and depreciation and amortization of $39.4 million partially offset
by the net loss of $21.3 million and deferred taxes of $13.6 million.
Net cash used in investing activities was $44.0 million for the nine months
ended September 30, 2001, which resulted from the net purchases of marketable
securities of $17.8 million, the acquisition of property and equipment of $17.5
million and the purchase of SCH for $8.7 million. For the nine months ended
September 30, 2000, net cash used in investing activities was $20.9 million,
which primarily resulted from the acquisition of property and equipment of $21.1
million.
Net cash provided by financing activities was $13.2 million for the nine
months ended September 30, 2001, which resulted from the proceeds received from
the issuance of our common stock from stock option exercises and our employee
stock purchase plan. For the nine months ended September 30, 2000, net cash
provided by financing activities was $7.6 million, which resulted from the
proceeds received from the issuance of our common stock of $14.5 million
partially offset by the repayment of a note payable of $6.8 million.
We believe our current cash balances and cash flow from operations, if any,
will be sufficient to meet the Company's working capital and capital expenditure
requirements for at least the next twelve months.
RISK FACTORS
The following risk factors and other information included in this report on
Form 10-Q should be carefully considered. The risks and uncertainties described
below are not the only ones we face. Additional risks and uncertainties not
presently known to us or that we currently deem less significant also may impair
our business operations. If any of the following risks actually occur, our
business, operating results and financial condition could be materially and
negatively affected.
14
Our quarterly operating results are volatile.
Our quarterly operating results have varied in the past and may vary in the
future. Our quarterly operating results may vary depending on a number of
factors, many of which are outside of our control, including:
. The dollar value of orders and the timing of when orders are received;
. Intense competition;
. Macroeconomic uncertainty and weakness;
. Market acceptance of our new products, applications and product
enhancements of our competitors;
. Changes in pricing policies or those of our competitors;
. The current challenging spending environment in our customers' IT
departments;
. Our ability to develop, introduce and market new products,
applications and product enhancements;
. Our ability to control costs;
. Quality control of products sold;
. Lengthy sales cycles, particularly with enterprise license
transactions;
. Delay in the recognition of revenue from enterprise license and
application service provider transactions;
. Success in expanding sales and marketing programs;
. Technological changes in our customers' environments;
. The mix of sales among our channels;
. Deferrals of customer orders in anticipation of new products,
applications or product enhancements;
. Market readiness to deploy our products for distributed computing
environments;
. Changes in our strategy or that of our competitors;
. Customer budget cycles and changes in these budget cycles;
. Foreign currency and exchange rates;
. Our ability to effectively manage and reduce our tax liabilities;
. Our ability to integrate recently acquired business lines;
. 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 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 and the general health of
their business; these trends are also difficult for us to predict.
Fluctuations in licensing activity from quarter to quarter further
impact royalty revenue, because initial license fees generally are
non-recurring and recognized upon the signing of a license agreement;
. 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;
. Macroeconomic factors may affect our customers' decision to license
our products or procure services;
. The storage management market is rapidly evolving;
15
. 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
may take a long time to complete;
. Due to general economic factors that currently affect our end-user
customers' businesses, those customers are being more deliberate in the
manner in which they make information technology spending decisions;
. 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 a different
application of our 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 losses will increase because only a small
portion of our expenses varies with our revenue.
We believe that period-to-period comparisons of our results of operations
may not be meaningful and should not be relied upon as indications of future
performance. Our operating results could be below the expectations of public
market analysts and investors in some future quarter or quarters. Our failure to
meet such expectations would likely cause the market price of our common stock
to decline.
We are currently subject to litigation.
Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against us and certain of our directors and officers. On May 1,
2000, the court consolidated the pending cases and, on May 10, 2000, appointed a
lead plaintiff, who filed a consolidated amended complaint on August 7, 2000.
Defendants moved to dismiss. On January 17, 2001, the court granted the motions
to dismiss with leave to amend. On February 13, 2001, plaintiffs filed a second
amended complaint, which generally alleges that, between April 22, 1999 and May
17, 2000, defendants made false or misleading statements of material fact about
our prospects and failed to follow generally accepted accounting principles in
violation of the federal securities laws. The complaint seeks an unspecified
amount in damages. Defendants answered the complaint in April 2001 denying all
allegations that they violated the federal securities laws.
On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our officers
and directors. We are named as a nominal defendant. The derivative case has been
related to the securities class action. Plaintiffs filed an amended complaint on
February 9, 2001, which generally alleges the same conduct as the shareholder
class action, and claims that defendants breached their fiduciary duties and
engaged in improper insider trading. The derivative complaint sought unspecified
damages and injunctive relief. Defendants moved to dismiss the derivative
complaint. On July 10, 2001, the court granted defendants' motion to dismiss
with leave to amend. Plaintiffs filed an amended complaint on August 23, 2001;
plaintiffs then moved to voluntarily dismiss the amended complaint with the
right to refile the complaint at a later date if they choose to do so.
Defendants have moved to permanently dismiss the amended 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, claiming that our
officers and directors breached their fiduciary duties for the same period, and
seek unspecified damages and injunctive relief. The state derivative cases have
been consolidated in San Mateo County. Plaintiffs filed a consolidated amended
complaint. Defendants filed a demurrer, which was denied on July 20, 2001.
Defendants have filed a writ petition with the California Court of Appeal and
California Supreme Court.
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
16
for the fourth quarter of 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 losses 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.
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 build and sustain broad market acceptance of NetWorker, would seriously
harm our business, operating results and financial condition. We cannot
reasonably predict NetWorker's remaining life for several reasons, including:
. The recent emergence of our market;
. The effect of new products, applications or product enhancements;
17
. 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, and the
technologies we acquired from Software Clearing House, Inc. in July 2001. We may
fail to develop and market new products that respond to technological changes or
evolving industry standards, experience difficulties that could delay or prevent
the successful development, introduction and marketing of these new products or
fail to develop new products that adequately meet the requirements of the
marketplace or achieve market acceptance. If so, our business, operating results
and financial condition would be seriously harmed.
We have introduced several new products already this year, and currently
plan to introduce and market several more 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 of or loss of revenue. If potential new products
are delayed or do not achieve market acceptance, our business, operating results
and financial condition would be seriously harmed. In the past, we have also
experienced delays in purchases of our products by customers anticipating our
launch of new products. Our business, operating results and financial condition
would be seriously harmed if customers defer material orders in anticipation of
new product introductions.
Our products may contain undetected errors.
Software products as complex as those we offer may contain undetected
errors or failures when first introduced or as new versions are released. We
have in the past discovered software errors in certain of our new products after
their introduction. As a result of those errors, we experienced delays or lost
revenue during the period required to correct these shipments, despite testing
by us and by our current and potential customers. In addition, customers have in
the past brought to our attention "bugs" in our software created by the
customers' unique operating environments. Although we have been able to fix such
software bugs in the past, we may not always be able to do so. These types of
circumstances may result in the loss of or delay in market acceptance of 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.
In addition, many of the large organizations that we target as customers have
lowered their rate of spending on enterprise software. 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 nine
months, and varies substantially from transaction to transaction;
. Enterprise license transactions often include multiple elements such as
product licenses and service and support;
. Recognition of revenue from enterprise license transactions may vary from
transaction to transaction;
18
. These transactions typically involve significant technical evaluation and
commitment of capital and other resources;
. A growing number of our direct-license customers are located outside the
United States, where the sales cycle can be lengthier than transactions
negotiated within the U.S.;
. Our customers are being more deliberate about information technology
spending decisions due to the current state of the overall economy; and
. Customers' internal procedures frequently cause delays in orders. Such
internal procedures include approval of large capital expenditures,
implementation of new technologies within their networks, and testing new
technologies that affect key operations.
Due to the large size of enterprise transactions, if orders forecasted for
a specific transaction for a particular quarter are not realized in that
quarter, our operating results for that quarter may be seriously harmed.
We rely on indirect sales channels.
We rely significantly on our distributors, systems integrators and value
added resellers, or collectively, resellers, for the marketing and distribution
of our products. Our agreements with resellers are generally not exclusive and
in many cases may be terminated by either party without cause. Many of our
resellers carry product lines that are competitive with ours. These resellers
may not give a high priority to the marketing of our products. Rather, they may
give a higher priority to other products, including the products of competitors,
or may not continue to carry our products. Events or occurrences of this nature
could seriously harm our business, operating results and financial condition. In
addition, we may not be able to retain any of our current resellers or
successfully recruit new resellers. Any such changes in our distribution
channels could seriously harm our business, operating results and financial
condition.
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 alliances and other resellers. The objective of our new approach is to
form stronger ties with specific companies with whom we have global alliances.
We are also restructuring our reseller networks in order to create greater
rewards for distributors and resellers that demonstrate a greater commitment to
us, as measured in net sales, technical certification and other factors. As a
result of these changes, we may negatively affect the volume of sales through
our strategic alliances or our resellers. If a significant number of resellers
were to cease doing business with us as a result of these changes, and sales
through the remaining resellers failed to compensate for the lost resellers,
this strategic change could seriously harm our business, operating results and
financial condition.
We depend on international revenue.
Our continued growth and profitability will require further expansion of
our international operations. To 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. Most of our
19
international sales are currently denominated in U.S. dollars. An increase in
the value of the U.S. dollar relative to foreign currencies could make our
products more expensive and, therefore, potentially less competitive in those
markets. In some markets, localization of our products and license documents is
essential to achieve or increase market penetration. We may incur substantial
costs and experience delays in localizing our products and license language. We
also may fail to generate significant revenue from localized products.
Additional risks inherent in our international business activities
generally include:
. Significant reliance on our distributors and other resellers who do not
offer our products exclusively;
. Unexpected changes in regulatory requirements; o Tariffs and other trade
barriers;
. Lack of acceptance of localized products, if any, in foreign countries;
. Longer negotiation and accounts receivable payment cycles;
. Difficulties in managing international operations;
. Potentially adverse tax consequences, including restrictions on the
repatriation of earnings;
. The burdens of complying with a wide variety of multiple local country
and regional laws; and
. The risks related to the current weakness in some regions, including,
without limitation, Europe and Asia. .
The occurrence of such factors could seriously harm our international sales
and, consequently, our business, operating results and financial condition.
We must manage our growth and expansion and hire and retain qualified
personnel.
We have recently hired a number of new executives as well as other
employees throughout the Company. Approximately 40% of our employees joined the
Company since the beginning of the year. 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.
Our investment in goodwill and intangibles resulting from our acquisitions
could become impaired.
As a result of our acquisitions in 1999 and in 2001, we recorded goodwill
and intangibles of $177.0 million of which $89.7 million was included on our
Condense Consolidated Balance Sheet as of September 30, 2001. 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.
As described above, we have hired a large number of new employees,
including executives in our sales, marketing and finance organizations, in the
past nine months. Our future success also depends on our continuing ability to
attract and retain highly qualified technical, sales and managerial personnel.
Despite recent weakness in the economy, competition for such highly qualified
personnel remains intense, and we may fail to retain our key technical, sales
and managerial employees or attract, assimilate or retain other highly qualified
technical, sales and managerial personnel in the future.
Our revenue recognition could be impacted by the unauthorized actions of
our personnel.
The recognition of our revenue depends on, among other things, the terms
negotiated in our contracts with our customers. Our personnel may act outside of
their authority and negotiate additional terms without our knowledge. In the
event that our sales personnel have negotiated terms that do not appear in the
contract and of which we are
20
unaware, whether the additional terms are written or verbal, we could be
prevented 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 remains intense, and we may fail
to retain our sales personnel or attract, assimilate or retain other highly
qualified sales personnel in the future. Any further disruption to our sales
force could seriously harm our business, operating results and financial
condition.
We depend on growth in the enterprise storage market.
All of our business is in the enterprise storage market. The enterprise
storage management market is still an emerging and dynamic market. Our future
financial performance will depend in large part on continued growth in the
number of organizations adopting company-wide storage and management solutions
for their client/server computing environments. The market for enterprise
storage management may not continue to grow at historic rates or at all. If this
market fails to grow or grows more slowly than we currently anticipate and we
are unable to capture market share from our competitors, our business, operating
results and financial condition would be seriously harmed.
We are affected by general economic and market conditions.
Segments of the computer industry have recently experienced significant
economic downturns characterized by decreased product demand, product
overcapacity, price erosion, work slowdowns and layoffs. These downturns appear
to coincide with the widely-reported weakness in the overall economy. Our
operations may experience substantial fluctuations from period-to-period as a
consequence of such industry trends, general economic conditions affecting the
timing of orders from major customers and other factors affecting capital
spending. The occurrence of such factors could seriously harm our business,
operating results or financial condition.
If we make unprofitable acquisitions or are unable to successfully
integrate any acquisition, our business would suffer.
We have in the past, and may in the future, acquire businesses, products or
technologies that we believe compliment or expand our existing business. In July
2001, we acquired Software Clearing House, Inc. ("SCH"), a software developer,
reseller and consulting organization based in Cincinnati, Ohio. Our ability to
achieve results in the remainder of 2001 and beyond will be dependent in part
upon our ability to successfully integrate the people, products and business
lines of SCH. In addition, we will need to work with SCH's customers and
business partners to establish new relationships based upon the broader range of
products and services available from us. Further, we must accomplish the
synergies identified during the acquisition process. Failure to execute on any
of these elements of the integration process could seriously harm our business,
operating results or financial condition.
We cannot assure you that any acquisitions or acquired businesses, products
or technologies associated therewith will generate sufficient revenue to offset
the associated costs of the acquisitions or will not result in other adverse
effects. Moreover, from time to time, we may enter into negotiations for the
acquisition of businesses, products or technologies but be unable or unwilling
to consummate the acquisitions under consideration. This could cause significant
diversion of managerial attention and out of pocket expenses to us. We could
also be exposed to litigation as a result of an unconsummated acquisition,
including the claims that we failed to negotiate in good faith, misappropriated
confidential information or other claims.
Protection of our intellectual property is limited.
Our success depends significantly upon proprietary technology. To protect
our proprietary rights, we rely on a combination of patents, copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions. We seek to protect our software, documentation and other written
materials under patent, trade secret
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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, we are aware that
unauthorized parties have attempted to transfer licenses to third parties, copy
aspects of our products or to obtain and use information that we regard as
proprietary. Policing unauthorized use and transfer of our products is
difficult, and software piracy can be expected to be a persistent problem. In
licensing our products, other than in enterprise license transactions, we rely
on "shrink wrap" licenses that are not signed by licensees. Such licenses may be
unenforceable 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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. While we are exposed with
respect to interest rate fluctuations in many countries, our interest income is
most sensitive to fluctuations in the general level of U.S. interest rates. In
this regard, changes in the U.S. interest rates affect the interest earned on
our cash, cash equivalents, short-term and long-term investments. We invest in
high quality credit issuers and, by policy, limit the amount of our credit
exposure to any one issuer. As stated in our policy, our first priority is to
reduce the risk of principal loss. Consequently, we seek to preserve our
invested funds by limiting default risk, market risk and reinvestment risk. We
mitigate default risk by investing in only high quality credit securities that
we believe to be low risk and by positioning our portfolio to respond
appropriately to a significant reduction in a credit rating of any investment
issuer or guarantor. The portfolio includes only marketable securities with
active secondary or resale markets to ensure portfolio liquidity.
The table below presents the carrying value and related weighted average
interest rates for our interest bearing instruments as of September 30, 2001
(dollars in millions).
Carrying Interest
Value Rate
-------- -------
Interest bearing instruments:
Cash equivalents--fixed rate ..... $ 45.3 3.1%
Investments--fixed rate .......... 73.4 5.3
--------
$ 118.7
========
Foreign Currency Risk. As a global concern, we face exposure to adverse
movements in foreign currency exchange rates. This exposure may change over time
as business practices evolve and could seriously harm our financial results.
Substantially all of our international sales are currently denominated in U.S.
dollars. An increase in the value of the U.S. dollar relative to foreign
currencies could make our products more expensive and therefore, reduce the
demand for our products. Reduced demand for our products could seriously harm
our financial results. Currently, we do not hedge against any foreign currencies
and as a result, could incur unanticipated gains or losses.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information concerning legal proceedings is incorporated herein by
reference to Note 6 of the condensed consolidated financial statements in Part I
of this Form 10-Q.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits: None.
(b) Reports on Form 8-K: The Company did not file any Reports on
Form 8-K during the quarter ended September 30, 2001.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEGATO SYSTEMS, INC.
By: /s/ Andrew J. Brown
-------------------------
Andrew J. Brown
Executive Vice President, Finance and
Chief Financial Officer
By: /s/ Cory J. Sindelar
-------------------------
Cory J. Sindelar
Vice President, Corporate Controller and
Principal Accounting Officer
Date: November 13, 2001
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