shares when trading opened Thursday, erasing nearly half the software developer's market value, on the surprise news from the night before that it had failed to meet fourth-quarter earnings projections and was restating how revenue is reported.
The shares, which began sliding in after-hours trades Wednesday night, were off 25, or 46%, to 29 11/16 at midday Thursday on the
stock market. (It closed Thursday down 24 7/8, or 45.54%, at 29 3/4.)
Legato, a Palo Alto, Calif.-based developer of data backup and recovery software, said it had reduced previously reported earnings and reduced its outlook for future earnings because the company's primary auditor,
, had changed the way Legato reports revenue.
The immediate source of investors' worries about Legato was a revision of the company's earnings growth estimates to about 50% in 2000, compared with estimates of about 70% late last year.
But apparent beyond the earnings news was the willingness of investors to violently dump a high-flying technology stock at the first sign that a company's earnings could fall short of estimates, or its outlook for the future changes for the worse. Technology stocks tend to move up in momentum trading, where buying begets more buying. But, as illustrated by Legato's furious fall, momentum can be just as strong of a selling force.
"You have a market right now where any change is bad news. All of a sudden, we have to deal with significantly lower earnings estimates," said Joseph Payne, senior vice president of research at
Hoak Breedlove Wesneski
, a Dallas-based investment firm. Payne covers Legato, but his firm has not underwritten any of the software maker's stock or debt.
Legato had reported late Wednesday that its fourth-quarter income came to $9.9 million, or 11 cents per share, excluding merger-related costs. That was well below
First Call/Thomson Financial's
consensus estimate for a profit of 19 cents per share.
Also, because of a change in the way its auditor recognizes Legato's revenue, the company restated third-quarter 1999 revenue to $65.9 million from the previously reported $71.7 million. That translates to a reduction in third-quarter earnings to 14 cents from 18 cents.
According to Payne, the accounting changes could have far-reaching consequences for the computer software industry because auditors now treat contracts more like a service transaction than a one-time sale.
In Legato's case, auditors decided to take two contracts signed during the fourth quarter and report them as they are carried out during 2000. Similarly, the auditors decided to report earnings from a contract signed in the third quarter during the first half of 2000.
"What they've done is take the software business and instilled the accounting practices that are more commonly seen in aerospace and construction, where contract revenues are not immediately reportable. We are now seeing them treat contract as future service," said Payne.
Because a large, respected accounting firm like PricewaterhouseCoopers was involved with re-assessing how a software company's revenues should be reported, it could serve as a precedent for other auditors who deal with software firms.
"This is going to turn out to affect more than Legato," added Payne.
Given the lower earnings estimates and changes in its accounting practices, some firms lowered their rating on Legato Thursday, including
Warburg Dillon Read
, which cut its rating to hold from buy.
re-rated the stock to neutral from strong buy, and
Salomon Smith Barney
moved the shares to neutral from buy.