OT - Accounting revision hammers Legato stock

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Looks like the auditors are tightening up on some of the reporting practices for software companies. Poor Legato - lost almost 50% of its market cap in one day. One wonder how this change may impact some of the big beasties like Oracle, or even (dare we say it?) Micro$oft...

Investors Abandon Legato After Accounting Revision

By Steven Vames (TheStreet.com/NYTimes.com Staff Reporter)

1/20/00 1:08 PM ET

Investors dumped Legato Systems (LGTO:NASDAQ - news) shares when trading opened Thursday, erasing nearly half the software developer's market value, on the surprise news from the night before that it had failed to meet fourth-quarter earnings projections and was restating how revenue is reported.

The shares, which began sliding in after-hours trades Wednesday night, were off 25, or 46%, to 29 11/16 at midday Thursday on the Nasdaq stock market.

Legato, a Palo Alto, Calif.-based developer of data backup and recovery software, said it had reduced previously reported earnings and reduced its outlook for future earnings because the company's primary auditor, PriceWaterhouseCoopers, had changed the way Legato reports revenue...


According to Payne, the accounting changes could have far-reaching consequences for the computer software industry because auditors now treat contracts more like a service transaction than a one-time sale.

In Legato's case, auditors decided to take two contracts signed during the fourth quarter and report them as they are carried out during 2000. Similarly, the auditors decided to report earnings from a contract signed in the third quarter during the first half of 2000.

"What they've done is take the software business and instilled the accounting practices that are more commonly seen in aerospace and construction, where contract revenues are not immediately reportable. We are now seeing them treat contract as future service," said Payne.

Because a large, respected accounting firm like PriceWaterhouseCoopers was involved with re-assessing how a software company's revenues should be reported, it could serve as a precedent for other auditors who deal with software firms.

"This is going to turn out to affect more than Legato," added Payne...

-- DeeEmBee (macbeth1@pacbell.net), January 20, 2000


And it appears that someone took advantage of knowledge that the drop was coming...

Legato Puts Fly Before the Stock Falls

By Erin Arvedlund (Staff Reporter)

1/20/00 1:40 PM ET

Looks like someone may have known Legato (LGTO:Nasdaq - news) was about to let some bad news out of the bag.

Heavy put activity in Legato options hit the most-actives list late Wednesday, not long before the company reported much worse-than-expected fourth-quarter earnings.

A phone call to the Chicago trading floor, where all the business in Legato options is done, found the frantic designated market-maker saying he was "too busy to talk right now." No surprise, given that the enterprise-software company's stock price was cut nearly in half Thursday, down 22 1/2 to 31 1/8.

On Wednesday, when the stock was still trading around 53, an investor bought about 3,000 January 60 puts for around 7 1/8 ($712.50).

A put option gives the holder the right to sell a stock at a specific price by a certain time and rises in value as the underlying stock price falls.

In the midst of Thursday's blood bath, that same January 60 put option was trading for 29 1/4 ($2,925). And the holders of Legato put options still have the right to sell the stock at 60, even though it is now trading at 30 13/16. More likely, though, they will simply sell the option back and realize one-day gains of more than 300%.

Options attract insider trading because of the tremendous leverage an investor can get. Buying a call option before a takeover bid or a put ahead of this kind of disaster costs a fraction of the price of actually buying shares and implies less risk than an outright short stock position.

The Chicago Board Options Exchange surveillance department declined to comment on the trading...

-- DeeEmBee (macbeth1@pacbell.net), January 20, 2000.

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