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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                               ----------------
                                   FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934

  For the fiscal year ended December 31, 2000

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934

  For the transition period from       to       .

                        Commission File Number: 0-26130

                               ----------------
                             LEGATO SYSTEMS, INC.
            (Exact name of registrant as specified in its charter)


               Delaware                              94-3077394
       (State of incorporation)         (I.R.S. Employer Identification No.)

                           2350 West El Camino Real
                        Mountain View, California 94040
                   (Address of principal executive offices)

                                (650) 210-7000
             (Registrant's telephone number, including area code)

                               ----------------
          Securities registered pursuant to Section 12(b) of the Act:

                                     None

          Securities registered pursuant to Section 12(g) of the Act:

                        Preferred Share Purchase Rights
                        Common Stock, $.0001 par value
                            (Title of each class).

   Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]

   Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]

   The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 16, 2001 was approximately $882,000,000. Shares of
Common Stock held by each officer and director have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.

   The number of shares outstanding of the registrant's common stock as of
March 16, 2001 was 88,029,645.

                      DOCUMENTS INCORPORATED BY REFERENCE

   Portions of the Registrant's definitive proxy statement (the "Proxy
Statement") relating to its 2001 annual meeting of stockholders to be held on
May 15, 2001 are incorporated by reference into Part III of this Annual Report
on Form 10-K. Except as expressly incorporated by reference, the Registrant's
Proxy Statement shall not be deemed to be part of this report.

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                              LEGATO SYSTEMS, INC.
                            FORM 10-K ANNUAL REPORT

                               FOR THE YEAR ENDED
                               DECEMBER 31, 2000

                               Table of Contents

                                     PART I

<TABLE>
 <C>      <S>                                                               <C>
 Item 1.  Business.......................................................     3
 Item 2.  Properties.....................................................    23
 Item 3.  Legal Proceedings..............................................    23
 Item 4.  Submission of Matters to a Vote of Security Holders............    24

                                    PART II

             Market for Registrant's Common Stock and Related Stockholder
 Item 5.  Matters........................................................    26
 Item 6.  Selected Consolidated Financial Data...........................    26
          Management's Discussion and Analysis of Financial Condition and
 Item 7.  Results of Operations..........................................    27
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.....    34
 Item 8.  Consolidated Financial Statements and Supplementary Data.......    34
          Changes in and Disagreements with Accountants on Accounting and
 Item 9.  Financial Disclosure...........................................    34

                                    PART III

 Item 10. Directors and Executive Officers of the Registrant.............    35
 Item 11. Executive Compensation.........................................    35
                      Security Ownership of Certain Beneficial Owners and
 Item 12. Management.....................................................    35
 Item 13. Certain Relationships and Related Transactions.................    35

                                    PART IV

          Exhibits, Financial Statement Schedules, and Reports on Form 8-
 Item 14. K..............................................................    36
 Signatures...............................................................   60
</TABLE>

                                       2
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                                     PART I

ITEM 1. BUSINESS

   The discussion in this report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, including
statements on our expectations, beliefs, intentions or strategies regarding the
future, including without limitation, our financial outlook, successful
introduction of new products and expansion of operation. All forward-looking
statements included in this document are based on information available to us
on the date hereof. We assume no obligation to update any such forward-looking
statements. Our actual results could differ materially from those indicated in
such forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, fluctuations in quarterly
operating results, uncertainty in future operating results, litigation,
competition, product concentration, technological changes, reliance on
enterprise license transactions, modifications in the application of accounting
policies, reliance on indirect sales channels, changes in marketing strategies,
dependence on international revenue, management of our growth and expansion,
the ability to attract and retain qualified personnel, and other risks
discussed in this item under the heading "Risk Factors" and the risks discussed
in our other Securities and Exchange Commission filings.

   We develop, market and support software products and services for
heterogeneous client/server computing environments in mid- to large-scale
enterprises. We are a technology leader in the network storage management
software market through our commitment to open, standards-based software
development. Our software delivers to customers a solution that is scalable,
high-performance and manageable and ensures high data and application
availability on a wide range of servers, clients, applications, databases and
storage devices. Our data protection products, primarily the NetWorker family
of products, and our data availability products, primarily our Legato Cluster
and wanCluster products, support many server platforms and accommodate a
variety of clients, applications, databases and storage devices. Our long-term
strategy is to create an integrated set of solutions centered on information
protection, availability and storage management that enhance and simplify
network computing as a whole.

The Legato Solution

   Our information protection, availability and management software products
and services have been designed to address the requirements of information
technology, or IT, professionals as they expand their enterprise and build
their e-business computing environments. Based on open standards, our
information protection solutions employ a client/server architecture to enable
customers with flexibility and choice in their decisions regarding computing
systems. We offer a consistent operating approach for our information
availability solutions which improves our customers' ability to deploy one
solution across a broad range of operating systems. Coupled with our
professional services offerings, we offer a cost-effective storage management
solution that scales to support large networks, supports heterogeneous
client/server computing environments, accomplishes storage management tasks
within stringent time constraints, reduces the cost of network administration
and employs an easy-to-use graphical user interface. The key advantages of our
solution include:

  . Scalability;

  . Heterogeneity;

  . Performance;

  . Ease of use; and

  . Data availability.


                                       3
<PAGE>

   Scalability. Our solution architecture is designed to enable scalable growth
within a company's computing environment. For our customers, this means that
they can be confident that their information protection strategy is resilient
to changes in servers, clients, storage sub-systems, and storage devices. Our
solutions can be configured or expanded to meet the needs of a changing and
dynamic network thereby extending a customer's investment protection. Our
architecture is modular, so that clients, servers and storage devices can be
upgraded or added without requiring redesign of the entire system. An existing
server can be quickly upgraded to a more powerful server with minimal
modification. Furthermore, our architecture can adapt to growing networks with
its ability to easily add clients to a given storage management server. For
example, a single NetWorker storage management server can be employed to manage
data located on hundreds of clients ranging from desktop computers to large
file servers.

   Heterogeneity. Our storage management solutions are designed to support a
wide range of servers, clients, applications, databases and storage devices.
Our family of storage management server products operates on the following
operating systems:

  . Linux;

  . NetWare;

  . Windows NT;

  . Windows 2000;

  . UNIX systems (AIX, Dynix/ptx, HP-UX, Irix Solaris, and Tru64); and

  . UNIX systems and Windows NT and Windows 2000 offered by our OEMs.

   Our products support server and desktop computer clients including:

  . Macintosh;

  . Mac OS;

  . NetWare;

  . Network Appliance

  . UNIX;

  . MPE/iX;

  . Windows;

  . Windows NT; and

  . Windows 2000.

   Our NetWorker Applications Modules support applications and databases
including:

  . DB2;

  . Informix;

  . Lotus Notes;

  . Microsoft Exchange;

  . Microsoft SQL;

  . Oracle;

  . SAP R/3; and

  . Sybase.

                                       4
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   Storage devices supported include most popular tape drives and optical and
tape robotic storage devices. All NetWorker server platforms inter-operate with
all supported clients. As a result, customers can mix and match clients and
servers as necessary to meet their specific requirements. In addition,
NetWorker's interoperability enables the flexibility to change storage
management server platforms without disrupting any client systems.

   Performance. Organizations usually need to accomplish storage management
functions (which tend to consume network bandwidth as large amounts of data are
transferred over the network) during a network's off-peak hours. Our NetWorker
storage management server can process data from many clients in parallel,
allowing high data volumes to be managed within stringent time constraints.
NetWorker is designed to take advantage of improvements in the physical
environment to deliver higher performance. As networks employ higher-speed
computers, faster and increased capacity storage devices and higher bandwidth
networking technologies, NetWorker is designed to exploit these capabilities to
move data quickly. Our data availability products, including Legato Cluster,
CoStandByServer and Legato Mirroring Extension, enable data exchange among
remote sites and disaster recovery without significant downtime and create
collaborative clusters of server resources across platforms, networks and
applications to ensure resource availability.

   Ease of use. Our storage management solutions have been designed to be easy
to use for both network administrators and end users. Our architecture permits
a network administrator to perform the storage management function for the
entire network either from the storage server or a client. The network
administrator can access our products through a number of graphical user
interfaces, including Windows, Windows NT and Windows 2000 and Motif. Network
administrators can also automate their storage operations by adding robotic
storage libraries, further reducing the need for human intervention. Our
architecture supports a simple user interface that permits end users to access
or recover copies of their files without the need for intervention by the
network administrator. Our Global Enterprise Management Systems, or G.E.M.S.,
product allows information system organizations the ability to globally manage
thousands of NetWorker storage servers.

   Data availability. Our data availability products, including our CoStandBy
Server, Octopus, and Cluster products, help to minimize the impact of failures
caused by system malfunction, human error, sabotage or natural disasters. These
data availability products are designed to monitor, replicate and support a
variety of UNIX-based and Windows NT and Windows 2000 operating systems,
hardware platforms, disk configurations, networks, applications and databases.
For example, if a server goes down, or for any reason stops providing service
to an application, Legato Cluster products can promptly select another server
to carry on service and allow users to continually access their data and
applications.

Architecture

   The most basic function of a storage management system is data protection.
The process of data protection involves making backup copies of data stored on
hard disks onto low-cost, high capacity removable media such as tapes and
optical disks.

   Our architecture provides reliable data protection services. Data may be
managed according to the application that produces it. For example, a
relational database may be frequently updated. To back up this kind of database
efficiently, it is necessary to understand how the database is constructed, so
that a consistent copy of the database can be made while it is undergoing
change and while the database is "on-line." Our architecture can accommodate
the data produced by different applications because of its Application Specific
Module, or ASM, technology. Each ASM can be tailored to the specific storage
management needs of a particular kind of application data, and all ASMs are
implemented using a modular architecture designed to permit new ASMs to be
easily integrated into our storage offerings.

   Once data is read from the client's hard disk, it is transmitted to the
storage management software that resides on the storage server using industry-
standard communications protocols such as TCP/IP and SPX/IPX.

                                       5
<PAGE>

A high-performance, integrated database is fundamental to the storage
management server engine. This database has two roles: to keep track of where
the storage management server has stored the data and to keep track of what
data is stored. Our architecture makes it possible for clients to query the
database as to what data is under management and for clients to access this
data themselves. This enables novice users to directly access the system,
thereby reducing the burden on network administrators.

   One of the most critical ways our architecture achieves its ability to
accommodate an increasing number of clients while retaining high performance is
by implementing parallel data transfers from the clients to the storage
management server in the same way that adding more tellers to serve customers
allows a bank to process more transactions in the same amount of time. When an
additional client's data is managed, it may be scheduled for processing by the
storage management server at the same time as the data from other clients.
Thus, one slow client need not slow down the entire storage management process.
Our architecture achieves this parallelism by writing multiple client data
streams to the tape simultaneously. This allows the full bandwidth of the tape
drive to be used as the data from many clients can be delivered to the tape
drive in the same amount of time as the data from one client. As a result, one
high-capacity tape drive can be shared effectively by more than one client on
the network, and, therefore, it may not be necessary to purchase several tape
drives to accomplish data protection in the required amount of time.

   An increasingly important function of the architecture to some end-users is
to facilitate the management of data according to its criticality. As an
example, a set of quarterly reports may be grouped together and filed away.
This data may not need to be accessed on a regular basis, but may need to be
retrievable for a period of years because of certain regulatory requirements.
This class of data is termed "archive" data, because it may be filed away for
future reference and need not be kept on-line. When archived data is needed, it
must be explicitly retrieved, typically from offsite storage. It is also
possible to archive data in such a way that it appears to be on-line, when it
in reality is stored elsewhere. This process is referred to as "hierarchical
storage management." The indexing technology embedded within our storage
products is designed to support the management of protected, archived, and
hierarchically managed data.

   In addition to data protection, an important function of the architecture is
data availability, which provides end- users access to the computing power,
data and applications they need, when and where they need them, including times
when data protection actually takes place. As organizations migrate or consider
migrating business-critical applications to distributed computing environments,
they frequently need to ensure that such applications are fully operational
around the clock. In order to facilitate data availability without significant
downtime, open application interfaces take place so that other applications can
share data. Open application interfaces layer over existing computing
environments, including data, systems, standard TCP/IP networks and
applications, without requiring additional programming or changes to the
existing applications. Therefore, the data protection process, as well as the
implementation of system and software upgrades, can occur without the
traditional downtime.

   To reduce the burden of expensive on-site administrative staff, our
architecture allows the storage management server to be managed remotely, from
an easy-to-use, graphical user interface familiar to the administrator. The use
of a common administrative protocol developed by us greatly facilitates the
development of diverse user interfaces that support remote administration. Our
family of storage management products can also automate a wide range of storage
management functions and can employ robotic storage devices to retrieve a
particular piece of removable storage media, thereby eliminating the need for
human intervention.

Products

   Our NetWorker family of storage management server software provides network
storage management services for a wide variety of platforms. NetWorker consists
of two basic components: a client module that accesses the data being managed
and a server module that performs the protection, management and control of
network data. Typically, the server module is selected to run on the platform
most familiar to the administrative staff in an organization; the client
modules are selected according to the type of computers installed on the

                                       6
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network. Our server software is available for NetWare, Windows NT, Windows
2000, Linux, several UNIX platforms, including Compaq (Digital), HP, IBM,
Silicon Graphics, Sequent and Sun versions of UNIX. A number of applications
and enhancement options are available for the storage server.

   The base NetWorker server product provides data protection services for
clients and includes client software for the same platform as the NetWorker
server, as well as support for a set of popular non-robotic storage devices. In
multiple platform environments, our customers must purchase the client software
for dissimilar platforms. The following client packages are currently
available:

  . ClientPak for UNIX, which supports a diverse set of UNIX clients,
    including Linux, Hewlett-Packard, Compaq (Digital), IBM, Sequent and Sun;

  . ClientPak for PC Desktops, Windows 95, Windows 98, Windows NT and Windows
    2000;

  . ClientPak for Windows NT and Windows 2000, which supports Window NT and
    Windows 2000 workstations and Windows NT and Windows 2000 Servers;

  . ClientPak for MPE/iX, which supports HP3000 MPE/iX systems;

  . ClientPak for Network Appliance, which supports Network Appliance filers
    via TCP/IP Ethernet connections;

  . ClientPak for Linux;

  . ClientPak for NetWare, which supports NetWare; and

  . ClientPak for Macintosh, which supports MacOS.

   The base NetWorker server product for Windows NT and Windows 2000, Linux,
UNIX and NetWare is also available through the following offerings, which
support a variety of NetWorker options:

  . Workgroup Edition--a storage management solution for small networks in
    corporate environments, which provides support for up to eight client
    connections and two storage devices;

  . Network Edition--an enterprise-strength storage management solution for
    distributed networks, which is packaged with support for up to ten
    clients and supports options that add client connections, expand client
    platform coverage and deliver advanced data management services; and

  . Power Edition--a storage management solution for customers with very
    large servers, clusters, or the requirement to drive high-speed devices,
    which features enhanced architecture to increase throughput while
    minimizing use of system resources and supports all standard NetWorker
    options.

   NetWorker for Linux and UNIX is licensed by the number of clients to be
supported and has the following storage management server options available:

  . Archive--the ability to archive data;

  . Autochanger--the ability to employ tape and optical jukeboxes of varying
    capacities;

  . Application Modules--the ability to utilize a family of add-on modules
    tailored for databases and business applications;

  . Client Connections--the ability to increase the number of clients of the
    storage management server beyond the ten supported by the base product;

  . Hierarchical Storage Management (HSM)--the ability to automatically
    migrate rarely-used files from primary to secondary storage (Solaris
    only);

  . High Speed Device Support--the ability to utilize high speed devices;

  . NDMP Support--the ability to provide local and remote data protection
    services for Network Attached Storage (NAS) devices, via the Network Data
    Management Protocol (NDMP);

                                       7
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  . Recovery Manager--the ability to provide automated "bare-metal" disaster
    recovery for Solaris systems;

  . Silo Support--the ability to leverage mainframe-class storage silos;

  . SNMP Modules--the ability to integrate with leading system management
    offerings; and

  . Storage Nodes--the ability to perform very high-speed backup locally,
    which is managed centrally.

   NetWorker for Windows NT and Windows 2000 is Microsoft BackOffice certified
and licensed by the number of clients to be supported and has the following
storage management server options available:

  . Archive--the ability to archive data;

  . Autochanger--the ability to employ tape and optical jukeboxes of varying
    capacities;

  . Application Modules--the ability to utilize a family of add-on modules
    tailored for databases and business applications such as SQL Server and
    Exchange Server;

  . Client Connections--the ability to increase the number of clients of the
    storage management server beyond the ten supported by the base product;

  . Hierarchical Storage Management (HSM)--the ability to automatically
    migrate rarely-used files from primary to secondary storage;

  . Open File Manager--the ability to protect open files;

  . Silo Support--the ability to leverage mainframe-class storage silos;

  . SNMP Module--the ability to integrate with leading system management
    offerings; and

  . Storage Nodes--the ability to perform very high-speed backup locally,
    which is managed centrally.

   NetWorker for NetWare is licensed by the number of clients to be supported
and has the following storage management server options available:

  . Archive--the ability to archive data;

  . Autochanger--the ability to employ tape and optical jukeboxes of varying
    capacities; and

  . Client Connections--the ability to increase the number of clients of the
    storage management server beyond the ten supported by the base product.

   NetWorker server software has an entry end-user list price from $1,150 to
$22,425, while a fully configured NetWorker system can have an end user list
price of over $100,000.

   Our data availability products, including our CoStandBy Server, Octopus and
Cluster products, complement the NetWorker family of products by providing
users with continual real-time access to data and applications and allow
systems to be backed up without the traditional downtime. Resources can be
transparently relocated to continue to provide services to users while system
changes are applied.

   Our wanCluster product complements the NetWorker family of products by
providing users with management of the EMC SRDF replication technology, and
automation of the disaster recovery activities necessary to bring a remote site
on-line.

   Our Celestra products allow users the ability to move data without
interrupting the server that owns the data. The capability of our Celestra
products may be useful for companies' electronic commerce environments, where
servers require accessibility 24 hours a day, 7 days a week.

   Our SmartMedia products allow customers to share tape libraries between
applications, which may be useful in storage area network environments, where
several servers share a single tape library.

                                       8
<PAGE>

Sales and Marketing

   Our strategy is to deploy a comprehensive sales, marketing and support
infrastructure to meet the storage management needs of users of complex
client/server networks worldwide. We use a multi-tier distribution model to
reach end-user customers, which range in size from individual corporate
departments or small businesses to large multinational corporations. Network
storage management software is an application that may be utilized across many
industries segments.

   We provide sales and pre-sales technical support to business partners and
end-user customers in North America from our corporate offices and from
regional offices in the following metropolitan areas:

   . Atlanta                      . Los Angeles


   . Boston                       . Montreal


   . Chicago                      . New York


   . Dallas                       . Seattle


   . Denver                       . Toronto


   . Houston                      . Washington, D.C.



   We reach the market through multiple distribution channels including:

  . Direct sales;

  . Resellers;

  . Distributors; and

  . OEMs.

   Direct sales. We have established a dedicated sales force to penetrate large
enterprise-wide opportunities. As storage requirements increase, storage
management applications increase in strategic importance to major enterprises.
We have recognized the need to establish even closer relationships with our
largest corporate clients. Customers participating in our enterprise sales
program have an assigned salesperson and an executive contact, participate in
our technical exchange program and work closely with us to develop large
projects for installations over a period of time. An enterprise sales
representative coordinates business partner activities across the customer's
enterprise and closely monitors customer satisfaction.

   Resellers and distributors. We have established regional sales offices to
increase the effectiveness of and support to our channel partners.

   North America Enterprise Solution Partners. Our North America Enterprise
Solution Partners program provides a significant source of revenue in North
America. The Enterprise Solution Partners program enables third-party
integrators specializing in storage management and client/server network
solutions to provide end user customers with complete solutions, including
systems and storage hardware, complementary software and our software. The
reseller is responsible for managing the sales and installation process in each
customer situation. In large, complex opportunities, our support personnel work
with the reseller to provide technical support. This approach enables us to
cost effectively achieve broader market coverage, while maintaining close
contact with end- user customers in order to obtain input on product direction
and to monitor customer satisfaction.

   North America Distributor Program. To further expand coverage in the
marketplace, we license our products to large regional and national
distributors who distribute the products to resellers with expertise in storage
management and integrating network solutions for end-users. We provide support
to these network solutions resellers. We currently have relationships with
various major distributors, including Access Graphics, Gates/Arrow, Ingram
Micro and Tech Data.

                                       9
<PAGE>

   International Reseller and Distributor Programs. We have similar reseller
and distributor programs internationally. We currently operate sales offices in
the following countries to support resellers and distributors throughout
various regions of the world, including, but not limited to:

   . Australia                    . Poland


   . Belgium                      . Singapore


   . Canada                       . South Korea


   . China                        . Spain


   . France                       . Sweden


   . Germany                      . Switzerland


   . Italy                        . Taiwan


   . Japan                        . United Kingdom

   . Netherlands

   International product sales were $75.7 million in 2000, $65.8 million in
1999 and $45.5 million in 1998, representing 33% of total revenue in 2000, 29%
of total revenue in 1999 and 27% of total revenue in 1998. The majority of
international sales during these periods were made in Europe and Canada. We
believe that international markets present an attractive growth opportunity and
are expanding the scope of our international operations. We have engaged, and
will continue to engage, international resellers and distributors in targeted
countries and are developing cooperative marketing programs with certain
resellers and distributors. In order to facilitate penetration in certain
markets, we, along with cooperation from certain international distributors,
are in the process of localizing certain products to certain targeted
languages.

OEMs.

   Source Code OEM Program. Our source code OEM program generates royalty
revenue for our business. Under this program, we license our software products,
in source code form, to leading computer system and software suppliers from
which we typically receive an initial license fee and ongoing royalty revenue.
The OEM partner is then responsible for porting our software to its unique
operating system environment, testing it, licensing it through the OEM
partner's direct sales force and distribution channels and providing the
primary customer support after installation. OEM partners work cooperatively to
incorporate their enhancements into our storage products on an ongoing basis.
The benefit of this approach for end-users is that they can acquire our family
of storage management products as part of a complete systems solution from a
single vendor, with such vendor providing a single point of contact for
customer support. The benefit to us has been access to our OEM partners'
customer bases, both in North America and overseas, without a commensurate
investment in fixed expense such as personnel, facilities and infrastructure.
We currently have source code OEM agreements in place with several computer
system and software suppliers, including:

  . Amdahl;

  . ePresence (formerly Banyan Systems);

  . Groupe Bull;

  . EMC;

  . Fujitsu-ICL;

  . NEC;

  . Siemens Nixdorf; and

  . WumpusWare

   Strategic Alliance Program. The Strategic Alliance program is an alternative
to the source code OEM program for major system providers who wish to offer our
products along with theirs, but prefer not to make an

                                       10
<PAGE>

investment in porting the source code to their platforms. For example, Sun
Microsystems, a private label reseller, licenses the object code for the
standard Legato products and licenses and supports the products under their
logo as described above for the source code OEM program. We also have
established strategic alliances with Hewlett-Packard, Informix and Oracle.

   No one customer accounted for more than 10% of our total revenue for 2000,
1999 or 1998.

Corporate Marketing

   We support our multi-tiered distribution efforts with marketing programs
designed to establish our image in key markets, differentiate our products, and
to generate end-user demand. Marketing programs include channel marketing,
product marketing, as well as programs specifically targeted to the North
American, European and other intercontinental markets. We participate in
industry forums and events, trade shows and advertise in key trade publications
and on the Internet. We work directly with industry analysts to update them on
our products. Leads are qualified by our inside sales staff and provided to our
channel partners. Additionally, resellers and distributors are provided with
promotional and educational materials and can qualify for market development
funding for specific promotional activities tailored for their solutions and
geography.

Service & Support

   We employ systems engineers, educators and storage consultants who work
closely with our direct sales, resellers and our customers to resolve issues
and provide solutions during pre-sales and post-sales.

   Support services. We offer maintenance, which consists of product updates
and technical support services. Product updates are included for the first year
with our software, and technical support may be purchased separately. Customers
may renew maintenance services annually or purchase future product updates.
Maintenance customers receive updates, enhancements and improvements to
supported software, such as support for new operating systems. Annual fees for
maintenance are calculated as a percentage of the customer's installed base of
products. The percentage is based upon the level of technical support selected
by the customer and is currently priced from 18% to 24% of product license list
price.

   Generally, customers covered by the Basic Maintenance offering receive
telephone or electronic support from 8 a.m. to 5 p.m. in the customer's local
time zone, Monday through Friday. Response times for open cases are based on
service level objectives and the severity level that the customer sets at the
time the case is opened. The Extended Maintenance offering provides the same
level of service while expanding the hours of coverage to 24 hours a day, 7
days a week. The Premier Maintenance offering provides 24-hour technical
support coverage, enhanced service level objectives, priority escalation
management and a designated premium support account manager, or PSAM. The PSAM
facilitates the resolution of issues, conducts monthly conference calls, and
maintains familiarity with their technological and operational environment.
Customers that do not have technical support or want service outside their
coverage hours can request support for an additional fee. The pricing for this
support ranges from $500 to $2,500 for each technical support service incident.
Additionally, we offer customers the opportunity to purchase either a six-month
or one-year on-site PSAM, for $150,000 and $200,000, respectively.

   Our support organization consists of an experienced staff of technical
support engineers providing telephone and electronic support via electronic
mail from our offices in California, Utah and Ontario, Canada. Our sales and
technical support organizations work closely together to ensure high levels of
overall customer satisfaction.

   In recent years, our installed base of customers has significantly
increased, as have the number of customers purchasing software maintenance
contracts. This dramatic growth caused a period of depressed customer
satisfaction. As a result of increased staffing and operational improvements,
we have successfully improved customer satisfaction. Continued investments in
people, technology and operational infrastructure are

                                       11
<PAGE>

intended to further improve customer satisfaction through decreased time to
resolution, easier access to relevant knowledge and efficiencies in our
operational workflows.

   Education services. Our educational services organization offers education
and training to end-users, resellers and partners. Education and training
classes cover theory, installation, operations, configuration and planning on
information protection, information availability and information management.
Training classes are offered through in-house facilities at our offices in
North America and Europe as well as at off-site locations. We also have several
highly qualified authorized training center providers, or ATCs, around the
world. Our authorized training center providers are required to pass a
certification program to be able to teach our customers and resellers. We are
pursuing an aggressive plan to expand our educational offerings through a well-
recognized training company on a worldwide basis. This plan is expected to
substantially increase the number of individuals and companies trained on our
products and to expand the delivery of training through live and on-demand
webcasts. We also provide on-site training services upon request by customers.
Fees for education and training services are charged separately from our
software products

   Consulting services. Our consultants are available to work closely with
customers' information systems organizations to assist our customers in
efficiently designing and building their complex storage environments,
tailoring our software products to achieve higher performance, and increasing
the degree of automation. We offer a wide range of tailored consulting services
targeted at solving our clients' complex storage issues. Some of these services
include initial assessments, architecture and design, installation,
configuration, deployment and management. We also offer a number of consulting
packages that provide customers with more specific topics, such as enterprise
analysis, storage network health check, replication and tape conversion. Fees
for consulting services are charged separately from our software products.

Research and Development

   Our investment in research and development was $56.6 million in 2000, $40.1
million in 1999 and $25.6 million in 1998. We anticipate that we will continue
to commit substantial resources to research and development in the future. To
date, our development efforts have not resulted in any capitalized software
development costs. In addition, we receive the benefits of additional testing
and product enhancements from each source code OEM's development group. Our
future success will depend upon our ability to develop and introduce new
software products, including new releases, applications and enhancements, on a
timely basis that keep pace with technological developments and emerging
industry standards and address the increasingly sophisticated needs of our
customers. In particular, our strategy is to continue to leverage the NetWorker
architecture to enhance the functionality of the product through new releases,
applications and product enhancements and integrate our other technologies into
solutions to meet the ongoing storage management requirements of our customers.
We cannot guarantee that we will be successful in developing and marketing new
products that respond to technological change or evolving industry standards,
that we will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these new products, or
that our new products will adequately meet the requirements of the marketplace
and achieve market acceptance. If we are unable, for technological or other
reasons, to develop and introduce new products in a timely manner in response
to changing market conditions or customer requirements, our business, operating
results and financial condition will be seriously harmed.

   As part of our ongoing development process, we released several new versions
of NetWorker and our Availability products during 2000 and intend to release
additional versions of NetWorker and Availability products in the future. In
addition, we released several new products, including, but not limited to:

  . wanCluster--disaster recovery automation through the integration of our
    Legato Cluster technology and EMC's SRDF product for remote data
    replication;

  . NetWorker 6.0--a major release of our NetWorker product that includes
    scalability enhancements as well as support for Networked Attached
    Storage ("NAS") via Network Data Management Protocol ("NDMP"); and

  . Celestra 1.5--a new release of our serverless backup solution for
    NetWorker.

                                       12
<PAGE>

   We cannot guarantee that these and future new products will achieve market
acceptance. The lack of market acceptance for these and future new products
will seriously harm our business, operating results and financial condition.

   We have research and development centers in the following locations:

  . Boulder, Colorado;

  . Burlington, Ontario, Canada;

  . Dublin, California;

  . Eden Prairie, Minnesota;

  . Marlborough, Massachusetts;

  . New Delhi, India;

  . Orem, Utah;

  . Palo Alto, California; and

  . Seattle, Washington.

Competition

   We operate in the enterprise storage management market, which is intensely
competitive, highly fragmented and characterized by rapidly changing technology
and evolving standards. Competitors vary in size and in the scope and breadth
of the products and services offered. Our major competitors include:

     Windows NT and Windows 2000 platforms:
       Computer Associates and
       Veritas.

     Unix platforms:
       Computer Associates;

       EMC (Epoch);

       Hewlett Packard;

       IBM (Tivoli); and

       Veritas.

Employees

   As of December 31, 2000, we had a total of 1,270 employees. Of the total,
454 were in sales and marketing, 364 in research and development, 298 in
service and support and 154 in general and administration. Our future success
depends, in significant part, upon the continued service of our key technical
and senior management personnel and our continuing ability to attract and
retain highly qualified technical, sales and managerial personnel. Competition
for such personnel is intense, and we cannot guarantee that we can retain our
key technical and managerial employees or that we can attract, assimilate or
retain other highly qualified technical, sales and managerial personnel in the
future. None of our employees are represented by a labor union. We have not
experienced any work stoppages and consider our relations with our employees to
be good.

Risk Factors

   The following risk factors and other information included in this Annual
Report on Form 10-K should be carefully considered. The risks and uncertainties
described below are not the only ones we face. Additional

                                       13
<PAGE>

risks and uncertainties not presently known to us or that we currently deem
less significant also may impair our business operations. If any of the
following risks actually occur, our business, operating results and financial
condition could be materially negatively affected.

 Our quarterly operating results are volatile.

   Our quarterly operating results have varied in the past and may vary in the
future. Our quarterly operating results may vary depending on a number of
factors, many of which are outside of our control, including:

  . The size and timing of orders;

  . Intense competition;

  . Macroeconomic uncertainty in the markets in which we operate;

  . Market acceptance of our new products, applications and product
    enhancements or our competitors;

  . Changes in pricing policies or those of our competitors;

  . Our ability to develop, introduce and market new products, applications
    and product enhancements;

  . Our ability to control costs;

  . Quality control of products sold;

  . Lengthy sales cycles, particularly with enterprise license transactions;

  . Delay in the recognition of revenue from enterprise license and
    application service provider transactions;

  . Modification in reseller relationships resulting in changes to the
    application of revenue recognition policies;

  . Success in expanding sales and marketing programs;

  . Technological changes in our markets;

  . The mix of sales among our channels;

  . Deferrals of customer orders in anticipation of new products,
    applications or product enhancements;

  . Market readiness to deploy our products for distributed computing
    environments;

  . Changes in our strategy or that of our competitors;

  . Customer budget cycles and changes in these budget cycles;

  . Foreign currency and exchange rates;

  . Our ability to effectively manage and reduce our tax liabilities;

  . Acquisition costs or other non-recurring charges in connection with the
    acquisition of companies, products or technologies;

  . Personnel changes; and

  . General economic factors.

 Our future operating results are uncertain.

   Our historical results of operations are not necessarily indicative of our
results for any future period. Expectations, forecasts, and projections by
others or us are by nature forward-looking statements, and it is likely that
future results will vary. Forward-looking statements that were reasonable at
the time made may ultimately prove to be incorrect or false. It is our general
policy and practice not to update our forward-looking

                                       14
<PAGE>

statements. Some investors in our securities inevitably will experience gains
while others will experience losses, depending on the prices at which they
purchase and sell securities. Prospective and existing investors are strongly
urged to carefully consider the various cautionary statements and risks set
forth in this report.

   We cannot predict our future revenue with any significant degree of
certainty for several reasons including:

  . License and royalty revenue are difficult to forecast. Our royalty
    revenue is dependent upon product license sales by OEMs of their products
    that incorporate our software. Accordingly, this royalty revenue is
    subject to OEMs' product cycles, which are also difficult to predict.
    Fluctuations in licensing activity from quarter to quarter further impact
    royalty revenue, because initial license fees generally are non-recurring
    and recognized upon the signing of a license agreement.

  . Product revenue in any quarter is substantially dependent on orders
    booked and shipped in that quarter since we operate with virtually no
    order backlog;

  . We do not recognize revenue on sales to domestic distributors until the
    products are sold through to end-users;

  . The storage management market is rapidly evolving;

  . Our sales cycles vary substantially from customer to customer, in large
    part because we are becoming increasingly dependent upon larger company-
    wide enterprise license transactions to corporate customers. Such
    transactions include product license, service and support components and
    take a long time to complete;

  . Macroeconomic factors may affect our customers' decision to license our
    products or procure services;

  . The timing of large orders can significantly affect revenue within a
    quarter;

  . The timing of recognition of revenue from enterprise license and
    application service provider transactions can significantly affect
    revenue within a quarter;

  . Modification in reseller relationships resulting in changes to the
    application of revenue recognition policies; and

   Our expense levels are relatively fixed and are based, in part, on our
expectations of our future revenue. Consequently, if revenue levels fall below
our expectations, our net income will decrease because only a small portion of
our expenses varies with our revenue.

   We believe that period-to-period comparisons of our results of operations
may not be meaningful and should not be relied upon as indications of future
performance. Our operating results could be below the expectations of public
market analysts and investors in some future quarter or quarters. Our failure
to meet such expectations would likely cause the market price of our common
stock to decline.

 We are currently subject to litigation.

   Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against certain of our directors and officers and us. On May 1,
2000, the court consolidated all of the pending cases and, on May 10, 2000,
appointed a lead plaintiff, who filed a consolidated amended complaint on
August 7, 2000. Defendants filed motions to dismiss. On January 17, 2001, the
Court entered an Order granting the motions to dismiss with leave to amend. On
February 13, 2001, plaintiffs filed a second amended complaint, which generally
alleges that, between April 22, 1999 and May 17, 2000, defendants made false or
misleading statements of material fact about the Company's prospects and failed
to follow generally accepted accounting principles in violation of the federal
securities laws. The complaint seeks an unspecified amount in damages.
Defendants will file an answer to the complaint in April 2001 denying all
allegations that they violated the federal securities laws.

                                       15
<PAGE>

   On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our
officers and directors. We are named as nominal defendant. The derivative case
has been related to the securities class action. Plaintiff moved to stay the
derivative case. On January 17, 2001, the Court denied plaintiffs' motion to
stay. Plaintiffs filed an amended complaint on February 9, 2001, which
generally alleges the same conduct as the shareholder class action, and claims
that defendants breached their fiduciary duties and engaged in improper insider
trading. The derivative complaint seeks unspecified damages and injunctive
relief. Defendants will move to dismiss the derivative complaint.

   On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as a nominal defendant. On May 23, 2000, a shareholder
derivative action was filed in the Superior Court of California, County of San
Mateo, against certain of our officers and directors. We are named as a nominal
defendant. Both state derivative complaints generally allege the same conduct
as the derivative action filed in federal court, claim that our officers and
directors breached their fiduciary duties for the period October 21, 1999
through April 3, 2000, and seek unspecified damages and injunctive relief. The
Santa Clara derivative case was transferred to San Mateo County and
consolidated with the San Mateo derivative case.

   The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second, and third quarters of 1999, and our revision of financial results for
the fourth quarter and fiscal 1999. We have been voluntarily cooperating with
the Staff of the Commission in its investigation.

   The Company and the individual defendants intend to defend all of these
actions vigorously. However, there can be no assurance that any of the
complaints discussed above will be resolved without costly litigation, or in a
manner that is not materially adverse to our financial position, results of
operations or cash flows. No estimate can be made of the possible loss or
possible range of loss associated with the resolution of these contingencies.

 Our market is highly competitive.

   We operate in the enterprise storage management market, which is intensely
competitive, highly fragmented and characterized by rapidly changing technology
and evolving standards. Competitors vary in size and in the scope and breadth
of the products and services offered. Our major competitors include:

     Windows NT and Windows 2000 platforms:
       Computer Associates and
       Veritas.

     Unix platforms:
       Computer Associates;

       EMC (Epoch);

       Hewlett Packard;

       IBM (Tivoli); and

       Veritas.

   We expect to encounter new competitors as we enter new markets. In addition,
many of our existing competitors are broadening their platform coverage. We
also expect increased competition from systems and network management
companies, especially those that have historically focused on the mainframe
market and are broadening their focus to include the client/server computer
market. In addition, since there are relatively low barriers to entry in the
software market, we expect additional competition from other established and
emerging companies. We also expect that competition will increase as a result
of future software industry consolidations. Increased competition could harm us
by causing, among other things, price reductions, reduced gross margins and
loss of market share.

                                       16
<PAGE>

   Many of our current and potential competitors have longer operating
histories and have substantially greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger customer
base, than we have. As a result, certain current and potential competitors can
respond more quickly to new or emerging technologies and changes in customer
requirements. They can also devote greater resources to the development,
promotion, sale and support of their products. In addition, current and
potential competitors may establish cooperative relationships among themselves
or with third parties. If so, new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. In addition, network
operating system vendors could introduce new or upgrade existing operating
systems or environments that include functionality offered by our products. If
so, our products could be rendered obsolete and unmarketable. For all the
foregoing reasons, we may not be able to compete successfully, which would
seriously harm our business, operating results and financial condition.

 We depend on our NetWorker product line.

   We currently derive, and expect to continue to derive, a substantial
majority of our revenue from our NetWorker software products and related
services. A decline in the price of or demand for NetWorker, or failure to
achieve broad market acceptance of NetWorker, would seriously harm our
business, operating results and financial condition. We cannot reasonably
predict NetWorker's remaining life for several reasons, including:

  . The recent emergence of our market;

  . The effect of new products, applications or product enhancements;

  . Technological changes in the network storage management environment in
    which NetWorker operates; and

  . Future competition.

 We must respond to rapid technological changes with new product offerings.

   The markets for our products are characterized by rapid technological
change, changing customer needs, frequent new software product introductions
and evolving industry standards. The introduction of products embodying new
technologies and the emergence of new industry standards could render our
existing products obsolete and unmarketable. To be successful, we need to
develop and introduce new software products on a timely basis that keep pace
with technological developments and emerging industry standards and address the
increasingly sophisticated needs of our customers. In addition, we need to
continue to integrate into our product lines the technologies of products we
acquired through the acquisitions of Intelliguard Software, Inc., Qualix Group,
Inc. (dba FullTime Software Inc.) and Vinca Corporation in 1999. We may fail to
develop and market new products that respond to technological changes or
evolving industry standards, experience difficulties that could delay or
prevent the successful development, introduction and marketing of these new
products or fail to develop new products that adequately meet the requirements
of the marketplace or achieve market acceptance. If so, our business, operating
results and financial condition would be seriously harmed.

   We currently plan to introduce and market several potential new products in
the next twelve months. Some of our competitors currently offer certain of
these potential new products. Such potential new products are subject to
significant technical risks. We may fail to introduce such potential new
products on a timely basis or at all. In the past, we have experienced delays
in the commencement of commercial shipments of our new products. Such delays
caused customer frustrations and delay or loss of product revenue. If potential
new products are delayed or do not achieve market acceptance, our business,
operating results and financial condition would be seriously harmed. In the
past, we have also experienced delays in purchases of our products by customers
anticipating our launch of new products. Our business, operating results and
financial condition would be seriously harmed if customers defer material
orders in anticipation of new product introductions.


                                       17
<PAGE>

   Software products as complex as those we offer may contain undetected errors
or failures when first introduced or as new versions are released. We have in
the past discovered software errors in certain of our new products after their
introduction. We experienced delays or lost revenue during the period required
to correct these shipments, despite testing by us and by our current and
potential customers. This may result in loss of or delay in market acceptance
of our products, which could seriously harm our business, operating results and
financial condition.

 We rely on enterprise license transactions.

   We have developed strategies to pursue larger enterprise license
transactions with corporate customers. However, we may not continue to
successfully market our products through larger enterprise license
transactions. Such failure would seriously harm our business, operating results
and financial condition. Our operating results are sensitive to the timing of
such orders. Such orders are difficult to manage and predict, because:

  . The sales cycle is typically lengthy, generally lasting three to six
    months, and varies substantially from transaction to transaction;

  . Enterprise license transactions often include multiple elements such as
    product licenses and service and support;

  . Recognition of revenue from enterprise license transactions may vary from
    transaction to transaction;

  . They typically involve significant technical evaluation and commitment of
    capital and other resources; and

  . Customers' internal procedures frequently cause delays in orders. Such
    internal procedures include approval of large capital expenditures,
    implementation of new technologies within their networks, and testing new
    technologies that affect key operations.

   Many of the large organizations that we target as customers have lowered
their rate of spending on enterprise software. Due to the large size of
enterprise transactions, if orders forecasted for a specific transaction for a
particular quarter are not realized in that quarter, our operating results for
that quarter may be seriously harmed.

   We have changed certain of our licensing practices and modified the
application of our accounting policies, which results in delaying revenue
recognition.

   During the past year, we have worked closely with our outside financial
auditors to ensure that our revenue recognition practices are consistent with
both our existing revenue recognition policies and the evolving guidance of the
AICPA on the treatment of certain software license transactions. Based upon our
recent experience with certain distributors and resellers, we began recognizing
revenue on transactions with certain channel members only upon receipt of
payment from those channel members. Further, we have modified our licensing
practices in negotiating certain of our enterprise software licenses. The
consequence of those changes is that the revenue from those licenses is
recognized ratably over the deployment term of those licenses rather than being
recognized all upon execution of the license. These are not changes in our
accounting policies; rather, they reflect a modification of our practices in
conformity with our long-standing policies and with generally accepted
accounting principles.

   The accumulated results of these changes could affect quarterly results by
shifting revenue out to future quarters that previously was recognized upon
acceptance of a purchase order from a channel member or upon execution of an
end-user license. Customer acceptance of the new enterprise license structure,
which was intended to build greater visibility into our longer-term revenue
stream, could also affect our quarterly results. For instance, if in a
particular quarter, more customers negotiate a license structure that mandated
revenue recognition upon license execution, revenue for that quarter would be
greater; if, however, those customers

                                       18
<PAGE>

accept a license structure that required ratable recognition of license
revenue, the same amount of revenue would be spread over several quarters. We
do not yet have sufficient experience to accurately predict what the balance
will be between up-front and ratable recognition of license revenues in a given
quarter on larger enterprise transactions.

 We rely on indirect sales channels.

   We rely significantly on our distributors, systems integrators and value
added resellers, or collectively, resellers, for the marketing and distribution
of our products. Our agreements with resellers are generally not exclusive and
in many cases may be terminated by either party without cause. Many of our
resellers carry product lines that are competitive with ours. These resellers
may not give a high priority to the marketing of our products. Rather, they may
give a higher priority to other products, including the products of
competitors, or may not continue to carry our products. Events or occurrences
of this nature could seriously harm our business, operating results and
financial condition. In addition, we may not be able to retain any of our
current resellers or successfully recruit new resellers. Any such changes in
our distribution channels could seriously harm our business, operating results
and financial condition.

   Our strategy is also to increase the proportion of our customers licensed
through OEMs. We may fail to achieve this strategy. We are currently investing,
and will continue to invest, resources to develop this channel. Such
investments could seriously harm our operating margins. We depend on our OEMs'
abilities to develop new products, applications and product enhancements on a
timely and cost-effective basis that will meet changing customer needs and
respond to emerging industry standards and other technological changes. Our
OEMs may not effectively meet these technological challenges. These OEMs are
not within our control, may incorporate the technologies of other companies in
addition to, or to the exclusion of, our technologies, and are not obligated to
purchase products from us. Our OEMs may not continue to carry our products. The
inability to recruit, or the loss of, important OEMs could seriously harm our
business, operating results and financial condition.

 We are modifying some of our marketing strategies.

   As noted above, we rely significantly upon resellers as part of our overall
marketing strategy. We are currently realigning our approach to working with
our strategic allies and other resellers. The objective of our new approach is
to form stronger ties with specific companies with whom we have global
alliances. We are also restructuring our reseller networks in order to create
greater rewards for distributors and resellers that demonstrate a greater
commitment to Legato, as measured in net sales, technical certification and
other factors. As a result of these changes, we may negatively affect the
volume of sales through our strategic alliances or our resellers. If a
significant number of resellers were to cease doing business with us as a
result of these changes, and sales through the remaining resellers failed to
compensate for the lost resellers, this strategic change could seriously harm
our business, operating results and financial condition.

 We depend on international revenue.

   Our continued growth and profitability will require further expansion of our
international operations. To successfully expand international operations, we
must establish additional foreign operations, hire additional personnel and
recruit additional international resellers. This will require significant
management attention and financial resources and could seriously harm our
operating margins. If we fail to further expand our international operations in
a timely manner, our business, operating results and financial condition could
be seriously harmed. In addition, we may fail to maintain or increase
international market demand for our products. Our international sales are
currently denominated in U.S. dollars. An increase in the value of the
U.S. dollar relative to foreign currencies could make our products more
expensive and, therefore, potentially less competitive in those markets. In
some markets, localization of our products and license documents is essential
to achieve or increase market penetration. We may incur substantial costs and
experience delays in localizing our products and license language. We may fail
to generate significant revenue from localized products.

                                       19
<PAGE>

   Additional risks inherent in our international business activities generally
include:

  . Significant reliance on our distributors and other resellers who do not
    offer our products exclusively;

  . Unexpected changes in regulatory requirements;

  . Tariffs and other trade barriers;

  . Lack of acceptance of localized products, if any, in foreign countries;

  . Longer accounts receivable payment cycles;

  . Difficulties in managing international operations;

  . Potentially adverse tax consequences, including restrictions on the
    repatriation of earnings;

  . The burdens of complying with a wide variety of foreign laws; and

  . The risks related to the global economic turbulence.

   The occurrence of such factors could seriously harm our international sales
and, consequently, our business, operating results and financial condition.

 We must manage our growth and expansion and hire and retain qualified
 personnel.

   We have recently hired a significant number of new senior executives as well
as other employees throughout the Company. We plan to further increase our
total headcount in order to more effectively seek out new customers and to
better serve our existing customers. We also plan to expand the geographic
scope of our customer base. This expansion has resulted and will continue to
result in substantial demands on our management resources.

   From time to time, we receive customer complaints about the timeliness and
accuracy of customer support. We plan to add customer support personnel in
order to address current customer support needs. If we are not successful in
hiring and retaining such personnel, our business, operating results and
financial condition could be seriously harmed. Our ability to compete
effectively and to manage future expansion of our operations, if any, will
require us to continue to improve our financial and management controls,
reporting systems and procedures on a timely basis, and to expand, train and
manage our employees in all areas of the business. Our failure to do so would
seriously harm our business, operating results and financial condition.

 Our investment in goodwill and intangibles resulting from our acquisitions
 could become impaired.

   As a result of our acquisitions in 1999, we recorded goodwill and
intangibles of $167.2 million, which is being amortized over a period of two to
five years. We will amortize $31.8 million in 2001, $29.5 million in 2002,
$28.6 million in 2003 and $14.0 million in 2004. To the extent we do not
generate sufficient cash flows to recover the net amount of the investment
recorded, the investment could be considered impaired and could be subject to
earlier write-off. In such event, our results of operations in any given period
could be negatively impacted, and the market price of our stock could decline.

 We rely on our key personnel.

   Our future performance depends on the continued service of our key
technical, sales and senior management personnel. Most of our technical, sales
or senior management personnel are not bound by employment agreements. The loss
of the services of one or more of our officers or other key employees could
seriously harm our business, operating results and financial condition.

   We recently experienced a period of high employee turnover and have hired a
number of new executives at the levels of director, vice president and above.
Our future success also depends on our continuing ability to

                                       20
<PAGE>

attract and retain highly qualified technical, sales and managerial personnel.
Competition for such personnel is intense, and we may fail to retain our key
technical, sales and managerial employees or attract, assimilate or retain
other highly qualified technical, sales and managerial personnel in the future.

 Our revenue recognition could be impacted by the actions of our sales
 personnel.

   The recognition of our revenue depends on, among other things, the terms
negotiated in our contracts with our customers. Our sales personnel may act
outside of their authority and negotiate additional terms without our
knowledge. To the extent that our sales personnel have negotiated terms that
are extraneous to the contract and of which we are unaware, whether the
additional terms are written or verbal, could prevent us from recognizing
revenue in accordance with our plans.

 We rely on our sales personnel.

   We experienced a number of voluntary resignations in our sales force during
the past year, including some of our senior level sales employees. Our future
success depends on our continuing ability to attract and retain highly
qualified sales personnel. Competition for such personnel is intense, and we
may fail to retain our sales personnel or attract, assimilate or retain other
highly qualified sales personnel in the future. Any further disruption to our
sales force could seriously harm our business, operating results and financial
condition.

 We depend on growth in the enterprise storage management market.

   All of our business is in the enterprise storage management market. The
enterprise storage management market is still an emerging market. Our future
financial performance will depend in large part on continued growth in the
number of organizations adopting company-wide storage and management solutions
for their client/server computing environments. The market for enterprise
storage management may not continue to grow at historic rates or at all. If
this market fails to grow or grows more slowly than we currently anticipate and
we are unable to capture market share from our competitors, our business,
operating results and financial condition would be seriously harmed.

 We are affected by general economic and market conditions.

   Segments of the computer industry have recently experienced significant
economic downturns characterized by decreased product demand, product
overcapacity, price erosion, work slowdowns, and layoffs. Our operations may
experience substantial fluctuations from period-to-period as a consequence of
such industry trends, general economic conditions affecting the timing of
orders from major customers, and other factors affecting capital spending. The
occurrence of such factors could seriously harm our business, operating results
or financial condition.

 Protection of our intellectual property is limited.

   Our success depends significantly upon proprietary technology. To protect
our proprietary rights, we rely on a combination of patents, copyright and
trademark laws, trade secrets, confidentiality procedures, and contractual
provisions. We seek to protect our software, documentation and other written
materials under patent, trade secret and copyright laws, which afford only
limited protection. However, we may not develop proprietary products or
technologies that are patentable, any issued patent may not provide us with any
competitive advantages or may be challenged by third parties, or the patents of
others may seriously impede our ability to do business.

   Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult, and software piracy can be expected to be a persistent problem. In
licensing our products, other than in enterprise license transactions, we rely
on "shrink wrap" licenses that are not signed by licensees.

                                       21
<PAGE>

Such licenses may be unenforceable under the laws of certain jurisdictions. In
addition, the laws of some foreign countries do not protect our proprietary
rights to as great an extent as do the laws of the United States. Our means of
protecting our proprietary rights may not be adequate. Our competitors may
independently develop similar technology, duplicate our products or design
around patents issued to us or other intellectual property rights of ours.

   From time to time, we have received claims that we are infringing third
parties' intellectual property rights. In the future, we may be subject to
claims of infringement by third parties with respect to current or future
products, trademarks or other proprietary rights. We expect that software
product developers will increasingly be subject to infringement claims as the
number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation, cause product shipment delays or require us to enter into royalty
or licensing agreements with third parties. If such royalty or licensing
agreements, if required, are not available on terms acceptable to us, our
business, operating results and financial condition could be seriously harmed.

 Defects in our products would harm our business.

   Our products can be used to manage data critical to organizations. As a
result, the licensing and support of products we offer may entail the risk of
product liability claims. Although we generally include provisions in our
license agreements that are intended to limit our liability, a successful
product liability claim brought against us could seriously harm our business,
operating results and financial condition.

 Our trading price is volatile.

   The trading of our common stock historically has been highly volatile, and
we expect that the price of our common stock will continue to fluctuate
significantly in the future. An investment in our common stock is subject to a
variety of significant risks, including, but not limited to the following:

  . Quarterly fluctuations in financial results or results of other software
    companies;

  . Changes in our revenue growth rates or our competitors' growth rates;

  . Announcements that our revenue or income are below analysts'
    expectations;

  . Changes in analysts' estimates of our performance or industry
    performance;

  . Announcements of new products by our competitors or by us;

  . Announcements of disappointing financial results from our competitors,
    strategic allies or major end users;

  . Developments with respect to our patents, copyrights, or proprietary
    rights or those of our competitors;

  . Sales of large blocks of our common stock;

  . Conditions in the financial markets in general;

  . Litigation; and

  . General business conditions and trends in the distributed computing
    environment and software industry.

   In addition, the stock market may experience extreme price and volume
fluctuations, which may affect the market price for the securities of
technology companies without regard to their operating performance or any of
the factors listed above. These broad market fluctuations may seriously harm
the market price of our common stock.


                                       22
<PAGE>

ITEM 2. PROPERTIES

   Our principal headquarters is located in approximately 105,000 square feet
of space in Mountain View, California. This facility is leased through December
2009. Our principal research and development facility is located in
approximately 96,000 square feet of space in Palo Alto, California. This
facility is leased through September 2006. Our principal sales and marketing
office is located in approximately 52,500 square feet of space in Sunnyvale,
California. This facility is leased through February 2007. Our principal
technical support facility is located in approximately 97,600 square feet of
space in Burlington, Ontario. This facility is leased through October 2010. We
also currently lease other domestic offices throughout the United States, as
well as international offices throughout the world.

ITEM 3. LEGAL PROCEEDINGS

   Beginning on January 20, 2000, a number of shareholder securities class
action complaints were filed in the U.S. District Court, Northern District of
California, against certain of our directors and officers and us. On May 1,
2000, the court consolidated all of the pending cases and, on May 10, 2000,
appointed a lead plaintiff, who filed a consolidated amended complaint on
August 7, 2000. Defendants filed motions to dismiss. On January 17, 2001, the
Court entered an Order granting the motions to dismiss with leave to amend. On
February 13, 2001, plaintiffs filed a second amended complaint, which generally
alleges that, between April 22, 1999 and May 17, 2000, defendants made false or
misleading statements of material fact about the Company's prospects and failed
to follow generally accepted accounting principles in violation of the federal
securities laws. The complaint seeks an unspecified amount in damages.
Defendants will file an answer to the complaint in April 2001 denying all
allegations that they violated the federal securities laws.

   On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our
officers and directors. We are named as nominal defendant. The derivative case
has been related to the securities class action. Plaintiff moved to stay the
derivative case. On January 17, 2001, the Court denied plaintiffs' motion to
stay. Plaintiffs filed an amended complaint on February 9, 2001, which
generally alleges the same conduct as the shareholder class action, and claims
that defendants breached their fiduciary duties and engaged in improper insider
trading. The derivative complaint seeks unspecified damages and injunctive
relief. Defendants will move to dismiss the derivative complaint.

   On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. We are named as a nominal defendant. On May 23, 2000, a shareholder
derivative action was filed in the Superior Court of California, County of San
Mateo, against certain of our officers and directors. We are named as a nominal
defendant. Both state derivative complaints generally allege the same conduct
as the derivative action filed in federal court, claim that our officers and
directors breached their fiduciary duties for the period October 21, 1999
through April 3, 2000, and seek unspecified damages and injunctive relief. The
Santa Clara derivative case was transferred to San Mateo County and
consolidated with the San Mateo derivative case.

   The Securities and Exchange Commission has entered a formal order of
investigation concerning our restatement of financial results for the first,
second, and third quarters of 1999, and our revision of financial results for
the fourth quarter and fiscal 1999. We have been voluntarily cooperating with
the Staff of the Commission in its investigation.

   We intend to defend all of these actions vigorously. There can be no
assurance that any of the complaints discussed above will be resolved without
costly litigation, or in a manner that is not materially adverse to our
financial position, results of operations or cash flows. No estimate can be
made of the possible loss or possible range of loss associated with the
resolution of these contingencies.


                                       23
<PAGE>

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   We did not submit any matters to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2000.

Executive Officers

   The following table sets forth information with respect to persons who
served as our executive officers as of March 23, 2001:

<TABLE>
<CAPTION>
   Name                     Age                        Positions
   ----                     ---                        ---------
   <S>                      <C> <C>
   David B. Wright.........  51 Chairman, President and Chief Executive Officer
   David L. Beamer.........  58 Executive Vice President, Worldwide Sales and Marketing
   Andrew J. Brown.........  41 Senior Vice President and Chief Financial Officer
   Thomas L. Panozzo.......  53 Senior Vice President, Service and Support
   James Chappell..........  40 Senior Vice President, Business Process and Development
   Charles Fonner..........  57 Vice President, Worldwide Marketing
   George J. Symons........  41 Vice President, Product Management and Development
   Jack Landers............  57 Vice President, Human Resources
   Cory J. Sindelar........  32 Vice President and Corporate Controller
</TABLE>

   David B. Wright has served as President and Chief Executive Officer of
Legato since October 2000 and Chairman of the Board of Directors since March
2001. Mr. Wright joined Legato following a thirteen-year career with Amdahl
Corporation, an integrated computing solutions company, where he served as
President and Chief Executive Officer since 1997. Before joining Amdahl, Mr.
Wright spent 11 years with IBM, an advanced information technology company,
serving in variety of staff and management positions. Mr. Wright holds a B.S.
in Physics and Mathematics from Xavier University in Cincinnati, Ohio and a
M.B.A. from Babson College. Mr. Wright serves on the Board of Directors of
Aspect Communications Corp., Insurance Services Office, Inc., INRANGE
Technologies Corp. and is the Chairman of the Silicon Valley Manufacturing
Group, a non-profit organization.

   David L. Beamer serves as the Executive Vice President, Worldwide Sales and
Marketing and is responsible for all corporate and service provider marketing,
worldwide sales and international market development. Mr. Beamer joined Legato
in January of 2001 as the Executive Vice President of Worldwide Sales. Before
joining Legato, Mr. Beamer was the President and Chief Operating Officer of
FileTek Corporation of Rockville, Maryland, a privately held software and
systems integration company. Prior to FileTek, Mr. Beamer was with Amdahl
Corporation for sixteen years, where he was a corporate officer for six years
and served in various sales, marketing, and senior management roles. Before
joining Amdahl, he was with IBM Corporation for eight years. Mr. Beamer holds a
B.S. in electrical engineering and a M.B.A. in Marketing and Finance from Ohio
State University.

   Andrew J. Brown joined Legato in October 2000 as the Senior Vice President
and Chief Financial Officer. Before joining Legato, Mr. Brown served as Vice
President, Finance and Chief Financial Officer of Adaptec, a data storage
access solution company, since August 1998. From July 1988 to August 1998, he
served in various financial roles within Adaptec including Vice President,
Corporate Controller and Principal Accounting Officer. Mr. Brown earned his
Bachelors degree in Accounting from Eastern Illinois University.

   Thomas L. Panozzo joined Legato in July 1999 as Senior Vice President,
Service and Support. Before joining Legato, Mr. Panozzo served as Vice
President, Customer Support, of Candle Corporation, a systems management
software company, from January 1997 to June 1999. From June 1966 to January
1997, he served in various positions at IBM, including Senior Project
Executive, Manager and Regional Manager. Mr. Panozzo holds a B.S. from the
Illinois Institute of Technology and a M.B.A. from Pepperdine University.


                                       24
<PAGE>

   James Chappell joined Legato in June 1992. In February 2001, Mr. Chappell
became Senior Vice President, Business Process and Development. From April 2000
to February 2001, he served as Vice President of Plans and Controls. From
October 1999 to April 2000, he served as Vice President and General Manager of
the Data Availability Division. From August 1998 to October 1999, he served as
our Vice President of Business Development. From June 1992 to July 1998, Mr.
Chappell held various sales and marketing management positions with Legato,
including general manager, manager of strategic businesses and director of
worldwide channel marketing. Before joining Legato, Mr. Chappell served as
President of The Connectivity Lab, a data communications consulting firm, from
March 1989 to March 1991. Mr. Chappell holds a B.S. in Computer Science from
Cal Poly University in San Luis Obispo, California.

   Charles Fonner joined Legato in February 2001 as Vice President, Worldwide
Marketing. Before joining Legato, Mr. Fonner served as President and Chief
Executive Officer of Npoint Corporation of Los Gatos, California, a privately
held software company. Prior to Npoint, Mr. Fonner was the Chief Operating
Officer of Tyecin Systems of Los Altos, California, a privately held software
company (acquired by Manugistics, Inc.). Prior to Tyecin, Mr. Fonner was with
Amdahl Corporation for 18 years, where he was a corporate officer for six
years. He served in various sales, marketing and senior management roles at
Amdahl. Before joining Amdahl, he was with IBM Corporation for ten years. Mr.
Fonner holds a degree in marketing from Bradley University.

   George J. Symons currently serves as Vice President, Product Management and
Development and is responsible for all engineering, product management, product
marketing and quality assurance activities. He joined Legato in April 1999 as
Vice President, Product Marketing and Management after FullTime was acquired by
Legato. Mr. Symons was Vice President of Engineering at FullTime Software since
April 1996. Mr. Symons holds a B.A. in Management Science and Computer Science
from the University of California, San Diego, and a M.B.A. from the University
of California, Los Angeles.

   Jack Landers joined Legato in August 2000 as Vice President, Human
Resources. Before joining Legato, Mr. Landers served as Vice President, Human
Resources for Pacific Gateway Exchange, Inc., an international long distance
telecommunications services provider. Additionally, Mr. Landers has held a
number of Senior Human Resources Management positions with Symantec Corp., Bay
Networks (now Nortel Networks) and Digital Equipment Corp. (now Compaq
Computers) Mr. Landers holds a B.A. in English Literature and a M.A in Teaching
from Boston College.

   Cory J. Sindelar joined Legato in December 2000 as Vice President and
Corporate Controller. Prior to joining Legato, Mr. Sindelar served as Corporate
Controller at iBEAM Broadcasting Corporation, a provider of an Internet
broadcast network and web casting services, from April 2000 to December 2000.
Mr. Sindelar also served as Senior Manager at PricewaterhouseCoopers LLP, a
global assurance and business advisory firm, based in the firm's San Jose
office from July 1998 to April 2000. Additionally, Mr. Sindelar has held
various accounting, auditing and controller positions with Arthur Andersen LLP
and C-Cube Microsystems. Mr. Sindelar holds a degree in accounting from
Georgetown University.

                                       25
<PAGE>

                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

   Our common stock is traded on the Nasdaq National Market under the symbol
LGTO. The following table sets forth the high and low closing sales prices of
our common stock for each quarter in the two-year period ended December 31,
2000. Such prices represent prices between dealers, do not include retail mark-
ups, markdowns or commissions and may not represent actual transactions.
<TABLE>
<CAPTION>
                                                         1999          2000
                                                     ------------- -------------
                                                      High   Low    High   Low
                                                     ------ ------ ------ ------
   <S>                                               <C>    <C>    <C>    <C>
   First Quarter.................................... $32.75 $20.75 $67.75 $25.19
   Second Quarter................................... $29.75 $15.25 $22.00 $ 9.88
   Third Quarter.................................... $49.13 $28.31 $15.25 $ 8.31
   Fourth Quarter................................... $79.25 $41.09 $12.81 $ 6.69
</TABLE>

   As of March 16, 2001, we had approximately 319 registered stockholders and
estimate that we had approximately 53,000 beneficial owners of our common
stock.

   We have never declared or paid a cash dividend on our common stock and do
not intend to pay cash dividends on our common stock in the foreseeable future.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

Five-Year Summary

<TABLE>
<CAPTION>
                                                 December 31,
                                  --------------------------------------------
                                    2000      1999   1998(2)  1997(2)  1996(3)
                                  --------  -------- -------- -------- -------
                                   (in thousands, except per share amounts)
<S>                               <C>       <C>      <C>      <C>      <C>
Revenue.......................... $231,395  $228,567 $167,907 $118,499 $88,920
Gross profit.....................  185,563   196,790  143,114   97,812  70,457
Income (loss) from operations....  (51,413)    2,991   27,815   21,589  15,747
Net income (loss)................  (35,249)    2,704   19,869   15,066  10,814
Basic net income (loss) per
 share(1)........................    (0.41)     0.03     0.26     0.21    0.16
Diluted net income (loss) per
 share(1)........................    (0.41)     0.03     0.24     0.19    0.14
Cash, cash equivalents and
 investments.....................  165,145   169,928  125,972   87,433  76,945
Total assets.....................  414,864   422,894  207,224  141,908 111,704
</TABLE>
--------
(1) See Note 2 of Notes to Consolidated Financial Statements.
(2) Selected financial data for the year-ended December 31, 1998 and 1997 was
    derived by combining Legato's selected financial data for the year-ended
    December 31, 1998 and 1997 with FullTime's financial data for the twelve-
    months ended December 31, 1998 and 1997, respectively.
(3) Selected financial data for the year-ended December 31, 1996 was derived by
    combining Legato's selected financial data for the year-ended December 31,
    1996 with FullTime's financial data for the fiscal year-ended June 30, 1997
    and 1996, respectively.

                                       26
<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

   The discussion in this report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, including
statements on our expectations, beliefs, intentions or strategies regarding the
future, including without limitation, our financial outlook, successful
introduction of new products and expansion of operation. All forward-looking
statements included in this document are based on information available to us
on the date hereof. We assume no obligation to update any such forward-looking
statements. Our actual results could differ materially from those indicated in
such forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, fluctuations in quarterly
operating results, uncertainty in future operating results, litigation,
competition, product concentration, technological changes, reliance on
enterprise license transactions, modifications in the application of accounting
policies, reliance on indirect sales channels, changes in marketing strategies,
dependence on international revenue, management of our growth and expansion,
the ability to attract and retain qualified personnel, and other risks
discussed in this item under the heading "Risk Factors" and the risks discussed
in our other Securities and Exchange Commission filings.

Overview

   Legato Systems, Inc. was incorporated in Delaware in September 1988. We
develop, market and support software products and services for heterogeneous
client/server computing environments in mid- to large-scale enterprises. We are
a technology leader in the network storage management software market through
our commitment to open, standards-based software development. Our software
delivers to customers a solution that is scalable, high-performance and
manageable and ensures high data and application availability on a wide range
of servers, clients, applications, databases and storage devices. Our data
protection products, primarily the NetWorker family of products, and our data
availability products, primarily our Legato Cluster and wanCluster products,
support many server platforms and accommodate a variety of clients,
applications, databases and storage devices. Our long-term strategy is to
create an integrated set of solutions centered on information protection,
availability and storage management that enhance and simplify network computing
as a whole.

   On August 6, 1998, we acquired Software Moguls, Inc., a developer of
advanced backup-retrieval products for the Windows NT and UNIX environments,
for 498,998 shares of our common stock. The acquisition had a total purchase
price of $10.9 million and was accounted for as a pooling of interests.

   On April 1, 1999, we acquired Intelliguard Software, Inc. and O.R.P., Inc.,
developers of standards-based storage management solutions of the storage area
networks, for 1,440,000 shares of our common stock and $9.0 million in cash.
The acquisition had a total purchase price of $55.4 million and was accounted
for as a purchase.

   On April 19, 1999, we acquired Qualix Group, Inc. (dba FullTime Software,
Inc.), a developer of distributed, enterprise-wide, cross-platform, adaptive
computing solutions than enable customers to proactively manage application
service level availability, for 3,442,000 shares of our common stock. The
acquisition had a total purchase price of $52.5 million and was accounted for
as a pooling of interests.

   On July 30, 1999, we acquired Vinca Corporation, a developer of high
availability and data protection software, for 1,531,000 shares of our common
stock, $18.8 million in cash and the assumption of options to purchase 590,000
share of our common stock. The acquisition had a total purchase price of $91.7
million and was accounted for as a purchase.

                                       27
<PAGE>

   For the acquisitions accounted for as pooling of interests, we restated our
financial statements to represent the combined financial results of previously
separate entities for all periods presented. For the acquisitions accounted for
as purchase business combinations, we recorded the results of operations of the
acquired companies with our results of operations as of the date of
acquisition.

Results of Operations

   Revenue. Revenue is derived from primarily two sources: (i) product license
revenue, derived from the sale of product licenses to resellers and end users,
including large-scale enterprises, and royalty revenue, derived from initial
license fees and ongoing royalties from product licenses of source code to
OEMs; and (ii) service and support revenue, derived from providing software
updates, support and education and consulting services to end users.

   Product license revenue is generally recognized when a signed contract or
other persuasive evidence of an arrangement exists, the software has been
shipped or electronically delivered, the license fee is fixed and determinable
and collection of resulting receivables is probable. For sales to domestic
distributors, product license revenue is recognized upon sale by the
distributor to the end user, since these distributors generally have unlimited
rights of return, and we historically have not been able to make reasonable
estimates of product returns for these distributors. We also incur additional
internal costs to assist our distributors in selling our products to end-users.
For sales to certain value-added resellers in the fiscal years ended December
31, 1999 and 2000, product license revenue is recognized upon receipt of cash
from these value-added resellers since the arrangements with these resellers
may include extended payment terms, which in some cases, are contingent upon
them receiving payment from their end-user customer. Estimated product returns
are recorded upon recognition of revenue from customers having rights of
return, including exchange rights for unsold products and product upgrades.
Provisions for estimated warranty costs and anticipated retroactive price
adjustments are recorded at the time products are shipped. Product license
revenue from royalty payments is recognized upon receipt of royalty reports
from OEMs related to their product sales. Revenue from subscription license
agreements, which include software, rights to future products and maintenance,
is recognized ratably over the term of the subscription period.

   Service and support revenue consists primarily of revenue received for
providing maintenance (i.e., software updates and technical support), on-site
support, consulting and training. Revenue from maintenance is recognized
ratably over the term of the agreements. Revenue allocated to education and
consulting services, or derived from the separate sales of these services, is
recognized as the related services are provided.

   When contracts contain multiple obligations (e.g. products, updates,
technical support and other services) wherein vendor specific objective
evidence exists for all undelivered elements, the Company accounts for the
delivered elements in accordance with the "Residual Method" prescribed by
Statement of Position 98-9. Any revenue related to updates or technical support
in these arrangements is recognized ratably over the term of the maintenance
arrangement.

<TABLE>
<CAPTION>
                                                                     % Change
                                                                    ------------
                                             2000    1999    1998   00/99  99/98
                                            ------  ------  ------  -----  -----
                                               (in millions)
   <S>                                      <C>     <C>     <C>     <C>    <C>
   Product license......................... $145.6  $161.1  $129.1   (10)%   25%
   Service and support.....................   85.8    67.5    38.8    27     74
                                            ------  ------  ------
     Total revenue......................... $231.4  $228.6  $167.9     1     36
                                            ======  ======  ======

Sources of Revenue as a Percent of Total Revenue.

<CAPTION>
                                             2000    1999    1998
                                            ------  ------  ------
   <S>                                      <C>     <C>     <C>     <C>    <C>
   Product license.........................     63%     70%     77%
   Service and support.....................     37      30      23
</TABLE>

                                       28
<PAGE>

   Product license revenue decreased for 2000, when compared to 1999, primarily
due to the implementation of our new software subscription licensing model
during the second quarter of 2000 and, to a lesser extent, a decrease in sales
volume of our software products resulting from the headcount turnover within
the sales force. The increase in product license for 1999, when compared to
1998, is primarily as a result of the continued acceptance of our NetWorker
family of products, particularly to large-scale enterprises, as well as
increased royalty revenue. The increase of sales and marketing personnel as
well as sales and marketing programs helped to increase the market acceptance
of our products and product sales.

   Service and support revenue increased for 2000, when compared to 1999,
primarily as a result of increased maintenance renewals over a larger installed
base and, to a lesser extent, growth in our consulting and education services.
The increase in service and support revenue for 1999, when compared to 1998, is
primarily attributable to the growth in the number of registered customers
electing to subscribe to support contracts and to renew software support
contracts after the initial one-year term. Our increase in internal staffing
for software support helped to increase new sales and renewals of our software
support contracts. We expect that service and support will increase in absolute
dollars in 2001, but at a growth rate less than in 2000.

Revenue by Geography.
<TABLE>
<CAPTION>
                                                                     % Change
                                                                    ------------
                                             2000    1999    1998   00/99  99/98
                                            ------  ------  ------  -----  -----
                                               (in millions)
   <S>                                      <C>     <C>     <C>     <C>    <C>
   Domestic................................ $155.7  $162.8  $122.4    (4)%   33%
   International...........................   75.7    65.8    45.5    15     45
                                            ------  ------  ------
     Total revenue......................... $231.4  $228.6  $167.9     1     36
                                            ======  ======  ======

Revenue by Geography as a Percent of Total Revenue.

<CAPTION>
                                             2000    1999    1998
                                            ------  ------  ------
   <S>                                      <C>     <C>     <C>     <C>    <C>
   Domestic................................     67%     71%     73%
   International...........................     33      29      27

   Domestic revenue decreased for 2000, when compared to 1999, primarily due to
a decrease in sales volume of our products given the turnover in the headcount
of the domestic sales force and the implementation of our new software
subscription licensing model during the second quarter of 2000. International
revenue increased primarily as a result of the continued market acceptance of
our products overseas as we continue to invest in international sales offices
and to sign international distributors and resellers. The majority of
international sales during these periods were made in Europe and Canada. We
intend to grow sales by increasing productivity of the domestic sales force and
further expanding our international operations. In order to successfully expand
international sales, we must continue to establish additional foreign
operations, hire additional personnel for these operations and recruit
additional international resellers.

Cost of Revenue.

<CAPTION>
                                                                     % Change
                                                                    ------------
                                             2000    1999    1998   00/99  99/98
                                            ------  ------  ------  -----  -----
                                               (in millions)
   <S>                                      <C>     <C>     <C>     <C>    <C>
   Product license......................... $  6.0  $  5.9  $  9.7     2%   (39)%
   Service and support.....................   39.8    25.9    15.1    54     71

Cost of Revenue as a Percent of Related Revenue.

<CAPTION>
                                             2000    1999    1998
                                            ------  ------  ------
   <S>                                      <C>     <C>     <C>     <C>    <C>
   Product license.........................      4%      4%      8%
   Service and support.....................     46      38      39
</TABLE>

                                       29
<PAGE>

   Cost of product license revenue includes costs of production personnel,
packaging and documentation, freight and royalties. Product gross margin
remained constant at 96% in 2000, when compared in 1999. Product gross margin
increased to 96% in 1999, when compared to 92% in 1998, primarily due to the
phase out of reselling third-party products through Qualix Direct telesales
organization prior to our acquisition in April 1999.

   Cost of service and support revenue includes costs associated with providing
customers with services, such as consulting and education, telephonic and on-
site support and product updates. Costs include primarily salaries and costs to
recruit, develop and retain personnel, packaging, documentation and delivery of
product updates and costs to maintain the infrastructure necessary to manage a
services organization. Cost of service and support revenue increased $13.9
million in 2000, when compared to 1999, and was driven by increases in the
support function and expansion of our consulting and education services.
Service and support headcount increased to 298 in 2000 from 238 in 1999. Cost
of service and support revenue increased $10.8 million in 1999, when compared
to 1998, primarily due to supporting a larger installed base of products as
well as providing higher support levels to customers. Service and support
headcount increased to 238 in 1999 from 141 in 1998. Service and support gross
margin decreased to 54% in 2000, when compared to 62% in 1999 and 61% in 1998,
primarily due to the increased staffing to support as discussed above and
outsourcing certain of our consulting arrangements.

   Total gross profit was $185.6 million in 2000, $196.8 million in 1999 and
$143.1 million in 1998, representing gross margin of 80% in 2000, 86% in 1999
and 85% in 1998. The decrease in total gross margin for 2000, when compared to
1999, relates primarily to the decrease in service and support gross margin
during 2000.

Operating Expenses.

<TABLE>
<CAPTION>
                                                                      % Change
                                                                     -----------
                                                2000   1999   1998   00/99 99/98
                                               ------  -----  -----  ----- -----
                                                 (in millions)
   <S>                                         <C>     <C>    <C>    <C>   <C>
   Sales and marketing........................ $106.7  $93.8  $72.0    14%   30%
   Research and development...................   56.6   40.1   25.6    41    56
   General and administrative.................   35.6   20.5   15.9    74    29

Operating Expenses as a Percent of Total Revenue.

<CAPTION>
                                                2000   1999   1998
                                               ------  -----  -----
   <S>                                         <C>     <C>    <C>    <C>   <C>
   Sales and marketing........................     46%    41%    43%
   Research and development...................     24     18     15
   General and administrative.................     15      9      9
</TABLE>

   Sales and marketing expenses consist primarily of employee-related costs
such as salaries, benefits, commissions and promotional and advertising
expenses. The increase in sales and marketing expenses of $12.9 million for
2000, when compared to 1999, was primarily attributable to increased recruiting
costs, air travel and facilities expenses and, to a lesser extent, an increase
in our headcount to 454 employees in 2000 from 449 employees in 1999. The
increase in sales and marketing expenses of $21.8 million in 1999, when
compared to 1998, was primarily attributable to an increase in employee-related
expenses resulting from increased headcount to 449 from 243 in 1998 and as a
result of additional marketing and promotional activities to increase awareness
of our products. We believe that sales and marketing expenses will increase in
2001 in absolute dollars, but decrease as a percentage of total revenue, as we
continue to moderately expand our sales and marketing staff.

   Research and development expenses consist primarily of employee-related
costs such as salaries, benefits and facilities and equipment costs. The
increase in research and development expenses of $16.5 million for

                                       30
<PAGE>

2000, when compared to 1999, was primarily attributable to increases in
salaries and benefits as headcount ramped significantly in 1999 as a result of
our acquisitions of Intelliguard in April 1999 and Vinca in July 1999. Under
purchase accounting, the results of operations of these companies were added to
our results of operations from the date of acquisition. Accordingly, we have a
full year of salary and benefits costs in 2000. The increase in research and
development expenses of $14.5 million for 1999, when compared to 1998, was
primarily attributable to the increased staffing and associated support for
engineers necessary to expand and enhance our product line. The number of
research and development personnel increased from 193 in 1998 to 384 employees
in 1999 and decreased to 364 employees in 2000. We believe that research and
development expenses will continue to increase slightly in absolute dollars,
but decrease as a percentage of total revenue, as we continue to invest in
developing new products and enhancing existing products.

   General and administrative expenses primarily include employee-related costs
of our finance, human resources, facilities, information systems and other
administrative departments. The increase in general and administrative expenses
of $15.1 million for 2000, when compared to 1999, was primarily attributable to
increases in salaries and other compensation, recruiting costs, legal and other
professional services and bad debt expense. The increase in general and
administrative expenses of $4.6 million for 1999, when compared to 1998, was
primarily attributable to increased staffing and related costs required to
manage and support our expansion. General and administrative personnel
increased from 83 employees in 1998 to 165 employees in 1999 and decreased to
154 employees in 2000. We expect that general and administrative expenses will
increase in absolute dollars, but decrease as a percentage of revenue, as we
make certain investments in infrastructure in the first half of 2001and
continue to expand our operations internationally.

   Amortization of intangibles was $38.1 million in 2000, $21.8 million in 1999
and $1.1 million in 1998. During 1999, we recorded additional intangibles
related to the acquisitions of Intelliguard totaling $58.7 million and Vinca
totaling $102.7 million. (See Note 7 to the Notes to the Consolidated Financial
Statements.) We are amortizing these intangibles on a straight-line basis over
periods ranging from seventeen months to five years from the dates of
acquisition. We expect to amortize intangibles of $31.8 million in 2001, $29.5
million in 2002, $28.6 million in 2003 and $14.0 million in 2004.

   We incurred acquisition-related expenses of $5.0 million related to FullTime
in 1999 and $0.6 million related to Software Moguls in 1998. Such expenses
consisted primarily of investment banking, accounting and other professional
fees and costs relating to the closure of duplicative facilities and severance
costs. In addition, we incurred professional fees of $1.3 million in connection
with our proposed acquisition of Ontrack Data International, Inc. during the
fourth quarter of 1999. In January 2000, we entered into a Mutual Termination
Agreement with Ontrack to immediately terminate the proposed acquisition. (See
Note 7 to the Notes to the Consolidated Financial Statements.) In connection
with our acquisitions of Intelliguard during the second quarter of 1999 and
Vinca during the third quarter of 1999, we purchased in-process research and
development of $3.2 million and $8.3 million, respectively. During 2000 and
1998, we did not acquire any purchased in-process research and development
projects.

   The fair value of Intelliguard's and Vinca's core technologies, existing
products, as well as the technology currently under development were determined
by independent appraisers using the income approach, which discounts expected
future cash flows to present value. The discount rates used in the present
value calculations were derived from a weighted average cost of capital
analysis, adjusted upward by a premium of 5% for the in-process projects from
the Intelliguard acquisition and 8.5% to 26% for the in-process projects from
Vinca acquisition to reflect additional risks inherent in the development life
cycle. We expect that the pricing models related to these acquisitions will be
considered standard within the high-technology industry. However, we have not
and do not expect to achieve a material amount of expense reductions or
synergies as a result of integrating the acquired in-process technology.
Therefore, the valuation assumptions do not include anticipated cost savings.

                                       31
<PAGE>

   The Intelliguard projects included in in-process research and development
and the percent complete, the estimated cost to complete and the value assigned
to each project follows (in thousands):

<TABLE>
<CAPTION>
                                        Estimate Percent Estimated Cost  Value
      Project                              Completion     To Complete   Assigned
      -------                           ---------------- -------------- --------
      <S>                               <C>              <C>            <C>
      A................................         9%            $340      $   780
      B................................        50%            $680        1,660
      C................................        17%            $170          730
                                                                        -------
                                                                        $ 3,170
                                                                        =======
</TABLE>
   The Vinca projects included in in-process research and development and the
percent complete, the estimated cost to complete and the value assigned to each
project as follows (in thousands):

<TABLE>
<CAPTION>
                                        Estimate Percent Estimated Cost  Value
      Project                              Completion     To Complete   Assigned
      -------                           ---------------- -------------- --------
      <S>                               <C>              <C>            <C>
      A................................        60%           $ 800      $   700
      B................................        60%             180          600
      C................................        90%             175        2,200
      D................................        90%             150        2,200
      E................................        90%             300        1,000
      F................................        30%           1,035          300
      G................................        80%           2,065          800
      H................................        40%           5,471          200
      I................................        20%           2,450          300
                                                                        -------
                                                                        $ 8,300
                                                                        =======
</TABLE>

   Continued development of these technologies remains a significant risk to
Legato due to the remaining effort to achieve technical viability, rapidly
changing customer markets, uncertain standards for new products and significant
competitive threats from numerous companies. The nature of efforts to develop
the acquired technology into commercially viable products consists principally
of planning, designing, coding and testing activities necessary to determine
that the product can meet market expectations, including functionality and
technical requirements. Failure to achieve the expected levels of revenue and
net income from these products will negatively impact the return on investment
expected at the time of the acquisition and potentially result in impairment of
any other assets related to the development activities.

   Interest Income, Net. Interest income, net was $6.6 million in 2000, $5.4
million in 1999 and $4.8 million in 1998. The increase in interest income, net
relates primarily to an increase in interest rates for 2000, when compared to
1999, and interest earned from the increased cash balances for 1999, when
compared to 1998.

   Provision for (Benefit from) Income Taxes. The benefit from income taxes was
$9.5 million in 2000 as compared to a provision for income taxes of $5.7
million in 1999 and $12.7 million in 1998, with an effective tax rate of 21% in
2000, 68% in 1999 and 39% in 1998. The difference in the effective tax rate for
2000, when compared to 1999, is primarily attributable to our net loss in 2000
versus net income in 1999 and the effect of non-deductible amortization and
foreign tax expense related to foreign income. The increase in the effective
tax rate for 1999, when compared to 1998, was primarily attributable to the
impact of non-deductible merger and amortization expenses incurred in
connection with the acquisitions of FullTime, Intelliguard and Vinca during
1999.

Liquidity and Capital Resources

   Our cash, cash equivalents and investments totaled $165.1 million as of
December 31, 2000 as compared to $169.9 million as of December 31, 1999. As of
December 31, 2000, we had working capital of $161.8

                                       32
<PAGE>

million, no long-term debt and stockholders' equity of $322.3 million. To date,
we have financed our operations primarily by cash from operations and sales of
our common stock.

   Net cash provided by operating activities was $11.8 million in 2000, $51.9
million in 1999 and $42.1 million in 1998. Net cash provided by operating
activities in 2000 consisted primarily of increases to accrued liabilities and
deferred revenue of $14.9 million, depreciation and amortization of $52.8
million, the tax benefit from stock option exercises of $4.6 million and a
provision for doubtful accounts and sales returns of $7.0 million partially
offset by the net loss of $35.2 million and increases in deferred tax assets of
$19.9 million and other assets of $10.4 million. Net cash provided by operating
activities in 1999 consisted primarily of net income of $2.7 million plus the
tax benefit from stock option exercises of $36.4 million, depreciation and
amortization of $32.9 million, the write-off of purchased in-process research
and development costs of $11.5 million, a provision for doubtful accounts and
returns reserve of $9.8 million offset by a change in operating assets and
liabilities of $12.9 million and by $28.5 million attributable to the change in
deferred taxes. Net cash provided by operating activities in 1998 consisted
primarily of net income of $19.9 million plus the tax benefit from stock option
exercises of $12.8 million, depreciation and amortization of $7.2 million and
the change in operating assets and liabilities of $2.2 million, offset by $8.4
million attributable to the change in deferred taxes.

   Net cash used in investing activities was $25.1 million in 2000, $52.6
million in 1999 and $8.0 million in 1998. Purchases of property and equipment
increased to $25.0 million in 2000 from $14.6 million in 1999 and from $14.5
million in 1998 as a result of supporting the growth in our operations as well
as investing in information technology infrastructure. In 1999, investing
activities also consisted of net payments of $24.3 million for the purchases of
Intelliguard and Vinca as well as a $5.0 million investment in a private
company. In 1998, the net cash used in investing activities primarily reflected
the purchase of property and equipment partially offset by a decrease in our
net cash investments.

   Net cash provided by financing activities was $8.3 million in 2000, $32.7
million in 1999 and $10.9 million in 1998. Net cash provided by financing
activities consisted primarily of proceeds received from the issuance of our
common stock. During 1999, we also received $6.8 million in connection with the
sale of one qualifying accounts receivable on a non-recourse basis. However,
subsequent to year-end, the agreement and related receivable was cancelled. As
a result, the proceeds received have been presented as a financing activity
rather than cash from operating activities. The short-term loan was repaid in
2000.

   Based on our current operating plan, we believe our current cash and
investment balances and cash flow from operations will be sufficient to meet
our working capital and capital expenditure requirements for at least the next
twelve months.

Disclosures About Market Risk

   Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. While we are exposed with
respect to interest rate fluctuations in many countries, our interest income is
most sensitive to fluctuations in the general level of U.S. interest rates. In
this regard, changes in the U.S. interest rates affect the interest earned on
our cash, cash equivalents, short-term and long-term investments. We invest in
high quality credit issuers and, by policy, limit the amount of our credit
exposure to any one issuer. As stated in our policy, our first priority is to
reduce the risk of principal loss. Consequently, we seek to preserve our
invested funds by limiting default risk, market risk and reinvestment risk. We
mitigate default risk by investing in only high quality credit securities that
we believe to be low risk and by positioning our portfolio to respond
appropriately to a significant reduction in a credit rating of any investment
issuer or guarantor. The portfolio includes only marketable securities with
active secondary or resale markets to ensure portfolio liquidity.

                                       33
<PAGE>

   Cash equivalents are highly liquid debt instruments with maturities of three
months or less as of the date of purchase. Investments with original maturities
greater than three months and remaining maturities less than one year are
classified as short-term investments. Investments with remaining maturities
greater than one year are classified as long-term investments. As of December
31, 2000, the carrying value approximated fair value. The table below presents
the carrying value and related weighted average interest rates for our
investments in marketable securities as of December 31, 2000 (dollars in
millions).
<TABLE>
<CAPTION>
                                                               Carrying Interest
                                                                Value     Rate
                                                               -------- --------
   <S>                                                         <C>      <C>
   Investment Securities:
     Short-term investments--fixed rate....................... $  40.7    4.7%
     Long-term investments--fixed rate........................     9.2    5.0
                                                               -------
       Total investment securities............................    49.9    4.8
     Cash equivalents--variable rate..........................   110.2    6.0
                                                               -------
                                                               $ 160.1    5.4
                                                               =======
</TABLE>

   Foreign Currency Risk. As a global concern, we face exposure to adverse
movements in foreign currency exchange rates. These exposures may change over
time as business practices evolve and could seriously harm our financial
results. Substantially all of our international sales are currently denominated
in U.S. dollars. An increase in the value of the U.S. dollar relative to
foreign currencies could make our products more expensive and therefore, reduce
the demand for our products. Reduced demand for our products could seriously
harm our financial results. Currently, we do not hedge against any foreign
currencies and as a result, could incur unanticipated gains or losses.

   Recent Accounting Pronouncements. In March 2000, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation an
Interpretation of APB Opinion No. 25." FIN 44 clarifies the application of
Opinion 25 for (a) the definition of employee for purposes of applying Opinion
25, (b) the criteria for determining whether a plan qualifies as a non-
compensatory plan, (c) the accounting consequence of various modifications to
the terms of a previously fixed stock option or award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
was effective July 1, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998, or January 12, 2000. The impact of FIN 44
did not have a material effect on our financial position or results of
operations.

   In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, or SAB 101, "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under certain
circumstances. The accounting and disclosures prescribed by SAB 101 were
effective for the year ended December 31, 2000 and did not have a significant
impact on our financial position or results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   The information required by Item 7A is incorporated by reference from the
section entitled "Disclosures About Market Risk" found in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

   The financial statements required by Item 8 are submitted as a separate
section of this Annual Report on Form 10-K. See Item 14.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

   None.

                                       34
<PAGE>

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

   The information required by Item 10 as to directors is incorporated by
reference from the sections entitled "Election of Directors" and "Compliance
with Reporting Requirements of Section 16(a)" in our definitive Proxy Statement
for our 2001 annual stockholders' meeting to be held on May 15, 2001.

   Our executive officers are listed at the end of Part I of this Annual Report
on Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

   The information required by Item 11 is incorporated by reference from the
section entitled "Director and Executive Compensation and Related Information"
in our definitive Proxy Statement for our 2001 annual stockholders' meeting to
be held on May 15, 2001.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   The information required by Item 12 is incorporated by reference from the
section entitled "Security Ownership of Certain Beneficial Owners and
Management" in our definitive Proxy Statement for our 2001 annual stockholders'
meeting to be held on May 15, 2001.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   The information required by Item 13 is incorporated by reference from the
section entitled "Certain Relationships and Related Transactions" in our
definitive Proxy Statement for our 2001 annual stockholders' meeting to be held
on May 15, 2001.

                                       35
<PAGE>

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

   (a) 1 Financial Statements

   Index to Consolidated Financial Statements

<TABLE>
<S>                                                                         <C>
Report of Independent Accountants.........................................   39
Consolidated Balance Sheets as of December 31, 2000 and 1999..............   40
Consolidated Statements of Operations for each of the three years in the
 period ended December 31, 2000...........................................   41
Consolidated Statement of Stockholders' Equity for each of the three years
 in the period ended December 31, 2000....................................   42
Consolidated Statements of Cash Flows for each of the three years in the
 period ended December 31, 2000...........................................   43
Notes to the Consolidated Financial Statements............................   44
</TABLE>

   (a) 2 Financial Statement Schedules

   All schedules have been omitted because they are not required or the
required information is shown in the financial statements or notes thereto.

   (a) 3 Exhibits

   The following exhibits are filed with this Annual Report on Form 10-K:

<TABLE>
<CAPTION>
 Exhibit
 Number                                Exhibit Title
 -------                               -------------
 <C>       <S>
 2.1(3)    Stock Purchase Agreement, dated as of January 5, 1996, among the
           Registrant, Innovus, Inc., 815598 Ontario, Inc., the stockholders of
           Innovus, Inc., and the stockholders of 815598 Ontario, Inc.

 2.2(3)    Stock Purchase Agreement, dated as of January 5, 1996, among the
           Registrant, Innovus Technologies, Inc., and the stockholders of
           Innovus Technologies, Inc.

 2.3(6)    Agreement and Plan of Reorganization, dated as of July 30, 1998, by
           and among Legato Systems, Inc., Aspen Acquisition Corp., Software
           Moguls, Inc., Sunil Khadilkar, Louis C. Cole and the Undersigned
           Stockholders.

 2.4(10)   Agreement and Plan of Reorganization, dated October 25, 1998, by and
           among Legato Systems, Inc., Hat Acquisition Corp. and Qualix Group,
           Inc.

 2.5(11)   Amendment No. 1 to the Agreement and Plan of Reorganization , dated
           October 25, 1998, by and among Legato Systems, Inc., Hat Acquisition
           Corp. and Qualix Group, Inc., dated February 9, 1999.

 2.6(12)   Agreement and Plan of Reorganization By and Among Legato Systems,
           Inc., Sundance Acquisition Corp., Vinca Corporation, the Canopy
           Group, Inc. (as Stockholders' Representative), and the Undersigned
           Stockholders of Vinca Corporation, dated June 7, 1999.

 3.1(6)(9) Amended and Restated Certificate of Incorporation of the Registrant,
           as amended to date.

 3.2(7)    Amended and Restated Bylaws of the Registrant adopted on May 23,
           1997.

 3.3(8)    Form of Certificate of Designation filed in connection with Rights
           Agreement, dated May 23, 1997.
</TABLE>

                                       36
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number                                 Exhibit Title
 -------                                -------------

 <C>         <S>
  4.7(8)     Rights Agreement, dated May 23, 1997 between the Company and
             Harris Trust and Savings Bank, including the Certificate of
             Designation of Series A Junior Participating Preferred Stock, Form
             of Right Certificate and Summary of Rights to Purchase Preferred
             Shares attached thereto as Exhibit A, B and C, respectively.

  4.8(6)     Registration Rights Agreement, dated July 30, 1998, by and between
             Legato Systems, Inc., a Delaware corporation and the Stockholders
             of Software Moguls, Inc.

  4.9(6)     Affiliates Agreement, dated July 30, 1998, between Legato Systems,
             Inc. a Delaware corporation and the Stockholders of Software
             Moguls, Inc.

 10.1(1)     Form of Indemnification Agreement entered into between the
             Registrant and it directors and officers.

 10.3(1)     The Registrant's 1995 Stock Option/Stock Issuance Plan, as amended
             to date.

 10.4(1)(5)  The Registrant's Employee Stock Purchase Plan.

 10.6(1)     Form of United States Reseller Terms and Conditions for Purchase
             of Legato Products.

 10.7(1)     Form of International Authorized Systems Integrator Agreement.

 10.8(1)     Form of Shrinkwrap License Agreement.

 10.9(1)(2)  Technology License and Distribution agreement, dated January 20,
             1995, between the Registrant and SunSoft, Inc.

 10.10(1)    Master Software License and Support Agreement between the
             Registrant and Open Software Foundation.

 10.11(1)    License Agreement, dated February 24, 1989, between the Registrant
             and The Regents of the University of California.

 10.12(1)    Software Agreement, dated January 20, 1989, between the Registrant
             and AT&T Information Systems, Inc.

 10.13(4)(5) The Registrant's International Employee Stock Purchase Plan.

 10.14(6)    Lease Agreement dated March 14, 1996 between the Registrant and
             Coherent, Inc., a Delaware corporation, and Legato Systems, Inc.,
             a Delaware corporation, regarding the space located at 3210 Porter
             Drive, Palo Alto, California.

 10.15       Separation Agreement, dated July 28, 2000, between the Registrant
             and Stephen C. Wise.

 10.16       Offer Letter from Registrant to David B. Wright, dated September
             25, 2000; Amendment to Employment Agreement between Registrant and
             David B. Wright, dated December 4, 2000; and Promissory Note
             between Registrant and David B. Wright, dated December 6, 2000.

 21.1        Subsidiaries of the Registrant.

 23.1        Consent of PricewaterhouseCoopers LLP, Independent Accountants.
</TABLE>
--------
(1) Incorporated by reference to the registrant's Registration Statement on
    Form S-1, filed May 9, 1995 (File No. 33-92072).
(2) Confidential treatment requested as to certain portions of this exhibit.
(3) Incorporated by reference to the registrant's Current Report on Form 8-K,
    dated January 19, 1996.
(4) Incorporated by reference to the registrant's Registration Statement on
    Form S-8, filed March 14, 1996 (File No. 333-2378).
(5) Compensatory plan or arrangement.

                                       37
<PAGE>

(6) Incorporated by reference to the registrant's Registration Statement on
    Form S-3, filed December 15, 1998 (File No. 333-64693).
(7) Incorporated by reference to the registrant's Current Report on Form 8-K,
    dated June 6, 1997.
(8) Incorporated by reference to the registrant's Form 8-A, dated May 30, 1997.
(9) Incorporated by reference to the registrant's Registration Statement on
    Form S-8, filed November 10, 1998 (File No. 333-67031).
(10) Incorporated by reference to the registrant's Current Report on Form 8-K,
     dated October 25, 1998.
(11) Incorporated by reference to the registrant's Registration Statement on
     Form S-4, filed on March 15, 1999 (File No. 333-74433).
(12) Incorporation by reference to the registrant's Registration Statement on
     Form S-4, filed on March 15, 1999 (File No.333-74433).

   (b) Reports on Form 8-K

     None.

   (c) Exhibits

     See (a) 3 above.

   (d) Financial Statement Schedule

     See Item 14. (a) 2 above.

                                       38
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
 Legato Systems, Inc.:

   In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Legato Systems, Inc and its subsidiaries as of December 31, 2000
and 1999, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2000 in conformity with
accounting principles generally accepted in the United States. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP

San Jose, California
January 26, 2001

                                       39
<PAGE>

                              LEGATO SYSTEMS, INC.

                          CONSOLIDATED BALANCE SHEETS
                    (in thousands, except per share amount)

<TABLE>
<CAPTION>
                                                             December 31,
                                                          --------------------
                                                            2000       1999
                                                          ---------  ---------
<S>                                                       <C>        <C>
                         ASSETS
Current assets:
  Cash and cash equivalents.............................. $ 110,274  $ 115,222
  Short-term investments.................................    40,626     42,983
  Accounts receivable, net...............................    47,655     53,387
  Other current assets...................................    20,465     10,112
  Deferred tax assets....................................    35,272     15,959
                                                          ---------  ---------
    Total current assets.................................   254,292    237,663
Long-term investments....................................    14,245     11,723
Property and equipment, net..............................    37,328     27,090
Intangible assets, net...................................   103,900    141,988
Long-term deferred tax assets............................     2,788      2,176
Other assets.............................................     2,311      2,254
                                                          ---------  ---------
                                                          $ 414,864  $ 422,894
                                                          =========  =========

          LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
  Accounts payable....................................... $   5,126  $   5,757
  Accrued liabilities....................................    33,551     26,107
  Short-term loan payable................................       --       6,847
  Deferred revenue.......................................    53,853     46,438
                                                          ---------  ---------
    Total current liabilities............................    92,530     85,149
                                                          ---------  ---------

Commitments and contingencies (Notes 6)

Stockholders' Equity:
  Common stock and capital in excess of par, $.0001 par
   value: 200,000 shares authorized; 87,389 and 85,382
   issued and outstanding, respectively..................   311,802    292,053
  Notes receivable from sale of stock....................      (341)      (345)
  Accumulated other comprehensive income (loss)..........        54        (31)
  Retained earnings......................................    10,819     46,068
                                                          ---------  ---------
    Total stockholders' equity...........................   322,334    337,745
                                                          ---------  ---------
                                                          $ 414,864  $ 422,894
                                                          =========  =========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       40
<PAGE>

                              LEGATO SYSTEMS, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                                    ---------------------------
                                                      2000      1999     1998
                                                    --------  -------- --------
<S>                                                 <C>       <C>      <C>
Revenue:
  Product license.................................  $145,612  $161,094 $129,133
  Service and support.............................    85,783    67,473   38,774
                                                    --------  -------- --------
    Total revenue.................................   231,395   228,567  167,907
                                                    --------  -------- --------
Cost of revenue:
  Product license.................................     6,020     5,907    9,696
  Service and support.............................    39,812    25,870   15,097
                                                    --------  -------- --------
    Total cost of revenue.........................    45,832    31,777   24,793
                                                    --------  -------- --------
Gross profit......................................   185,563   196,790  143,114
                                                    --------  -------- --------
Operating expenses:
  Sales and marketing.............................   106,738    93,764   72,017
  Research and development........................    56,579    40,057   25,645
  General and administrative......................    35,571    20,484   15,874
  Amortization of intangibles.....................    38,088    21,785    1,118
  Acquisition-related expenses....................       --      6,239      645
  In-process research and development.............       --     11,470      --
                                                    --------  -------- --------
    Total operating expenses......................   236,976   193,799  115,299
                                                    --------  -------- --------
Income (loss) from operations.....................   (51,413)    2,991   27,815
Interest and other income, net....................     6,803     5,448    4,799
Interest expense..................................       172       --       --
                                                    --------  -------- --------
Income (loss) before provision for (benefit from)
 income taxes.....................................   (44,782)    8,439   32,614
Provision for (benefit from) income taxes.........    (9,533)    5,735   12,745
                                                    --------  -------- --------
Net income (loss).................................  $(35,249) $  2,704 $ 19,869
                                                    ========  ======== ========
Basic net income (loss) per share.................  $  (0.41) $   0.03 $   0.26
                                                    ========  ======== ========
Diluted net income (loss) per share...............  $  (0.41) $   0.03 $   0.24
                                                    ========  ======== ========
Shares used in basic net income (loss) per share
 calculations.....................................    86,727    82,420   76,762
                                                    ========  ======== ========
Shares used in diluted net income (loss) per share
 calculations.....................................    86,727    89,351   83,074
                                                    ========  ======== ========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                   statements

                                       41
<PAGE>

                              LEGATO SYSTEMS, INC.

                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                                 (in thousands)

<TABLE>
<CAPTION>
                                         Common Stock
                                        ---------------
                                                 Par
                                                Value
                                                 and
                                               Capital    Notes                  Accumulated
                                                  in    Receivable   Deferred       Other                   Total
                          Comprehensive         Excess  From Sale     Stock     Comprehensive Retained  Stockholders'
                          Income (Loss) Shares  of Par   of Stock  Compensation Income (Loss) Earnings     Equity
                          ------------- ------ -------- ---------- ------------ ------------- --------  -------------
<S>                       <C>           <C>    <C>      <C>        <C>          <C>           <C>       <C>
Balance, December 31,
 1997...................                74,917 $ 91,533   $ (175)     $ (22)        $ (94)    $ 23,495    $ 114,737
Stock issued under
 option plans...........                 3,345    8,913     (170)       --            --           --         8,743
Stock issued under
 employee stock purchase
 plan...................                   434    2,183      --         --            --           --         2,183
Tax benefit from stock
 option exercises.......                   --    12,814      --         --            --           --        12,814
Stock-based
 compensation...........                   --       --       --          18           --           --            18
Unrealized gain on
 investments............    $     165      --       --       --         --            165          --           165
Net income..............       19,869      --       --       --         --            --        19,869       19,869
                            ---------   ------ --------   ------      -----         -----     --------    ---------
                            $  20,034
                            =========
Balance, December 31,
 1998...................                78,696  115,443     (345)        (4)           71       43,364      158,529
Stock issued under
 option plans...........                 3,483   21,296      --         --            --           --        21,296
Stock issued under
 employee stock purchase
 plan...................                   561    4,524      --         --            --           --         4,524
Stock issued for
 acquisitions...........                 2,642  114,344      --         --            --           --       114,344
Tax benefit from stock
 option exercises.......                   --    36,446      --         --            --           --        36,446
Stock-based
 compensation...........                   --       --       --           4           --           --             4
Unrealized loss on
 investments............    $    (102)     --       --       --         --           (102)         --          (102)
Net income..............        2,704      --       --       --         --            --         2,704        2,704
                            ---------   ------ --------   ------      -----         -----     --------    ---------
                            $   2,602
                            =========
Balance, December 31,
 1999...................                85,382  292,053     (345)       --            (31)      46,068      337,745
Payment on notes
 receivable.............                   --       --         4        --            --           --             4
Stock issued under
 option plans...........                 1,547    9,251      --         --            --           --         9,251
Stock issued under
 employee stock purchase
 plan...................                   460    5,777      --         --            --           --         5,777
Tax benefit from stock
 option exercises.......                   --     4,620      --         --            --           --         4,620
Stock-based
 compensation...........                   --       101      --         --            --           --           101
Unrealized gain on
 investments............    $      85      --       --       --         --             85          --            85
Net loss................      (35,249)     --       --       --         --            --       (35,249)     (35,249)
                            ---------   ------ --------   ------      -----         -----     --------    ---------
                            $ (35,164)
                            =========
Balance, December 31,
 2000...................                87,389 $311,802   $ (341)     $ --          $  54     $ 10,819    $ 322,334
                                        ====== ========   ======      =====         =====     ========    =========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       42
<PAGE>

                              LEGATO SYSTEMS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                                              2000
                                                    ---------------------------
                                                      2000      1999     1998
                                                    --------  --------  -------
<S>                                                 <C>       <C>       <C>
Cash flows from operating activities:
Net income (loss).................................. $(35,249) $  2,704  $19,869
Adjustments to reconcile net income (loss) to net
 cash provided by operating activities:
  Deferred taxes (net of effect of acquisitions)...  (19,925)  (28,514)  (8,427)
  Depreciation and amortization....................   52,848    32,930    7,190
  In-process research and development..............      --     11,470      --
  Provision for doubtful accounts and sales
   returns.........................................    6,995     9,837    8,411
  Tax benefit from stock option exercises..........    4,620    36,446   12,814
  Changes in operating assets and liabilities:
    Accounts receivable............................   (1,263)  (19,116) (18,972)
    Other assets...................................  (10,410)   (3,493)  (1,111)
    Accounts payable...............................     (631)      502    1,289
    Accrued liabilities............................    7,444   (10,105)  13,518
    Deferred revenue...............................    7,415    19,268    7,506
                                                    --------  --------  -------
      Net cash provided by operating activities....   11,844    51,929   42,087
                                                    --------  --------  -------
Cash flows from investing activities:
 Purchase of available-for-sale securities.........  (63,417) (103,886) (64,491)
 Maturities and sales of available-for-sale
  securities.......................................   63,337    96,873   71,139
 Acquisition of property and equipment.............  (24,998)  (14,618) (14,514)
 Payment for purchase of subsidiaries, net of cash
  assumed..........................................      --    (24,252)     --
 Investment in other securities....................      --     (5,000)     --
 Other.............................................      --     (1,672)    (129)
                                                    --------  --------  -------
      Net cash used in investing activities........  (25,078)  (52,555)  (7,995)
                                                    --------  --------  -------
Cash flows from financing activities:
 Proceeds from issuance of common stock............   15,028    25,820   10,930
 Proceeds from (repayment of) short-term loan......   (6,847)    6,847      --
 Other.............................................      105         4      --
                                                    --------  --------  -------
      Net cash provided by financing activities....    8,286    32,671   10,930
                                                    --------  --------  -------
        Net increase (decrease) in cash and cash
         equivalents...............................   (4,948)   32,045   45,022
Cash and cash equivalents at beginning of year.....  115,222    83,177   38,155
                                                    --------  --------  -------
Cash and cash equivalents at end of year........... $110,274  $115,222  $83,177
                                                    ========  ========  =======
Supplemental cash flow information:
 Cash paid for income taxes........................ $  2,247  $  3,702  $    13
 Cash paid for interest............................      172       --       --
Non-cash transactions:
 Issuance of common stock and stock options
  exchanged in purchase business combinations......      --    114,344      --
 Deferred tax liability recorded in business
  combinations.....................................      --     22,740      --
 Unrealized gain (loss) on investments.............       85      (102)     165
 Common stock exchanged for notes receivable.......      --        --       170
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       43
<PAGE>

                              LEGATO SYSTEMS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. The Company

   Legato Systems, Inc. ("Legato" or the "Company"), incorporated in Delaware
in September 1988, develops, markets and supports software products and
services for heterogeneous client/server computing environments in mid- to
large-scale enterprises. Legato is a technology leader in the network storage
management software market through our commitment to open, standards-based
software development. Its software delivers to customers a solution that is
scalable, high-performance and manageable and ensures high data and application
availability on a wide range of servers, clients, applications, databases and
storage devices. Legato's data protection products, primarily the NetWorker
family of products, and data availability products, primarily our Legato
Cluster and wanCluster products, support many server platforms and accommodate
a variety of clients, applications, databases and storage devices.

2. Summary of Significant Accounting Policies

   Principles of Consolidation and Basis of Presentation. The consolidated
financial statements include the Company's accounts and the accounts of its
wholly owned subsidiaries and branch offices. All significant intercompany
balances and transactions have been eliminated. Certain prior year consolidated
financial statement balances have been reclassified to conform to the 2000
presentation.

   Foreign Currency Translation. Assets and liabilities of foreign
subsidiaries, where the functional currency is the local currency, are
translated using exchange rates in effect at the end of the period, and revenue
and costs are translated using average exchange rates for the period. Gains and
losses on the translation into U.S. dollars of amounts denominated in foreign
currencies are included in net income for those operations whose functional
currency is the U.S. dollar, and as a separate component of stockholders'
equity for those operations whose functional currency is the local currency.

   Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

   Cash, Cash Equivalents and Investments. Cash equivalents are highly liquid
debt instruments with maturities of three months or less as of the date of
purchase. Investments with original maturities greater than three months and
remaining maturities less than one year are classified as short-term
investments. Investments with remaining maturities greater than one year are
classified as long-term investments.

   Management determines the appropriate classification of its investments in
debt securities at the time of purchase. Debt securities classified as held-to-
maturity are stated at amortized cost based on our intent to hold such
securities until maturity. The amortized cost of debt securities is adjusted
for amortization of premiums and accretion of discounts to maturity. Such
amortization and accretion are included in interest income, net. Debt
securities classified as available-for-sale are carried at fair value, with the
unrealized gains or losses, net of tax, reported as a separate component of
stockholders' equity until realized. The cost of securities sold is determined
using the specific identification method when computing realized gains and
losses. Realized gains or losses were not significant in 2000, 1999 and 1998.

   Concentration of Credit Risk. Financial instruments that potentially subject
Legato to concentrations of credit risk consist principally of cash
investments, short-term and long-term investments and accounts receivable.
Legato's investment policy primarily limits investments to short-term, low-risk
instruments.

                                       44
<PAGE>

                              LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Financial instruments are executed with financial institutions with strong
credit ratings, which minimizes risk of loss due to non-payment. Legato has not
experienced any losses due to credit impairment related to its financial
instruments. Concentration of credit risk related to accounts receivable is
limited due to the varied customers comprising Legato's customer base and their
dispersion across geographies. We do not currently hold derivative instruments
or engage in hedging activities.

   Property and Equipment. Property and equipment are stated at cost.
Depreciation for property and equipment is provided using the straight-line
method over the estimated useful lives of the respective assets, which is
generally two to five years for computer equipment, computer software and
office furniture and three to ten years for furniture and fixtures.
Depreciation for leasehold improvements is provided using the straight-line
method over the shorter of the estimated useful lives of the respective assets
or the remaining lease term.

   Capitalized Software Development Costs. Capitalization of software
development costs begins upon the establishment of technological feasibility of
the product and ends when the product is available for general release to
customers. Capitalized costs are then amortized on a straight-line basis over
the estimated product life, or on the ratio of current revenue to the total
projected product revenue, whichever is greater. To date, the period between
achieving technological feasibility, which the Company has defined as the
establishment of a working model and typically occurs when beta testing
commences, and the general availability of such software has been short. As
such, software development costs qualifying for capitalization have been
insignificant.

   Long-lived Assets. Legato reviews long-lived assets, certain identifiable
intangible assets and goodwill related to these assets for impairment. For
assets to be held and used, including acquired intangibles, Legato initiates a
review whenever events or changes in circumstances indicate that the carrying
value of a long-lived asset may not be recoverable. Recoverability of an asset
is measured by comparison of its carrying value to the future undiscounted cash
flows that the asset is expected to generate. Any impairment to be recognized
is measured by the amount by which the carrying value exceeds the projected
discounted future operating cash flows. Assets to be disposed of and for which
management has committed a plan to dispose of the assets, whether through sale
or abandonment, are reported at the lower of carrying value or fair value less
costs to sell. To date, Legato has not recorded any impairment charges against
the value of long-lived assets.

   Revenue Recognition. Revenue is derived from primarily two sources: (i)
product license revenue, derived from the sale of product licenses to resellers
and end users, including large-scale enterprises, and royalty revenue, derived
from initial license fees and ongoing royalties from product licenses of source
code to OEMs; and (ii) service and support revenue, derived from providing
software updates, support and education and consulting services to end users.

   Product license revenue is generally recognized when a signed contract or
other persuasive evidence of an arrangement exists, the software has been
shipped or electronically delivered, the license fee is fixed and determinable
and collection of resulting receivables is probable. For sales to domestic
distributors, product license revenue is recognized upon sale by the
distributor to the end user, since these distributors generally have unlimited
rights of return, and Legato historically has not been able to make reasonable
estimates of product returns for these distributors. The Company also incurs
additional internal costs to assist our distributors in selling its products to
end-users. For sales to certain value-added resellers in the fiscal years ended
December 31, 1999 and 2000, product license revenue is recognized upon receipt
of cash from these certain value-added resellers since the arrangements with
these resellers may include extended payment terms, which in some cases, are
contingent upon them receiving payment from their end user customer. Estimated
product returns are recorded upon recognition of revenue from customers having
rights of return, including exchange rights for unsold products and product
upgrades. Provisions for estimated warranty costs and anticipated retroactive
price adjustments are recorded at the time products are shipped. Product
license revenue

                                       45
<PAGE>

                              LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

from royalty payments is recognized upon receipt of royalty reports from OEMs
related to their product sales. Revenue from subscription license agreements,
which include software, rights to future products and maintenance, is
recognized ratably over the term of the subscription period.

   Service and support revenue consists primarily of revenue received for
providing software updates, technical support for software products, on-site
support, consulting and training. Revenue from updates and support is
recognized ratably over the term of the agreements. Revenue allocated to
education and consulting services, or derived from the separate sales of these
services, is recognized as the related services are provided.

   When contracts contain multiple obligations (e.g. products, updates,
technical support and other services) wherein vendor specific objective
evidence exists for all undelivered elements, the Company accounts for the
delivered elements in accordance with the "Residual Method" prescribed by
Statement of Position 98-9. Any revenue related to updates or technical support
in these arrangements is recognized ratably over the term of the maintenance
arrangement.

   Advertising Expenses. Advertising costs are expensed as incurred and totaled
approximately $2,046,000 in 2000, $3,701,000 in 1999 and $3,104,000 in 1998.

   Comprehensive Income (Loss). Comprehensive income (loss) includes unrealized
gains and losses on investments that are available for sale, the impact of
which has been excluded from net income (loss) and reflected instead in equity.
Legato has reported the components of comprehensive income (loss) on its
consolidated statement of stockholders' equity.

   Net Income (Loss) Per Share. Basic net income (loss) per share is computed
by dividing net income (loss) by the weighted average shares of common stock
outstanding during the year. Diluted net income per share is computed by
dividing net income by the weighted average shares of common stock and
potential common shares outstanding during the year. Potential common shares
outstanding consist of dilutive shares issuable upon the exercise of
outstanding options to purchase common stock as computed using the treasury
stock method. For the year in which Legato had a loss, potential common shares
outstanding are excluded from the computation of diluted net loss per share as
their effect is anti-dilutive.

   Recent Accounting Pronouncements. In March 2000, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation an
Interpretation of APB Opinion No. 25." FIN 44 clarifies the application of
Opinion 25 for (a) the definition of employee for purposes of applying Opinion
25, (b) the criteria for determining whether a plan qualifies as a non-
compensatory plan, (c) the accounting consequence of various modifications to
the terms of a previously fixed stock option or award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
was effective July 1, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998, or January 12, 2000. The impact of FIN 44
did not have a material effect on the financial position or results of
operations of the Company.

   In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under certain
circumstances. The accounting and disclosures prescribed by SAB 101 were
effective for the year ended December 31, 2000 and did not have a significant
impact on Legato's financial position or results of operations.

                                       46
<PAGE>

                             LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


3. Financial Instruments

   Investments. A summary of Legato's investments in marketable securities,
excluding an investment in the preferred stock of a private company with a
cost basis of $5,000,000, follows (in thousands):

<TABLE>
<CAPTION>
                                                              December 31,
                                                           --------------------
                                                             2000       1999
                                                           ---------  ---------
   <S>                                                     <C>        <C>
   Money market funds..................................... $ 106,344  $ 103,000
   State and local municipality notes.....................    32,690     43,530
   U.S. government notes..................................     1,120        --
   Auction rate securities................................    19,991     18,398
                                                           ---------  ---------
     Total investment securities..........................   160,145    164,928
   Less: cash equivalents.................................  (110,274)  (115,222)
                                                           ---------  ---------
     Total short-term and long-term investments........... $  49,871  $  49,706
                                                           =========  =========
</TABLE>

   The contractual maturities of these investments as of December 31, 2000
were as follows (in thousands):

<TABLE>
      <S>                                                              <C>
      Due in less than 1 year......................................... $ 40,626
      Due in 1 to 2 years.............................................    9,245
                                                                       --------
                                                                       $ 49,871
                                                                       ========
</TABLE>

   The carrying value of cash equivalents and investments approximates fair
value (based on quoted market prices) of such investments. Accordingly, the
gross realized and unrealized gains and losses were immaterial for each of the
three years in the period ended December 31, 2000. The equity securities of
the private company are recorded at cost.

   Financing. We entered into a factoring agreement during 1999 under which we
sold one qualifying accounts receivable with a balance of $7,000,000, for
which we have not recognized the related revenue, to a large financing
institution on a non-recourse basis. This transfer was initially recorded as a
transfer of an asset and accounted for in accordance with SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." The transfer of the accounts receivable for
cash is reported in our statements of cash flows as an operating activity.
However, subsequent to year-end, the agreement and related receivable was
cancelled. As a result, the $7,000,000 has been presented as a short-term
loan. This amount was net of a discount for interest and fees of $153,000 and
was repaid in April 2000.

                                      47
<PAGE>

                              LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


4. Consolidated Balance Sheet Detail

<TABLE>
<CAPTION>
                                                               December 31,
                                                            -------------------
                                                              2000       1999
                                                            ---------  --------
                                                              (in thousands)
<S>                                                         <C>        <C>
Accounts receivable:
  Trade accounts receivable................................ $  55,386  $ 57,121
  Allowances for doubtful accounts and product returns.....    (7,731)   (3,734)
                                                            ---------  --------
                                                            $  47,655  $ 53,387
                                                            =========  ========
Property and equipment:
  Computer equipment and software.......................... $  46,114  $ 31,926
  Furniture and fixtures...................................    10,138     6,181
  Office equipment.........................................     4,474     2,668
  Leasehold improvements...................................    11,676     7,117
                                                            ---------  --------
                                                               72,402    47,892
  Accumulated depreciation.................................   (35,074)  (20,802)
                                                            ---------  --------
                                                            $  37,328  $ 27,090
                                                            =========  ========
Intangible assets:
  Goodwill (useful life of 5 years)........................ $  87,257  $ 87,257
  Patents (useful life of 5 years).........................    23,600    23,600
  Distribution channel (useful life of 5 years)............    21,800    21,800
  Purchased technology (useful life of 2-5 years)..........    20,430    20,430
  Trademarks (useful life of 5 years)......................     7,300     7,300
  Assembled workforce (useful life of 3 years).............     5,360     5,360
  Other intangible assets (useful life of 3-5 years).......     1,390     1,390
                                                            ---------  --------
                                                              167,137   167,137
Accumulated amortization...................................   (63,237)  (25,149)
                                                            ---------  --------
                                                            $ 103,900  $141,988
                                                            =========  ========
Accrued liabilities:
  Accrued compensation and benefits........................ $  14,806  $ 16,867
  Other accrued liabilities................................    18,745     9,240
                                                            ---------  --------
                                                            $  33,551  $ 26,107
                                                            =========  ========
</TABLE>

5. Allowances for Doubtful Accounts and Product Returns

<TABLE>
<CAPTION>
                                   Balance
                                     at     Charged Charged             Balance
                                  Beginning Against    to               at End
                                   of Year  Revenue Expenses Deductions of Year
                                  --------- ------- -------- ---------- -------
                                                 (in thousands)
<S>                               <C>       <C>     <C>      <C>        <C>
Year ended December 31, 2000.....  $3,734   $5,138   $1,857   $(2,998)  $7,731
Year ended December 31, 1999.....   3,896    9,531      306    (9,999)   3,734
Year ended December 31, 1998.....   1,837    7,578      833    (6,352)   3,896
</TABLE>

6. Commitments and Contingencies

   Operating Leases. Legato leases its operating facilities under non-
cancelable operating leases that expire at various dates through 2010. Certain
of these leases contain renewal options. Rent expense was $12,124,000

                                       48
<PAGE>

                              LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

in 2000, $8,535,000 in 1999 and $5,650,000 in 1998. In 2000, the Company
entered into non-cancelable sub-leases that expire at various dates through
2003 and recognized sub-lease income of $1,689,000 in 2000, which was offset
against rent expense. As of December 31, 2000, future minimum lease commitments
and sub-lease income were as follows (in thousands):

<TABLE>
<CAPTION>
                                                             Operating Sub-lease
      Year ending December 31,                                Leases    Income
      ------------------------                               --------- ---------
      <S>                                                    <C>       <C>
        2001................................................ $ 11,035   $4,836
        2002................................................    9,668    2,839
        2003................................................    8,283      207
        2004................................................    6,998      --
        2005................................................    6,366      --
        Thereafter..........................................   12,458      --
                                                             --------   ------
                                                             $ 54,808   $7,882
                                                             ========   ======
</TABLE>

   Litigation. Beginning on January 20, 2000, a number of shareholder
securities class action complaints were filed in the U.S. District Court,
Northern District of California, against certain of our directors and officers
and the Company. On May 1, 2000, the court consolidated all of the pending
cases and, on May 10, 2000, appointed a lead plaintiff, who filed a
consolidated amended complaint on August 7, 2000. Defendants filed motions to
dismiss. On January 17, 2001, the Court entered an order granting the motions
to dismiss with leave to amend. On February 13, 2001, plaintiffs filed a second
amended complaint, which generally alleges that, between April 22, 1999 and May
17, 2000, defendants made false or misleading statements of material fact about
the Company's prospects and failed to follow generally accepted accounting
principles in violation of the federal securities laws. The complaint seeks an
unspecified amount in damages. Defendants will file an answer to the complaint
in April 2001 denying all allegations that they violated the federal securities
laws.

   On February 1, 2000, a shareholder derivative action was filed in the U.S.
District Court, Northern District of California, against certain of our
officers and directors. The Company was named as a nominal defendant. The
derivative case has been related to the securities class action. Plaintiffs
moved to stay the derivative case. On January 17, 2001, the Court denied
plaintiffs' motion to stay. Plaintiffs filed an amended complaint on February
9, 2001, which generally alleges the same conduct as the shareholder class
action, and claims that defendants breached their fiduciary duties and engaged
in improper insider trading. The derivative complaint seeks unspecified damages
and injunctive relief.

   On April 13, 2000, a shareholder derivative action was filed in the Superior
Court of California, County of Santa Clara, against certain of our officers and
directors. The Company was named as a nominal defendant. On May 23, 2000, a
shareholder derivative action was filed in the Superior Court of California,
County of San Mateo, against certain of our officers and directors. The Company
was named as a nominal defendant. Both state derivative complaints generally
allege the same conduct as the derivative action filed in federal court, claim
that our officers and directors breached their fiduciary duties for the period
October 21, 1999 through April 3, 2000, and seek unspecified damages and
injunctive relief. The Santa Clara derivative case was transferred to San Mateo
County and consolidated with the San Mateo derivative case.

   The Securities and Exchange Commission ("SEC") has entered a formal order of
investigation concerning the Company's restatement of financial results for the
first, second, and third quarters of 1999, and its revision of financial
results for the fourth quarter and fiscal 1999. Legato has been voluntarily
cooperating with the SEC in its investigation.

   The Company and the individual defendants intend to defend all of these
actions vigorously. There can be no assurance that any of the complaints
discussed above will be resolved without costly litigation, or in a

                                       49
<PAGE>

                              LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

manner that is not materially adverse to our financial position, results of
operations or cash flows. No estimate can be made of the possible loss or
possible range of loss associated with the resolution of these contingencies.

   We are also engaged in certain legal and administrative proceedings
incidental to our normal business activities. While it is not possible to
determine the ultimate outcome of these legal and administrative actions at
this time, we believe that any liabilities resulting from such proceedings, or
claims which are pending or known to be threatened, will not have a material
adverse effect on our financial position or results of operations.

7. Acquisitions

   For acquisitions accounted for under the pooling-of-interests method, we
restated the accompanying financial statements and financial data to represent
the combined financial results of the previously separate entities for all
periods presented. No significant adjustments were required to conform the
accounting policies of the acquired companies. For acquisitions accounted for
under the purchase method, our consolidated results of operations include the
operating results of the acquired companies subsequent to their respective
acquisition dates. Acquired assets and liabilities were recorded at their
estimated fair values at the dates of acquisition, and the aggregate purchase
price plus costs directly attributable to the completion of acquisitions have
been allocated to the assets and liabilities acquired.

   Qualix Group, Inc. In April 1999, Legato completed its acquisition of Qualix
Group, Inc. (dba FullTime Software, Inc.), or FullTime, a developer of
distributed, enterprise-wide, cross-platform, adaptive computing solutions that
enable customers to proactively manage application service level availability.
Legato issued 3,442,000 shares of common stock in exchange for all the common
stock and options of FullTime and accounted for the acquisition as a pooling of
interests. In connection with the acquisition of FullTime, Legato incurred
merger related expenses of $4,968,000, consisting primarily of charges for
transaction fees, involuntary termination benefits, non-cancelable obligations
and write-offs of leasehold improvements for sales and administrative offices
that were duplicative and vacated.

   Software Moguls, Inc. In August 1998, Legato issued 498,998 shares of common
stock in exchange for all the outstanding shares of Software Moguls, Inc., a
developer of advanced backup-retrieval products for the Windows NT and UNIX
environments, and accounted for the acquisition as a pooling of interests.

   The table below presents the separate results of operations for FullTime and
Software Moguls for the periods prior to the combination (in thousands):

<TABLE>
<CAPTION>
                                                              Year Ended
                                                             December 31,
                                                          -------------------
                                                            1999       1998
                                                          ---------  --------
   <S>                                                    <C>        <C>
   Revenue:
     Legato Systems, Inc................................. $ 223,477  $142,233
     FullTime............................................     5,090    24,729
     Software Moguls.....................................       --        945
                                                          ---------  --------
                                                          $ 228,567  $167,907
                                                          =========  ========
   Net income (loss):
     Legato Systems, Inc................................. $   5,334  $ 28,111
     FullTime............................................    (4,012)  (11,643)
     Software Moguls.....................................       --       (403)
                                                          ---------  --------
       Total.............................................     1,322    16,065
       Adjustment to reflect elimination of valuation
        allowance........................................     1,382     3,804
                                                          ---------  --------
                                                          $   2,704  $ 19,869
                                                          =========  ========
</TABLE>

                                       50
<PAGE>

                              LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   Ontrack Data International, Inc. In November 1999, Legato signed a
definitive agreement to acquire Ontrack Data International, Inc. ("Ontrack"), a
provider of data recovery software and service solutions. In January 2000, the
Company entered into a Mutual Termination Agreement with Ontrack to immediately
terminate the proposed acquisition. In connection with the terminated
acquisition, Legato incurred expenses of $1,271,000, which consisted primarily
of investment banking, accounting and other professional fees.

   Intelliguard Software, Inc. In April 1999, Legato completed its acquisition
of Intelliguard Software, Inc. and O.R.P., Inc. (collectively, "Intelliguard"),
developers of standards-based storage management solutions for storage area
networks. The Company (i) issued 1,440,000 shares of our common stock with a
fair market value of $42.5 million, calculated based on the average of the
share price three days prior to the announcement of the acquisition on January
28, 1999 and three days after this date, and (ii) provided cash consideration
of $9.0 million for all of the outstanding stock of Intelliguard and incurred
transaction costs consisting primarily of professional fees of $3.9 million,
resulting in a total purchase price of $55.4 million. The results of operations
of Intelliguard have been included with our results of operations since April
1, 1999, the date of acquisition.

   The fair value of the assets of Intelliguard, which was determined through
established valuation techniques used in the software industry, and a summary
of the consideration exchanged for these assets follows (in thousands):

<TABLE>
   <S>                                                              <C>
   Tangible assets, primarily cash, accounts receivable and
    property and equipment......................................... $  1,919
   Purchased software products.....................................   11,930
   Purchased in-process research and development...................    3,170
   Assembled workforce.............................................      860
   Non-compete agreements..........................................      690
   Goodwill........................................................   45,215
   Liabilities assumed.............................................   (8,429)
                                                                    --------
                                                                    $ 55,355
                                                                    ========
</TABLE>

   The Intelliguard projects included the following in-process research and
development projects and each project's respective percentage completion, the
estimated cost to complete and the value assigned (in thousands):

<TABLE>
<CAPTION>
                                                    Estimate  Estimated
                                                   of Percent  Cost To   Value
      Project                                      Completion Complete  Assigned
      -------                                      ---------- --------- --------
      <S>                                          <C>        <C>       <C>
      A...........................................     9%       $340    $   780
      B...........................................    50%       $680      1,660
      C...........................................    17%       $170        730
                                                                        -------
                                                                        $ 3,170
                                                                        =======
</TABLE>

   Vinca Corporation. In July 1999, Legato completed its acquisition of Vinca
Corporation ("Vinca"), a developer of high availability and data protection
software. Legato (i) issued approximately 1,531,000 shares of common stock with
an approximate value of $54.3 million, calculated based on the average of the
share price for the ten days preceding three days prior to the closing date,
the date the number of shares was fixed, and (ii) exchanged options to purchase
approximately 590,000 shares of common stock with an approximate value of $17.6
million and provided cash consideration of $18.8 million for all of the
outstanding stock and options of Vinca. The fair market value of the exchanged
options to purchase 590,000 shares of common stock was calculated using the
Black-Scholes option-pricing model with the following assumptions: 1) expected
volatility

                                       51
<PAGE>

                              LEGATO SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

of 81%, 2) weighted-average risk-free interest rate of 5.68%, 3) expected term
of approximately five years and 4) no expected dividends. In connection with
the acquisition, we incurred transaction costs consisting primarily of
professional fees of $1.0 million, resulting in a total purchase price of $91.7
million. The results of operations of Vinca have been included with our results
of operations since July 30, 1999, the date of acquisition.

   The fair value of the assets of Vinca, which was determined through
established valuation techniques used in the software industry, and a summary
of the consideration exchanged for these assets follows (in thousands):

<TABLE>
   <S>                                                              <C>
   Total purchase price............................................ $  91,705
   Deferred tax assets.............................................    22,740
                                                                    ---------
                                                                    $ 114,445
                                                                    =========
   Assets acquired:
     Tangible assets, primarily cash, accounts receivable and
      property and equipment....................................... $  10,858
     Patents and core technology...................................    23,600
     Distribution channel..........................................    22,500
     Completed products............................................     5,200
     Purchased in-process research and development.................     8,300
     Assembled workforce...........................................     4,500
     Trademarks....................................................     7,300
     Goodwill......................................................    39,621
     Liabilities assumed...........................................    (7,434)
                                                                    ---------
                                                                    $ 114,445
                                                                    =========
</TABLE>

   The Vinca projects included the following in-process research and
development projects and each project's respective percentage completion, the
estimated cost to complete and the value assigned (in thousands):

<TABLE>
<CAPTION>
                                                    Estimate
                                                   of Percent Estimated  Value
      Project                                      Completion   Cost    Assigned
      -------                                      ---------- --------- --------
      <S>                                          <C>        <C>       <C>
      A...........................................     60%     $  800   $   700
      B...........................................     60%        180       600
      C...........................................     90%        175     2,200
      D...........................................     90%        150     2,200
      E...........................................     90%        300     1,000
      F...........................................     30%      1,035       300
      G...........................................     80%      2,065       800
      H...........................................     40%      5,471       200
      I...........................................     20%      2,450       300
                                                                        -------
                                                                        $ 8,300
                                                                        =======
</TABLE>

   The amounts allocated to the purchased in-process technology were determined
based on appraisals completed by independent third parties using established
valuation techniques and was expensed upon acquisition, because technological
feasibility had not been established and no future alternative uses existed.
The value of these projects was determined by estimating the costs to develop
the purchased in-process technology into commercially viable products,
estimating the resulting net cash flows from the sale of the products resulting
from the completion of the projects reduced by the portion of the revenue
attributable to core technology, and discounting the net cash flows back to
their present value. Amounts allocated to intangible

                                       52
<PAGE>

assets and goodwill resulting from the above acquisitions are amortized over
periods ranging from seventeen months to five years from the date of
acquisition.

   Summarized below are our unaudited pro forma results of operations as though
Intelliguard and Vinca had been acquired at the beginning of the periods
presented. Adjustments have been made for estimated increases in amortization
for purchased software products, assembled work force and non-compete
agreements and related income tax effects (in thousands, except per share
amounts):

<TABLE>
<CAPTION>
                                                       Year Ended December 31,
                                                       ------------------------
                                                          1999         1998
                                                       -----------  -----------
      <S>                                              <C>          <C>
      Revenue......................................... $   237,766  $   196,410
      Net loss........................................      (3,604)      (9,376)
      Basic and diluted loss per share................       (0.04)       (0.12)
</TABLE>

   The above amounts are based upon certain assumptions and estimates which we
believe are reasonable and do not reflect any benefit from economies of scale
which might be achieved from combined operations. The pro forma financial
information presented above is not necessarily indicative of either the results
of operations that would have occurred had the acquisitions taken place at the
beginning of the periods presented or of future results of operations of the
combined companies. The charges for in-process research and development and
merger-related expenses have not been included in the unaudited pro forma
results because it is nonrecurring and directly related to the acquisition.

8. Stockholders' Equity

   Stock Splits. Legato effected two-for-one splits of our common stock (in the
form of a stock dividends) on April 17, 1998 and August 13, 1999. These stock
splits have been retroactively reflected in our consolidated financial
statements.

   Preferred Stock. The Company is authorized to issue 5,000,000 shares of
preferred stock, none of which are issued or outstanding. The Board of
Directors has the authority to issue the preferred stock in one or more series
and to fix rights, preferences, privileges and restrictions, and the number of
shares constituting any series and the designation of such series, without any
further vote or action by the stockholders.

   Net Income (Loss) Per Share. A reconciliation of the weighted average common
shares used to calculate basic net income (loss) per share to the weighted
common and potential common shares used to calculate diluted net income (loss)
per share is provided as follows (in thousands):

<TABLE>
<CAPTION>
                                                            Year Ended December
                                                                    31,
                                                            --------------------
                                                             2000   1999   1998
                                                            ------ ------ ------
   <S>                                                      <C>    <C>    <C>
   Weighted average common shares outstanding to calculate
    net income (loss) per share...........................  86,727 82,420 76,762
     Effect of dilutive securities--common stock options..     --   6,931  6,312
                                                            ------ ------ ------
   Weighted average common and potential common shares
    used to calculate diluted net income (loss) per
    share.................................................  86,727 89,351 83,074
                                                            ====== ====== ======
</TABLE>

   Options to purchase approximately 15,529,000 shares of common stock at the
weighted average price of $15.20 per share were outstanding as of December 31,
2000, but were not included in the computation of diluted net loss per share
because their effect would be anti-dilutive. Certain shares of common stock
issuable upon exercise of stock options were excluded from the calculation of
diluted net income per share because the options' exercise price was greater
than the average market price of the common shares.

   1995 Stock Option/Stock Issuance Plan. As of December 31, 2000, under the
1995 Stock Option/Stock Issuance Plan (the "1995 Plan"), approximately
30,160,000 shares of common stock have been authorized for

                                       53
<PAGE>

issuance. The share reserve automatically increases on the first trading day in
each calendar year by the lesser of (i) the number of shares equal to 3% of the
total number of shares of our common stock outstanding on December 31 of the
immediately preceding calendar year and (ii) 3,000,000 shares. Options to
purchase shares may be granted and shares may be issued directly under the 1995
Plan. Options must have an exercise price not less than 100% and 85% of fair
market value of the common stock on the date of grant for incentive stock
options and non-statutory stock options, respectively. The purchase price for
shares issued directly may not be less than 85% of fair market value on the
date of grant. Options generally vest over four years, whereby 25% of the
shares become exercisable one year after the grant date and monthly thereafter
over 36 months, and terminate ten years after their original grant date.

   The 1995 Plan is divided into three separate components: (i) the
Discretionary Option Grant Program, under which employees, non-employee Board
members who are not serving on our Compensation Committee and consultants may,
at the discretion of the Compensation Committee, be granted options to purchase
shares of common stock, (ii) the Stock Issuance Program, under which such
persons may, at the Compensation Committee's discretion, be issued shares of
common stock directly, through the purchase of such shares or in consideration
of the past performance of services, and (iii) the Automatic Option Grant
Program, under which option grants will automatically be made at periodic
intervals to eligible non-employee Board members to purchase shares of common
stock at an exercise price equal to 100% of their fair market value on the
grant date. Each individual who first becomes a non-employee Board member will
receive a 96,000 share option grant on the date such individual joins the
Board, provided such individual has not been previously employed by us. In
addition, at each Annual Stockholders Meeting, each individual who has served
as a non-employee Board member for at least six months prior to such Annual
Meeting and who is to continue to serve as a non-employee Board member after
the meeting will receive an additional option grant to purchase 24,000 shares
of common stock, whether or not such individual has been in our prior
employment. As of December 31, 2000, approximately 11,248,000 shares of common
stock remained available for grant under our stock option plans.

   A summary of option activity follows (in thousands, except per share
amounts):

<TABLE>
<CAPTION>
                                         Year Ended December 31,
                             --------------------------------------------------
                                  2000             1999             1998
                             ---------------- ---------------- ----------------
                                     Weighted         Weighted         Weighted
                                     Average          Average          Average
                             Shares   Price   Shares   Price   Shares   Price
                             ------  -------- ------  -------- ------  --------
<S>                          <C>     <C>      <C>     <C>      <C>     <C>
Outstanding at beginning of
 year......................  12,114   $16.98  10,719   $7.49   11,083   $3.87
  Options granted and
   assumed.................   9,453    15.42   6,422   27.41    4,039   12.86
  Options exercised........  (1,547)    5.98  (3,483)   6.01   (3,345)   2.55
  Options forfeited........  (5,128)   21.92  (1,544)  15.58   (1,058)   5.88
                             ------   ------  ------   -----   ------   -----
Outstanding at end of
 year......................  14,892    15.43  12,114   16.98   10,719    7.49
                             ======   ======  ======   =====   ======   =====
Options exercisable at end
 of year...................   4,820    11.29   4,143    6.49    3,947    3.42
Weighted average fair value
 of options granted during
 the year..................            12.10           15.14             7.32
</TABLE>

                                       54
<PAGE>

   As of December 31, 2000, the options outstanding and exercisable by exercise
price are as follows (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                    Options
                                        Options Outstanding       Exercisable
                                    --------------------------- ---------------
                                            Weighted
                                             Average   Weighted        Weighted
                                            Remaining  Average         Average
                                           Contractual Exercise        Exercise
Range of Exercise Prices            Shares    Life      Price   Shares  Price
------------------------            ------ ----------- -------- ------ --------
<S>                                 <C>    <C>         <C>      <C>    <C>
$  0.19 - $ 5.94...................  1,910    5.04      $3.32   1,871   $3.27
  6.00 -   9.33....................    993    8.76       8.64     224    7.99
  9.47 -   9.75....................  2,946    9.80       9.74      20    9.68
  9.88 -  11.27....................  2,860    8.36      10.88   1,397   11.07
 11.31 -  17.56....................  1,749    8.97      14.12     349   15.68
 17.66 -  23.56....................  1,681    8.16      20.56     601   20.98
 24.22 -  28.94....................  1,680    8.89      26.72     141   27.40
 29.25 -  73.44....................  1,041    8.72      46.08     217   40.37
 75.13 -  77.00....................     32    8.99      75.44     --      --
                                    ------                      -----
                                    14,892    8.38      15.43   4,820   11.29
                                    ======                      =====
</TABLE>

   Employee Stock Purchase Plan. The Employee Stock Purchase Plan and
International Employee Stock Purchase Plan (collectively, the "ESPP") has
reserved for issuance 5,200,000 shares of common stock and is administered over
offering periods of 24 months each, with each offering period divided into four
consecutive six-month purchase periods beginning August 1 and February 1 of
each year. Eligible employees may designate not more than 10% of their cash
compensation (up to $25,000 per employee) to be deducted each pay period for
the purchase of common stock under the ESPP, and participants may not purchase
more than 4,000 shares of stock in any one six-month purchase period. On the
last business day of each purchase period, shares of common stock are purchased
with the employee's payroll deductions accumulated during the six months,
generally at a price per share of 85% of the market price of the common stock
on the employee's entry date into the applicable offering period or the last
day of the applicable purchase period, whichever is lower. As of December 31,
2000, there were 2,836,830 shares of common stock reserved for future issuance
under the ESPP.

   Stockholder Rights Plan. In May 1997, we adopted a stockholder rights plan,
or the Rights Plan, in which preferred stock rights were distributed as a
rights dividend at a rate of one right for each share of common stock held as
of the close of business on June 23, 1997. The Rights Plan is designed to deter
coercive or unfair takeover tactics and to prevent an acquirer from gaining
control of the Company without offering a fair price in the event we are
confronted in the future with coercive or unfair takeover tactics. The rights
expire on May 23, 2007.

   Profit Sharing Plan. The Company has a 401(k) Profit Sharing Plan (the
"Plan") covering all of our employees. Under the Plan, participating employees
may elect to contribute up to 15% of their eligible compensation, subject to
certain limitations. The Company may make contributions to the Plan at the
discretion of the Board of Directors and has contributed $844,000 in 2000,
$1,121,000 in 1999 and $662,000 in 1998.

                                       55
<PAGE>

   Fair Value Disclosures. Had compensation cost for the Company's fixed stock
option and employee stock purchase plans been based on the fair value at the
date of grant for the awards under a method prescribed by SFAS No. 123,
"Accounting for Stock-Based Compensation," Legato's net income (loss) and net
income (loss) per share would have been adjusted to the following pro forma
amounts (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                                     --------------------------
                                                       2000     1999     1998
                                                     --------  -------  -------
   <S>                                               <C>       <C>      <C>
   Net income (loss)--as reported..................  $(35,249) $ 2,704  $19,869
   Net income (loss)--pro forma....................   (79,616)  (9,752)   8,382
   Basic net income (loss) per share--as reported..     (0.41)    0.03     0.26
   Basic net income (loss) per share--pro forma....     (0.92)   (0.12)    0.11
   Diluted net income (loss) per share--as
    reported.......................................     (0.41)    0.03     0.24
   Diluted net income (loss) per share--pro forma..     (0.92)   (0.12)    0.10
</TABLE>

   The fair value of options granted and shares purchased under the ESPP
program was estimated at the date of grant using a Black-Scholes option pricing
model with the following weighted average assumptions assuming a dividend yield
of zero for all periods:

<TABLE>
<CAPTION>
                                                      Year Ended December 31
                                                   -----------------------------
                                                     2000      1999      1998
                                                   --------- --------- ---------
   <S>                                             <C>       <C>       <C>
   Stock options:
     Expected volatility..........................      100%       79%       85%
     Risk-free interest rate......................      6.2%      4.8%      5.2%
     Expected life................................   4 years   4 years   4 years
   Employee stock purchase plan:
     Expected volatility..........................      100%       79%       85%
     Risk-free interest rate......................      6.1%      4.8%      5.2%
     Expected life................................ 0.5 years 0.5 years 0.5 years
</TABLE>

   These pro forma amounts may not be representative of the effects on reported
net loss for future years as options vest over several years and additional
awards are generally made each year.

9. Income Taxes

   The provision for (benefit from) income taxes consists of the following (in
thousands):

<TABLE>
<CAPTION>
                                                     Year Ended December 31
                                                    ---------------------------
                                                      2000      1999     1998
                                                    ---------  -------  -------
   <S>                                              <C>        <C>      <C>
   Current:
     Federal....................................... $   3,079  $15,881  $16,026
     State.........................................       541    2,389    4,111
     Foreign.......................................     3,761    1,642    1,035
                                                    ---------  -------  -------
                                                        7,381   19,912   21,172
                                                    ---------  -------  -------
   Deferred:
     Federal.......................................   (14,808) (11,474)  (7,649)
     State.........................................    (1,793)  (2,389)    (464)
     Foreign.......................................      (313)    (314)    (314)
                                                    ---------  -------  -------
                                                     (16,914)  (14,177)  (8,427)
                                                    ---------  -------  -------
                                                    $ (9,533)  $ 5,735  $12,745
                                                    =========  =======  =======
</TABLE>


                                       56
<PAGE>

   In 2000, loss before benefit from income taxes consisted of a loss from U.S.
operations of $47,568,000 and income from foreign operations of $2,786,000. In
1999, income before provision for income taxes consisted of income from U.S.
operations of $5,918,000 and income from foreign operations of $2,521,000. In
1998, income before provision for income taxes consisted of income from U.S.
operations of $31,220,000 and income from foreign operations of $1,394,000. The
tax benefit associated with dispositions from employee stock plans for 2000,
1999, and 1998 by $4,620,000, $36,446,000 and $12,814,000, respectively. Such
benefit was recorded to common stock and capital in excess of par and a
reduction to taxes payable or an increase to deferred tax assets. The effective
tax rate differs from the statutory federal income tax rate as follows:

<TABLE>
<CAPTION>
                                             Year Ended December 31,
                                                     ---------------------------
                                                       2000      1999     1998
                                                     --------   -------  -------
   <S>                                               <C>        <C>      <C>
   Statutory federal income tax rate................    (35.0)%    35.0%   35.0%
   State income taxes, net of federal benefit.......     (2.1)     (8.0)    6.8
   Tax exempt interest income.......................     (1.8)     (6.6)   (1.8)
   Research and experimental credit.................     (3.1)    (21.6)   (1.1)
   Losses not benefited.............................      2.2       --      0.1
   Non-deductible merger costs......................      --        8.8     --
   In-process research and development..............      8.9      54.4     --
   Foreign taxes....................................      6.9       2.0     --
   Other............................................      2.7       4.0     0.1
                                                     --------   -------  ------
                                                       (21.3)%     68.0%   39.1%
                                                     ========   =======  ======
</TABLE>

   As of December 31, 2000, the Company has federal and California net
operating loss carryforwards of approximately $56,300,000 and $14,800,000
available to reduce future federal and California taxable income, respectively.
These federal and California carryforwards begin to expire in 2019 and 2004,
respectively. In addition to these carryforwards, as a result of our
acquisition of FullTime and Vinca in 1999, we also have federal and state net
operating loss carryforwards of $19,500,000 and $5,700,000 available to offset
future federal and state taxable income, respectively. These federal and state
carryforwards begin to expire in 2010 and 2003, respectively. The extent to
which the FullTime and Vinca loss carryforwards can be used to offset future
taxable income are limited under Section 382 of the Internal Revenue Code and
applicable state tax law. An adjustment to recognize the benefit of FullTime's
net operating loss in 1998 has been made to these consolidated financial
statements resulting in a decrease in the provision for income taxes of
$3,804,000 for 1998.

   As of December 31, 2000, the Company has federal and California research and
experimentation tax credit carryforwards of $7,200,000 and $3,000,000,
respectively. These federal tax credit carryforwards begin to expire in 2019,
and the California tax credit carryforwards do not expire. In addition to these
tax credit carryforwards, as a result of our acquisition of FullTime in 1999,
the Company has federal research and experimentation tax credit carryforwards
of $726,999, which begin to expire in 2012. The extent to which the FullTime
tax credit carryforwards can be used to offset future taxes are limited under
Section 383 of the Internal Revenue Code.

   As of December 31, 2000, the Company has federal alternative minimum tax
credit carryforwards of $650,000, which do not expire. In addition, the Company
has foreign tax credit carryforwards of $1,400,000, which begin to expire in
2003.

   For financial reporting purposes, the tax effect of the net operating loss
and tax credit carryforwards has been recorded as deferred tax assets.

   Prior to the acquisition, FullTime provided a valuation allowance for its
net deferred tax assets related primarily to loss carryforwards generated since
inception in 1990. Upon acquisition of FullTime, the Company determined that
estimated combined taxable income was sufficient to conclude that such net
deferred tax assets

                                       57
<PAGE>

of FullTime would be realized. Accordingly, the valuation allowance was
eliminated. As a result of our acquisition of Software Moguls in August 1998,
which was accounted for as a pooling of interests, additional tax provisions
were not required since Software Moguls was a non-taxable S-corporation prior
to the acquisition.

   Significant components of our deferred tax assets and liabilities are as
follows (in thousands):

<TABLE>
<CAPTION>
                                                               December 31,
                                                             ------------------
                                                               2000      1999
                                                             --------  --------
   <S>                                                       <C>       <C>
   Deferred tax assets:
     Allowances, accrued liabilities and other.............. $  7,180  $  3,227
     Accrued compensation and benefits......................    1,359     1,343
     State taxes............................................      --        360
     Net operating loss and credit carryforwards............   31,597    22,365
     Intangible asset--purchased technology.................    8,630     3,261
     Deferred revenue.......................................    4,425    11,029
     Other..................................................    2,759       --
                                                             --------  --------
                                                               55,950    41,585
   Deferred tax liabilities:
     Goodwill--Vinca acquisition............................  (17,890)  (23,137)
     Intangible asset--purchased technology.................      --       (313)
                                                             --------  --------
                                                             $ 38,060  $ 18,135
                                                             ========  ========
</TABLE>

10. Industry and Geographic Segment Information

   Management uses one measurement of profitability for its business. Our
software products and related services are developed and marketed to support
heterogeneous client/server computing environments and mid- to large-scale
enterprises. Revenue information on a product basis is as follows (in
thousands):

<TABLE>
<CAPTION>
                                                      Year Ended December 31,
                                                     --------------------------
                                                       2000     1999     1998
                                                     -------- -------- --------
   <S>                                               <C>      <C>      <C>
   Product license:
     NetWorker and related NetWorker products....... $117,806 $142,067 $110,477
     Other products.................................   27,806   19,027   18,656
   Service and support..............................   85,783   67,473   38,774
                                                     -------- -------- --------
                                                     $231,395 $228,567 $167,907
                                                     ======== ======== ========
</TABLE>

                                       58
<PAGE>

   We market our products and related services to customers in the United
States, Canada, Europe and Asia Pacific. Product revenue and long-lived-asset
information by geographic areas are as follows (in thousands):

<TABLE>
<CAPTION>
                                                       Year Ended December 31,
                                                      --------------------------
                                                        2000     1999     1998
                                                      -------- -------- --------
   <S>                                                <C>      <C>      <C>
   Revenue:
     United States................................... $155,654 $162,790 $122,424
     Europe..........................................   51,873   48,041   37,212
     Other countries.................................   23,868   17,736    8,271
                                                      -------- -------- --------
                                                      $231,395 $228,567 $167,907
                                                      ======== ======== ========
   Long-lived assets:
     United States................................... $134,237 $163,336 $ 18,390
     Europe..........................................    2,427    2,206    1,113
     Other countries.................................    4,564    3,536    3,859
                                                      -------- -------- --------
                                                      $141,228 $169,078 $ 23,362
                                                      ======== ======== ========
</TABLE>

   The revenue information by geographical area is based on the country of
destination. Other than the United States, no country accounted for more than
10% of our total revenue for 2000, 1999 and 1998. No one customer accounted for
more than 10% of our total revenue for 2000, 1999, and 1998.

11. Selected Quarterly Financial Data--(Unaudited)

<TABLE>
<CAPTION>
                           Year Ended December 31, 2000        Year Ended December 31, 1999
                         -----------------------------------  ---------------------------------
                           4th       3rd      2nd      1st      4th      3rd     2nd      1st
                         --------  -------  -------  -------  -------  ------- -------  -------
                                      (in thousands, except per share data)
<S>                      <C>       <C>      <C>      <C>      <C>      <C>     <C>      <C>
Total revenue........... $ 58,424  $54,170  $58,281  $60,520  $65,127  $67,931 $51,564  $43,945
Gross profit............   45,259   43,075   46,895   50,334   55,693   59,907  44,132   37,058
Net income (loss).......  (13,937)  (3,744)  (7,581)  (9,987)    (359)   1,396  (1,093)   2,760
Basic earnings (loss)
 per share..............    (0.16)   (0.04)   (0.09)   (0.12)   (0.00)    0.02   (0.01)    0.04
Diluted earnings (loss)
 per share..............    (0.16)   (0.04)   (0.09)   (0.12)   (0.00)    0.02   (0.01)    0.03
</TABLE>

                                       59
<PAGE>

                                   SIGNATURES

   Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

                                          LEGATO SYSTEMS, INC.

                                                  /s/ David B. Wright
                                          By: _________________________________
                                                      David B. Wright
                                               President and Chief Executive
                                                          Officer

Date: March 28, 2001

                               POWER OF ATTORNEY

   KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints David B. Wright and Andrew J. Brown, and each of
them, as his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments (including post-
effective amendments) to this Annual Report on Form 10-K, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact and agents, or any of
them, or their or his substitutes, may lawfully do or cause to be done by
virtue thereof.

   Pursuant to the requirements of the Securities Exchange Act of 1934, the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated have signed this report below.

<TABLE>
<CAPTION>
              Signature                          Title                   Date
              ---------                          -----                   ----

<S>                                    <C>                        <C>
       /s/ David B. Wright             Chairman, President and      March 28, 2001
______________________________________  Chief Executive Officer
           David B. Wright              (Principal Executive
                                        Officer)

       /s/ Andrew J. Brown             Senior Vice President and    March 28, 2001
______________________________________  Chief Financial Officer
           Andrew J. Brown              (Principal Financial
                                        Officer)
      /s/ Eric A. Benhamou             Director                     March 28, 2001
______________________________________
           Eric A. Benhamou

     /s/ H. Raymond Bingham            Director                     March 28, 2001
______________________________________
          H. Raymond Bingham

      /s/ Brendan J. Dawson            Director                     March 28, 2001
______________________________________
          Brendan J. Dawson
</TABLE>


                                       60
<PAGE>

<TABLE>
<CAPTION>
              Signature                          Title                   Date
              ---------                          -----                   ----

<S>                                    <C>                        <C>
      /s/ Kenneth A. Goldman           Director                     March 28, 2001
______________________________________
          Kenneth A. Goldman

    /s/ Christopher B. Paisley         Director                     March 28, 2001
______________________________________
        Christopher B. Paisley

       /s/ David N. Strohm             Director                     March 28, 2001
______________________________________
           David N. Strohm
</TABLE>

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