<PAGE> 1
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER 00-28247
------------------------
MCAFEE.COM CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 77-0503003
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
</TABLE>
535 OAKMEAD PARKWAY
SUNNYVALE, CALIFORNIA 94085
(408) 992 8100
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
------------------------
Indicate by check mark whether 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, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of October 31, 2000, the number of outstanding shares of the
registrant's Class A common stock, $.001 par value, was 8,616,936. The number of
outstanding shares of registrant's Class B common stock, par value $.001, was
36,000,000, all of which are beneficially owned by Network Associates, Inc.
This document contains 39 pages.
The Exhibit Index is on page 38.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2
MCAFEE.COM CORPORATION
FORM 10-Q
SEPTEMBER 30, 2000
------------------------
CONTENTS
<TABLE>
<CAPTION>
ITEM
NUMBER PAGE
------ ----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets: September 30, 2000
and December 31, 1999..................................... 1
Condensed Consolidated Statements of Operations and
Comprehensive Income: Three and nine months ended
September 30, 2000 and September 30, 1999................. 2
Condensed Consolidated Statements of Cash Flows: Nine
months ended September 30, 2000 and September 30, 1999.... 3
Notes to Condensed Consolidated Financial Statements........ 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 11
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 16
PART II: OTHER INFORMATION
Item 1. Legal Proceedings........................................... 36
Item 2. Changes in Securities and Use of Proceeds................... 36
Item 6. Exhibits and Reports on Form 8-K............................ 36
SIGNATURES........................................................... 37
EXHIBIT INDEX........................................................ 38
</TABLE>
i
<PAGE> 3
MCAFEE.COM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 28,045 $ 67,321
Short-term marketable securities.......................... 20,020 6,427
Accounts receivable, net of allowance for doubtful
accounts and sales returns reserve of $907 at September
30, 2000 and $600 at December 31, 1999................. 4,495 3,486
Prepaid expenses and other current assets................... 1,339 943
Deferred taxes.............................................. 5,374 --
-------- --------
Total current assets.............................. 59,273 78,177
Long-term marketable securities............................. 23,524 12,751
Fixed assets, net........................................... 8,728 4,359
Intangible and other assets................................. 18,744 --
-------- --------
Total assets...................................... $110,269 $ 95,287
======== ========
LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 2,860 $ 1,256
Accrued liabilities....................................... 10,089 8,447
Deferred revenue.......................................... 23,571 21,280
Payable to NAI............................................ 7,441 8,313
Tax payable to NAI........................................ 5,374 --
Other liabilities......................................... 10 --
-------- --------
Total liabilities................................. 49,345 39,296
-------- --------
STOCKHOLDERS' EQUITY
Preferred stock, $.001 par value:
Authorized: 5,000,000 shares; None outstanding............ -- --
Common stock, Class A; $.001 par value:
Authorized: 100,000,000 shares; Issued and outstanding:
8,609,046 shares at September 30, 2000 and 7,206,250 at
December 31, 1999...................................... 9 7
Common stock, Class B; $.001 par value:
Authorized 65,000,000; 36,000,000 shares issued and
outstanding at September 30, 2000 and December 31,
1999................................................... 36 36
Additional paid-in capital.................................. 114,269 89,221
Other comprehensive loss.................................... (601) (56)
Accumulated deficit......................................... (52,789) (33,217)
-------- --------
Total stockholders' equity........................ 60,924 55,991
-------- --------
Total liabilities and stockholders' equity........ $110,269 $ 95,287
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
<PAGE> 4
MCAFEE.COM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
2000 1999 2000 1999
------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue.......................................... $12,561 $ 6,763 $ 34,726 $ 16,094
------- -------- -------- --------
Cost of revenue:
Product costs.................................. 365 284 1,126 2,066
Technology costs............................... 1,969 1,508 6,000 4,860
License fee payable to NAI..................... 469 606 1,774 1,707
------- -------- -------- --------
Total cost of revenue.................. 2,803 2,398 8,900 8,633
------- -------- -------- --------
Gross margin..................................... 9,758 4,365 25,826 7,461
Operating expenses:
Research and development....................... 3,820 1,755 10,104 4,458
Marketing and sales............................ 8,498 6,608 27,734 14,061
General and administrative..................... 2,332 1,513 6,430 3,490
Amortization of intangibles.................... 1,824 -- 4,098 --
Stock-based compensation....................... 565 5,625 565 7,251
------- -------- -------- --------
Total operating costs and expenses..... 17,039 15,501 48,931 29,260
------- -------- -------- --------
Loss from operations................... (7,281) (11,136) (23,105) (21,799)
Interest and other income and expense, net....... 1,220 -- 3,755 --
------- -------- -------- --------
Income before provision for income taxes......... (6,061) (11,136) (19,350) (21,799)
Provision for income taxes..................... 130 -- 222 --
------- -------- -------- --------
Net loss............................... $(6,191) $(11,136) $(19,572) $(21,799)
======= ======== ======== ========
Other comprehensive income:
Unrealized gain on securities.................. 155 -- 54 --
Foreign currency translation loss.............. (161) -- (599) --
------- -------- -------- --------
Comprehensive loss............................... $(6,197) $(11,136) $(20,117) $(21,799)
======= ======== ======== ========
Net loss per share............................... $ (0.14) $ (0.31) $ (0.45) $ (0.61)
======= ======== ======== ========
Shares used in per share calculation -- basic and
diluted........................................ 44,413 36,000 43,882 36,000
======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
<PAGE> 5
MCAFEE.COM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(19,572) $(21,799)
Adjustments to reconcile net income to net cash (used in)
provided from operating activities (net of the effects
of acquisitions):
Depreciation and amortization.......................... 5,755 540
Stock-based compensation............................... 565 7,251
Deferred taxes......................................... (5,374) --
Allowance for doubtful accounts........................ 307 --
Changes in assets and liabilities:
Accounts receivable.................................. (1,049) (1,648)
Prepaid expenses and other assets.................... (518) (91)
Accounts payable and accrued liabilities............. 2,209 6,024
Deferred revenue..................................... 2,291 13,481
-------- --------
Net cash (used in) provided by operating
activities...................................... (15,386) 3,758
-------- --------
Cash flows from investing activities:
Purchases and other changes of marketable securities,
net.................................................... (24,312) --
Additions to fixed assets................................. (6,004) (1,344)
Purchase of other investments............................. (1,000)
Acquisitions, net of cash acquired........................ (1,959) --
-------- --------
Net cash used in investing activities............. (33,275) (1,344)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock under stock option
and stock purchase plans............................... 5,025 --
Change in amount due to NAI............................... 4,502 (4)
Other..................................................... (142) --
-------- --------
Net cash provided by (used in) financing
activities...................................... 9,385 (4)
-------- --------
Net increase in cash and cash equivalents................... (39,276) 2,410
Cash and cash equivalents at beginning of period............ 67,321 --
-------- --------
Cash and cash equivalents at end of period.................. $ 28,045 $ 2,410
======== ========
Non cash investing and financing activities:
Unrealized gain on available-for-sale securities.......... $ 54 $ --
======== ========
Acquisitions by issuance of common stock.................. $ 19,600 $ --
======== ========
Contribution of fixed assets from NAI..................... $ -- $ 2,674
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 6
MCAFEE.COM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. DESCRIPTION OF THE COMPANY AND BASIS OF PRESENTATION
Description of the Company
McAfee.com Corporation, a publicly traded, majority owned subsidiary of
Networks Associates, Inc. ("NAI"), was incorporated in December 1998, and
commenced operations as a separate legal entity in January 1999. Prior to
January 1, 1999, this business was operated as a part of NAI.
The Company is an Internet destination site, which allows users to secure,
repair, update, upgrade and manage their personal computers (PCs) over the
Internet. The Company's electronic commerce activities include, software
licensing, sponsorship and co-hosting, and advertising. The Company's objective
is to become the leading and most trusted online destination where consumers
secure, repair, update, upgrade and manage their PCs and other Internet access
devices.
Basis of Presentation
The unaudited consolidated financial statements have been prepared by the
Company without audit in accordance with instructions to Form 10-Q and Article
10 of Regulation S-X. The consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. In the opinion of management,
all adjustments, consisting only of normal recurring adjustments considered
necessary for a fair presentation, have been included.
The accompanying interim financial statements should be read in conjunction
with the financial statements and related notes included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1999. Certain information
and footnote disclosures normally included in annual financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted as permitted by rules and regulations of the Securities and
Exchange Commission. The results of operations for the three and nine months
ended September 30, 2000 are not necessarily indicative of the results to be
expected for the full year or for any future periods.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 137 and SFAS
138. SFAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments as well as other
hedging activities, and is effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000. The Company believes the adoption of these
pronouncements will not have a material impact on the Company's financial
position and results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." In addition the SEC released, in October 2000, interpretative
guidance on SAB 101 in the form of frequently asked questions and responses
thereto. SAB 101 and the frequently asked questions and responses provide
guidance for revenue recognition under certain circumstances. The Company is
currently evaluating the impact of SAB 101 on its financial statements and
related disclosures, but does not expect that such impact, if any, will be
material. The accounting and disclosures prescribed by SAB 101 will be effective
for our fiscal year ending December 31, 2000.
In March 2000, the FASB issued FASB Interpretation No. 44 (FIN44),
"Accounting for Certain Transactions Involving Stock Compensation, an
interpretation of APB Opinion No. 25" ("Interpretation"). The Interpretation is
intended to clarify certain problems that have arisen in practice since the
issuance of
4
<PAGE> 7
MCAFEE.COM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
APB 25. The Interpretation provides guidance, some of which is a significant
departure from current practice. The Interpretation generally provides for
prospective application for grants or modifications to existing stock options or
awards made after June 30, 2000. However, for certain transactions the guidance
is effective after December 15, 1998 and January 12, 2000. The Company adopted
the guidance in FIN 44 effective July 1, 2000. The effects of the implementation
are discussed in note 4 to the notes to these financial statements.
3. BUSINESS COMBINATIONS
On February 15, 2000, the Company acquired all of the outstanding capital
stock of Signal 9 Solutions Canada, Inc. ("Signal 9"), a privately held provider
of personal firewall software, for $2.0 million in cash and 385,001 shares of
the Company's Class A common stock. The acquisition was accounted for using the
purchase method of accounting and the total purchase price was approximately
$18.3 million, including transaction costs. The Company analyzed the intangible
assets to determine whether any amount should be recorded as in-process research
and development, however the Company determined that the acquired technologies
and products are largely dependent on the core technology and that new versions
are released frequently and contain incremental rather than fundamental
improvements. Based on this analysis $18.0 million was recorded as purchased
technology and goodwill, and is being amortized on a straight-line basis over
three years.
As of March 31, 2000 the Company finalized its purchase price allocation as
follows (in thousands):
<TABLE>
<S> <C>
Cash....................................................... $ 2,000
Stock...................................................... 16,074
Transaction costs.......................................... 237
-------
Total purchase price....................................... $18,311
=======
Net assets acquired and liabilities assumed................ $ 302
Intangibles................................................ 18,009
-------
Total allocation of purchase price......................... $18,311
=======
</TABLE>
In June 2000 the Company acquired another company, for $250,000 in cash and
165,000 shares of Class A common stock. The acquisition was accounted for using
the purchase method of accounting and the total purchase price was approximately
$4.3 million, including transaction costs. The Company analyzed the intangible
assets to determine whether any amount should be recorded as in-process research
and development, however the Company determined that the acquired technologies
are largely dependent on the core technology and that new versions are released
frequently and contain incremental rather than fundamental improvements. Based
on this analysis $4.3 million was recorded as goodwill, and is being amortized
on a straight-line basis over three years. The activities of the acquired
company were insignificant.
Pro forma information with respect to revenue and net loss, as if the
Company had acquired these companies on January 1, 1999 does not materially
differ from the historical information presented, subject to the amortization of
goodwill, which would have been approximately $1.8 million in each of the three
months ended September 30, 2000 and September 30, 1999 and approximately $5.5
million in each of the nine months ended September 30, 2000 and September 30,
1999.
4. STOCK BASED COMPENSATION
On April 22, 1999, NAI offered to substantially all of its employees,
excluding executive officers, the right to cancel certain outstanding stock
options and receive new options with exercise prices at the current fair market
value of the stock. Options to purchase a total of 10.3 million shares were
canceled and the same number of new options were granted at an exercise price of
$11.063, which was based on the closing price of
5
<PAGE> 8
MCAFEE.COM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NAI's common stock on April 22, 1999. Under the guidance in FIN 44 the repriced
options are subject to variable accounting. The new options vest at the same
rate that they would have vested under previous option plans. As a result,
options to purchase approximately 3.3 million shares at $11.063 were vested and
outstanding at September 30, 2000.
In connection with the establishment of the Company, employees who were to
transfer from NAI were offered the option to have their unvested options in NAI
cancelled and replaced with new options for the Company's shares and keep their
vested NAI options. The NAI options cancelled were included in those which were
repriced as of April 22, 2000. This resulted in the Company issuing options to
purchase 1.1 million shares. In addition the Company's employees retained
options to purchase 368,717 shares of NAI common stock.
Under the guidance in FIN 44 the new options issued to the employees of the
Company are considered to be replacement options and, therefore, are also
subject to variable accounting. In addition the Company must account for the NAI
options retained by its employees using the variable accounting model.
As a result the Company must remeasure the compensation expense on these
options based on movements since July 1, 2000 in either the Company's or NAI's
stock price. Until the Company's stock price exceeds $26.063 (the price on July
1, 2000), there will not be any further impact of the variable accounting
treatment. The actual compensation charge to be recorded is remeasured at the
end of each reporting period until the option is either exercised, cancelled
without replacement or is forfeited. Once the option is exercised, cancelled
without replacement or forfeited it is remeasured for the final time and the
compensation charge fixed. As at July 1, 2000 the Company's stock price was
$26.063, and NAI's stock price was $20.38. As of September 30, 2000 the stock
prices were $14.875 and $22.625 respectively.
The Company expenses the compensation charge calculated to the statements
of operations over the remaining vesting period using the accelerated method
detailed in FIN 28 "Accounting for Stock Appreciation Rights and Other Variable
Stock Option or Award Plans". If the option is fully vested any charge is
recorded in income immediately.
As of September 30, 2000 the Company has options to purchase 721,748 shares
of its common stock and options to purchase 101,755 shares of NAI stock, which
are subject to variable accounting. During the three months ended September 30,
2000 the Company recorded stock based compensation expense of $565,000. The
ultimate amount of compensation to be recorded in respect of these options is
dependent upon movements in the stock price of the Company and NAI respectively.
As a result the Company's results of operations may fluctuate in future based on
these movements. In addition the actual charge recorded could be materially
different to that calculated as of September 30, 2000.
5. SEGMENT AND MAJOR CUSTOMER INFORMATION
The Company identifies its operating segments based on business activities,
management responsibility and geographical location. The Company has organized
its operations into a single operating segment, providing delivery of
personalized e-commerce offerings and local content. Further, the Company
derives the significant majority of its revenues from operations in the United
States.
At September 30, 2000, one customer had an accounts receivable balance
representing 13% of our total accounts receivable balance. No other customer had
an accounts receivable balance that exceeded 10% at September 30, 2000. For the
three months ended September 30, 2000 the largest customer accounted for 15% of
our total revenue.
6
<PAGE> 9
MCAFEE.COM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
6. NET LOSS PER SHARE
Net loss available to common shareholders and weighted average shares
outstanding are the same for basic and fully diluted earnings per share
calculations for all periods presented.
The fully diluted earnings per share calculations for the three and nine
months ended September 30, 2000 exclude outstanding options to purchase
4,604,450 shares. The fully diluted earnings per share calculations for the
three and nine months ended September 30, 1999 excludes outstanding options to
purchase 5,104,504 shares.
7. RELATED PARTY TRANSACTIONS
Change in Control Agreements
Srivats Sampath entered into an agreement with the Company dated July 14,
2000, which provides that, if his employment is involuntarily terminated other
than for cause within twelve months of (i) a sale of 50% of the Company's
shares, (ii) a Network Associates change of control, if the Company is majority
owned by them at the time, or (iii) a sale of substantially all of the Company's
assets, he will be entitled to receive severance payments for twelve months
after such a termination. The payments would be based on his base salary at the
time of termination. In addition, the agreement provides that if his employment
with the Company is terminated other than for cause within twelve months of any
such event, his outstanding options, that would vest two years from the date of
termination, will become fully vested and immediately exercisable.
Evan Collins entered into an agreement with the Company dated July 14,
2000, which provides that, if his employment is involuntarily terminated other
than for cause within twelve months of (i) a sale of 50% of the Company's
shares, (ii) a Network Associates change of control, if the Company is majority
owned by them at the time, or (iii) a sale of substantially all of the Company's
assets, he will be entitled to receive severance payments for twelve months
after such a termination. The payments would be based on his base salary at the
time of termination. In addition, the agreement provides that if his employment
with the Company is terminated other than for cause within twelve months of any
such event, his outstanding options, that would vest two years from the date of
termination, will become fully vested and immediately exercisable.
Other Related Party Transactions
The Company has entered into certain agreements with Network Associates,
Inc. ("NAI") for the purpose of defining their ongoing relationship. These
agreements were developed in the context of a parent/subsidiary relationship and
therefore are not the result of arms-length negotiations between independent
parties. Although these agreements or the transactions contemplated by these
agreements may not have been effected on terms at least as favorable to the
Company as could have been obtained from unaffiliated third parties, the Company
believes that these agreements taken as a whole are fair to both parties and
that the amount of the expenses contemplated by the agreements would not be
materially different if the Company operated on a stand-alone basis.
Corporate Management Services Agreement. On January 1, 1999, the Company
entered into a Corporate Management Services Agreement with NAI under which NAI
provides the Company certain administrative services. Under this agreement, NAI
provides to the Company services relating to tax, accounting, insurance,
employee benefits administration, corporate record-keeping, payroll, information
technology infrastructure, and facilities management. In addition, the Company
may request certain additional services to be provided from time-to-time in the
future, with the fee for such additional services subject to negotiation between
the parties. The initial monthly fee that the Company is required to pay for
these services under the agreement is a portion of the costs to NAI plus a 10%
mark-up. The Company's share of such costs is calculated based on headcount.
Under this agreement NAI charged the Company $1.1 million in the three months
ended
7
<PAGE> 10
MCAFEE.COM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
September 30, 2000 and $1.1 million in the three months ended September 30,
1999. NAI charged the Company $4.1 million in the nine months ended September
30, 2000 and $2.5 million in the nine months ended September 30, 1999.
The corporate management services agreement may be terminated either by the
Company upon 30 days notice, or by NAI when it ceases to own a majority of the
Company's outstanding voting stock. Following a termination of this agreement,
the Company may be unable to secure these services from others on acceptable
terms. If the Company is unsuccessful in obtaining acceptable provision of these
services upon termination of the corporate management services agreement, the
Company's future financial performance could be adversely affected.
Cross License Agreement. The Company entered into a technology cross
license agreement with NAI through one of NAI's wholly owned subsidiaries. Under
this agreement, NAI has granted the Company worldwide non-exclusive patent
licenses and exclusive copyright licenses for the sale or licensing of software
products or software services to certain OEMs and end users solely via the
Internet. Eligible end users include only single-node, individual consumers. In
consideration for the license and rights granted under this license, the Company
is required to pay NAI a royalty on revenues from related product and
subscription sales, initially at a rate of 20% commencing on January 1, 1999 and
declining 1.625% per quarter until the rate is 7% in the quarter beginning
January 1, 2001, and remaining at 7% thereafter. The rate for the three months
ended September 30, 2000 is 10.25%. Also under this agreement, the Company has
granted NAI non-exclusive patent licenses and exclusive copyright licenses for
the sale of products to enterprise customers through any method of distribution
including the Internet and to end users through any method excluding the
Internet. In consideration for the rights granted under this license, NAI is
required to pay the Company a royalty of $250,000 per quarter.
The Company was charged royalties under this agreement of $719,000 in the
three months ended September 30, 2000, $856,000 in the three months ended
September 30, 1999, $2.5 million in the nine months ended September 30, 2000 and
$2.5 million in the nine months ended September 30, 1999.
Asset Contribution and Receivables Settlement Agreement. The Company
entered into an asset contribution agreement with NAI effective as of January 1,
1999 that transfers ownership of certain assets to the Company. Among the assets
transferred to the Company are: a number of co-hosting and technology agreements
to which NAI is a party; revenues from advertising and sponsorship agreements
involving the Company; ownership rights in 3 patent applications; computers and
Internet infrastructure hardware; and any other assets which both NAI and the
Company's board of directors agree to transfer at a future date. All assets
transferred from NAI have been recorded as a permanent contribution to capital,
at NAI's carryover basis. No liabilities were transferred to the Company, except
for those directly resulting from the assets transferred.
Revolving Loan Agreement. In January 1999, the Company entered into a
revolving loan agreement with NAI. Under the agreement, NAI has agreed to make
available to the Company up to $30 million in cash as a revolving loan. The
interest rate under this revolving loan is equal to the one-month LIBOR rate.
The revolving loan is repayable in full on January 1, 2001, the termination date
of the agreement. As of September 30, 2000, no amounts were outstanding under
this agreement.
Tax Sharing Agreement. The Company and NAI have entered into a tax-sharing
agreement under which the Company calculates income taxes on a separate return
basis. The Company will be included in NAI's consolidated group for federal
income tax purposes for so long as NAI beneficially owns at least 80% of the
total voting power and the value of the outstanding common stock. Each member of
a consolidated group is jointly and severally liable for the federal income tax
liability of each other member of the consolidated group. Accordingly, although
the tax-sharing agreement allocates tax liabilities between the Company and NAI,
during the period in which the Company is included in NAI's consolidated group,
the Company could
8
<PAGE> 11
MCAFEE.COM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
be liable in the event that any federal tax liability is incurred, but not
discharged, by any other members of NAI's consolidated group.
Under the tax sharing agreement, NAI and each other member has agreed to
indemnify the Company if the Company is required to pay any tax liability amount
in excess of its hypothetical separate income tax liability, provided the
Company is not in default in its obligation to pay such hypothetical separate
income tax liability to NAI. The tax sharing agreement will terminate if the
Company is no longer eligible to join NAI in the filing of a consolidated
federal income tax return.
Joint Cooperation Agreement. The Company has entered into a Joint
Cooperation and Master Services Agreement with NAI which governs the provision
of technology services among the parties. Under this agreement, NAI's anti-virus
emergency response team (AVERT) will provide us with research and solutions for
virus events. The agreement also contains standard terms and conditions
governing the provision of technology services from one party to the other under
statements of work that may be negotiated from time to time. Currently we have
entered into one such statement of work under which we provide Network
Associates the infrastructure and technical support services for Network
Associates' web site (www.nai.com). Network Associates pays us a fee for these
services in an amount equal to ten percent of our total quarterly technology
costs plus a ten percent service charge. Although we are obligated to provide
these services until December 31, 2000 under this statement of work, the Company
and NAI agreed that NAI take over the running of the NAI web site as of May 1,
2000. The charge to NAI under this statement of work was zero for the three
months ended September 30, 2000 and approximately $176,000 for the three months
ended September 30, 1999. The charge was approximately $247,000 for the nine
months ended September 30, 2000 and approximately $432,000 for the nine months
ended September 30, 1999. This amount has been offset against technology costs.
Indemnification and Voting Agreement. The Company has entered into an
indemnification and voting agreement with NAI which became effective on December
2, 1999. Except under certain specified circumstances, NAI will indemnify the
Company for all losses related to any third party claims relating to events or
circumstances arising out of actions or inaction of NAI, including its
subsidiaries and officers and directors, on or prior to December 2, 1999.
Additionally, for so long as NAI owns at least 20% of the Company's outstanding
voting power, it will vote its shares of the Company's common stock in favor of
the election of two independent directors.
Registration Rights Agreement. The Company has entered into a registration
rights agreement with NAI that entitles NAI to include its shares of Company
common stock in any future registration of common stock made by the Company,
other than any registration statement relating to an acquisition or a stock
option plan. In addition, at any time after May 2, 2000, NAI or certain
transferees can request that the Company file a registration statement so they
can publicly sell their shares. The Company has agreed pursuant to the terms of
this registration rights agreement to pay all costs and expenses, other than
underwriting discounts and commissions, related to shares to be sold by NAI or
certain transferees in connection with any such registration.
Japanese Distribution Agreement. On April 28, 2000, the Company entered
into a Master Distribution Agreement, retroactive to January 1, 2000, with NAI
KK, a majority-owned Japanese subsidiary of Network Associates, Inc. Under the
terms of the agreement, NAI KK will be the exclusive distributor of the
Company's products in the Japanese PC OEM channel for an initial term of three
years. The Company will receive a license fee of fifty percent (50%) net sales
revenue received by NAI KK from its distribution in this channel. The Company,
in turn, will pay NAI KK a revenue share of ten percent (10%) of net sales
revenue it initially receives from PC OEM customers that subsequently purchase a
subscription to McAfee Clinic.
9
<PAGE> 12
MCAFEE.COM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Lease Agreement. In February 2000, the Company entered into a lease
agreement to rent a facility of approximately 55,000 square feet commencing on
May 1, 2000. This lease is set to expire in 2006. The lease agreement required a
letter of credit for approximately $305,000. This letter of credit has been
guaranteed by NAI.
8. LITIGATION
From time to time, we may be involved in legal proceedings and litigation
arising in the ordinary course of business.
Simple.com v. McAfee.com. On August 1, 2000, Simple.com ("Simple") filed a
complaint against the Company alleging that the Company misappropriated Simple's
trade secrets and infringed Simple's copyrights in certain software code. The
complaint includes seven claims for relief: copyright infringement; breach of
contract; misappropriation of trade secrets; statutory unfair competition;
common-law unfair competition; conversion; and breach of the covenant of good
faith and fair dealing. The complaint seeks preliminary and permanent injunctive
relief preventing the Company from using the information that the Company
allegedly acquired from Simple. The complaint also seeks compensatory damages in
an amount alleged to be not less than $18 million, plus interest. The complaint
also seeks statutory, exemplary and punitive damages as well as recovery for
unjust enrichment. The Company answered the complaint on August 30, 2000,
denying all the material allegations in the complaint and asserting affirmative
defenses. No discovery has occurred to date. The Company has agreed to pursue
non-binding mediation once discovery is substantially complete. The Company
believes it has meritorious defenses and intends to defend this action
vigorously.
Hilgraeve v. Network Associates. On September 15, 1997, Network Associates
was named as a defendant in a patent infringement action filed by Hilgraeve
Corporation ("Hilgraeve") in the United States District Court, Eastern District
of Michigan. Hilgraeve alleges that Network Associates' VirusScan product
infringes a Hilgraeve patent which was issued on June 7, 1994. Hilgraeve's
action seeks injunctive relief and unspecified money damages. The District Court
granted Network Associates' motion for summary judgment of non-infringement on
May 20, 1999 and entered judgment in favor of Network Associates on July 7,
1999. On August 2, 2000 the United States Court of Appeal for the Federal
Circuit vacated in part, affirmed in part, and remanded the case to the District
Court for further proceedings. The Court has set a schedule for a further
summary judgment hearing which will be held in or around March 2001. No trial
date is set.
On October 10, 2000, Hilgraeve filed another complaint against Network
Associates, also in the United States District Court, Eastern District of
Michigan. Hilgraeve alleges that Network Associates' Webshield product infringes
the same Hilgraeve patent in the first suit. Hilgraeve's action seeks injunctive
relief and unspecified money damages.
10
<PAGE> 13
MCAFEE.COM CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the condensed
consolidated financial statements and related notes included elsewhere in this
report. The results shown herein are not necessarily indicative of the results
to be expected for the full year or any future periods.
This Report on Form 10-Q contains forward-looking statements, including but
not limited to those specifically identified as such, that involve risks and
uncertainties. The statements contained in this Report on Form 10-Q that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act, including without
limitation statements regarding the Company's expectations, beliefs, intentions
or strategies regarding the future. All forward-looking statements included in
this Report on Form 10-Q are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward-looking statements. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of a
number of factors, including, but not limited to, those set forth in "Risk
Factors" and elsewhere in this Report on Form 10-Q.
OVERVIEW
We are currently a majority-owned subsidiary of NAI. We were incorporated
in December 1998 and, effective January 1, 1999 NAI contributed to us its
consumer e-commerce business, which began operations in January 1996. To date,
NAI has provided a number of administrative and support services to us and we
will continue to rely on NAI to provide many of these services for the
foreseeable future. These services are based on NAI's management's estimate of
the cost of these services and are using a percentage of total expenses for the
services provided, based on headcount. See Note 7 of notes to financial
statements. In light of the above, you should not consider our historical
financial statements to be representative of future results.
We are a provider of hosted, version-less PC security and management
products and services over the Internet. We derive our revenue from:
- software subscriptions for our hosted PC security and management
applications provided on our web site, including McAfee Clinic, Firewall,
Wireless Security Center and Oil Change, our initial hosted subscription
service;
- products, software and subscription licenses sold through the McAfee
Store as well as through e-retail distributors, such as Beyond.com and
America Online, and computer original equipment manufacturers, or OEMs,
such as Hewlett Packard and Toshiba. The McAfee Store is the location on
our web site where consumers can purchase McAfee-branded products through
secure, credit-card based transactions;
- sponsorship arrangements in which we provide access to other vendors' web
sites;
- co-hosting arrangements where products and services are branded under
both our brand and that of our partners; and
- banner advertising and other advertising space on our web site sold by us
or our partners to third parties.
Historically, substantially all of our net revenue has come from software
licenses sold through the McAfee Store, OEMs and other e-retail distributors. In
particular, sales of our anti-virus products accounted for approximately 19% of
our net revenue in the three months ended September 30, 2000. Furthermore,
during the three months ended September 30, 2000, approximately 15% of our net
revenue was derived from the sale of software licenses through Beyond.com.
11
<PAGE> 14
REVENUE RECOGNITION
Revenue recognition varies depending on the product or service sold:
- Recognition of net revenue at the time of delivery from the sale of
software products sold through both the McAfee Store and our e-retail
distributors, such as Beyond.com and America Online, and sales to OEMs,
varies depending on the product being sold. For products that include
future upgrades, updates or services, such as VirusScan licenses, a
percentage of the revenue is deferred and recognized ratably over the
period for which these upgrades, updates or services are provided,
usually one year. The amount deferred is based on the price of these
upgrades, updates and future services when sold separately. For the
majority of our products, however, we do not sell these upgrades, updates
and services separately and therefore we typically defer a substantial
portion of total revenue and recognize it ratably over one year. Products
sold through our e-retail distributors are sold by us to them at a
discount from list price and additionally, some of our e-retail
distributors may purchase product for inventory. We recognize revenue for
these products when they are sold to the end user.
- Revenue from the fees received for providing sponsorships, co-hosting
arrangements and software subscriptions for our hosted applications is
deferred at the time of the transaction and is recognized ratably over
the term of the arrangement or the subscription term.
- Revenue from banner advertising and other advertising space on our web
site is typically recognized as advertisement impressions are delivered.
As a result, our ability to increase revenue and the rate at which we
increase revenue in any future period is directly impacted by the nature of the
underlying revenue and that portion which is deferred.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
net revenue represented by certain items in our Statement of Operations.
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------
2000 1999 2000 1999
----- ------ ----- ------
<S> <C> <C> <C> <C>
Net revenue............................................... 100.0% 100.0% 100.0% 100.0%
Cost of net revenue:
Product................................................. 2.9 4.2 3.2 12.8
Technology costs........................................ 15.7 22.3 17.3 30.2
License fees............................................ 3.7 9.0 5.1 10.6
----- ------ ----- ------
Total cost of net revenue....................... 22.3 35.5 25.6 53.6
----- ------ ----- ------
Operating expenses:
Research and development................................ 30.4 26.0 29.1 27.7
Marketing and sales..................................... 67.7 97.7 79.9 87.3
General and administrative.............................. 18.6 22.3 18.5 21.7
Amortization of intangibles............................. 14.5 -- 11.8 --
Stock-based compensation................................ 4.5 83.2 1.6 45.1
----- ------ ----- ------
Total operating expenses........................ 135.7 229.2 140.9 181.8
----- ------ ----- ------
Loss from operations...................................... (58.0) (164.7) (66.5) (135.4)
Interest and other income and expense, net................ 9.7 -- 10.8 --
----- ------ ----- ------
Income before provision for income taxes.................. (48.3) (164.7) (55.7) (135.4)
Provision for income taxes................................ (1.0) -- (0.7) --
----- ------ ----- ------
Net loss.................................................. (49.3)% (164.7)% (56.4)% (135.4)%
===== ====== ===== ======
</TABLE>
12
<PAGE> 15
Net Revenue. Net revenue increased to $12.6 million in the three months
ended September 30, 2000 from $6.8 million in the three months ended September
30, 1999. Net revenue increased to $34.7 million in the nine months ended
September 30, 2000 from $16.1 million in the nine months ended September 30,
1999. These increases were primarily a result of the official launch of our
website in the second quarter of 1999, revenue related to subscriptions for
McAfee Clinic which we began charging for in September 1999, McAfee Personal
Firewall which we began selling on March 15, 2000, as well as revenue from
sponsorship and co-hosting arrangements and advertising on our site. During the
quarter ended September 30, 2000 a significant portion of our net revenue was
derived from sponsorship, e-commerce and advertising relationships with Internet
companies. In future periods, the amount and timing of similar revenue may be
adversely impacted by a number of factors including the capital market
volatility and the willingness of third parties to enter into sponsorship and
advertising arrangements with online companies in general, and McAfee.com in
particular. See "Risks Related to our Business -- Volatility in the capital
markets and a slowdown in the business of Internet companies may substantially
reduce our revenue and lengthen our sales cycle.
Cost of Net Revenue. Cost of net revenue includes product costs, technology
costs and license fees to NAI (See Note 7 to notes to financial statements).
Technology costs are included in cost of net revenue because these costs
represent the cost of selling our products and services over the Internet.
Technology costs consist of Internet connection charges, co-location costs for
maintaining server sites, salary and benefit expenses for personnel maintaining
our web site and other related costs associated with the maintenance of the web
site. On a percentage basis, cost of net revenue decreased due to higher net
revenue. Cost of net revenue increased to $2.8 million in the three months ended
September 30, 2000 from $2.4 million in the three months ended September 30,
1999. Cost of net revenue increased to $8.9 million in the nine months ended
September 30, 2000 from $8.6 million in the nine months ended September 30,
1999. These increases were primarily due to increased product sales as well as
an increase in technology costs resulting from an increase in spending on
infrastructure.
Cost of net revenue may continue to increase in absolute dollars, but may
fluctuate as a percentage of net revenue over time as we continue to expand our
operations.
Research and Development. Research and development costs consist primarily
of salary and benefits for our development and technical staff, computer and
equipment depreciation as well as allocated overhead expenses. Research and
development expenses increased to $3.8 million in the three months ended
September 30, 2000 from $1.8 million in the three months ended September 30,
1999. Research and development expenses increased to $10.1 million in the nine
months ended September 30, 2000 from $4.5 million in the nine months ended
September 30, 1999. This increase was primarily due to the significant
investment in research and development headcount and infrastructure as we
continue to expand and enhance our product and service offerings. As a
percentage of net revenue, research and development expenses were 30% in the
three months ended September 30, 2000, 26% in the three months ended September
30, 1999, 29% in the nine months ended September 30, 2000 and 28% in the nine
months ended September 30, 1999.
We are focusing our research and development resources on providing
next-generation software services for Internet access devices initially focused
on PC security and management delivered via the Internet, contextual e-commerce
and contextual advertising. Research and development expenses may grow in
absolute dollars as we continue to invest in development and enhancement of our
products and services, but may fluctuate as a percentage of net revenue. We also
expect an increase in research and development expenses related to the
anticipated future international expansion of our business. The timing and
amount of our research and development expenses may vary significantly based
upon the number of new products and significant upgrades under development and
products acquired, if any, during a given period.
Marketing and Sales. Marketing and sales expenses consist primarily of
salary, commissions and benefits for marketing and sales employees as well as
expenses associated with advertising and promotions. Marketing and sales
expenses increased to $8.5 million in the three months ended September 30, 2000,
from $6.6 million in the three months ended September 30, 1999. Marketing and
sales increased to $27.7 million in the nine months ended September 30, 2000
from $14.1 million in the nine months ended September 30, 1999. This increase
was primarily due to a significant investment in the marketing of our products
and services,
13
<PAGE> 16
including advertising and promotions, as well as development of strategic
relationships with a variety of Internet companies, including America Online, or
AOL, and Excite@Home, or Excite. We have also continued our advertising campaign
to build brand awareness and increased the number of sales and marketing
personnel. As a percentage of net revenue, marketing and sales expenses were 68%
in the three months ended September 30, 2000, 98% in the three months ended
September 30, 1999, 80% in the nine months ended September 30, 2000 and 87% in
the nine months ended September 30, 1999.
Marketing and sales expenses may increase in absolute dollars over time as
we continue to aggressively market our products and services to attract new paid
subscribers; continue to establish strategic relationships with third parties;
and expand internationally. However, we expect that our marketing and sales
expenses may fluctuate as a percentage of net revenue.
General and Administrative. General and administrative expenses consist
principally of charges under the corporate services agreement with NAI and of
salary and benefit expenses for administrative personnel. Under the corporate
services agreement, NAI is providing services relating to tax, accounting,
insurance, employee benefits administration, corporate record-keeping, payroll,
information technology infrastructure, and facilities management. The expenses
are allocated based on relative headcount and include a 10% mark-up from NAI's
allocated expenses. In turn, we allocate a portion of these charges related to
facilities and information technology infrastructure to marketing and sales and
research and development. This allocation is based on the headcount of these
departments. Although we believe that we benefit from the services provided by
NAI, the corporate services agreement gives us the right to obtain these
services from a third party, and we may do so to the extent that we are able to
obtain these services on more economical terms.
General and administrative expenses increased to $2.3 million in the three
months ended September 30, 2000 from $1.5 million in the three months ended
September 30, 1999. General and administrative expenses increased to $6.4
million in the nine months ended September 30, 2000 from $3.5 million in the
nine months ended September 30, 1999. The increases were also due public company
expenses as well as an increase in the charge from NAI as a result of a
significant increase in headcount resulting from our increased investment in
infrastructure and expansion of operations. We also increased the allowance for
doubtful accounts by $307,000 in the quarter ended September 30, 2000. As a
percentage of net revenue, general and administrative expenses were 19% in the
three months ended September 30, 2000, 22% in the three months ended September
30, 1999, 19% in the nine months ended September 30, 2000 and 22% in the nine
months ended September 30, 1999. General and administrative expenses may
increase in absolute dollars in the future, but may fluctuate as a percentage of
net revenue, as we expand our operations.
Stock-Based Compensation. As discussed in note 4 to the notes to the
financial statements the Company adopted FIN 44 effective July 1, 2000. As a
result of this adoption and as discussed in note 4 to the notes to the financial
statements the Company must account for options to purchase 1,134,700 shares of
its Common Stock and options to purchase 142,645 shares of NAI stock issued to
its employees using the variable method of accounting. As a result of this the
Company recorded a stock based compensation charge of $565,000 during the three
months ended September 30, 2000. As of September 30, 2000 options to purchase
721,748 shares of the Company's common stock and options to purchase 101,755
shares of NAI common stock which are subject to remeasurement under variable
accounting, were outstanding. The ultimate charge recorded in respect of these
option depends upon the movement in the stock prices of the Company and NAI and
the timing of exercise, cancellation or forfeiture of the options. As a result
the actual charge recorded could be materially higher than estimated as of
September 30, 2000. In addition this charge could vary significantly from
quarter to quarter based on movements in the stock price of the Company and NAI.
In January 1999, five officers of NAI were granted options to purchase
3,420,000 shares of our Class A common stock. These options originally vested
over four years. Since these officers are not our employees, those options are
accounted for at fair market value. The determination of the total compensation
to be recognized in connection with these grants requires the remeasurement of
the fair value of the options each reporting period until the options are fully
vested. Compensation expense is reflected in our results of operations over the
vesting period. On September 22, 1999, with the agreement of the option holders,
we cancelled options for 1,710,000 shares and amended the remaining options to
make them fully vested. As a
14
<PAGE> 17
result of this change we recorded a charge of approximately $5.7 million,
including a charge for options to purchase 388,500 shares granted to NAI
employees in September, October and December 1999.
Amortization of intangibles. We expensed approximately $1.8 million of
amortization related to intangibles in the three months ended September 30, 2000
and $4.1 million in the nine months ended September 30, 2000. Intangibles
consist of purchased goodwill and certain technology acquired through the
acquisition of Signal 9 in February 2000 and a privately held Delaware company
in June 2000.
Interest and other income and expense, net. Interest and other income and
expense, net, increased to $1.2 million in the three months ended September 30,
2000 from zero in the three months ended September 30, 1999 and $3.8 million in
the nine months ended September 30, 2000 from zero in the nine months ended
September 30, 1999. This increase is due to interest income from the investment
of the net proceeds from the issuance of common stock in our initial public
offering in December 1999.
Provision for Income Taxes. Our operations are included in NAI's
consolidated U.S. tax returns. The provision for income taxes in the three and
nine months ended September 30, 2000 relates primarily to withholding tax on the
intercompany royalty payment under our agreement with NAI KK. No income tax
provision has been included because net losses were incurred throughout the
reporting period. We have entered into a tax sharing agreement with NAI
effective as of December 2, 1999. Presentation of tax attributes have been
adjusted to reflect the completion of the 1999 consolidated U.S. tax return and
the impact of the intercompany tax sharing agreement. See Note 7 for a more
detailed description of the NAI tax sharing agreement.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2000, we had $28.0 million in cash and cash equivalents
and $43.5 million in marketable securities, for a combined total of $71.6
million. $7.4 million is due to NAI related to cash payments made on our behalf
by NAI, as well as intercompany charges from NAI, in the nine months ended
September, 2000, net of a payment of $7.0 million made to NAI in September to
settle previously outstanding amounts. Also $5.4 million is due to NAI related
to deferred taxes (see Note 7 for an explanation of the tax sharing agreement
with NAI). At September 30, 2000, we also had in place an intercompany revolving
loan agreement under which NAI has agreed to make up to $30 million available to
us. The interest rate under this revolving loan is equal to the one-month LIBOR
rate, which fluctuates daily and was 6.6% on September 30, 2000. The revolving
loan is payable in full on January 1, 2001, the termination date of the
agreement. As of September 30, 2000, there were no amounts outstanding under the
revolving loan agreement.
Net cash used in operating activities was $15.4 million in the nine months
ended September 30, 2000, resulting primarily from the net loss of $19.6 million
as well as increases in deferred taxes, accounts receivable and prepaid and
other assets, partially offset by depreciation and amortization and a decrease
in accounts receivable and increases in accounts payable and accrued liabilities
and deferred revenue.
Net cash provided by operating activities was $3.8 million in the nine
months ended September 30, 1999, resulting primarily from a $13.5 million
increase in deferred revenue as well as increases in accounts payable and
accrued liabilities, partially offset by net loss before depreciation and
amortization and stock-based compensation.
Net cash used in investing activities was $33.3 million in the nine months
ended September 30, 2000, resulting from purchases and other changes in
marketable securities and other investments, purchases of fixed assets,
leasehold improvements related to our new facility as well as the purchase of
Signal 9 Solutions and certain other technology. Net cash used in investing
activities was $1.3 million in the nine months ended September 30, 1999 related
to the purchase of fixed assets.
Net cash provided by financing activities was $9.4 million in the nine
months ended September 30, 2000 resulting primarily from proceeds from issuance
of common stock under our stock option and stock purchase plans, as well as an
increase in the amount payable to NAI largely as a result of the deferred taxes.
Net cash used in financing activities was $4,000 in the nine months ended
September 30, 1999 resulting from the change in the amount payable to NAI.
15
<PAGE> 18
To date, a significant portion of our revenue has been derived from
sponsorship, e-commerce and advertising relationships with Internet companies.
Volatility in the capital markets and a slowdown in the business of many
Internet companies has impacted adversely many of our past and potential
Internet company customers, particularly early stage companies and those
companies that have undertaken expansive advertising campaigns to build an
online marketing presence. As a result of these actual or potential
difficulties, our Internet company customers, many of whom are early stage
companies or have engaged in their own large advertising campaigns, may:
- Reduce their sponsorship, e-commerce and advertising relationships with
us;
- Elect not to enter into long-term agreements, or agreements involving
large up-front payments or slotting fees paid to us;
- Require shorter-term agreements with us and payments made over time based
on actual performance; and
- Face difficulties in paying for existing or new obligations owed to us.
These events would act to lengthen our sales cycle and reduce our revenue
and correspondingly adversely impact our business.
We believe our available cash and anticipated cash flow from operations
will be sufficient to fund our working capital and capital expenditure
requirements for at least the next 12 months, although this may not be
sufficient to fund our working capital beyond the next 24 months. However, we
may seek to raise additional capital during that period. We cannot assure you
that we will not require additional funds during the next 12 months. Even if
these additional funds are not required, we may decide to seek additional equity
or debt financing. There can be no assurance that such financing will be
available on acceptable terms, if at all, or that such financing will not be
dilutive to our stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the Company's market risk during the
three months ended September 30, 2000. For additional information, refer to
Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company's Form 10-K for the year ended December 31, 1999.
16
<PAGE> 19
RISK FACTORS
The following risk factors should be considered in conjunction with the
information in this Report on Form 10-Q.
RISKS RELATED TO OUR RELATIONSHIP WITH NETWORK ASSOCIATES
We are currently a majority-owned subsidiary of Network Associates. We were
incorporated in December 1998 and effective January 1, 1999 Network Associates
contributed the assets of its consumer e-commerce business to us.
WE DO NOT OWN MUCH OF THE CORE TECHNOLOGY AND INTELLECTUAL PROPERTY UNDERLYING
OUR CURRENT PRODUCTS AND OUR CURRENTLY PLANNED PRODUCTS
Much of the core technology and intellectual property underlying our
current products and our currently planned products is licensed to us by Network
Associates under a license agreement. This license agreement has a perpetual
term subject to specific termination provisions contained in the agreement. This
license agreement:
- restricts our use of the licensed technology to providing single-user
consumer licenses for our products and services sold over the Internet or
for Internet-based products and licensing the technology to original
equipment manufacturers for sale to individual consumers;
- allows Network Associates to continue to sell "shrink-wrapped" boxed
products incorporating the licensed technology through non-online
distribution channels, such as retail stores;
- prevents us from offering products from companies other than Network
Associates if Network Associates offers a competitive product;
- grants to Network Associates a license to all technology that we create
based on the copyrights that we license from Network Associates;
- does not enable us to independently enforce Network Associates'
intellectual property rights in the licensed technology against third
parties; and
- allows Network Associates to terminate the cross license if we fail to
cure any material breach of the cross license within 30 days after being
notified by Network Associates of the breach, subject to mandatory
dispute resolution prior to the effectiveness of any proposed
termination.
Despite precautions that we and Network Associates may take, third parties
could copy or otherwise obtain or use the proprietary information without
authorization or develop similar technology independently. If Network Associates
fails to adequately and timely protect the technology it licenses to us, our
business may be adversely affected.
OUR AGREEMENTS WITH NETWORK ASSOCIATES ARE NOT THE RESULT OF ARM'S LENGTH
NEGOTIATIONS AND AS A RESULT THE AGREEMENTS MAY BE LESS FAVORABLE TO US THAN IF
THE AGREEMENTS WERE NEGOTIATIONS WERE AT ARM'S LENGTH
Our agreements with Network Associates were negotiated when we were a
wholly-owned subsidiary of Network Associates and one of our two directors at
that time was a director and the chief executive officer of Network Associates.
In addition, Srivats Sampath, our president and the other director at the time,
was employed by Network Associates prior to joining McAfee.com in December 1998.
WE MAY BE UNABLE TO PURSUE BUSINESS OPPORTUNITIES AVAILABLE TO US BECAUSE OF OUR
RELATIONSHIP WITH NETWORK ASSOCIATES
We do not currently have a clear policy in place with Network Associates to
delineate business opportunities between us and Network Associates (including
its other companies such as myCIO.com), except that the license agreement
restricts each party from selling licensed products in specified markets and
prevents us from offering products based on technology competitive with that
provided to us by Network
17
<PAGE> 20
Associates. The complexity and fluid nature of the marketplace and the rapid
technological changes in how services are distributed over the Internet make it
likely that the scope of the license agreement with Network Associates will be
difficult to interpret in future cases. Our failure or Network Associates'
failure to properly interpret the restrictive provisions contained in this
license agreement could result in either party pursuing business opportunities
that are prohibited under the license agreement, and could confuse potential
customers and require the attention of our senior management to resolve.
Furthermore, our ability to take advantage of a specific business opportunity
may be affected by Network Associates' representation on our board of directors,
its voting control over us and our comparatively limited resources. As a result,
we may be unable to successfully pursue business opportunities available to both
Network Associates and us.
OUR HOSTED PRODUCTS AND SERVICES CURRENTLY COMPETE WITH SOME OF NETWORK
ASSOCIATES' EXISTING PRODUCTS AND MAY COMPETE WITH FUTURE NETWORK ASSOCIATES'
PRODUCTS AND SERVICES, WHICH WOULD SIGNIFICANTLY LIMIT OUR BUSINESS
OPPORTUNITIES
Network Associates will continue to offer competing products through
traditional non-online distribution channels, such as retail stores. These
products include "shrink wrapped," boxed versions of McAfee VirusScan and McAfee
Office, a suite of products which incorporates a number of the features included
in our online products and services. We compete with these Network Associates
products based on a number of factors, including price, preferred method of
software delivery, and consumer convenience. Network Associates also provides
hosted online products and services to business users through its MyCIO.com
subsidiary. Our license agreement with Network Associates currently restricts
our use of the licensed technology to providing single-user consumer licenses
and grants Network Associates a license to the proprietary technology which
enables us to provide hosted products and services. As a result, absent Network
Associates' consent, we are unable to pursue business customers for our online
products and services and we may experience customer confusion, each of which
would harm our business or limit our business opportunities
NETWORK ASSOCIATES' ABILITY TO EXERT CONTROL OVER US COULD RESULT IN ACTIONS
THAT ARE NOT CONSISTENT WITH THE INTERESTS OF OUR OTHER STOCKHOLDERS,
PARTICULARLY WITH RESPECT TO A CHANGE OF CONTROL
Network Associates' substantial voting control over us could conflict with
the interests of our other stockholders. Our capital stock consists of Class A
common stock and Class B common stock. Holders of Class A common stock are
entitled to one vote per share, and Network Associates, as the sole holder of
Class B common stock, is entitled to three votes per share. In the event that
Network Associates transfers Class B common stock to a third party, the
transferred Class B common stock automatically converts to Class A common stock
upon transfer. As of September 30, 2000, Network Associates owned 36,000,000
shares, or 100%, of the outstanding Class B common stock, representing
approximately 93% of the overall voting power of our outstanding stock. As long
as the shares of Class B common stock held by Network Associates represent more
than 25% of our outstanding voting capital stock, Network Associates will have a
majority of the voting power represented by our outstanding stock. This voting
power will enable Network Associates to:
- elect our entire board of directors and, as a result, control matters
requiring board approval, subject to Network Associates' contractual
obligation to vote in favor of at least two independent directors or at
least a majority of independent directors if a change of control of
Network Associates takes place that is not approved by the Network
Associates continuing directors;
- control matters submitted to a stockholder vote, including mergers and
consolidations with third parties and the sale of all or substantially
all of our assets; and
- otherwise control or influence the business direction and policies of
McAfee.com.
In light of its voting control and board influence, Network Associates will
have significant influence over matters requiring approval of our board of
directors and stockholders. Two of our current board members are affiliated with
Network Associates. William Larson is Network Associates' chief executive
officer and Prabhat Goyal is Network Associates' chief financial officer. Our
business could be adversely affected if these directors act in favor of Network
Associates' interests over ours while on our board of directors.
18
<PAGE> 21
Network Associates' voting control and board influence may have the effect
of discouraging many types of transactions involving a change of control,
including transactions in which the holders of Class A common stock might
otherwise receive a premium for their shares over the then-current market price.
In addition, we have elected not to be subject to Section 203 of the Delaware
General Corporation Law, which would otherwise provide certain restrictions on
"business combinations" between us and any party acquiring a 15% or greater
interest in our voting stock other than in a transaction approved by our board
of directors and in certain cases by our stockholders. As a result, for example,
as long as Network Associates owns more than 50% of the outstanding common
stock, Network Associates could effect a change in control of McAfee.com through
sales of its shares without our other stockholders having an opportunity to
participate in the transaction.
BECAUSE NETWORK ASSOCIATES CONSOLIDATES OUR OPERATING RESULTS WITH ITS OWN, IT
MAY ATTEMPT TO RESTRICT OUR EXPENDITURES, WHICH COULD ADVERSELY AFFECT OUR
BUSINESS IN THE LONG TERM
As long as Network Associates owns common stock having at least a majority
of our voting power, it will continue to consolidate our operating results with
its own for accounting purposes. Our business strategy will require us to incur
large expenses resulting in significant losses as we attempt to establish our
brand by increasing our marketing efforts and establishing strategic
relationships. Incurring large expenses for these purposes may conflict with
Network Associates' interests in maximizing its net earnings, and Network
Associates may attempt to influence our expenditures in a manner that limits our
losses in the short term but may not be in our best interests in the long term.
WE RELY ON NETWORK ASSOCIATES TO ADEQUATELY PROTECT AND DEFEND OUR LICENSED
TECHNOLOGY AND INTELLECTUAL PROPERTY AND ANY FAILURE BY NETWORK ASSOCIATES TO DO
SO COULD ADVERSELY AFFECT OUR BUSINESS
We rely on Network Associates to protect the technology and intellectual
property that it licenses to us through a combination of patent, trademark,
trade secret and copyright law and contractual restrictions. Despite Network
Associates' precautionary measures, third parties could copy or otherwise obtain
or use the licensed technology and intellectual property without authorization.
Our license agreement with Network Associates does not permit us to take
independent legal action against third parties to enforce Network Associates'
intellectual property rights. In the future Network Associates may be, subject
to litigation related to the technology licensed to us. Adverse determinations
in that litigation could:
- result in the loss of Network Associates, and as a result, our
proprietary rights, which could prevent us from selling our products;
- subject us to significant liabilities; or
- require Network Associates and/or us to seek licenses from third parties.
OUR BUSINESS MAY BE HARMED BY THE LITIGATION TO WHICH NETWORK ASSOCIATES IS A
PARTY WITH RESPECT TO ANTI-VIRUS TECHNOLOGY IT LICENSES TO US
Hilgraeve and Trend Micro have each filed suit against Network Associates
with respect to the anti-virus technology that we license from Network
Associates. The Trend Micro suit was recently settled. See Note 8 to Notes to
Condensed Consolidated Financial Statements for a description of these pending
actions. In addition to naming Network Associates as a defendant in these
litigation matters, these claimants may seek to name us as a defendant in
related actions and seek damages from us. Under the terms of an indemnification
agreement with Network Associates, it has agreed to indemnify and defend us and
hold us harmless from any losses as a result of these or other intellectual
property claims known prior to December 2, 1999. The litigation process is
subject to inherent uncertainties and we and/or Network Associates may not
prevail in these matters, or we and/or Network Associates may be unable to
obtain licenses with respect to any patents or other intellectual property
rights of third parties that may be held valid or infringed upon by us through
our use of intellectual property licensed to us by Network Associates.
Uncertainties inherent in the litigation process include, among other things,
the complexity of the technologies involved, potentially adverse changes in the
law and discovery of facts unfavorable to Network Associates or McAfee.com. In
addition, any involvement in legal actions
19
<PAGE> 22
regarding our intellectual property rights could be expensive and could distract
our management from our day-to-day operations.
BECAUSE WE LICENSE OUR ANTI-VIRUS AND OTHER TECHNOLOGY FROM NETWORK ASSOCIATES,
OUR ABILITY TO COMPETE IN OUR MARKETS DEPENDS IN PART ON THE SUCCESS OF NETWORK
ASSOCIATES' RESEARCH AND DEVELOPMENT
Under our license agreement with Network Associates, Network Associates
licenses to us all future improvements based on the licensed technologies. Our
research and development efforts will initially focus on adapting the licensed
technology for sales of products and services over the Internet. Specifically,
we do not plan to undertake independent research and development efforts
relating to the anti-virus technology licensed from Network Associates but
instead plan to rely on future improvements developed by Network Associates. As
a result, our ability to introduce additional or enhanced anti-virus products is
directly impacted by the success of Network Associates' related research and
development efforts. If Network Associates does not commit sufficient resources
to these efforts, or if its efforts are unsuccessful or untimely, the quality of
our anti-virus products would suffer and we would be required to commit
significant resources to our own research and development efforts. If we are
required to do so, our ability to maintain any technological leadership
currently provided by Network Associates would be severely constrained by our
relatively limited capital resources, engineering capabilities and other
resources necessary to timely develop and introduce additional or enhanced
anti-virus products. This would significantly harm our competitive position and
business.
We expect to rely on Network Associates' ongoing research and development
efforts to keep our anti-virus products up-to-date. Accordingly, we will not
control whether these products will:
- continue to recognize and eliminate new computer viruses;
- incorrectly report the presence or absence of computer viruses;
- incorporate leading-edge technology; or
- be adequately protected from infringement by third parties or infringe
upon the intellectual property rights of third parties.
BECAUSE WE SHARE THE MCAFEE BRAND WITH NETWORK ASSOCIATES, ITS ACTIVITIES
RELATED TO ITS MCAFEE-BRANDED PRODUCTS COULD HARM OUR BRAND AND OUR COMPETITIVE
POSITION
The value of our McAfee.com brand is closely linked to the reputation of
Network Associates' McAfee-branded software, such as VirusScan. Network
Associates owns the McAfee trademark and will continue to maintain the right to
control the sale of McAfee and other Network Associates-branded "shrink-wrapped"
boxed software into non-online and corporate channels. Our McAfee.com brand and
competitive position could be harmed by:
- publicity surrounding inadequate levels of consumer support for, or poor
performance of, Network Associates' McAfee-branded products, particularly
McAfee VirusScan; and
- customer confusion related to Network Associates' continued sale of
McAfee-branded products in non-online channels and corporate channels
including the on-line offering of anti-virus products to businesses.
The McAfee.com web site address, or domain name, and the McAfee trademark
are important to our business and are licensed to us by Network Associates. If
we were to lose the McAfee.com domain name or the use of this trademark, our
business would be harmed, and we would need to devote substantial resources
towards developing an independent brand identity.
WE RELY ON NETWORK ASSOCIATES TO PROVIDE CRITICAL SERVICES TO US, AND FAILURE ON
ITS PART TO EFFECTIVELY DO SO COULD ADVERSELY AFFECT OUR BUSINESS
We currently rely on Network Associates for some cash management functions,
tax and payroll administration, insurance, employee benefits administration and
other services. We have entered into a
20
<PAGE> 23
services agreement with Network Associates for the continued provision of these
services. Until otherwise terminated, this agreement will continue in effect
through the end of December 2000 with automatic one-year renewal periods
following this date. This agreement was not the result of arm's length
negotiation since we were a wholly-owned subsidiary of Network Associates at the
time we negotiated and entered into the agreement. As a result, the agreement
may be less favorable to us than if it was negotiated at arm's length. If this
agreement is terminated or if Network Associates fails to satisfactorily provide
these services, we would be required to provide these services internally or
find a third-party provider of these services. Any services we choose to provide
internally may not be as cost-effective as those that Network Associates is
currently providing, particularly in light of our lack of experience as an
independent organization. If we are required to obtain these services from a
third party, we may be unable to do so in a timely, efficient and cost effective
manner, or the services we receive may be inferior to those that Network
Associates is currently providing.
RISKS RELATED TO OUR BUSINESS
WE HAVE A HISTORY OF LOSSES AND FURTHER LOSSES ARE LIKELY
As of September 30, 2000 we had aggregate net losses of approximately $52.8
million. Our net losses as a percentage of net revenue were 49% in the three
months ended September 30, 2000, and 165% in the three months ended September
30, 1999. We continue to incur significant net operating losses for the
foreseeable future. We may never become profitable, or if we do earn a profit in
any period, we may be unable to sustain or increase our profitability on a
quarterly or annual basis. It is critical to our success that we continue to
devote financial, sales and management resources to developing brand awareness
for our web site and our online PC security and management products and
services. As a result, we expect that our operating expenses may increase
significantly during the next several years, as we incur additional expenses
related to:
- development, marketing and promotion of products and services;
- development of our web site and related infrastructure;
- development and maintenance of strategic relationships; and
- increased employee headcount.
With the addition of these operating expenses, we will need to generate
significant additional revenues to achieve profitability.
VOLATILITY IN THE CAPITAL MARKETS AND A SLOWDOWN IN THE BUSINESS OF MANY
INTERNET COMPANIES MAY SUBSTANTIALLY REDUCE OUR REVENUE AND LENGTHEN OUR SALES
CYCLE
To date, a significant portion of our revenue has been derived from
sponsorship, e-commerce and advertising relationships with Internet companies.
Volatility in the capital markets and a slowdown in the business of many
Internet companies has impacted adversely many of our past and potential
Internet company customers, particularly early stage companies and those
companies that have undertaken expansive advertising campaigns to build an
online marketing presence. As a result of these actual or potential
difficulties, our Internet company customers, many of whom are early stage
companies or have engaged in their own large advertising campaigns, may:
- Reduce their sponsorship, e-commerce and advertising relationships with
us;
- Elect not to enter into long-term agreements, or agreements involving
large up-front payments or slotting fees paid to us;
- Require shorter-term agreements with us and payments made over time based
on actual performance; and
- Face difficulties in paying for existing or new obligations owed to us.
These events would act to lengthen our sales cycle and reduce our revenue
and correspondingly adversely impact our business.
21
<PAGE> 24
OUR APPLICATIONS SERVICE PROVIDER BUSINESS MODEL IS UNPROVEN, AND OUR SUCCESS
DEPENDS ON MARKET ACCEPTANCE OF OUR HOSTED APPLICATIONS
Historically, substantially all of our revenue has come from software sales
through our web site and other online resellers, such as Beyond.com. Our current
strategy is to expand upon this base and broaden our role as an applications
service provider, or ASP, providing consumers with online access to PC security
and management software applications hosted on our servers. Under this ASP
model, consumers "rent versus buy" our software, which means PC users purchase a
license to use the software hosted on our servers for a limited duration of time
with all version updates included, as opposed to purchasing a single version of
traditional software with perpetual access to only one version. We believe we
are among the first consumer focused ASPs, and this concept may not achieve
acceptance in the market. We began providing our application services online in
October 1998 when we updated Oil Change and introduced it as our initial online
subscription service following the acquisition of CyberMedia, Inc. by Network
Associates. In April 1999, we significantly redesigned our web site and
introduced our McAfee Clinic hosted services. To build awareness and demand for
our hosted products and services, we offered our McAfee Clinic and other
products and services for free prior to September 2, 1999, when we began
charging a subscription fee for McAfee Clinic. Consumer acceptance of our hosted
products and services is highly uncertain and subject to a number of potential
factors, including:
- consumers' reluctance to pay a subscription fee for our hosted services
which were offered for free prior to September 2, 1999 and at a fee
substantially lower than our current subscription fee until early 2000;
- consumers' reluctance to change their software purchasing behavior in
favor of services hosted on our servers;
- consumer concerns regarding the effectiveness of hosted PC products and
services compared with software that is entirely on a user's PC;
- unwillingness by consumers to incur ongoing subscription fees for hosted
products and services previously offered for free;
- consumer concerns about whether the Internet is fast and reliable enough
to deliver critical PC security and management functions effectively; and
- our ability to properly price our products and services to generate the
greatest revenue potential.
Our online services are designed to protect consumer privacy by ensuring
that all PC scans are done locally at the PC, all information about the user's
PC is transmitted to us anonymously and no scanned data is stored by us.
However, consumers' misconceptions about this process could prevent our ASP
model from achieving market acceptance.
IF WE ARE UNABLE TO EFFECTIVELY SELL RENEWAL SUBSCRIPTIONS TO OUR SERVICES, OUR
BUSINESS WILL BE HARMED
We derive a substantial portion of our revenue from the sale of annual
subscriptions to our various services. In addition to attracting new
subscribers, in order to expand our subscriber base we need to achieve a high
rate of customers renewing their subscriptions upon expiration. Until recently
we did not have the infrastructure in place to automatically renew expiring
subscriptions and we had not sought permission from our customers to
automatically renew their subscriptions upon expiration. Since we began charging
for our services in September of 1999, we have only recently begun the process
of contacting our subscribers to offer renewals. Our lack of experience in this
aspect of our business may reduce our effectiveness in obtaining subscription
renewals. Many of our subscribers paid substantially less than our current
retail price for their initial subscription and may be unwilling to renew their
subscription at a higher price. We have and will be required to expend
substantial marketing, customer service and technical resources to promote
subscription renewals and we are offering discounted prices to increase the rate
of subscription renewals. This effort may result in higher costs and in reduced
average subscription revenue per subscriber. If we are unable to renew
subscribers at a sufficient rate, we would likely be unable to maintain or
increase our subscriber base and our business will be harmed.
22
<PAGE> 25
ANY FAILURE TO SUCCESSFULLY EXPAND OUR CONTEXTUAL E-COMMERCE SERVICES COULD
LIMIT OUR POTENTIAL GROWTH
We plan to expand our contextual e-commerce services, in which we provide
product recommendations based on a customer's particular PC, attached hardware,
such as printers and monitors, internal peripheral devices, such as hard drives
and graphics cards, and software, such as Windows 95 and Quicken. The success of
our contextual e-commerce services requires that we continue to properly scan
the user's PC system and identify the PC configuration. In addition, we will be
unable to successfully complete the rollout of our contextual e-commerce
services unless we take the following actions:
Obtain Relevant Content. For our recommendations to be accurate, we must
successfully obtain and maintain:
- relationships with vendors, such as hardware and software distributors,
who agree to have their products included in our database of products we
recommend to consumers for purchase;
- interoperability information to ensure that our recommended products are
compatible with the consumer's PC system configuration; and
- relationships with third party providers of information, such as product
reviews and ratings, about the products included in our contextual
product database.
To date we have secured only a limited amount of the content needed to
successfully provide our contextual e-commerce services. To obtain this content,
particularly online product information, product reviews and interoperability
information, we may have to pay fees or enter into revenue-sharing agreements.
We may not be successful in our efforts to enter into mutually satisfactory
revenue-sharing arrangements with content providers.
Establish Revenue-Generating Arrangements with Vendors. We must
successfully negotiate revenue generating arrangements with our vendors.
Potential revenue-generating arrangements with our vendors may include:
- a referral fee or a share in the product revenue based on the type and
value of products purchased as a result of our product recommendation;
- guaranteed minimum payments paid by participating vendors in exchange for
their inclusion in our contextual product database, perhaps on an
exclusive basis depending on the product;
- slotting fees paid by vendors to ensure that their products receive
preferential listing in our list of recommended products; and
- licenses of our technology to third parties with whom we have strategic
relationships in exchange for license fees or revenue sharing.
We have been unable and may continue to be unable to establish and maintain
mutually satisfactory revenue generating arrangements. E-commerce is a
relatively new concept and our ability to enter into these arrangements and
their success is dependent on the degree to which e-commerce is broadly adopted
by consumers.
Establish Consumer Trust and Generate Related Revenue. We must establish
consumer trust and generate related revenue through our contextual e-commerce
services. To do so, we must successfully and consistently recommend a broad
selection of high-quality and reliable products at competitive prices. In
addition, for us to generate revenue through our contextual e-commerce services,
consumers must purchase the products recommended by our service. We believe that
a significant number of consumers will use our service to gather product
recommendations and information and purchase products from sources with whom we
do not have revenue sharing relationships, such as traditional retail channels
or third-party online sources. If our vendors offer low-quality or unreliable
products or do not properly distribute and support their products, consumers
could lose trust in us. Consumers could also lose trust in us as a result of our
only recommending the products of vendors who have separately agreed to be
included in our database or giving priority to those vendors who have paid us a
slotting fee for preferential treatment.
23
<PAGE> 26
WE RECENTLY INTRODUCED CONTEXTUAL ADVERTISING, AND THE FAILURE OF THIS SERVICE
COULD ADVERSELY AFFECT OUR BUSINESS
Contextual advertising is based on selling advertising targeted to
consumers based on their PC configuration, attached peripherals and software. We
will be unable to successfully establish and maintain our contextual advertising
product unless we take the following actions:
Provide Proper System Scanning. Our scanning software must accurately scan
the user's PC system in order to provide relevant targeted advertisements.
Obtain Advertisers Willing to Pay a Premium for Targeted
Advertisements. The market for contextual advertising is still developing and
advertisers may be unwilling to utilize contextual advertising or pay a premium
for this product. Our ability to charge higher rates for contextual advertising
is subject to a number of factors including the number and demographics of the
users of our web site, the amount of time users spend on our web site and the
degree to which users of our web site purchase the advertised products.
ANY FAILURE ON OUR PART TO DEVELOP, MAINTAIN AND ENHANCE STRATEGIC RELATIONSHIPS
WILL LIMIT OUR ABILITY TO EXPAND OUR DISTRIBUTION AND GROW OUR BUSINESS
Our distribution strategy will require us to develop and maintain strategic
relationships with third parties including Internet portals, Internet shopping
sites, and Internet access providers. We believe that the maintenance and
enhancement of our relationship with Beyond.com and the establishment of
additional strategic relationships in other areas of our business will be
critical if we are to expand our business. In August 2000, we extended our
current agreement with Beyond.com, retroactive to July 1, 2000, which is the
largest reseller of our software and the exclusive reseller of third-party
software sold on our web site. The new agreement expires on June 30, 2001.
Through the Beyond.com reseller arrangement, Beyond.com purchases licenses to
our software from us for resale at the time a customer decides to purchase it,
paying us for these licenses on a monthly basis. In the three months ended
September 30, 2000, approximately 15% of our net revenue was derived from the
sale of software licenses through Beyond.com. Although we intend to pursue
additional strategic relationships in the future, these efforts may not be
successful. To secure and maintain key strategic relationships, we may be
required to pay significant fees and/or grant exclusive rights. Even if we do
succeed in establishing these relationships, they may not result in our
generating additional subscriber or customer relationships or increased
revenues.
WE MAY BE UNSUCCESSFUL IN OUR PLANS TO MARKET OUR SERVICES TO BUSINESSES.
To date, we have focused on selling our products and services to individual
consumers. We intend to expand the scope of our marketing, sales and
distribution to included small and medium sized businesses. Currently, however,
our license agreement with Network Associates restricts our ability to sell
products and services to businesses and we may be unable to enter or compete
effectively in the business marketplace due to these contractual limitations. We
lack experience in selling to and supporting business customers, and will likely
face serious competition in this market segment. Accordingly, businesses may be
reluctant to adopt our products and services. We are likely to incur substantial
incremental costs associated with marketing and supporting a business focused
service. This may reduce the resources available for our consumer services
business, and negatively impact our revenues and operating results.
WE FACE RISKS ASSOCIATED SELLING CO-BRANDED THIRD PARTY SERVICES FROM OUR SITE.
We will begin selling third party products and services from our site in
the near future, some of which will be branded with or contain the third party's
brand name as well as our own. We face several risks associated selling such
products and services, including:
- customer resistance to co-branded products;
- increased costs associated with the integration, production, sale and
support of additional services including the payment of license fees and
royalties for co-branded products;
24
<PAGE> 27
- harm to our goodwill and reputation customers become confused by the use
of our brand to sell products that we do not own;
- harm to our goodwill and reputation if products sold under our brand name
do not perform in accordance with expectations;
- that the third parties will go out of business and/or fail to support or
update the products or services or otherwise fail to honor their
commitments to us; and
- that the technology underlying the third party products or services
infringes upon the intellectual property of other unrelated parties or
exposes us to other forms of legal liability.
Should any of these risks materialize, we may fail to recognize the
benefits that otherwise would result from the sale of those products and
services.
OUR SUCCESS DEPENDS UPON OUR MANAGEMENT TEAM'S ABILITY TO WORK EFFECTIVELY
TOGETHER AND OUR ABILITY TO RETAIN THEM
Because our senior management currently consists of individuals who have
worked together for a relatively short period of time our management may be
unable to work together effectively. Our Vice President of Marketing joined the
Company in May 2000 and our current Vice President of Sales has served on an
interim basis since July 2000. We are substantially dependent on the continued
services of our senior management, including Srivats Sampath, our chief
executive officer, and Evan Collins, our chief financial officer, as well as key
technical and engineering personnel. We do not have employment agreements with
any of our senior management or key personnel and we do not maintain any "key
person" life insurance policies. If our management team fails to work together
effectively, or if we lose the services of any other members of senior
management or key personnel, our business could be harmed.
OUR FAILURE TO HIRE AND RETAIN KEY MANAGEMENT PERSONNEL AND OTHER QUALIFIED
INDIVIDUALS COULD HARM OUR BUSINESS
In addition to retaining and motivating our current management and
technical employees, we must attract and train new employees in key areas of our
company, including marketing and sales, research and development and web
information technologies functions. We may be unable to successfully attract,
train, retain and motivate key management personnel and other highly skilled
technical, sales and marketing and customer support personnel. Competition for
these individuals is intense, especially in the San Francisco Bay Area. If we
fail to either retain our current employees, or fail to attract and train new
employees, our business could be harmed. Recent volatility in our stock price
may make it more difficult for us to retain existing employees and attract new
employees. An increase in employee turnover may impede our productivity,
increase our costs and degrade our overall technical and management experience
harming our business.
OUR INABILITY TO EFFECTIVELY MANAGE OUR WEB SITE TRAFFIC AND INFORMATION
TECHNOLOGY INFRASTRUCTURE COULD HARM OUR BUSINESS
We have experienced significant growth and fluctuations in traffic to our
web site. To meet increased traffic demands and potential future traffic
increases, we recently expanded our information technology, or IT,
infrastructure and continue to add additional infrastructure based on our
anticipated requirements.
We have experienced significant temporary increases in traffic to our web
site in response to particular events, such as the Melissa and Chernobyl
computer virus outbreaks in the first half of 1999, and the I Love You computer
virus outbreaks in the three months ended June 30, 2000, each of which
approximately tripled our then average daily web site traffic. To respond to
sudden traffic increases, we must expand and maintain the capacity of our IT
infrastructure. If we are unable to effectively expand our IT infrastructure to
accommodate traffic increases, consumers may experience difficulties in
accessing our web site or in downloading products and information from our web
site. This could materially harm our business.
25
<PAGE> 28
The impact of traffic increases would likely be most severe during
unanticipated events such as virus outbreaks. Currently, our web site
infrastructure supporting our web site operates at approximately 12% capacity
based on average daily traffic levels. These capacity estimates are based on
measuring existing web site traffic against the bandwidth specifications of our
installed hardware.
Currently, Beyond.com provides electronic distribution for software
products sold on our web site. If we were to elect to provide our own electronic
distribution of these products and the related updates and upgrades, we would
need to increase our IT infrastructure.
WE RELY ON BEYOND.COM FOR SOFTWARE LICENSE SALES AND PRODUCT FULFILLMENT, AND
ANY FAILURE BY BEYOND.COM TO PERFORM THIS SERVICE EFFECTIVELY COULD ADVERSELY
AFFECT OUR BUSINESS
During the three months ended September 30, 2000, approximately 15% of our
net revenue was derived from the sale of our software licenses through
Beyond.com. Included in these revenues are software licenses sold on our web
site for which Beyond.com acts as a reseller and provides product fulfillment.
Beyond.com provides fulfillment for these products whether they are distributed
electronically by Beyond.com or in "shrink-wrapped" box format shipped to
customers. If Beyond.com does not provide these services in a timely and
satisfactory manner, we would be required to replace Beyond.com and our business
could be harmed.
WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE FOR A NUMBER
OF REASONS THAT COULD CAUSE OUR STOCK PRICE TO FLUCTUATE
We expect that our quarterly and long-term revenues and operating results
will fluctuate significantly in the future based upon a number of factors, many
of which are not within our control.
We have significantly increased our operating expenses to expand our
marketing and sales activities and have expanded our operating infrastructure.
We may be required to continue incurring substantial operating expenses to
maintain and expand our business. We base our operating expenses on anticipated
market growth and our operating expenses are relatively fixed in the short term.
We may be unable to accurately assess market growth rates and accordingly we may
incorrectly forecast and budget operating expenses. As a result, if our revenues
are lower than we expect, our quarterly and long-term operating results may not
meet the expectations of public market analysts or investors, which could cause
the market price of our common stock to decline.
In prior periods, our net revenue and operating results have fluctuated on
a quarterly basis. For example, during the year ended December 31, 1999, we
recorded approximately 34% of our total net revenue in the three months ended
December 31, 1999, approximately 28% in the three months ended September 30,
1999, approximately 24% in the three months ended June 30, 1999 and
approximately 14% in the three months ended March 31, 1999. During the year
ended December 31, 1998, we recorded approximately 32% in the three months ended
December 31, 1998, approximately 27% in the three months ended September 30,
1998, approximately 24% in the three months ended June 30, 1998 and
approximately 17% of our total net revenue in the three months ended March 30,
1998.
It is likely that in some future period, our operating results or our
financial analyst forecasts of future operating results may be below
expectations of public market analysts or investors. If this occurs, our stock
price may drop. The primary factors that may affect our quarterly and long-term
revenues and operating results include the following:
- the number of visitors to our web site, the proportion of visitors that
become registered users, the proportion of registered users that convert
to paying online subscribers and the rate at which they renew their
subscriptions;
- seasonality, such as during summer months, when Internet usage is
typically lower;
- the number of visitors to our web site who purchase products offered
through our web site and the mix of products purchased;
26
<PAGE> 29
- the amount of advertising purchased on our web site and the price we may
be able to charge for advertising on our web site;
- our success in licensing our contextual e-commerce technology;
- the amount and timing of our operating expenses and capital expenditures;
- the percentage of revenue which is deferred, which may fluctuate based on
the change in product mix and/or pricing;
- costs related to potential acquisitions of businesses or technologies;
and
- our success in branding and marketing third party products and services.
BECAUSE OUR HISTORICAL FINANCIAL STATEMENTS ARE DERIVED FROM NETWORK ASSOCIATES'
HISTORIC FINANCIAL RESULTS PRIOR TO THE TIME WE ADOPTED OUR CURRENT BUSINESS
MODEL, THEY MAY NOT BE INDICATIVE OF OUR FUTURE PERFORMANCE
Our financial statements are derived from the historic books and records of
Network Associates. Furthermore, although historically substantially all of our
revenues have come from traditional software sales, our current strategy is to
expand our role as an ASP, providing consumers with online access to software
applications hosted on our servers. For these reasons, we do not believe that
our historical operating results are representative of our business model going
forward. As a result, you should not rely on comparisons of our historical
operating results as an indicator of our future performance.
THE GROWTH OF OUR NET REVENUE DEPENDS TO A SIGNIFICANT EXTENT UPON THE CONTINUED
DEMAND FOR OUR ANTI-VIRUS PRODUCTS AND SERVICES
We believe that to date a significant portion of the traffic to our web
site has been generated by consumer demand for our anti-virus products and
services. A decline in the demand for, or the price that consumers are willing
to pay for, our anti-virus products and services as a result of competition, an
erosion of brand loyalty, perceived degradation in product quality,
technological changes, the bundling by third parties of anti-virus functionality
into their products or services or other factors would harm our business and
operating results. We license the technology underlying our anti-virus products
and services from Network Associates and we are therefore dependent on the
continued quality and availability of Network Associates' anti-virus technology.
COMPETITION FROM OTHER VENDORS MAY RENDER OUR PRODUCTS OBSOLETE OR LEAD TO
REDUCED SALES OF OUR PRODUCTS OR REDUCED MARKET SHARE
Vendors of hardware and of operating system software or other software,
such as e-mail software, may enhance their products or bundle separate products
to include PC security and management software similar to our products. This
competition from vendors and their widespread inclusion of products that perform
some of the same or similar functions as our products within computer hardware
or other software, such as those offered by our current competitors Dell and
Microsoft, could render our products duplicative or obsolete and result in
reduced sales and market share. Even if these incorporated products are inferior
or more limited than our products, consumers may nevertheless believe that the
incorporated products eliminate the need to purchase our products separately. If
we are unable, either directly or indirectly through Network Associates, to
develop new PC security and management products to further enhance operating
systems or other software and to successfully replace any obsolete products, our
business would suffer.
IF OUR PRODUCTS AND SERVICES ARE NOT EFFECTIVE, OUR REPUTATION AND BUSINESS MAY
BE HARMED AND CONSUMERS MAY MAKE PRODUCT LIABILITY CLAIMS AGAINST US
Our PC security and management software products and services are used to
protect and manage PCs. If these products and services are not effective, our
reputation will be harmed and demand for our products and services could
decrease, which would materially adversely affect our business. As a result, we
could face potential product liability and related claims. Our anti-virus
products and services may fail to effectively detect and respond to existing or
newly developed computer viruses. In addition, our anti-virus technology may
cause
27
<PAGE> 30
a "false alarm" by detecting viruses that do not actually exist. Our PC
management services may not perform effectively, causing a consumer to
accidentally lose or delete a file and other data. Any of the foregoing events
could harm our reputation and our business and could lead to claims against us.
This risk is especially acute for anti-virus software because of the rate at
which new viruses are introduced, the challenges involved in widely distributing
software updates before customers have been infected by new viruses, and the
severity of the harm that consumers may suffer as a result of viruses. Because
we license the technology underlying our anti-virus products and services from
Network Associates, the quality of these products and services depends on
Network Associates' research and development efforts. We seek to limit our
exposure to potential product liability claims through limitation of liability
provisions in our electronic and shrink wrap licenses and through disclaimers.
However, these measures, particularly those involving unsigned licenses, may not
be effective under the laws of some jurisdictions.
WE MAY BE INVOLVED IN LEGAL PROCEEDINGS AND LITIGATION ARISING IN THE ORDINARY
COURSE OF BUSINESS
The Company's principal assets are its intellectual property, and the
Company competes in an increasingly competitive market. There has been
substantial litigation regarding intellectual property rights of technology
companies. The Company currently is subject to litigation related to its
intellectual property. There can be no assurance that developments will not
arise out of such pending litigation or any other litigation to which the
Company may become party, which could have a material adverse effect on the
Company's business, financial condition and results of operation.
On August 1, 2000, Simple.com ("Simple") filed a complaint against the
Company alleging that the Company misappropriated Simple's trade secrets and
infringed Simple's copyrights in certain software code. The complaint includes
seven claims for relief: copyright infringement; breach of contract;
misappropriation of trade secrets; statutory unfair competition; common-law
unfair competition; conversion; and breach of the covenant of good faith and
fair dealing. The complaint seeks preliminary and permanent injunctive relief
preventing the Company from using the information that the Company allegedly
acquired from Simple. The complaint also seeks compensatory damages in an amount
alleged to be not less than $18 million, plus interest. The complaint also seeks
statutory, exemplary and punitive damages as well as recovery for unjust
enrichment. The Company answered the complaint on August 30, 2000, denying all
the material allegations in the complaint and asserting affirmative defenses. No
discovery has occurred to date. The Company has agreed to pursue non-binding
mediation once discovery is substantially complete.
Although the Company intends to defend itself vigorously against the claims
asserted against it in the foregoing actions or matters, there can be no
assurance that such pending litigation will not have a material adverse effect
on the Company's business, financial condition or operating results. The
litigation process is subject to inherent uncertainties and no assurance can be
given that the Company will prevail in any such matters, or will be able to
obtain licenses, on commercially reasonable terms, or at all, under any patents
or other intellectual property rights that may be held valid or infringed by the
Company or its products. Uncertainties inherent in the litigation process
involve, among other things, the complexity of the technologies involved,
potentially adverse changes in the law and discovery of facts unfavorable to the
Company.
IF MICROSOFT TECHNOLOGY FAILS TO MAINTAIN ITS MARKET SHARE OUR BUSINESS WILL BE
ADVERSELY AFFECTED
Currently, our online services are designed exclusively for PCs running
Microsoft's Windows 95, Windows 98, Windows 2000 and Windows NT operating
systems. For our web browser interface, we utilize Microsoft's Internet Explorer
technology. We do not support Netscape browser technology except through use of
specialized software, commonly referred to as "plug-ins," that must be
downloaded over the Internet, a potentially time-consuming and complicated
process. For such plug-ins to work, Microsoft's Internet Explorer must reside on
the user's PC. If Microsoft's technology fails to continue to be broadly
accepted by consumers, or if consumers migrate to other technologies that we do
not support, our business would be harmed.
28
<PAGE> 31
OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND TO COMPETE WE MUST
CONTINUALLY ADAPT TO THESE CHANGES AND INTRODUCE NEW PRODUCTS AND SERVICES THAT
ACHIEVE BROAD MARKET ACCEPTANCE
The market for Internet products and services is subject to rapid
technological developments, evolving industry standards and consumer demands,
and frequent new product introductions and enhancements. To remain competitive,
we must continue to enhance and improve the ease of use, responsiveness,
functionality and features of our web site. These efforts may require us to
internally develop increasingly complex technologies or license them from either
Network Associates or other parties. Developing and integrating new products,
services or technologies into our web site could be expensive and
time-consuming. Any new features, functions or services may not achieve market
acceptance or enhance our brand loyalty. If we fail to develop and introduce or
acquire new features, functions or services effectively on a timely basis, we
may be unable to continue to attract new users or to retain our existing users.
Furthermore, we may not succeed in incorporating new Internet technologies, or
to do so, we may incur substantial expenses. We must also work through our
strategic relationships to expand and enhance the content on our web site.
COMPETITION FROM OTHER COMPANIES THAT OFFER PC SECURITY AND MANAGEMENT SERVICES
COULD REDUCE OUR NET REVENUE AND MARKET SHARE
A large number of Internet companies compete for users, advertisers,
e-commerce transactions and other sources of online revenue. The market for PC
security and management products is intensely competitive and we expect
competition to increase in the near-term. Competitive factors affecting our
market include:
- relatively low barriers to entry, allowing current and new competitors to
launch new Internet sites at a relatively low cost using commercially
available software;
- the ability of some of our present and future competitors to offer their
products and services for free;
- new technologies that may increase competitive pressures by enabling our
competitors to offer lower-cost services; and
- web-based applications that direct Internet traffic to web sites and
users to computer management services that compete with ours.
Increased competition could result in price reductions, diminished market
share and loss of subscribers, which could materially harm our business. We
believe that competition for consumers of PC security and management services
will continue to increase as the Internet grows as a commercial medium and as
consumer ownership of PCs and other Internet access devices becomes more
widespread. To respond to changes in the competitive environment, we may, from
time to time, make pricing, service or marketing decisions or acquisitions that
could harm our business.
In the market for anti-virus software products, we compete primarily
against Symantec and Trend Micro Systems, which offer software licenses to
anti-virus software products, including boxed products sold through retail store
channels. In the market for hosted PC security and management solutions, we also
compete primarily against Symantec and Trend Micro Systems, as well as other PC
utility vendors. In particular, Symantec and Trend Micro Systems both offer
online anti-virus services. Symantec has recently introduced a set of online
security services in addition to its anti-virus service that may begin to
compete with and dilute the market share of our services. In the future, we may
also compete against PC and system vendors such as Dell, Compaq, IBM, Gateway
and Intel that may seek to provide a higher level of support and service to
their customers. In particular, Dell has announced an online customer support
initiative that includes online PC management services. Operating system and
application vendors such as Microsoft provide or plan to provide hosted services
to better manage Windows-based PCs. Online PC content sites such as CNET and
ZDNet provide or have announced their intention to provide hosted services to
enhance their web sites. We are also aware of smaller entrepreneurial companies
that are focusing significant resources on developing and marketing these
services to consumers.
In the market for e-commerce, we compete primarily with established online
retailers such as Beyond.com, Gigabuys.com, Outpost.com and PC-related content
sites such as CNET and ZDNet. We also
29
<PAGE> 32
compete with online comparative shopping services and advertising space provided
by major Internet sites such as America Online, Yahoo!, Amazon.com, Lycos,
MSN.com and Excite. Some current and many potential competitors have longer
operating histories, larger customer bases and greater brand recognition in
other business and Internet markets than we do. Some of these competitors also
have significantly greater financial, marketing, technical and other resources.
Other online computer management services may be acquired by, receive
investments from or enter into commercial relationships with larger, more
established and better financed companies. As a result, some of our competitors
may be able to devote more resources to marketing and promotional campaigns,
adopt more aggressive pricing policies and devote substantially more resources
to web site and systems development than we are able to provide. Increased
competition may result in reduced operating margins, loss of market share and
diminished value of our brand.
OUR INTENDED EXPANSION INTO INTERNATIONAL MARKETS COULD EXPOSE US TO RELATED
RISKS THAT COULD HARM OUR BUSINESS
We currently are expanding our operations outside the United States. To
expand our business, we intend to continue to develop subscriber relationships
with users outside of the United States. Expansion of our business to
international consumers poses significant challenges, including the creation of
non-English language or localized versions of our web site. Conducting business
outside of the United States is subject to additional risks, including:
- difficulties related to online payment processing, including foreign
currency issues and transacting with consumers who do not have credit
cards;
- currency fluctuations;
- providing customer support in local languages and time zones;
- the burden of complying with foreign laws, including uncertain and
evolving privacy and consumer protection laws of Europe, which may
include restrictions on e-mail marketing;
- difficulties in securing an international provider of fulfillment
services for shrink-wrapped software; and
- political or economic instability or constraints on international trade.
Any of the foregoing factors could adversely affect our future
international operations, and as a result, harm our business and financial
results.
WE MAY FACE LIABILITY RELATING TO CONTENT ON, OR PRODUCTS AND SERVICES SOLD
FROM, OUR WEB SITE
Our web site provides third-party content and links to other web sites. We
could be exposed to claims related to copyright or trademark infringement,
errors or omissions or other wrongful acts by the third parties whose content we
provide or whose web sites are linked with ours. We enter into agreements with
purchase of products or services through direct or indirect links to or from our
web site. These arrangements may expose us to additional legal risks and
uncertainties, including government regulation and potential liabilities to
consumers of these products and services, even if we do not provide the products
and services ourselves.
IF WE ARE UNSUCCESSFUL IN PROTECTING OUR INTELLECTUAL PROPERTY AND PROPRIETARY
RIGHTS, WE MAY BE UNABLE TO PREVENT THIRD PARTIES FROM USING THESE RIGHTS AND WE
MAY LOSE THESE RIGHTS OR BE REQUIRED TO PAY DAMAGES OR ROYALTIES
We regard substantial elements of our web site and the underlying
technology as proprietary. Despite our precautionary measures and those of
Network Associates, it is possible that third parties could copy or otherwise
obtain and use our proprietary information without authorization or develop
similar technology independently, and the intellectual property laws on which we
rely may be ineffective in preventing such unauthorized copying or use.
Other companies may own, obtain or claim trademarks that could prevent,
limit or interfere with our use of the trademark that we use. The McAfee.com web
site address, or domain name, and the McAfee
30
<PAGE> 33
trademark are important to our business and are licensed to us by Network
Associates. If we were to lose the McAfee.com domain name or the use of this
trademark, our business would be harmed and we would need to devote substantial
resources towards developing an independent brand identity. From time to time,
third parties may claim that our products and services infringe upon their
rights. These claims might require us to pay damages or royalties. Any
infringement claims, with or without merit, could lead to costly litigation that
could absorb significant management time and require substantial expenses.
Legal standards relating to the validity, enforceability and scope of
protection of proprietary rights in Internet-related businesses are uncertain
and evolving, and we can give no assurance regarding the future viability or
value of any of our proprietary rights.
WE COULD FACE CLAIMS BY OUR CUSTOMERS FOR INVASION OF PRIVACY
We collect and use data from our customers to process their orders for our
services as well as in the operation of our services and targeting advertising
on our website through our proprietary "Silhouette" profiling technology. This
creates the potential for claims to be made against us based on invasion of
privacy or other legal theories. Although we carry general liability insurance,
our insurance may not cover potential claims of this type or may not be adequate
to indemnify us for all liability that may be imposed.
PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND DELAWARE LAW AND
OUR RELATIONSHIP WITH NETWORK ASSOCIATES MAY DISCOURAGE TAKEOVER ATTEMPTS
Certain provisions of Delaware law and our certificate of incorporation and
bylaws could have the effect of delaying or preventing a third party from
acquiring us, even if a change in control would be beneficial to our
stockholders. For example, we have a classified board of directors whose members
serve staggered three-year terms and are removable only for cause. These
provisions could make it more difficult for a third party to acquire us, even if
doing so would benefit our stockholders. Furthermore, as of September 30, 2000,
Network Associates owned 36,000,000 shares, or 100%, of our outstanding Class B
common stock, with each Class B share entitled to three votes. As a result,
Network Associates will have sufficient voting power to control the direction
and policies of McAfee.com.
WE MAY NEED ADDITIONAL FINANCING TO ACHIEVE OUR BUSINESS OBJECTIVES, AND IF SUCH
FINANCING IS UNAVAILABLE, OUR BUSINESS COULD BE HARMED AND OUR PLANNED EXPANSION
COULD BE LIMITED
We may need to obtain additional financing to fund more rapid expansion, to
expand our marketing activities, to develop new or enhance existing services or
products, to respond to competitive pressures or to acquire complementary
services, businesses or technologies. We may also need to raise funds in the
future to meet our working capital needs. Additional financing may not be
available on terms favorable to us, or at all. If adequate funds are not
available or are not available on acceptable terms, we may be required to lower
our operating expenses by scaling back our operations, such as reducing our
marketing and research and development expenditures.
INTERNET STOCKS HAVE BEEN VOLATILE AND OUR STOCK PRICE MAY FLUCTUATE
SIGNIFICANTLY, AND MAY CAUSE A DECLINE IN THE PRICE OF OUR SHARES
The trading prices of many Internet stocks, including ours, have
experienced extreme price and volume fluctuations. These fluctuations have often
been unrelated or disproportionate to the operating performance of these
companies. During the first nine months of 2000, our closing stock price on the
NASDAQ ranged from a high of $55.50 to a low of $13.375, and the closing price
on October 31, 2000 was $6.875. The trading price of our stock is likely to
remain highly volatile and may be significantly affected by factors including
actual or anticipated fluctuations in our operating results, new products
introduced by us or our competitors, conditions and trends in the software or
e-commerce industries, changes in financial estimates by securities analysts,
general market conditions and other factors. Any negative change in the public
perception of the prospects of Internet or e-commerce companies in general could
also depress our stock price regardless of our business, prospects or operating
results.
31
<PAGE> 34
WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE ACQUISITIONS AND MINORITY
INVESTMENTS
On February 15, 2000 we completed the acquisition of Signal 9 Solutions
Canada, Inc. and on June 14, 2000 we completed the acquisition of a privately
held Delaware company. As part of our growth strategy, we may acquire additional
companies, products and technologies which are complementary to our business or
make investments in complementary companies. These activities involve a number
of risks and we may not realize the expected benefits of these transactions.
The integration of an acquired company or technology involves a complex,
time consuming and expensive process. Following any acquisition, we must operate
as a combined organization utilizing common information communication systems,
operating procedures, financial controls and human resource practices. In order
to successfully integrate Signal 9 and other potential acquisitions, we may need
to, among other things, successfully:
- attract and retain key management and other personnel;
- integrate the acquired products into our suite of product offerings both
from an engineering and a sales and marketing perspective;
- integrate and support preexisting supplier, distribution and customer
relationships;
- coordinate research and development efforts;
- integrate sales forces; and
- consolidate duplicate facilities.
The difficulties of integrating an acquired company may be exacerbated by
the geographic distance between the companies, the complexity of the
technologies and operations being integrated, and the disparate corporate
cultures being combined. Successful acquisitions may be more difficult to
accomplish in the high technology industry than in other industries, and will
require the dedication of our management resources. Management's focus on the
integration of operations may distract attention from our day-to-day business,
and may disrupt key research and development, marketing or sales efforts. In
addition, it is common in the technology industry for aggressive competitors to
attract customers and recruit key employees away from companies during the
integration phase of an acquisition. If we cannot successfully integrate any
potential acquisition, our business could suffer.
Recently, we began making venture and strategic minority investments in
complementary pre-public companies with complementary products, services and
technologies. In September 2000, we made one minority venture investment of $1.0
million. We are currently investigating other strategic minority venture
investments.
Our acquisitions and strategic investments involve a number of risks and we
may not realize the expected benefits of these transactions. We may lose all or
a portion of our investment, particularly in the case of our strategic minority
investments. Our available cash and our securities may be used to acquire
companies or products, or make minority investments which could result in
significant acquisition-related charges to earnings and dilution to our
stockholders. Moreover, if we acquire a company, we may have to incur or assume
that company's liabilities, including liabilities that are unknown at the time
of acquisition, which may result in a material adverse effect on us.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE
NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT
In future periods we will experience significant charges related to the
amortization of purchased technology and goodwill in connection with the
acquisitions of Signal 9 in February 2000 and a privately held Delaware company
in June 2000 accounted for under the purchase method of accounting. In addition,
if we later determine that this purchased technology and goodwill is impaired,
we will be required to take a related non-recurring charge to earnings.
32
<PAGE> 35
INTERNET INDUSTRY RISKS
IF USE OF THE INTERNET DOES NOT CONTINUE TO GROW AND RELIABLY SUPPORT THE
DEMANDS PLACED ON IT BY ELECTRONIC COMMERCE, OUR MARKET AND ABILITY TO ATTRACT
NEW SUBSCRIBERS TO OUR SERVICES WILL BE HARMED AND WE MAY EXPERIENCE LOSS OF
SALES
Our success depends upon continued growth in the use of the Internet as a
medium of commerce. If the Internet develops more slowly than we expect as a
medium of commerce, our business may be seriously harmed. Broad acceptance and
adoption of the Internet by consumers and businesses for our online PC products
and services will only occur if the Internet provides them with more efficient
and cost effective methods of obtaining the products and services offered by
McAfee.com.
GOVERNMENT LEGISLATION AND REGULATION OF THE INTERNET MAY LIMIT THE GROWTH OF
OUR BUSINESS AND OUR ABILITY TO MARKET OUR PRODUCTS AND SERVICES
A number of legislative and regulatory proposals under consideration by
federal, state, local and foreign governmental organizations may lead to laws or
regulations concerning various aspects of the Internet, including online
content, user privacy, direct mail marketing, access charges, liability for
third-party activities and jurisdiction. Additionally, it is uncertain how
existing laws will be applied to the Internet. The adoption of new laws or the
application of existing laws may decrease the growth in the use of the Internet,
which could in turn decrease the usage and demand for our services or materially
increase our cost of doing business.
Some local telephone carriers have asserted that the increasing popularity
and use of the Internet has burdened the existing telecommunications
infrastructure, and that many areas with high Internet use have begun to
experience interruptions in telephone service. These carriers have petitioned
the Federal Communications Commission to impose access fees on Internet service
providers and online service providers. If access fees are imposed, the costs of
communicating on the Internet could increase substantially, potentially slowing
the increasing use of the Internet. This could in turn decrease demand for our
services or materially increase our cost of doing business.
A number of European countries have enacted laws restricting the marketing
of products and services using e-mail. These restrictions could hinder or
restrict the sales and marketing of our products and services in Europe. If
similar restrictions were also adopted in the United States or other countries,
our business would be materially harmed.
CURRENT AND FUTURE LEGISLATION COULD LIMIT OUR ABILITY TO EXPAND OUR CONTEXTUAL
E-COMMERCE SERVICES AND LICENSING EFFORTS
Legislation has recently been enacted in several states restricting the
sending of unsolicited commercial e-mail. The federal government and several
other states are considering, or have considered, similar legislation. Although
the provisions of these current and contemplated laws vary, they generally limit
or prohibit both the transmission of unsolicited commercial e-mails and the use
of forged or fraudulent routing and header information. Some states, including
California, require that unsolicited e-mails include "opt-out" instructions and
that senders of such e-mails honor any "opt-out" requests.
In addition, the European Union's Directive on Data Protection, adopted in
1998, requires that the electronic transfer of personal data take place only to
non-EU countries that provide an adequate level of privacy protection.
Uncertainty over whether the U.S. will be deemed to provide an adequate level of
privacy protection means that we cannot be certain that this EU Directive will
have no impact on our expansion of our contextual e-commerce services,
particularly if we choose to target new market opportunities in Europe. Future
legislation or the application of existing legislation may harm our business.
There is a growing body of laws and regulations applicable to access to or
commerce on the Internet. Due to the increasing popularity and use of the
Internet, it is likely that a growing number of laws and regulations will be
adopted at the international, federal, state and local level relating to the
Internet or e-commerce services covering issues such as user privacy, pricing,
content, copyrights, distribution, antitrust and characteristics and quality of
services. Further, the growth and development of the market for e-commerce
33
<PAGE> 36
may prompt calls for more stringent consumer protection laws that may impose
additional burdens on those companies conducting business online. The adoption
of any additional laws or regulations may impair the growth of the Internet or
e-commerce. In turn, the adoption of these laws and regulations could increase
our cost of doing business because we currently rely on direct targeted e-mail
campaigns as an element of our marketing and sales strategy. Moreover, the
applicability to the Internet of existing laws in various jurisdictions
governing issues such as property ownership, sales and other taxes, libel and
personal privacy is uncertain and may take years to resolve. Any such new
legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business or the
application of existing laws and regulations to the Internet could harm our
business.
TAXATION OF INTERNET TRANSACTIONS COULD SLOW THE GROWTH OF E-COMMERCE AND HARM
OUR BUSINESS
The tax treatment of electronic commerce is currently unsettled. A number
of proposals have been made at the federal, state and local levels and by
various foreign governments to impose taxes on the sale of goods and services
and other e-commerce activities. Recently, the Internet Tax Information Act was
signed into law, placing a three-year moratorium on new state and local taxes on
Internet commerce. However, future laws may impose taxes or other regulations on
e-commerce, which could substantially impair the growth of e-commerce and
materially and adversely affect our business.
IF THE MARKET FOR WEB ADVERTISING DEVELOPS MORE SLOWLY THAN EXPECTED, OUR
BUSINESS MAY BE ADVERSELY AFFECTED
Our ability to generate advertising revenues from selling banner
advertisements, contextual advertisements and sponsorships on our web site will
depend on, among other factors, the continued development of the Internet as an
advertising medium, the amount of traffic to our web site and our ability to
achieve and demonstrate user demographic characteristics that are attractive to
advertisers. Most potential advertisers and their advertising agencies have only
limited experience with the Internet as an advertising medium and have not
devoted a significant portion of their advertising expenditures to
Internet-based advertising. No standards have been widely accepted to measure
the effectiveness of web advertising. If these standards do not develop,
existing advertisers might reduce their current levels of Internet advertising
or eliminate their spending entirely. The widespread adoption of technologies
that permit Internet users to selectively block out unwanted graphics, including
advertisements attached to web pages, could also adversely affect the growth of
the Internet as an advertising medium. Furthermore, advertisers have
traditionally relied upon advertising media other than the Internet, such as
newsprint and magazines, and have invested substantial resources in these other
advertising methods. Therefore, advertisers may be reluctant to adopt a new
strategy and advertise on the Internet.
IF THE INTERNET INFRASTRUCTURE DOES NOT CONTINUE TO DEVELOP, THE GROWTH OF OUR
BUSINESS MAY BE ADVERSELY AFFECTED
The recent growth in Internet traffic has caused episodes of diminished
performance, requiring Internet service providers and users of the Internet to
upgrade their infrastructures. Our ability to maintain and increase the speed
with which we provide services to consumers and to increase the scope of these
services is limited by and dependent upon the speed and reliability of the
Internet. Consequently, the emergence and growth of the market for our services
is dependent on the performance of and future improvements to the Internet.
IF OUR INTERNAL NETWORK INFRASTRUCTURE IS DISRUPTED BY COMPUTER HACKERS OR BY
OTHER OCCURRENCES, OUR BUSINESS MAY BE ADVERSELY AFFECTED
Our operations depend upon our ability to maintain and protect our computer
systems, most of which are located in Santa Clara, California. We also contract
with a third party to maintain a fully redundant computer system to prevent
disruption of our operations in the event of a system failure in our Santa Clara
facility. Given our high profile in the security software market, we are an
attractive target for skilled computer users commonly referred to as "hackers"
who attempt to gain unauthorized access to computers or computer networks. In
the past, we have been a target of hackers who have, among other things,
attempted to penetrate our network security or created viruses to sabotage or
otherwise attack our web site. While to date these efforts
34
<PAGE> 37
have been discovered quickly and their adverse impact has been limited, similar
efforts or viruses may be created or replicated in the future. In this event,
our web site or users' computer systems could be damaged and, as a result,
demand for our software products may suffer. In addition, we could be subject to
denial of service attacks, a type of Internet attack that bombards a web site
with information requests, eventually causing the web site to overload, delaying
or disrupting service. Our relationships with our subscribers and customers may
be adversely affected if the security measures that we use to protect their
personal information, such as credit card numbers, are not effective, causing
our revenues to decrease and our business to suffer. We might be required to
expend significant capital and resources to protect against, or to alleviate,
problems caused by hackers. In addition to purposeful security breaches, the
inadvertent transmission of computer viruses could expose us to litigation or
harm our reputation.
We have not experienced any material outages to date. However, our systems
are vulnerable to damage from break-ins, unauthorized access, vandalism, fire,
floods, earthquakes, power loss, telecommunications failures and similar events.
Although we maintain insurance against fires, floods and general business
interruptions, the amount of coverage may not be adequate in any particular
case.
35
<PAGE> 38
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information with respect to this item is incorporated by reference to Note
8 of the Notes to the Condensed Consolidated Financial Statements included
herein on page 10 of this Report on Form 10-Q.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On December 1, 1999, a registration statement on Form S-1 (No. 333-87609)
was declared effective by the SEC, pursuant to which 7,187,500 shares of the
Company's common stock were offered and sold for the account of the Company at a
price of $12.00 per share, generating gross offering proceeds of $86.3 million.
The managing underwriters were Morgan Stanley Dean Witter, Hambrecht & Quist and
Robertson Stephens. In connection with the offering, the Company incurred $6.0
million in underwriting discounts and commissions, and approximately $1.3
million in other related expenses. The net proceeds from the offering, after
deducting the foregoing expenses, were approximately $78.9 million. McAfee.com
has used a portion of the net proceeds of the offering to fund working capital
and sales and marketing expenditure and to acquire Signal 9 Solutions in
February 2000 and a privately held Delaware company in June 2000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The exhibits listed in the accompanying Exhibit Index are
filed or incorporated by reference as part of this Report.
(b) The Company filed no reports on Form 8-K during the three months ended
September 30, 2000.
36
<PAGE> 39
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, and
the results and regulations promulgated thereunder, the registrant has duly
caused this amended report to be signed on its behalf by the undersigned
thereunto duly authorized.
MCAFEE.COM CORPORATION
By: /s/ EVAN COLLINS
------------------------------------
Evan Collins
Vice President Administration,
Chief Financial Officer and
Secretary
Date: November 13, 2000
37
<PAGE> 40
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
----------- ------------- --------
<C> <S> <C>
3.2 Amended and Restated Certificate of Incorporation of
McAfee.com Corporation, dated December 2, 1999(1)...........
10.1 Form of Indemnification Agreement between the Company and
each of its directors and officers(1).......................
10.2 1999 Amended and Restated Stock Plan and form of agreements
thereunder(1)...............................................
10.3 1999 Director Option Plan and form of agreements
thereunder(1)...............................................
10.4 1999 Employee Stock Purchase Plan and form of agreements
thereunder(1)...............................................
10.5 Corporate Management Services Agreement between the Company
and Networks Associates, Inc., dated as of January 1,
1999(1).....................................................
10.6 Technology Cross License Agreement between McAfee.com and
Networks Associates, Inc., dated as of January 1, 1999(1)...
10.7 Registration Rights Agreement between McAfee.com and
Networks Associates, Inc., dated as of January 1, 1999(1)...
10.8 Asset Contribution and Receivables Settlement Agreement
between McAfee.com and Networks Associates, Inc., dated as
of January 1, 1999(1).......................................
10.9 Intercompany Revolving Loan Agreement between McAfee.com and
Networks Associates, Inc., dated as of January 1, 1999(1)...
10.10 Tax Sharing Agreement between McAfee.com and Networks
Associates, Inc., dated as of January 1, 1999(1)............
10.11 Indemnification and Voting Agreement between McAfee.com and
Networks Associates, Inc. dated August 20, 1999(1)..........
10.12 Joint Cooperation and Master Services Agreement between
McAfee.com and Networks Associates, Inc. dated as of January
1, 1999(1)..................................................
10.13 Amended and Restated Electronic Software Reseller/Web
SiteServices Agreement between Beyond.com Corporation and
McAfee.com, dated as of May 17, 1999(1).....................
10.14 Stockholders Agreement between McAfee.com and Network
Associates, Inc., dated as of October 31, 1999(1)...........
10.15 Lease Agreement dated February 14, 2000 for facility at 535
Oakmead Parkway, Sunnyvale, California by and between RNM
535 Oakmead L.P.(2).........................................
10.16 Master OEM Distributor Agreement between McAfee.com and
Network Associates K.K.(3)..................................
10.17 Change in Control Agreement dated July 14, 2000, between
McAfee.com and Srivats Sampath(4)...........................
10.18 Change in Control Agreement dated July 14, 2000, between
McAfee.com and Evan Collins(4)..............................
10.19 Amendment No. 1 to the Amended and Restated Electronic
Software Reseller/ Web SiteServices Agreement between
Beyond.com Corporation and McAfee.com, dated as of May 17,
2000(4).....................................................
27.1 Financial Data Schedule.....................................
</TABLE>
---------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 filed with the Commission on December 2, 1999.
(2) Incorporated by reference from the Registrant's Current Report on Form 10-K
filed with the Commission on March 29, 2000.
38
<PAGE> 41
(3) Incorporated by reference from the Registrant's Current Report on Form 10-Q
filed with the Commission on May 8, 2000.
(4) Incorporated by reference from the Registrant's Current Report on Form 10-Q
filed with the Commission on August 11, 2000.
39
