-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EIpK7OUr2otqn4m+Vh2CgqcvGIZjFQrP/uLRcz8Z9SSw3v5Vd1RztrigtwVSSrxf 2v/KZjF2Hkd4rMciKwBtSg== 0000891618-99-002242.txt : 19990517 0000891618-99-002242.hdr.sgml : 19990517 ACCESSION NUMBER: 0000891618-99-002242 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VERITAS SOFTWARE CORP CENTRAL INDEX KEY: 0000867666 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 942823068 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-22712 FILM NUMBER: 99622045 BUSINESS ADDRESS: STREET 1: 1600 PLYMOUTH STREET CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 BUSINESS PHONE: 6503358000 MAIL ADDRESS: STREET 1: 1600 PLYMOUTH ST CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 10-Q 1 FORM 10-Q FOR QUARTER ENDED MARCH 31, 1999 1 ================================================================================ 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 MARCH 31, 1999 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: 0-22712 VERITAS SOFTWARE CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 94-2823068 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1600 PLYMOUTH STREET MOUNTAIN VIEW, CALIFORNIA 94043 (650) 335-8000 (ADDRESS, INCLUDING ZIP CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES AND REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) ---------------- 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 of the registrant's common stock outstanding as of April 30, 1999 was 48,194,733 shares. ================================================================================ 2 VERITAS SOFTWARE CORPORATION INDEX PART I: FINANCIAL INFORMATION
PAGE NO. -------- Item 1. Condensed Consolidated Financial Statements............................ Condensed Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998............................................................... 3 Condensed Consolidated Statements of Income for the Three Months Ended March 31, 1999 and 1998 ......................................... 4 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 1999 and 1998................................................ 5 Notes to Condensed Consolidated Financial Statements................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................. 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk............. 25 PART II: OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K....................................... 27 SIGNATURE........................................................................ 28
2 3 PART I: FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS VERITAS SOFTWARE CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) ASSETS
MARCH 31, DECEMBER 31, 1999 1998 --------- --------- (UNAUDITED) Current assets: Cash and cash equivalents .......................... $ 111,324 $ 139,086 Short-term investments ............................. 97,225 72,040 Accounts receivable, net of allowance for doubtful accounts of $2,800 at March 31, 1999 and $2,572 at 50,210 52,697 December 31, 1998 Prepaid expenses ................................... 21,309 13,509 --------- --------- Total current assets .......................... 280,068 277,332 Long-term investments ................................. 47,859 31,925 Property and equipment, net ........................... 32,528 26,518 Other assets .......................................... 14,421 13,342 --------- --------- Total assets .................................. $ 374,876 $ 349,117 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ................................... $ 4,390 $ 4,958 Accrued compensation and benefits .................. 7,473 11,267 Other accrued liabilities .......................... 11,488 11,196 Income taxes payable ............................... 17,388 13,424 Deferred revenue ................................... 43,149 37,645 --------- --------- Total current liabilities ..................... 83,888 78,490 Deferred rent ......................................... 733 773 Convertible subordinated notes ........................ 100,000 100,000 Stockholders' equity: Common stock ....................................... 206,911 199,858 Accumulated deficit ................................ (15,833) (29,416) Deferred compensation .............................. (24) (32) Accumulated other comprehensive income (loss) ...... (799) (556) --------- --------- Total stockholders' equity .................... 190,255 169,854 --------- --------- Total liabilities and stockholders' equity .... $ 374,876 $ 349,117 ========= =========
See accompanying notes to condensed consolidated financial statements. 3 4 VERITAS SOFTWARE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ---------------------- 1999 1998 -------- -------- Net revenue: User license fees ............................... $ 55,786 $ 30,689 Services ........................................ 16,118 8,393 -------- -------- Total net revenue .......................... 71,904 39,082 Cost of revenue: User license fees ............................... 1,955 1,966 Services ........................................ 6,527 4,500 -------- -------- Total cost of revenue ...................... 8,482 6,466 -------- -------- Gross profit ....................................... 63,422 32,616 Operating expenses: Selling and marketing ........................... 26,823 13,059 Research and development ........................ 13,816 7,549 General and administrative ...................... 3,289 2,170 -------- -------- Total operating expenses ................... 43,928 22,778 -------- -------- Income from operations ............................. 19,494 9,838 Interest and other income, net ..................... 3,031 2,685 Interest expense ................................... (1,433) (1,420) -------- -------- Income before income taxes ......................... 21,092 11,103 Provision for income taxes ......................... 7,509 2,048 -------- -------- Net income ......................................... $ 13,583 $ 9,055 ======== ======== Net income per share - basic ....................... $ 0.28 $ 0.20 ======== ======== Net income per share - diluted ..................... $ 0.26 $ 0.18 ======== ======== Number of shares used in computing per share amounts - basic ................................. 47,822 46,434 ======== ======== Number of shares used in computing per share amounts - diluted ............................... 53,136 50,950 ======== ========
See accompanying notes to condensed consolidated financial statements. 4 5 VERITAS SOFTWARE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999 1998 --------- --------- Cash flows from operating activities: Net income ....................................... $ 13,583 $ 9,055 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .................. 2,718 1,171 Amortization of bond issuance costs ............ 107 107 Deferred rent .................................. (40) (39) Changes in operating assets and liabilities: Accounts receivable ......................... 2,487 463 Prepaid expenses ............................ (7,800) 1,207 Other assets ................................ (1,271) (426) Accounts payable ............................ (568) 385 Accrued compensation and benefits ........... (3,794) (1,959) Other accrued liabilities ................... 292 2,868 Income taxes payable ........................ 3,964 1,423 Deferred revenue ............................ 5,504 1,072 --------- --------- Net cash provided by operating activities .......... 15,182 15,327 Cash flows from investing activities: Purchases of investments ......................... (83,409) (105,748) Investment maturities ............................ 42,290 82,474 Purchase of property and equipment ............... (8,635) (4,691) --------- --------- Net cash used for investing activities ............. (49,754) (27,965) Cash flows from financing activities: Proceeds from issuance of common stock ........... 7,053 4,309 --------- --------- Net cash provided by financing activities .......... 7,053 4,309 Effect of exchange rate changes .................... (243) 3 --------- --------- Net decrease in cash and cash equivalents .......... (27,762) (8,326) Cash and cash equivalents at beginning of period ... 139,086 75,629 --------- --------- Cash and cash equivalents at end of period ......... $ 111,324 $ 67,303 ========= ========= Supplemental disclosures: Cash paid for taxes .............................. $ 3,217 $ 513
See accompanying notes to condensed consolidated financial statements. 5 6 VERITAS SOFTWARE CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary for a fair presentation have been included. The results for the interim periods presented are not necessarily indicative of the results that may be expected for any future period. The following information should be read in conjunction with the consolidated financial statements and notes thereto included in the VERITAS Software Corporation's Annual Report on Form 10-K for the year ended December 31, 1998. 2. NET INCOME PER SHARE Basic net income per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of common shares and dilutive potential common shares outstanding during the period. Potential common shares consist of employee stock options using the treasury stock method. The following table sets forth the computation of basic and diluted net income per common share:
THREE MONTHS ENDED MARCH 31, ------------------- 1999 1998 ------- ------- Numerator: Net income .......................................................... $13,583 $ 9,055 ======= ======= Denominator: Denominator for basic net income per share - weighted-average shares. 47,822 46,434 Common stock equivalents ............................................ 5,314 4,516 ------- ------- Denominator for diluted net income per share ........................ 53,136 50,950 ======= ======= Basic net income per share ............................................. $ 0.28 $ 0.20 ======= ======= Diluted net income per share ........................................... $ 0.26 $ 0.18 ======= =======
Common stock equivalents included in the denominator for purposes of computing diluted net income per share do not include 2,325,581 shares issuable upon conversion of the 5.25% Convertible Subordinated Notes, as their effect would be anti-dilutive for all periods presented. 6 7 VERITAS SOFTWARE CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) 3. ACCUMULATED OTHER COMPREHENSIVE INCOME The following are the components of comprehensive income:
THREE MONTHS ENDED MARCH 31, ----------------------- 1999 1998 -------- -------- Net income ....................................... $ 13,583 $ 9,055 Foreign currency translation adjustments ......... (243) (83) -------- -------- Comprehensive income ............................. $ 13,340 $ 8,972 ======== ========
4. BUSINESS COMBINATIONS On February 3, 1999, VERITAS completed the acquisition of OpenVision Australia Pty. Ltd., a company principally engaged in reselling VERITAS software products and services throughout Australia and New Zealand, for a total cost of approximately $300,000 in cash. The business combination has been accounted for as a purchase and the purchase price assigned to the fair value of specific tangible and intangible assets acquired. On February 8, 1999, VERITAS completed the acquisition of the Pune, India operations of Frontier Software Development (India) Private Limited, a company principally engaged in the development of customized software, for a total cost of approximately $2.4 million. Of this amount, VERITAS paid $1.3 million in cash and agreed to pay Frontier certain earn-out payments totaling $1.1 million over the next two years. The business combination has been accounted for as a purchase and the purchase price assigned to the fair value of specific tangible and intangible assets acquired. 5. SEGMENT INFORMATION The Company operates in one segment, storage management solutions. The Company's products and services are sold throughout the world, through direct, original equipment manufacturer, other reseller and distributor channels. The Company's chief operating decision maker, the chief executive officer, evaluates the performance of the Company based upon stand-alone software product and service revenue by product channels and revenues by geographic regions of the segment and does not receive separate, discrete financial information about asset allocation, expense allocation or profitability from the Company's storage products or services. 7 8 VERITAS SOFTWARE CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) Geographic information:
THREE MONTHS ENDED MARCH 31, --------------------- 1999 1998 ------- ------- User license fees (1): United States ........ $43,228 $22,447 Europe (2) ........... 8,917 5,416 Other (3) ............ 3,641 2,826 ------- ------- Total ............ 55,786 30,689 ------- ------- Services (1): United States ........ 12,578 6,606 Europe (2) ........... 2,679 1,663 Other (3) ............ 861 124 ------- ------- Total ............ 16,118 8,393 ------- ------- Total net revenue .... $71,904 $39,082 ======= =======
MARCH 31, DECEMBER 31, 1999 1998 ------- ------- Long-lived assets (4): United States ........ $31,625 $25,202 Europe (2) ........... 4,184 3,644 Other (3) ............ 578 380 ------- ------- Total ............ $36,387 $29,226 ======= =======
(1) License and services revenues are attributed to geographic regions based on location of customers. (2) Europe includes the Middle East and Africa. (3) Other includes Canada and the Asia Pacific region. (4) Long-lived assets include all long-term assets except those specifically excluded under SFAS No. 131, such as deferred income taxes and long-term investments. Reconciliation to total assets reported:
MARCH 31, DECEMBER 31, 1999 1998 -------- -------- Total long-lived assets ........... $ 36,387 $ 29,226 Other assets, including current ... 338,489 319,891 -------- -------- Total consolidated assets .... $374,876 $349,117 ======== ========
Sales to one customer accounted for approximately $8.9 million, or 12%, of the Company's net revenues in the three months ended March 31, 1999. 8 9 VERITAS SOFTWARE CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) 6. POTENTIAL ACQUISITIONS On October 5, 1998, the Company entered into an Agreement and Plan of Reorganization pursuant to which the Company will acquire the Network and Storage Management Group business (NSMG) of Seagate Software, Inc. (SSI), a subsidiary of Seagate Technology, Inc. Security holders of the Company will have approximately 60% of the fully-diluted equity of the combined company. SSI and certain holders of options to purchase common stock of SSI will receive common stock and rights to acquire common stock representing approximately 40% of the combined company's fully-diluted equity securities. Based on the issuance of approximately 34.6 million shares of VERITAS common stock, and the closing price of VERITAS common stock as of March 31, 1999, the total estimated purchase price is $3.1 billion. The transaction is expected to be completed in May 1999, subject to the approval of the VERITAS and SSI stockholders, and other conditions. On September 1, 1998, the Company entered into a Combination Agreement to acquire TeleBackup Systems Inc. (TeleBackup), a Canadian corporation. TeleBackup designs, develops and markets software solutions for local and remote backup and recovery of electronic information stored on networked, remote and mobile personal computers. As a result of the Combination Agreement, TeleBackup will become a wholly-owned subsidiary of the Company in exchange for the issuance, to the holders of TeleBackup common shares and options to purchase TeleBackup common shares, of between 1,555,000 and 1,900,000 shares of the Company's common stock or its economic equivalent, number of such shares depending upon the trading price of the Company's common stock on the Nasdaq National Market prior to the closing of the transaction. Based on the closing price of VERITAS common stock as of March 31, 1999, the total estimated purchase price is $132.5 million. The proposed acquisition is structured to qualify as a tax-free stock transaction in Canada. The transaction is expected to close in May 1999, subject to stockholder approval and other conditions. The NSMG and TeleBackup acquisitions will be accounted for by the Company using the purchase method of accounting. Following consummation of these transactions, the Company currently expects to incur a charge of approximately $202.8 million per fiscal quarter primarily related to the amortization of goodwill and other intangible assets over a four-year period. The Company also expects to incur charges to operations for a one-time write-off related to in-process research and development costs in the fiscal quarter in which these transactions are consummated. These charges are currently estimated to be approximately $103.1 million. Such amounts are preliminary and are subject to change upon the final determination of the purchase price of both NSMG and TeleBackup at the time of closing of each transaction. In addition, as a result of the NSMG acquisition, the Company expects to incur a restructuring charge in the same fiscal quarter that these transactions are consummated. This one-time restructuring charge relates primarily to exit costs with respect to duplicative facilities, which the Company plans to vacate. The Company estimates this restructuring charge to be in the range of $8.0 to $11.0 million. Such costs are in addition to the liability for the estimated costs to vacate facilities of NSMG, which will become duplicative upon the closing of the NSMG transaction, which liability will be assumed by the Company and included as a part of the purchase price. 7. FACILITIES LEASE COMMITMENT During the first quarter of 1999, VERITAS signed a letter of intent to enter into an agreement to lease real estate to be built by the lessor. In a separate agreement, VERITAS was retained by the lessor as its agent for the construction of the facility. The leases for land and improvements will be classified as operating leases. The various agreements provide for minimum lease payments which begin, generally, upon completion of construction, which is expected to be June 2001, as well as certain residual value guarantees. Pre development costs incurred by VERITAS were approximately $1.4 million through March 31, 1999, and were subsequently reimbursed by the lessor. 9 10 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933, that involve risks and uncertainties. These forward-looking statements include statements regarding our expectations, beliefs, intentions or strategies regarding the future. All these forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Some of the factors could cause actual results to differ from those projected in these forward-looking statements. Readers are urged to carefully review and consider the various disclosures made by us in this report, and those detailed from time to time in our reports and filings with the Securities and Exchange Commission, that attempt to advise interested parties of the risks and factors that may affect our business. OVERVIEW VERITAS is the leading independent supplier of enterprise data storage management solutions, providing advanced storage management software for open system environments. Our products provide performance improvement and reliability enhancement features that are critical for many commercial applications. These products enable protection against data loss and file corruption, rapid recovery after disk or system failure, the ability to process large files efficiently and the ability to manage and backup large networks of systems without interrupting users. In addition, VERITAS' products provide an automated failover between computer systems organized in clusters sharing disk resources. VERITAS' highly scalable products can be used independently, and certain products can be combined to provide interoperable client/server storage management solutions. VERITAS' products offer centralized administration with a high degree of automation, enabling customers to manage complex, distributed environments cost effectively by increasing system administrator productivity and system availability. VERITAS also provides a comprehensive range of services to assist customers in planning and implementing storage management solutions. VERITAS markets its products and associated services to original equipment manufacturers and end-user customers through a combination of direct sales and indirect sales channels. These indirect sales channels include resellers, value added resellers, hardware distributors, application software vendors and systems integrators. VERITAS derives its user license fee revenue from shipments of its software programs to end-user customers through direct sales channels, indirect sales channels and original equipment manufacturer customers. VERITAS' original equipment manufacturer customers either bundle VERITAS' products with the original equipment manufacturer products licensed by such original equipment manufacturers or offer them as options. Certain original equipment manufacturers may also resell VERITAS' products. VERITAS receives a user license fee each time the original equipment manufacturer licenses a copy of the original equipment manufacturer's products to a customer that incorporates one or more of VERITAS' products. VERITAS' license agreements with its original equipment manufacturer customers generally contain no minimum sales requirements and there can be no assurance that any original equipment manufacturer will either commence or continue shipping operating systems incorporating VERITAS' products in the future. Moreover, following the execution of new agreements between VERITAS and original equipment manufacturer customers and resellers, a significant period of time may elapse before any revenues to VERITAS are generated due to the development work which VERITAS must generally undertake under such agreements and the time needed for the sales and marketing organizations within such customers and distributors to become familiar with and gain confidence in VERITAS' products. VERITAS' services revenue consists of fees derived from annual maintenance agreements, from consulting and training services and from porting fees. The original equipment manufacturer maintenance agreements covering VERITAS products provide for technical and emergency support and minor unspecified product upgrades for a fixed annual fee. The maintenance agreements covering products that are licensed through channels other than through original equipment manufacturer channels provide for technical support and unspecified product upgrades for an annual service fee based on the number of user licenses purchased and the level of service subscribed. Porting fees consist of fees derived from porting and other non-recurring engineering efforts when VERITAS ports, or adapts, its storage management products to an original equipment manufacturer's operating system and when VERITAS develops certain new product features or extensions of existing product features at the request of a customer. In most cases, VERITAS retains the rights to technology derived from porting and non-recurring engineering work for licensing to other customers and therefore generally does such work on a relatively low, and sometimes negative, margin. 10 11 VERITAS has made, and intends to continue to make, a substantial investment in porting its products to new operating systems, including Windows NT. The success of the Windows NT product development may be dependent on receipt of development funding from third parties, including Microsoft, and failure to receive such funding could hamper VERITAS' efforts to timely expand its products into the Windows NT market. The porting and development process requires substantial capital investment and the devotion of substantial employee resources to such effort and the added focus on Windows NT development has required, and will continue to require, VERITAS to hire additional personnel. Under an agreement with Microsoft, VERITAS has committed to develop a functional subset of the VERITAS Volume Manager product that will be ported to and embedded in Windows NT. The agreement also requires VERITAS to develop a disk management graphical user interface designed specifically for Windows NT. Microsoft has provided VERITAS with significant funding towards such development effort. VERITAS recognizes revenue under the development contract with Microsoft on a percentage-of-completion basis consistent with its policy for revenue recognition for other similar agreements. The payment terms in the Microsoft agreement do not directly correlate to the timing of development efforts and therefore revenue recognition does not directly correlate to contract billings. The Microsoft relationship requires VERITAS to expand its marketing and sales operations to deal with higher volume markets in which VERITAS has limited experience. See "Factors That May Affect Future Results -- VERITAS plans to port products to new operating system and we face uncertainties in porting products and developing new products" and "-- We will be distributing our products through multiple distribution channels, each of which is subject to risks." VERITAS' international sales are generated primarily through its international sales subsidiaries. International revenue outside the United States and Canada, most of which is collectible in foreign currencies, accounted for 18% of the Company's total revenues for the three months ended March 31, 1999 and 22% of total revenues for the three months ended March 31, 1998. VERITAS' international revenue increased 56% from $8.4 million for the three months ended March 31, 1998 to $13.1 million for the three months ended March 31, 1999. Since much of VERITAS' international operating expenses are also incurred in local currencies, the relative impact of exchange rates on net income or loss is relatively less than the impact on revenues. Although VERITAS' operating and pricing strategies take into account changes in exchange rates over time, VERITAS' operating results may be significantly affected in the short term by fluctuations in foreign currency exchange rates. VERITAS' international subsidiaries purchase licenses from the parent company resulting in intercompany receivables and payables. These receivables and payables are carried on each company's books at the local currency that existed at the time of the transaction. Such receivables and payables are eliminated for financial statement reporting purposes. Prior to elimination, the amounts carried in foreign currencies are converted to U.S. Dollars at the then current rate, or "marked to market." The marked to market process may give rise to currency gains and losses. Such gains or losses are recognized on VERITAS' statement of operations as a component of other income, net. To date, such gains or losses have not been material. VERITAS believes that its success depends upon continued expansion of its international operations. VERITAS currently has sales and service offices in the United States, Canada, Japan, the United Kingdom, Germany, France, Sweden, Switzerland and the Netherlands, a development center in India, and resellers located in North America, Europe, Asia Pacific, South America and the Middle East. International expansion may require VERITAS to establish additional foreign offices, hire additional personnel and recruit additional international resellers, resulting in the diversion of significant management attention and the expenditure of financial resources. To the extent that VERITAS is unable to effect these additions efficiently, growth in international sales will be limited, which would have a material adverse effect on VERITAS' business, operating results and financial condition. International operations also subject VERITAS' to a number of risks inherent in developing and selling products outside the United States, including potential loss of developed technology, limited protection of intellectual property rights, imposition of government regulation, imposition of export duties and restrictions, cultural differences in the conduct of business, and political and economic instability. Furthermore, certain global markets, including Asia, Russia and Latin America, are currently undergoing significant economic turmoil which could result in deferral of purchase of information technology products and services by potential customers located in such markets, thereby further limiting VERITAS' ability to expand international operations. See "Factors That May Affect Future Results -- Expanding our international sales depends on economic stability in regions that recently have been unstable." On September 1, 1998, the Company entered into a Combination Agreement to acquire TeleBackup Systems Inc. (TeleBackup), a Canadian corporation. TeleBackup designs, develops and markets software solutions for local and 11 12 remote backup and recovery of electronic information stored on networked, remote and mobile personal computers. As a result of the Combination Agreement, TeleBackup will become a wholly-owned subsidiary of the Company in exchange for the issuance, to the holders of TeleBackup common shares and options to purchase TeleBackup common shares, of between 1,555,000 and 1,900,000 shares of the Company's common stock or its economic equivalent, number of such shares depending upon the trading price of the Company's common stock on the Nasdaq National Market prior to the closing of the transaction. Based on the closing price of VERITAS common stock as of March 31, 1999, the total estimated purchase price is $132.5 million. The proposed acquisition is structured to qualify as a tax-free stock transaction in Canada. The transaction is expected to close in May 1999, subject to stockholder approval and other conditions. On October 5, 1998, the Company entered into an Agreement and Plan of Reorganization pursuant to which the Company will acquire the Network and Storage Management Group business (NSMG) of Seagate Software, Inc. (SSI), a subsidiary of Seagate Technology, Inc. Security holders of the Company will have approximately 60% of the fully-diluted equity of the combined company. SSI and certain holders of options to purchase common stock of SSI will receive common stock and rights to acquire common stock representing approximately 40% of the combined company's fully-diluted equity securities. Based on the issuance of approximately 34.6 million shares of VERITAS common stock, and the closing price of VERITAS common stock as of March 31, 1999, the total estimated purchase price is $3.1 billion. The transaction is expected to be completed in May 1999, subject to the approval of the VERITAS and SSI stockholders, and other conditions. The NSMG and the TeleBackup acquisitions will be accounted for by VERITAS using the purchase method of accounting. Following consummation of these transactions, VERITAS currently expects to incur charges of approximately $202.8 million per fiscal quarter primarily related to the amortization of acquired goodwill and other intangibles over a four-year period. VERITAS also expects to incur charges to operations for a one-time write-off related to acquired in-process research and development costs in the fiscal quarter in which these transactions are consummated. These charges are currently estimated to be approximately $103.1 million. Such amounts are preliminary and are subject to change upon the final determination of the purchase price of both NSMG and TeleBackup at the time of closing of each transaction. In addition, as a result of the NSMG combination, VERITAS expects to incur a restructuring charge in the same fiscal quarter that these transactions are consummated. This one-time restructuring charge relates primarily to exit costs with respect to duplicative facilities, which VERITAS plans to vacate. VERITAS estimates this restructuring charge to be in the range of $8.0 million to $11.0 million. Such costs are in addition to the liability for the estimated costs to vacate facilities of NSMG, which will become duplicative upon the closing of the NSMG transaction, which liability will be assumed by VERITAS and included as a part of the purchase price. The NSMG business is primarily focused on the development, marketing and sale of Windows NT network and storage management software products that enable IT professionals within an enterprise to manage distributed network resources and to secure and protect enterprise data. Such products include features such as system backup, disaster recovery, migration, replication, automated client protection, storage resource management, scheduling, event correlation and desktop management. On February 3, 1999, VERITAS completed the acquisition of OpenVision Australia Pty. Ltd., a company principally engaged in reselling VERITAS software products and services throughout Australia and New Zealand, for a total cost of approximately $300,000 in cash. The business combination has been accounted for as a purchase and the purchase price assigned to the fair value of specific tangible and intangible assets acquired. On February 8, 1999, VERITAS completed the acquisition of the Pune, India operations of Frontier Software Development (India) Private Limited, a company principally engaged in the development of customized software, for a total cost of approximately $2.4 million. Of this amount, VERITAS paid $1.3 million in cash and agreed to pay Frontier certain earn-out payments totaling $1.1 million over the next two years. The business combination has been accounted for as a purchase and the purchase price assigned to the fair value of specific tangible and intangible assets acquired. 12 13 RESULTS OF OPERATIONS The following table sets forth the percentage of total revenue represented by certain line items from the Company's condensed consolidated statement of operations for the three months ended March 31, 1999 and 1998, respectively, and the percentage changes between the comparable periods:
PERCENTAGE OF PERIOD-TO-PERIOD TOTAL NET REVENUE PERCENTAGE CHANGE ------------------ ------------------ THREE MONTHS ENDED THREE MONTHS ENDED MARCH 31, MARCH 31, 1999 ------------------ ------------------ 1999 1998 COMPARED TO 1998 ------ ----- ------------------ Net revenue: User license fees ..................... 78% 79% 82% Services .............................. 22 21 92% ---- ---- Total revenue ................. 100 100 84% Cost of revenue: User license fees ..................... 3 5 (1)% Services .............................. 9 12 45% ---- ---- Total cost of revenue ......... 12 17 31% ---- ---- Gross profit ............................ 88 83 95% Operating expenses: Selling and marketing ................. 37 33 105% Research and development .............. 19 19 83% General and administrative ............ 5 6 52% ---- ---- Total operating expenses ...... 61 58 93% ---- ---- Income from operations .................. 27 25 Interest and other income, net .......... 4 7 Interest expense ........................ (2) (4) ---- ---- Income before income taxes .............. 29 28 Provision for income taxes............... (10) (5) ---- ---- Net income .............................. 19% 23% ==== ==== Gross margin: User license fees ..................... 96% 94% Services .............................. 60% 46%
Net Revenue VERITAS' total net revenue increased 84% from $39.1 million for the three months ended March 31, 1998 to $71.9 million for the three months ended March 31, 1999. VERITAS believes that the percentage increase in total revenue achieved in this period is not necessarily indicative of future results. VERITAS' revenue is comprised of user license fees and service revenue. Growth in user license fees has been driven primarily by increasing market acceptance of VERITAS' products, introduction of new products and a larger percentage of total license revenue generated through the direct sales channel. Service revenue is derived primarily from contracts for software maintenance and technical support and, to a lesser extent, consulting services, training services and porting fees. The growth in service revenue has been driven primarily by increased sales of service and support contracts on new license sales and, to a lesser extent, by increasing renewals of these contracts by VERITAS' installed base of licensees. VERITAS also experienced an increase in demand for consulting and training services. Porting fees are derived from VERITAS' funded development efforts that are typically associated with VERITAS' agreements with original equipment manufacturers. User license fees were 78% of total net revenue for the three months ended March 31, 1999, and 79% of total net revenue for the three months ended March 31, 1998. User License Fees. User license fees increased 82% from $30.7 million for the three months ended March 31, 1998 to $55.8 million for the three months ended March 31, 1999. The increase was primarily the result of continued growth in market acceptance of VERITAS' software products, a greater volume of large end-user transactions, increased revenue from original equipment manufacturer resales of bundled and unbundled VERITAS products and the 13 14 introduction of new products. In particular, VERITAS' user license fees from storage products increased by approximately 57% for the three months ended March 31, 1999 as compared to the three months ended March 31, 1998, and accounted for 75% of user license fees in the three months ended March 31, 1999 and 87% of user license fees in the three months ended March 31, 1998. Service Revenue. Service revenue increased 92% from $8.4 million for the three months ended March 31, 1998 to $16.1 million for the three months ended March 31, 1999. The increase was primarily due to increased sales of service and support contracts on new licenses, renewal of service and support contracts on existing licenses and, to a lesser extent, an increase in demand for consulting and training services. Cost of Revenue Cost of user license fees consists primarily of royalties, media, manuals and distribution costs. Cost of service revenue consists primarily of personnel-related costs in providing maintenance, technical support, consulting and training to customers, and development efforts in porting. Gross margin on user license fees is substantially higher than gross margin on service revenue, reflecting the low materials, packaging and other costs of software products compared with the relatively high personnel costs associated with providing maintenance, technical support, consulting, training services and development efforts. Cost of service revenue also varies based upon the mix of maintenance, technical support, consulting and training services. Cost of User License Fees. Cost of user license fees remained relatively constant at $2.0 million for each of the three month periods ended March 31, 1999 and March 31, 1998. Gross margin on user license fees increased from 94% for the three months ended March 31, 1998 to 96% for the three months ended March 31, 1999. The gross margin on user license fees may vary from period to period based on the license revenue mix and certain products having higher royalty rates than other products. VERITAS does not expect significant improvements in gross margin on user license fees. Cost of Service Revenue. Cost of service revenue increased 45% from $4.5 million for the three months ended March 31, 1998 to $6.5 million for the three months ended March 31, 1999. Gross margin on service revenue increased from 46% for the three months ended March 31, 1998 to 60% for the three months ended March 31, 1999. The increase in absolute dollars was primarily due to personnel additions in our customer support and training and consulting organizations, in anticipation of increased demand for such services. The improvement in gross margin in the three months ended March 31, 1999 compared to the three months ended March 31, 1998 was a result of increased productivity and higher service revenue growth due to a larger installed customer base paying support revenue. Operating Expenses Selling and Marketing. Selling and marketing expenses consist primarily of salaries, related benefits, commissions, consultant fees and other costs associated with VERITAS' sales and marketing efforts. Selling and marketing expenses increased 105% from $13.1 million for the three months ended March 31, 1998 to $26.8 million for the three months ended March 31, 1999. Selling and marketing expenses as a percentage of total net revenue increased from 33% for the three months ended March 31, 1998 to 37% for the three months ended March 31, 1999. The increase was primarily the result of higher personnel and related costs associated with increased staffing. VERITAS intends to continue to expand its global sales and marketing infrastructure, and accordingly, VERITAS expects its selling and marketing expenses to increase in absolute dollars but not to change significantly as a percentage of revenue in the future. Research and Development. Research and development expenses consist primarily of salaries, related benefits, third-party consultant fees and other engineering-related costs. Research and development expenses increased 83% from $7.5 million for the three months ended March 31, 1998 to $13.8 million for the three months ended March 31, 1999. The increase was due primarily to increased staffing levels. As a percentage of total net revenue, research and development expenses remained consistent at 19% for the three months ended March 31, 1999 and 1998. VERITAS believes that a significant level of research and development investment is required to remain competitive, and expects such expenses will continue to increase in absolute dollars in future periods, although such expenses may decline slightly as a percentage of total net revenue to the extent revenue increases. Research and development expenses can be expected to fluctuate from time to time to the extent that VERITAS makes periodic incremental investments in research and development and VERITAS' level of revenue fluctuates. 14 15 General and Administrative. General and administrative expenses consist primarily of salaries, related benefits and fees for professional services, such as legal and accounting services. General and administrative expenses increased 52% from $2.2 million for the three months ended March 31, 1998 to $3.3 million for the three months ended March 31, 1999. General and administrative expenses as a percentage of revenue declined from 6% to 5%. The increase in absolute dollars was primarily due to additional personnel costs and other expenses associated with VERITAS enhancing its infrastructure to support expansion of its operations. General and administrative expenses are expected to increase in absolute dollars, but not to change significantly as a percentage of revenue in the future, as VERITAS expands its operations. Interest and Other Income, Net. Interest and other income, net increased 13% from $2.7 million for the three months ended March 31, 1998 to $3.0 million for the three months ended March 31, 1999. The increase was due primarily to increased amounts of interest income attributable to the higher level of funds available for investment. Foreign exchange transaction gains and losses which are included in other income, net, have not had a material effect on VERITAS' results of operations. Interest Expense. Interest expense remained consistent at $1.4 million for the three months ended March 31, 1999 and 1998. Interest expense consists primarily of interest accrued under the Convertible Subordinated Notes issued by VERITAS in October 1997. Income Taxes. VERITAS had effective tax rates of 36% for the three months ended March 31, 1999 and 18% for the three months ended March 31, 1998. VERITAS' 1998 effective tax rate is lower than the combined federal and state statutory rates primarily due to the utilization of federal net operating loss carryforwards and other credit carryforwards, offset by the impact of state and foreign taxes. VERITAS' effective tax rate for the three months ended March 31, 1999 was higher than the effective tax rate for the three months ended March 31, 1998 primarily due to a lower benefit being derived from net operating loss carryforwards in 1999 relative to a higher level of pre-tax income. The realization of VERITAS' net deferred tax assets, which relate primarily to net operating loss carryforwards and temporary differences, is dependent on generating sufficient taxable income in future periods. Although realization is not assured, management believes it is more likely than not that the net deferred tax asset will be realized. The amount of the net deferred tax assets considered realizable, however, could be reduced or increased in the near term if estimates of future taxable income are changed. Management intends to evaluate the realizability of the net deferred tax assets on a quarterly basis to assess the need for the valuation allowance. New Accounting Pronouncements. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 establishes methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. VERITAS will be required to implement SFAS No. 133 for its fiscal year ending December 31, 2000. VERITAS' foreign currency exchange rate hedging activities have been insignificant to date and VERITAS does not believe that the impact of SFAS No. 133 will be material to its financial position, results of operations or cash flows. In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1 requires that entities capitalize certain costs related to internal-use software once certain criteria have been met. VERITAS has implemented SOP 98-1 for its fiscal year ending December 31, 1999 and the impact of SOP 98-1 to VERITAS' financial position, results of operations and cash flows was not material. In December 1998, the AICPA issued SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions". SOP 98-9 amends SOP 97-2 "Software Revenue Recognition" to require recognition of revenue using the "residual method" when certain criteria are met. VERITAS will be required to implement these provisions of SOP 98-9 for its fiscal year ending December 31, 2000. Effective in December 1998, SOP 98-9 also amends SOP 98-4 (an earlier amendment to SOP 97-2) to extend the deferral of the application of certain passages of SOP 97-2 provided by SOP 98-4. VERITAS does not believe the impact of SOP 98-9 will be material to VERITAS' financial position, results of operations and cash flows. 15 16 LIQUIDITY AND CAPITAL RESOURCES VERITAS' cash, cash equivalents and short-term investments totaled $208.5 million at March 31, 1999 and represented 56% of total assets. Cash and cash equivalents are highly liquid with original maturities of ninety days or less. Short-term investments consist mainly of investment grade commercial paper, market auction preferreds and other medium-term notes. At March 31, 1999, VERITAS had $100.0 million of long-term obligations and stockholders' equity was approximately $190.3 million. Net cash provided by operating activities was $15.2 million in the three months ended March 31, 1999, and $15.3 million in the three months ended March 31, 1998. For the three months ended March 31, 1999, cash provided by operating activities resulted primarily from net income, an increase in deferred revenue, and a reduction in accounts receivable offset somewhat by an increase in prepaid expenses. For the three months ended March 31, 1998, cash provided by operating activities increased primarily as a result of higher net income, increases in accrued liabilities and deferred revenue balances and reductions in prepaid expenses and accounts receivable. VERITAS' investing activities used cash of $49.8 million in the three months ended March 31, 1999 primarily due to the net increase in short-term and long-term investments of $41.1 million and capital expenditures of $8.6 million. VERITAS' investing activities used cash of $28.0 million in the three months ended March 31, 1998 due to the net increase in short-term investments of $23.3 million and capital expenditures of $4.7 million. Financing activities provided cash of $7.1 million in the three months ended March 31, 1999, and $4.3 million in the three months ended March 31, 1998 from the issuance of common stock under VERITAS' employee stock plans. In October 1997, VERITAS issued $100.0 million of 5.25% Convertible Subordinated Notes due 2004 (the Notes), for which VERITAS received net proceeds of $97.5 million. The Notes provide for semi-annual interest payments each May 1 and November 1, commencing on May 1, 1998. The Notes are convertible into shares of VERITAS' common stock at any time prior to the close of business on the maturity date, unless previously redeemed or repurchased, at a conversion price of $43.00 per share, subject to adjustment in certain events. On or after November 5, 2002, the Notes will be redeemable over the period of time until maturity at the option of VERITAS at declining premiums to par. The debt issuance costs are being amortized over the term of the Notes using the interest method. The issuance of the Notes resulted in a ratio of long-term debt to total capitalization at March 31, 1999 of approximately 34%. As a result of this additional indebtedness, VERITAS' principal and interest payment obligations have increased substantially. The degree to which VERITAS will be leveraged could materially and adversely affect VERITAS' ability to obtain financing for working capital, acquisitions or other purposes and could make it more vulnerable to industry downturns and competitive pressures. VERITAS will require substantial amounts of cash to fund scheduled payments of principal and interest on its indebtedness, including the Notes, future capital expenditures and any increased working capital requirements. If VERITAS is unable to meet its cash requirements out of cash flow from operations, there can be no assurance that it will be able to obtain alternative financing. During the first quarter of 1999, VERITAS signed a letter of intent to enter into an agreement to lease real estate to be built by the lessor. In a separate agreement, VERITAS was retained by the lessor as its agent for the construction of the facility. The leases for land and improvements will be classified as operating leases. The various agreements provide for minimum lease payments which begin, generally, upon completion of construction, which is expected to be June 2001, as well as certain residual value guarantees. Pre development costs incurred by VERITAS were approximately $1.4 million through March 31, 1999, and were subsequently reimbursed by the lessor. VERITAS believes that its current cash, cash equivalents and short-term investment balances and cash flow from operations will be sufficient to meet VERITAS' working capital and capital expenditure requirements for at least the next 12 months. Thereafter, VERITAS may require additional funds to support its working capital requirements or for other purposes and may seek to raise such additional funds through public or private equity financing or from other sources. There can be no assurance that additional financing will be available at all or that if available, such financing will be obtainable on terms favorable to VERITAS. 16 17 YEAR 2000 COMPLIANCE BACKGROUND OF YEAR 2000 ISSUES We are aware of the issues associated with the programming code in existing computer systems as the millennium approaches. Many currently installed computer systems and software products are unable to distinguish between twentieth century dates and twenty-first century dates because such systems may have been developed using two digits rather than four to determine the applicable year. For example, computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This error could result in system failures, generation of erroneous data or miscalculations causing disruption of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. As a result, many companies' software and computer systems may need to be upgraded or replaced to comply with such Year 2000 requirements. The Year 2000 problem is pervasive and complex. Significant uncertainty exists in the software industry concerning the potential impact of Year 2000 problems. We are assessing the potential overall impact of the impending century change on our business, financial condition and results of operations. STATE OF READINESS Based on our assessment to date, we believe the current versions of its software products and services are "Year 2000 ready" -- that is, they are capable of adequately distinguishing twenty-first century dates from twentieth century dates. New products are being designed and tested to be Year 2000 ready. Although our products have undergone, or will undergo, our normal quality testing procedures, there can, however, be no assurance that our products will contain all necessary date code changes. Furthermore, use of our products in connection with other products which are not Year 2000 ready, including non-compliant hardware, software and firmware may result in the inaccurate exchange of dates and result in performance problems or system failure. In addition, original equipment manufacturer derivative versions of older VERITAS products may not be Year 2000 ready. Any failure of our products to perform, including system malfunctions associated with the onset of year 2000, could result in claims against us. However, success of our Year 2000 compliance efforts may depend on the success of its customers in dealing with the Year 2000 issue, as we have formally notified all customers of the Year 2000 readiness of its products. Although we have not been a party to any litigation or arbitration proceeding to date that involves Year 2000 compliance issues with our products or services, there can be no assurance that we will not in the future be required to defend its products or services in such proceedings, or to negotiate resolutions of claims based on Year 2000 issues. The costs of defending and resolving Year 2000 related disputes, regardless of the merits of such disputes, and any liability we have for Year 2000 related damages, including consequential damages, could harm on our business. In addition, we believe that purchasing patterns of customers and potential customers may be affected by Year 2000 compliance issues as organizations expend significant resources to correct their current software systems for Year 2000 compliance. These expenditures may result in reduced funding available to such entities for other information technology purchases, such as those products and services offered by us. Furthermore, customers and potential customers may defer information technology purchases generally until early in the next millennium to avoid Year 2000 compliance problems. Any such deferral of purchases by our customers or potential customers could harm our business. Our business depends on numerous systems that could potentially be impacted by Year 2000 related problems. Those systems include, among others: hardware and software systems used by us to deliver products and services to our customers (including software supplied by third parties); communications networks such as the wide area network and local area networks upon which we depend to communicate product orders to our manufacturing and distribution operations and to develop products; the internal systems of VERITAS' customers and suppliers; software products sold to customers; the hardware and software systems used internally by our in the management of our business; and non-information technology systems and services used by us in the management of our business, such as power, telephone systems and building systems. We are currently in the process of evaluating our information technology infrastructure in order to identify and modify any products, services or systems, including hardware, software and firmware, that are not Year 2000 ready. Based on our initial analysis of the systems potentially impacted by conducting business in the twenty-first century, we 17 18 are applying a phased approach to making such systems, and accordingly, our operations, ready for the year 2000. Beyond awareness of the issues and scope of systems involved, the phases of activities in process include: an assessment of specific underlying computer systems, programs and hardware; renovation or replacement of Year 2000 non-compliant technology; validation and testing of critical systems certified by third-party suppliers to be Year 2000 ready; and implementation of Year 2000 ready systems. The table below describes the status and timing of such phased activities.
TARGETED IMPACTED SYSTEMS STATUS COMPLETION ---------------- ------ ---------- Software products sold to customers Software products tested and Q3 1998 available for customers (completed) Communication networks used to carry Assessment inventory completed Q4 1998 products and provide services (completed) Hardware and software systems used Assessment inventory completed Q4 1998 to manage the Company's business (completed) Hardware and software systems used Assessment completed Q1 1999 to deliver products and services (completed) Hardware and software systems used Validation, testing and Q2 1999 products and provide services remediation in process (including desktops) Communication networks used to carry Validation, testing and Q2 1999 products and provide services remediation in process Hardware and software systems used Validation, testing and Q2/Q3 1999 to manage the Company's business remediation Non-information technology systems Systems upgraded or replaced as Q3 1999 and services appropriate, testing and implementation
Extensive Year 2000 testing will be conducted on all systems considered critical to us. To date, we have not encountered any material problems in this regard with our computer systems or any other equipment that might be subject to such problems. In the event that any of our significant suppliers or customers does not successfully and timely achieve Year 2000 compliance, our business or operations could be adversely affected. This could result in system failures or generation of erroneous information and could cause significant disruption to business activities. We are reviewing what further actions are required to make all software systems used internally Year 2000 ready as well as actions needed to mitigate vulnerability to problems with suppliers and other third parties' systems. COSTS TO ADDRESS YEAR 2000 ISSUES The total cost of our Year 2000 compliance activities has not been, and is not anticipated to be, material to our business, results of operations and financial condition. We estimate specific Year 2000 expenses to date to be not more than $0.3 million and do not expect total costs of the compliance activities to exceed $0.7 million. These costs and the timing in which we plan to complete our Year 2000 modification and testing processes are based on our estimates. However, there can be no assurance that we will timely identify and remedy all significant Year 2000 problems, that remediation efforts will not involve significant time and expense, or that such problems will not harm our business. CONTINGENCY PLANS We do not presently have a contingency plan for handling Year 2000 problems that are not detected and corrected prior to their occurrence. Any failure of VERITAS to address any unforeseen Year 2000 issue could harm our business. Full contingency plans are scheduled for completion by September 1, 1999. 18 19 FACTORS THAT MAY AFFECT FUTURE RESULTS In addition to other information in this Quarterly Report on Form 10-Q, the following factors should be considered carefully in evaluating the Company and its business. The acquisition of the NSMG business is risky. VERITAS' proposal to acquire the Seagate Software Network & Storage Management Group, or NSMG, business subjects VERITAS to further risks and uncertainties that could harm our business, financial condition and results of operations, in the near term at least, as a result of a number of factors, including: o the potential disruption of our business that might result from employee and customer uncertainty, or lack of management focus, following the acquisition, in connection with integrating the operations of VERITAS and the NSMG business, o the possibility that the acquisition might not be consummated; o the effects of the acquisition on our stock price, our sales and operating results, our ability to attract and retain key management, marketing and technical personnel and the progress of certain of its development projects; and o the risk that the announcement of the acquisition could result in decisions by customers to defer purchases of our products or those of the NSMG business. We might fail to integrate the businesses of VERITAS, the Network & Storage Management Group and TeleBackup Product line integration will be difficult. If we complete the acquisitions of the NSMG business and TeleBackup, which is not assured, New VERITAS will need to integrate three independent businesses. One key issue will be the integration of the product offerings of the Network & Storage Management Group business and TeleBackup with those of VERITAS. This product line integration will involve consolidation of products with duplicative functionality, coordination of research and development activities, and convergence of the technologies supporting the various products. For example, VERITAS' NetBackup product and the Network & Storage Management Group's Seagate Backup Exec product share many features and functions, and the Network & Storage Management Group's Seagate Client Exec product is very similar to TeleBackup's TSInfoPro. Technology convergence will be particularly difficult because the products of VERITAS and the Network & Storage Management Group business lack a common technology architecture. In particular, the Network & Storage Management Group products were not designed for the degree of scalability that VERITAS' products were designed for, nor for use on the variety of operating systems. Further, we have no experience with product and technology integration on the scale contemplated by the NSMG combination. Other business integration issues could arise. Other problems inherent in integrating the businesses of VERITAS, the Network & Storage Management Group business and TeleBackup include: o maintaining brand recognition for key products of the Network & Storage Management Group business products, such as Seagate Backup Exec, and of the TeleBackup product, TSInfoPro, while migrating customer identification of the brands to New VERITAS; o resolving channel conflicts that may arise between the original equipment manufacturer and direct sales distribution channels of VERITAS and the retail channels of the Network & Storage Management Group business; o coordinating, integrating and streamlining geographically dispersed operations, such as engineering facilities in: Mountain View, California; San Luis Obispo, California; Roseville, Minnesota; Heathrow, Florida; Durham, North Carolina; Tacoma Park, Maryland; Boulder, Colorado; Boston, Massachusetts; Cambridge, Massachusetts; Bellevue, Washington; Calgary, Alberta; and Pune, India; and o coping with customers' uncertainty about continued support for duplicative New VERITAS products. 19 20 The integration will be expensive and is likely to interrupt our business activities. Any of these risks could harm New VERITAS' revenues and results of operations. Management and employee integration issues could arise. Potential management and employee integration problems include: o resolving differences between the corporate cultures of VERITAS and the Network & Storage Management Group business; and o integrating the management teams of all three companies successfully. New VERITAS will incur significant accounting charges in connection with the combinations that will reduce its earnings immediately and in the future The significant costs of integration associated with the combinations increases the risk that we will not realize the anticipated benefits. Because New VERITAS will account for the NSMG combination and the TeleBackup combination as purchases, we expect to incur non-cash charges of approximately $103.1 million to our statements of operations, related to the write-off of in-process research and development. We also will record goodwill and other intangible assets of approximately $3,244.7 million. This amount will be amortized over four years, and will result in charges to operations of approximately $202.8 million per quarter. Such amounts are preliminary and are subject to change upon the final determination of the purchase price of both NSMG and TeleBackup at the time of closing of each transaction. In addition, we expect to incur a restructuring charge upon closing, currently expected in the first half of 1999, in the range of $8.0 million to $11.0 million, primarily related to costs for duplicative facilities which New VERITAS plans to vacate. These costs are in addition to the liability for the estimated costs to New VERITAS to vacate facilities of the Network & Storage Management Group business which will become duplicative upon the completion of the NSMG combination. Our operating results may fluctuate significantly as a result of factors outside our control, which could adversely affect our stock price Fluctuations in our net income are likely to affect the market price of our common stock in a manner that may be unrelated to our long-term operating performance. In addition, the number of factors that could affect our results makes an investment in VERITAS more risky than many other investments. Our revenue in any quarter will depend substantially on orders we receive and ship in that quarter. In addition, we typically receive a significant portion of orders in any quarter during the last two weeks of the quarter, and we cannot predict whether those orders will be placed, fulfilled and shipped in that period. If we have lower revenues than we expect, we probably will not be able to reduce our operating expenses quickly in response. Therefore, any significant shortfall of revenue or delay of customer orders could have an immediate adverse effect on our operating results in that quarter. The operating results of VERITAS have fluctuated in the past, and are likely to fluctuate significantly in the future. Factors that could affect our operating results include: o timing and magnitude of sales through original equipment manufacturers; o the unpredictability of the timing and level of sales to resellers and our direct sales force, which tend to generate sales later in our quarters than original equipment manufacturer sales; o timing and magnitude of large orders; o timing and amount of our marketing, sales and product development expenses; o cost and time required to develop new software products; 20 21 o the introduction, timing and market acceptance of new products; o our ability to deliver products that are Year 2000 ready; o timing of revenue recognition for sales of software products and services; o changes in data storage and networking technology or introduction of new operating system upgrades by original equipment manufacturers, which could require us to modify our products or develop new products; o relative growth rates of the Windows NT and UNIX markets; o timing of Microsoft's release of the next version of Windows NT, or Windows 2000, and the rate of adoption of Windows 2000 by users; o pricing policies and distribution terms; and o the timing and magnitude of acquisitions. We will depend on large orders with lengthy sales cycles for a significant portion of our revenues Customer orders can range in value from a few thousand to over a million dollars. The length of time between initial contact with a potential customer and sale of a product, or our sales cycle, outside the retail channel is typically complex and lengthy, so it can last from three to nine months. These direct sales also represent our largest orders. Therefore, our revenues for a period are likely to be affected by the timing of larger orders, which makes those revenues difficult to predict. Our revenues for a quarter could be reduced if large orders forecasted for a certain quarter are delayed or are not realized. The cycle factors that could delay or defer an order, include: o time needed for technical evaluations of our software by customers; o customer budget restrictions; o customer internal review and testing procedures; and o engineering work needed to integrate our software with the customers' systems. We will face many difficulties in managing a larger company VERITAS has recently grown rapidly. We expect VERITAS to continue to grow, so you should bear in mind that the larger company will create new challenges for our existing management. If we fail to meet those challenges the value of your investment may decline. This growth is likely to strain our management control systems and resources, including decision support, accounting and management information systems. We will need to continue to improve our financial and management controls and our reporting systems and procedures to manage our employees and to obtain additional facilities. VERITAS will need to hire and retain many new sales and engineering personnel, which is difficult VERITAS' challenge includes personnel needs that are more acute than those facing most companies. VERITAS will need to hire many additional sales and engineering personnel. Competition for individuals with these skills is intense, particularly in many of the areas where VERITAS will seek to hire those persons. Additions of new personnel and departures of existing personnel can be disruptive to our business and can result in the departure of other employees. We will also remain dependent on the continued service of our key personnel. Even though VERITAS intends to enter into employment agreements with key management personnel, these agreements cannot prevent the departure of those employees. We do not have key person life insurance covering any of our personnel, nor do we currently intend to obtain any of this insurance. 21 22 We will be distributing our products through multiple distribution channels, each of which is subject to risks Direct sales. We depend on our direct sales force to sell our products. This also involves a number of risks, including: o long sales cycles for direct sales; o our need to hire, train, retain and motivate our sales force; and o the length of time it takes our new sales representatives to become productive. Original equipment manufacturers. A portion of our revenues are expected to come from original equipment manufacturers that incorporate our storage management software into systems they sell. We will have no control over the shipping dates or volumes of systems the original equipment manufacturers ship. They have no obligation to ship systems incorporating our software. They do not have to recommend or offer our software products exclusively or at all, and have no minimum sales requirements. They can terminate our relationship at any time. These original equipment manufacturers could choose to develop their own storage management products internally and incorporate those products into their systems in lieu of our products. Our business could be harmed if some or all of our current original equipment manufacturers discontinued selling New VERITAS' products. Development agreements for original equipment manufacturers. We have important original equipment manufacturer agreements with Hewlett-Packard, Sun Microsystems, Microsoft, Dell, Seagate Technology and Compaq Computer. Under these agreements we develop "lite" versions of our products to be included in these original equipment manufacturers' systems software and products. Developing products for these original equipment manufacturers causes us to divert significant resources from other activities which are also important to our business. If these "lite versions" do not result in substantial revenue, our business could be adversely affected. VERITAS' distribution channels could conflict with one another We have many different distribution channels. Our original equipment manufacturers, resellers and direct sales force may target similar sales opportunities, which could lead to inefficient allocation of sales resources. We may also try to sell full versions of the products to customers of the original equipment manufacturers for whom we have developed "lite" versions of our products. This would result in us marketing similar products to end-users. These overlapping sales efforts could also adversely affect our relationships with our original equipment manufacturers and other sales channels and result in them being less willing to market our products aggressively. If our indirect sales decline, we would need to accelerate our investments in alternative distribution channels. We may not be able to do this in a timely manner, or at all. Risks relating to our development agreements with Microsoft We have important agreements with Microsoft under which we develop software for its Windows operating system. However, if we do not develop these products in time for the release of Microsoft's Windows 2000 (formerly known as Windows NT 5.0), operating system, Microsoft will not include them in this operating system. Even if we do develop these products on time, Microsoft is not obligated under the agreements to include them in this operating system. If for any reason our software is not included in Windows 2000 we will lose our expected opportunity to market additional products to the Windows NT installed customer base, as well as suffer negative publicity. In addition, we would lose the investment we have made in developing products for inclusion in Windows 2000. Risks of delay of release of Windows 2000. Microsoft is not required to release Windows 2000 on any particular date. Therefore, if the release of this operating system is delayed, it will be more difficult for us to market and sell our products to Windows NT users. Microsoft could develop competing products. Microsoft can also develop enhancements to and derivative products from our software products that are embedded in Windows NT products. If Microsoft developed any enhancements or derivative products, or its own base products with equivalent functionality, Microsoft could choose to compete with us. 22 23 Sales of a small number of product lines will make up a substantial portion of our revenues We expect to derive a substantial majority of our revenue from a limited number of software products and expects to continue to do so for the foreseeable future. For example, in the three months ended March 31, 1999, VERITAS derived approximately 75% of its license revenue from storage management products, which include Volume Manager, File System and NetBackup. If many customers do not purchase these products as a result of competition, technological change or other factors, our revenues would decrease. Our products have relatively short life cycles Our software products have a limited life cycle and it is difficult to estimate when they will become obsolete. This makes it difficult for us to forecast revenue and makes your investment in VERITAS more risky. If we do not develop and introduce new products before our existing products have completed their life cycles, we would not be able to sustain our level of sales. In addition, to succeed, many customers must adopt our new products early in the product's life cycle. Therefore, if we do not attract sufficient customers early in a product's life, we may not realize the amount of revenues we anticipated for the product. We cannot be sure that we will continue to be successful in marketing our key products. We derive significant revenues from only a few customers Sales to a small number of customers generate a disproportionate amount of our revenue. For example, in the three months ended March 31, 1999, we derived 12% of our revenue from sales to Sun Microsystems. If Sun Microsystems or any other significant customer were to reduce its purchases from us, our revenues and therefore our business would be harmed unless we were to increase sales to other customers substantially. We do not have a contract with Sun Microsystems or any other customer that requires the customer to purchase any specified number of software licenses from us. Therefore, we cannot be sure that these customers will continue to purchase our products at current levels. VERITAS plans to port products to new operating systems and we face uncertainties in porting products and developing new products Certain of VERITAS' products operate primarily on certain versions of the UNIX computer operating system. VERITAS is redesigning, or porting, certain of its software products to operate on the Windows NT operating system. VERITAS is also developing new products for UNIX as well as for Windows NT. We may not be able to accomplish any of this work quickly or cost-effectively. These activities require substantial capital investment, substantial employee resources and the cooperation of the owners of the operating systems to or for which the products are being ported or developed. For example, VERITAS' porting and development work for the Windows NT market has required it to hire additional personnel with Windows NT expertise and to devote engineering resources to these projects. Operating system owners have no obligation to assist in these porting or development efforts. In particular, we must obtain from them a source code license to certain portions of the operating system software, in order to port our products to or develop products for that operating system. If they do not grant us a license or if they do not renew our license, we would not be able to expand our product line easily into other areas. For example, we rely on a source code license from Microsoft with respect to our Windows NT development projects. Microsoft is under no obligation to renew the source code license, which is subject to annual renewal. We face intense competition on several fronts VERITAS faces a wide variety of tough competitors. Our principal competitors include: o internal development groups within original equipment manufacturers that provide storage management functions with their systems, such as Sun Microsystems for its Solaris System, Compaq for its Digital UNIX, IBM for its AIX System and Microsoft for its Windows NT; o other software vendors and hardware companies that offer products with some of our products' features, such as controller and disk subsystem manufacturers; 23 24 o hardware and software vendors that offer storage application products, such as the Cheyenne division of Computer Associates, for its ARCserve product; EMC, for its Enterprise Data Manager product; IBM, for its ADSTAR Distributed Storage Manager product; Intelliguard, for its BudTool product; Spectralogic, for its Alexandria Network Librarian product; StorageTek, for its REELbackup product; Hewlett-Packard, for its Omniback product; and Legato Systems, for its NetWorker and GEMS products; and o hardware and software vendors that offer high availability and clustering products, such as Fulltime Software, Inc., formerly known as Qualix Group Inc., for its Qualix HA product; Sun Microsystems, for its Sun Cluster product; and Hewlett-Packard, for its HP-ServiceGuard product. Many of our competitors have substantially greater financial and technical resources than VERITAS and may attempt to increase their presence in the storage management market by acquiring or forming strategic alliances with other competitors or business partners. Expanding our international sales depends on economic stability in regions that recently have been unstable We plan to expand in overseas markets, such as Asia, Russia and Latin America, that have recently experienced significant economic turmoil. Continued turmoil could adversely affect our plans to increase sales in these regions. Economic recession could also affect our ability to maintain or increase sales in these or other regions in the future. Our concern is that recession could lead to: o restrictions on government spending imposed by the International Monetary Fund; o customers' reduced access to working capital to fund software purchases; o higher interest rates; and o reduced bank lending or other sources of financing for customers and potential customers. Any of these factors could cause foreign customers to not purchase our products. Our foreign-based operations and sales create special problems that could hurt our results We will have significant offshore operations, including development facilities, sales personnel and customer support operations. For example, as of March 31, 1999, VERITAS had approximately 135 engineers located in Pune, India, performing product development work. These offshore operations are subject to certain inherent risks, including: o potential loss of developed technology through piracy, misappropriation, or more lax laws regarding intellectual property protection; o imposition of governmental controls, including trade restrictions; o fluctuations in currency exchange rates and economic instability; o longer payment cycles for sales in foreign countries; o difficulties in staffing and managing the offshore operations; o seasonal reductions in business activity in the summer months in Europe and other countries; and o political unrest, particularly in areas in which we have facilities. In addition, our international sales will be denominated in local currency, creating risk of foreign currency translation gains and losses that could affect our financial results. If we generate profits or losses in foreign countries, our effective income tax rate could also be harmed. The currency instability in Asia and other foreign financial markets 24 25 may make our products more expensive than products sold by other vendors that are priced in one of the affected currencies. Therefore, foreign customers may choose not to purchase our products. VERITAS has a significant amount of debt VERITAS sold $100.0 million principal amount of 5.25% convertible subordinated notes in October 1997. The annual interest payments will be $5.25 million which VERITAS expects to fund from its cash flow from operations. As of March 31, 1999, the ratio of VERITAS' long term debt to total capitalization was 34%. VERITAS will need substantial amounts of cash to fund interest payments and to repay the principal amount of debt when it matures, while at the same time funding capital expenditures and other working capital needs. While VERITAS' cash flow has been sufficient to fund such interest payments to date, if VERITAS cannot meet its cash requirements from the cash generated by its business, it may not be able to respond to changing business or economic conditions adequately, make acquisitions or otherwise fund its business. If VERITAS does not have sufficient cash to repay this debt when it matures, it may not be able to refinance this debt on reasonable terms or at all. This debt could be declared immediately due and payable if it does not make timely payments on this debt. VERITAS' acquisition strategy involves risks VERITAS plans to pursue a strategy of growth through acquisition. VERITAS has grown aggressively through acquisitions in the past and expects to pursue acquisitions in the future. Acquisitions involve a number of special risks and challenges, including: o our management's attention may be diverted, particularly in the case of multiple concurrent acquisitions; o we must integrate the target's operations and employees with our existing business; o we may have difficulty incorporating technology into our existing product lines; o key employees may leave; and o we may have difficulty presenting a unified corporate image. In the past, we have lost certain employees of acquired companies whom we desired to retain. In some cases, the integration of the operations of acquired companies took longer than initially anticipated. In addition, if the employees of target companies remain geographically dispersed from our existing staff, we may not realize some or all of the anticipated economies of scale. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FOREIGN EXCHANGE RATE SENSITIVITY VERITAS does not use derivative financial instruments for speculative purposes. VERITAS engages in exchange rate hedging from time to time but such activity has been insignificant to date and VERITAS does not hold or issue foreign exchange contracts for trading purposes. VERITAS' international sales are generated primarily through its international sales subsidiaries. Most international revenue outside the United States and Canada is collectible in foreign currencies. Since much of our international operating expenses are also incurred in local currencies, the impact of exchange rates on net income or loss is relatively less than the impact on revenues. Although VERITAS' operating and pricing strategies take into account changes in exchange rates over time, VERITAS' operating results may be significantly affected in the short term by fluctuations in foreign currency exchange rates. VERITAS' international subsidiaries purchase licenses from the parent company resulting in intercompany receivables and payables. These receivables and payables are carried on each company's books at the historical local currency that existed at the time of the transaction. Such receivables and payables are eliminated for financial statement reporting purposes. Prior to elimination, the amounts carried in foreign currencies are converted to U.S. Dollars at the then current rate or "marked to market". The marked to market process may give rise to currency gains and losses. Such gains or losses are 25 26 recognized on VERITAS' statement of operations as a component of other income, net. To date, any such gains or losses have not been material. VERITAS does not believe its total exposure to be significant. INTEREST RATE SENSITIVITY VERITAS' exposure to market risk for changes in interest rates relates primarily to our investment portfolio and long-term debt obligations. The primary objective of VERITAS' investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. VERITAS' portfolio includes money markets funds, commercial paper, market auction preferreds, government agency notes and medium-term notes. The diversity of the portfolio helps VERITAS to achieve its investment objective. As of March 31, 1999, approximately 91% of VERITAS' entire portfolio will mature in one year or less and approximately 41% of our investment portfolio matures less than 90 days from the date of purchase. Long-term debt of $100.0 million consists of 5.25% Convertible Subordinated Notes (the Notes) due 2004. The interest rate on these notes is fixed and the Notes provide for semi-annual interest payments of approximately $2.6 million each May 1 and November 1. The Notes are convertible into VERITAS' common stock at any time prior to the close of business on the maturity date, unless previously redeemed or repurchased, subject to adjustment in certain events. The following table presents the amounts of VERITAS' cash equivalents, investments and debt that may be subject to interest rate risk and the average and fixed interest rates as of March 31, 1999 by year of maturity:
2000 AND FAIR VALUE 1999 THEREAFTER TOTAL TOTAL ------------ ------------ ---------- ----------- (IN THOUSANDS) Cash equivalents and short-term investments ................. $ 194,330 -- $ 194,330 $ 194,330 Average interest rate ......... 5.04% -- 5.04% 5.04% Long-term investments ......... $ 499 $ 47,360 $ 47,859 $ 47,859 Average interest rate ......... 5.86% 5.20% 5.21% 5.21% Long-term debt ................ -- $ 100,000 $ 100,000 $ 187,791 Fixed interest rate ........... -- 5.25% 5.25% 5.25%
26 27 PART II: OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS The following exhibits are filed herewith:
EXHIBIT NUMBER 27.1 Financial Data Schedule (EDGAR only)
(b) REPORTS ON FORM 8-K No current Reports on Form 8-K were filed by the registrant during the quarter ended March 31, 1999. 27 28 SIGNATURE 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, on May 13, 1999. VERITAS SOFTWARE CORPORATION /s/ KENNETH E. LONCHAR ----------------------------------------------- Kenneth E. Lonchar Senior Vice President, Finance (Principal Financial and Accounting Officer) 28 29 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 27.1 Financial Data Schedule (EDGAR only)
29 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1999, AND THE CONSOLIDATED STATEMENT OF INCOME FOR THE QUARTER ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 111,324 97,225 53,010 2,800 0 280,068 54,606 22,078 374,876 83,888 100,000 0 0 48 190,207 374,876 55,786 71,904 1,955 8,482 43,928 0 1,433 21,092 7,509 13,583 0 0 0 13,583 0.28 0.26
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