UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from _______ to _______
COMMISSION FILE NUMBER 0-20558
------------------------
NETWORKS ASSOCIATES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0316593
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
------------------------
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)
------------------------
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 [ ]
116,575,046 shares of the registrant's common stock, $0.01 par value, were
outstanding as of July 31, 1998.
================================================================================
NETWORKS ASSOCIATES, INC.
FORM 10-Q, JUNE 30, 1998
------------------------
CONTENTS
ITEM NUMBER
-----------
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets:
June 30, 1998 and December 31, 1997.....................
Condensed Consolidated Statements of Operations:
Three and six months ended June 30, 1998 and 1997.......
Condensed Consolidated Statements of Cash Flows:
Three months ended June 30, 1998 and 1997...............
Notes to Condensed Consolidated Financial
Statements..............................................
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings.............................................
ITEM 2. Changes in Securities.........................................
ITEM 4. Submission of Matters to a Vote of Security Holders...........
ITEM 6. Exhibits and Reports om Form 8-K..............................
SIGNATURES.............................................................
EXHIBIT INDEX..........................................................
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................... $101,634 $124,784
Marketable securities............................. 451,794 151,042
Accounts receivable, net of allowances for
doubtful accounts and returns of $6,086 and
$3,662 at June 30, 1998 and December 31, 1997.... 175,010 136,650
Prepaid expenses, taxes and other................. 52,228 62,738
----------- -----------
Total current assets........................ 780,666 475,214
Marketable securities............................... 122,438 109,184
Fixed assets, net................................... 49,238 36,731
Deferred taxes...................................... 70,276 16,173
Intangibles and other assets........................ 61,323 18,397
----------- -----------
Total assets................................ $1,083,941 $655,699
=========== ===========
LIABILITIES
Current liabilities:
Accounts payable.................................. 34,084 19,007
Accrued liabilities............................... 101,402 147,598
Deferred taxes.................................... 31,023 --
Deferred revenue.................................. 82,132 72,911
Long-term debt, current portion................... 3,769 153
----------- -----------
Total current liabilities................... 252,410 239,669
Deferred taxes, less current portion.............. 16,634 2,117
Deferred revenue, less current portion............ 30,183 11,069
Long-term debt and other liabilities.............. 356,460 2,352
----------- -----------
Total liabilities........................... 655,687 255,207
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; authorized:
5,000,000 shares -- --
Common stock, $.01 par value; authorized:
450,000,000 shares; issued and outstanding:
115,807,784 shares at June 30, 1998 and
111,294,113 shares at December 31, 1997........... 1,158 1,116
Additional paid-in capital.......................... 333,607 241,171
Retained earnings................................... 93,489 158,205
----------- -----------
Total stockholders' equity.................. 428,254 400,492
----------- -----------
Total liabilities and stockholders' equity.. $1,083,941 $655,699
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenue....................... $212,454 $152,780 $408,785 $301,260
Operating costs and expenses:
Cost of net revenue............. 38,939 25,595 75,763 52,640
Research and development........ 27,614 23,257 55,125 43,253
Marketing and sales............. 58,685 48,102 124,500 91,671
General and administrative...... 12,437 14,520 23,609 28,151
Amortization of intangibles..... 2,756 213 3,548 317
Acquisition and other related
costs......................... 150,910 -- 150,910 19,504
---------- ---------- ---------- ----------
Total operating costs and
expenses................... 291,341 111,687 433,455 235,536
---------- ---------- ---------- ----------
Income (loss) from
operations................. (78,887) 41,093 (24,670) 65,724
Interest and other income and
expense, net.................... 3,275 5,060 8,382 8,403
---------- ---------- ---------- ----------
Income (loss) before
provision for income taxes. (75,612) 46,153 (16,288) 74,127
Provision for income taxes........ 25,569 17,380 49,034 34,355
---------- ---------- ---------- ----------
Net income (loss)............ ($101,181) $28,773 ($65,322) $39,772
========== ========== ========== ==========
Net income (loss) per share --
basic........................... ($0.87) $0.26 ($0.57) $0.36
========== ========== ========== ==========
Shares used in per share
calculation -- basic............ 115,690 109,335 115,098 111,920
========== ========== ========== ==========
Net income (loss) per share --
diluted......................... ($0.87) $0.25 ($0.57) $0.35
========== ========== ========== ==========
Shares used in per share
calculation -- diluted.......... 115,690 115,155 115,098 115,236
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... ($65,322) $39,772
Adjustments to reconcile net income to net cash provided
from operating activities:
Acquired in-process research and development......... 97,001 19,504
Depreciation and amortization........................ 15,288 10,402
Interest on convertible notes........................ 6,609 --
Unrealized gain on investments....................... (157) (693)
Deferred taxes....................................... 20,116 (2,348)
Changes in assets and liabilities:
Accounts receivable................................ (37,367) (27,883)
Prepaid expenses, taxes and other.................. (22,939) 4,819
Accounts payable and accrued liabilities........... (31,118) 10,674
Deferred revenue................................... 28,335 12,847
Other.............................................. 730 (197)
----------- -----------
Net cash provided by operating activities....... 11,176 66,897
----------- -----------
Cash flows from investing activities:
Purchase of intangibles................................. 1,036 --
Purchases of investment securities, net................. (312,767) (16,687)
Additions to fixed assets............................... (24,145) (21,623)
Acquisition of Magic Solutions, Inc. ................... (136,843) --
Acquisition of Compusul................................. -- (2,709)
Acquisition of 3DV Technology, Inc. .................... -- (20,000)
Acquisition of Secure Networks, Inc. ................... 8,497 --
----------- -----------
Net cash used in investing activities........... (464,222) (61,019)
----------- -----------
Cash flows from financing activities:
Effect of exchange rate fluctuations.................... (2,390) (534)
Issuance of common stock................................ 2,248 11
Repayments of notes payable............................. -- (90)
Sale of convertible debentures.......................... 346,284 50
Stock option exercises.................................. 60,231 25,444
Tax benefit from exercise of nonqualified stock options. 23,191 24,898
Exercise of warrant..................................... 332 --
Repurchase of common stock.............................. -- (28,102)
----------- -----------
Net cash provided by financing activities....... 429,896 21,677
----------- -----------
Net increase in cash and cash equivalents................. (23,150) 27,555
Cash and cash equivalents at beginning of period.......... 124,784 120,450
----------- -----------
Cash and cash equivalents at end of period................ $101,634 $148,005
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE>
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation:
The accompanying 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 results of operations for
the three and six month periods ended June 30, 1998 are not necessarily
indicative of the results to be expected for the full year or for any
future periods. The accompanying consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements contained in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission on February 17, 1998. The
balance sheet at December 31, 1997 has been derived from the audited
financial statements as of and for the year ended December 31, 1997, but
does not include all the information and footnotes required by generally
accepted accounting principles for complete financial statements.
2. Recent Accounting Pronouncements
In October 1997, the AICPA issued Statement of Position No. 97-2
("SOP 97-2") "Software Revenue Recognition," which the Company has
adopted for transactions entered into during the year beginning January
1, 1998. SOP 97-2 provides guidance for recognizing revenue on software
transactions and supersedes previous guidance provided by SOP 91-1,
"Software Revenue Recognition." Under SOP 97-2, revenue from product
licenses is recognized when a signed agreement or other persuasive
evidence of an arrangement exists, the software or system has been
shipped (or software has been electronically delivered), the license fee
is fixed and determinable, and collection of the resulting receivable is
probable. For contracts with multiple elements/obligations, (e.g.
software products, upgrades/enhancements, maintenance and services),
revenue is allocated to each element of the arrangement based on the
Company's evidence of fair value as determined by the amount charged
when the element is sold separately. Maintenance revenue for providing
product updates and customer support is deferred and recognized ratably
over the service period. Revenue on rental units under operating leases
and service agreements is recognized over the term of the rental
agreement or the period during which services are expected to be
performed. Revenue generated from products sold through traditional
channels where the right of return exists is reduced by reserves for
estimated sales returns.
In March 1998, the AICPA issued Statement of Position No. 98-4 ("SOP
98-4"), "Deferral of the Effective Date of a Provision of SOP 97-2,
Software Revenue Recognition." SOP 98-4 defers, for one year, the
application of certain passages in SOP 97-2, which limit what is
considered vendor-specific objective evidence ("VSOE") necessary to
recognize revenue for software licenses in multiple-element arrangements
when undelivered elements exist. Additional guidance is expected prior
to adoption of any resulting final amendments related to the deferred
provisions of SOP 97-2. Because of the uncertainties related to the
outcome of these proceedings, the impact, if any, on future financial
results of the Company is not currently determinable. Adoption of the
remaining provisions of SOP 97-2, as amended, did not have a material
impact on revenue recognition during the first or second quarters of
1998.
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income,"
effective January 1, 1998. This statement requires the disclosure of
comprehensive income and its components in a full set of general-purpose
financial statements. Comprehensive income is defined as net income plus
revenues, expenses, gains and losses that, under generally accepted
accounting principles, are excluded from net income. The components of
comprehensive income, which are excluded from net income, are not
significant individually or in aggregate, and therefore, no separate
statement of comprehensive income has been presented.
In July 1997, the Financial Accounting Standards Board issued
Statement of Accounting Standards No. 131 (SFAS 131), "Disclosures about
Segments of an Enterprise and Related Information", which requires
companies to report certain information about operating segments,
including certain information about their products, services, the
geographic areas in which they operate and their major customers. This
statement supersedes FASB Statements Nos. 14, 18, 24 and 30. SFAS 131 is
effective for financial statements for fiscal years beginning after
December 15, 1997. The Company is evaluating the requirements of SFAS
131 and the effects, if any, on the Company's current reporting and
disclosures.
In June 1998, the Financial Accounting Standards Board issued
Statement of Accounting Standards No. 133 (SFAS 133), "Accounting for
Derivative Instruments and Hedging Activities". SFAS 133 requires the
Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through
net income. If the derivative is a hedge, depending on the nature of
the hedge, changes in the fair value of the derivative are either offset
against the change in fair value of assets, liabilities, or firm
commitments through earnings or recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective
portion of a derivative's change in fair value will be immediately
recognized in earnings. SFAS 133 is effective for years beginning after
June 15, 1999, but companies can early adopt as of the beginning of any
fiscal quarter that begins after June 1998. The Company is evaluating
the requirements of SFAS 133, but does not expect this pronouncement to
materially impact the Company's results of operations.
3. NET INCOME PER SHARE
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted net income
per share calculations is provided as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator -- basic
Net income (loss)................. ($101,181) $28,773 ($65,322) $39,772
========== ========== ========== ==========
========== ========== ========== ==========
Numerator -- diluted
Net income (loss)................. ($101,181) $28,773 ($65,322) $39,772
Interest on convertible
debentures, net of tax.......... -- -- -- --
---------- ---------- ---------- ----------
Net income (loss) available
to common stockholders.......... ($101,181) $28,773 ($65,322) $39,772
========== ========== ========== ==========
========== ========== ========== ==========
Denominator -- basic
Basic weighted average common
shares outstanding.............. 115,690 109,335 115,098 111,920
========== ========== ========== ==========
Denominator -- diluted
Basic weighted average common
shares outstanding.............. 115,690 109,335 115,098 111,920
Effect of dilutive securities:
Common stock options.............. -- 5,820 -- 3,316
---------- ---------- ---------- ----------
Diluted weighted average shares... 115,690 115,155 115,098 115,236
========== ========== ========== ==========
========== ========== ========== ==========
Net income (loss) per share --
basic........................... ($0.87) $0.26 ($0.57) $0.36
========== ========== ========== ==========
Net income (loss) per share --
diluted......................... ($0.87) $0.25 ($0.57) $0.35
========== ========== ========== ==========
</TABLE>
4. Acquisitions
Secure Networks, Inc.
On May 15, 1998, the Company acquired Secure Networks, Inc.
("Secure"). The aggregate consideration payable in the acquisition was
567,000 shares of the Company's Common Stock in a transaction accounted
for as a pooling of interests. Secure is a developer and licensor of
network security auditing software based in Canada.
Trusted Information Systems
On April 28, 1998, the Company acquired Trusted Information Systems
("TIS"), a publicly-held provider of comprehensive security systems for
computer networks. In the acquisition, a wholly owned subsidiary of the
Company merged with and into TIS; TIS became a wholly owned subsidiary
of the Company; and all outstanding common stock of TIS was converted
into approximately 6.8 million shares of Common Stock of the Company, at
an exchange ratio of 0.4845. The Company also assumed all outstanding
options and other rights to acquire TIS capital stock.
This transaction was accounted for as a pooling of interests.
Financial statements for the three months ended March 31, 1998 and the
year ended December 31, 1997 have been restated to include the results
of TIS. The results for periods prior to January 1, 1997 have not been
restated as the effect was immaterial. The opening retained earnings
for the year ended December 31, 1997 have been restated to reflect the
results of TIS prior to January 1, 1997. Separate and combined results
of operations the three months ended March 31, 1998 and for the year
ended December 31, 1997 are as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Three
Months
Ended Year Ended
March 31, December 31,
1998 1997
---------- ------------
<S> <C> <C>
Revenues:
Networks Associates.......... $188,415 $612,193
TIS.......................... 7,917 35,666
---------- ------------
Combined..................... $196,332 $647,859
========== ============
Net income (loss):
Networks Associates.......... $41,582 ($28,356)
TIS.......................... (5,722) (8,564)
---------- ------------
Combined..................... $35,860 ($36,920)
========== ============
Net income (loss) per share --
diluted:
Networks Associates.......... $0.37 ($0.27)
========== ============
TIS.......................... ($0.76) ($1.31)
========== ============
Combined..................... $0.30 ($0.34)
========== ============
</TABLE>
Magic Solutions International, Inc.
On April 1, 1998, the Company acquired all of the outstanding capital
stock and options of Magic Solutions International, Inc. ("Magic
Solutions"), a privately held provider of internal help desk and asset
management solutions, for approximately $110 million in cash. The
acquisition was accounted for using the purchase method of accounting
and approximately $97 million was expensed as purchased in-process
research and development. The remaining excess of the purchase price,
including transaction costs, over the net assets acquired was $26.7
million of which, $18.8 million has been recorded as purchased
technology and trademarks and $7.9 million as goodwill which are being
amortized on a straight-line basis over 5 and 7 years, respectively.
5. Stock Dividend
On April 30, 1998 the Company declared a 3:2 stock split effected
through a stock dividend, payable to all holders of record of Common
Stock on May 12, 1998, as one share of Common Stock for every two shares
of Common Stock outstanding. The stock dividend was distributed on June
1, 1998. All per share data contained herein (including information as
to the convertibility of the Debentures into Common Stock) has been
restated to reflect the increased number of shares outstanding as a
result of such stock split.
6. Litigation
The Company has changed its legal name to "Networks Associates, Inc."
and has begun conducting business as "Network Associates." Two
companies, (Network Associates, Inc. in Kansas ("NAI-Kansas"); and
Network Associates, Inc. in Oregon ("NAI-Oregon")) and Ronald L. Meyers
("Meyers"), a California resident doing business as The Network
Associates, have made unresolved claims (including various trademark
claims) or demands with respect to the Company's use of the name Network
Associates. On March 26, 1998, the Company commenced a declaratory
judgement action in the United States District Court, Northern District
of California against all three of the above-cited claimants. the
Company seeks a declaration that its use of the NETWORK ASSOCIATES title
does not violate the federal, state or common law rights of any of the
defendants. Defendants NAI-Oregon and NAI-Kansas have since been granted
extensions of time in which to respond to the Complaint; defendant
Meyers has not yet been served. NAI-Kansas has moved to dismiss the
claims against it for lack of personal jurisdiction.
On April 24, 1997, the Company was served by Symantec with a suit
filed in the United States District Court, Northern District of
California, San Jose Division, alleging copyright infringement and
unfair competition by the Company. Symantec alleges that the Company's
computer software program called "PC Medic" copied portions of
Symantec's computer software program entitled "CrashGuard." Symantec's
complaint sought injunctive relief and unspecified money damages. On
July 20, 1997, Symantec sought leave to amend its complaint to include
additional allegations of copyright infringement and trade secret
misappropriation pertaining to the Company's "VirusScan" product.
Symantec sought injunctive relief and unspecified money damages. On
October 6, 1997, the Court issued an order granting Symantec's motion to
amend its complaint and enjoining the Company from shipping any product
containing either an approximately 30-line routine found in Crash Guard
or an approximately 100-line routine found in a Symantec DLL. The
Court's order expressly stated that "the court is not enjoining the sale
or distribution of [McAfee's] current product." On December 19, 1997,
the Court denied Symantec's motion to enjoin sale or distribution of the
Company's current PC Medic product. On April 1, 1998, Symantec filed an
amended complaint including additional allegations of trade secret
misappropriation, unfair competition, interference with economic
advantage and contractual relations and violations of the Racketeer
Influenced and Corrupt Organization Act ("RICO"), in connection with the
alleged use by the Company employees of proprietary Symantec customer
information. On April 10, 1998, the Company moved to dismiss the RICO
claims. Symantec also filed a motion for a preliminary injunction
relating to these new allegations which was scheduled for hearing on
June 5, 1998. Trial is currently set for September 1998.
On June 9, 1998, the Court dismissed Symantec's unfair competition
claim regarding allegations concerning source code with prejudice and
dismissed Symantec's racketeering claim without prejudice. On June 15,
1998, the Court entered a stipulated preliminary injunction prohibiting
the Company from making use of any Symantec customer list data.
On May 13, 1997, Trend Micro, Inc. ("Trend") filed suit in United
States District Court for the Northern District of California against
both the Company and Symantec. Trend alleges that the Company's
"WebShield" and "GroupShield" products infringe a Trend patent which
issued on April 22, 1997. Trend's complaint seeks injunctive relief and
unspecified money damages. On June 6, 1997, the Company filed its answer
denying any infringement. the Company also filed counterclaims against
Trend alleging unfair competition, false advertising, trade libel, and
interference with prospective economic advantage. On September 19, 1997,
Symantec filed a motion to sever Trend's action against the Company from
its action against Symantec. The Company did not oppose Symantec's
motion to sever, other than to recommend a joint hearing on patent claim
interpretation. On December 19, 1997, the Court granted Symantec's
motion to sever and adopted the Company's recommendation regarding a
joint hearing on patent claim interpretation. As a result of the Court's
decision, Trend's actions against the Company and Symantec will proceed
separately. The Court has set the date for the joint patent claim
interpretation hearing for September 1998. Thirty days after the joint
patent claim interpretation hearing, the Court has indicated it will set
further dates for discovery and trial.
On May 6, 1997, RSA Data Security, Inc. ("RSA") filed a lawsuit
against PGP, a wholly owned subsidiary of the Company since December 9,
1997, in San Mateo County Superior Court. RSA seeks a declaration from
the court that certain paragraphs of a license agreement between PGP and
Public Key Partners (the "License Agreement") have been terminated and
certain other paragraphs have survived RSA's purported termination of
the License Agreement. RSA, which purports to act on behalf of Public
Key Partners, also seeks an accounting of PGP's sales of products
subject to the License Agreement. PGP denies that RSA has the authority
to act on behalf of Public Key Partners, and denies that the License
Agreement has been breached or terminated in whole or in part. On May
22, 1997, PGP filed a motion to compel arbitration of the action
pursuant to an Arbitration clause in the License Agreement. PGP's motion
was granted on October 9, 1997. The Court stayed the state court
proceedings and ordered the action to arbitration.
On October 14, 1997, RSA filed a patent infringement lawsuit
against PGP in the United States District Court for the Northern
District of California. RSA alleges PGP has infringed one of the patents
which was licensed to PGP under the License Agreement. On November 4,
1997, PGP moved to stay the federal action, or, in the alternative,
compel it to arbitration. On December 23, 1997, RSA filed a motion to
amend its complaint to include the Company as defendant. On March 2,
1998, the court granted PGP's motion to stay the federal patent action.
On April 15, 1998, RSA filed a patent infringement lawsuit against
the Company in the United States District Court for the Northern
District of California, alleging that the Company has infringed the same
patent as in the earlier lawsuit against PGP. Counsel for RSA has orally
indicated that RSA will stipulate to stay this lawsuit on the same basis
as the prior lawsuit against PGP. On May 13, 1998, RSA filed a copyright
infringement suit in the United States District Court for the Northern
District of California seeking an injunction against Network Associates
and its Trusted Information Systems subsidiary from using certain RSA
software.
All four of the above RSA cases were settled on May 29, 1998, and
were dismissed in June, 1998.
On September 15, 1997, the Company was named as a defendant in a
patent infringement action filed by Hilgraeve Corporation ("Hilgraeve")
in the United States District Court for the Eastern District of
Michigan. Hilgraeve alleges that the Company's VirusScan product
infringes a Hilgraeve patent which was issued on June 7, 1994.
Hilgraeve's action seeks injunctive relief and unspecified money
damages. The case is in discovery. Discovery is presently scheduled to
be completed by December 15, 1998. There is a status conference
scheduled for September 22, 1998. A trial date has been set for June,
1999.
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.
7. Subsequent Events
On August 13, 1998, the Company acquired Dr. Solomon's Group PLC
("Dr Solomon's"), (the "Acquisition"), a European-based publicly-held
provider of anti-virus software products for approximately 15.3 million
shares of the Company's Common Stock (including 1.7 million shares held
in trust pending the exercise of certain outstanding and fully vested Dr
Solomon's options). In the Acquisition, each outstanding ordinary share
of Dr Solomon's was exchanged for 0.27625 shares of Common Stock of the
Company. The Company assumed all outstanding options to acquire Dr
Solomon's ordinary shares.
The acquisition will be accounted for under the pooling of interests
method of accounting. Historical financial data in future reports will
be restated to include Dr Solomon's data. The following unaudited pro
forma summary presents the combined results of operations as if the
Acquisition had been completed on January 1, 1995.
<TABLE>
<CAPTION>
(unaudited pro forma)
(in thousands, except per share data)
Three Months Ended
Year Ended December 31, March 31,
---------------------------------- -------------------
1997 1996 1995 1998 1997
---------- ------------ ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net revenue................... $727,229 $466,069 $302,245 $220,580 $164,393
========== ============ ========== ========= =========
Net income (loss)............. ($36,915) $7,374 $43,203 $39,402 $11,859
========== ============ ========== ========= =========
Net income (loss) per share --
diluted..................... ($0.30) ($0.07) $0.41 $0.30 $0.09
========== ============ ========== ========= =========
</TABLE>
The pro forma summary financial data for the years ended December
31, 1997, 1996 and 1995, reflects the combination of the statements of
operations of the Company for the years ended December 31, 1997, 1996
and 1995 and the aggregation of the unaudited quarterly statements of
operations of Dr Solomon's for the years ended November 31, 1997, 1996
and 1995. The pro forma summary financial data for the three month
periods ended March 31, 1998 and 1997 reflects the combination of the
statements of operations of the Company for the three months ended March
31, 1998 and 1997 and the statements of operations of Dr Solomon's for
the three months ended February 28, 1998 and 1997.
Estimated direct transaction costs of approximately $18 million
associated with the Acquisition, consisting of transaction fees for
investment bankers, attorneys, accountants, financial printing and other
related charges will be charged to operations in the three months ended
September 30, 1998. It is expected that the Company and Dr Solomon's
will incur additional significant charges to operations, which are not
currently reasonably estimable, to reflect the costs associated with
integrating the two companies. This charge has not been reflected in
the pro forma financial data. There can be no assurance that the
combined company will not incur additional charges to reflect costs
associated with the Acquisition or that management will be successful in
its efforts to integrate the two companies.
On July 30, 1998, the Company acquired Anyware Seguridad Informatica,
S.A. ("Anyware"). The aggregate consideration payable in the acquisition
was 228,204 shares of the Company's Common Stock in a transaction
accounted for as a pooling of interests. Anyware is a developer and
distributor of anti-virus software products based in Madrid, Spain. On
June 29, 1998, the Company acquired CSB Consulenza Software di Base
S.r.l. ("CSB"). The aggregate consideration payable in the acquisition
was 9,815 shares of the Company's Common Stock in a transaction
accounted for as a pooling of interests. CSB is a reseller of software
applications and services based in Milan, Italy. The effect of these
two acquisitions is not material.
On July 28, 1998, the Company announced that it had entered into a
definitive merger agreement to acquire CyberMedia, Inc. ("CyberMedia"),
a provider of desktop utility software solutions. Under the terms of
the agreement, a subsidiary of the Company will commence a tender offer
for all outstanding shares of CyberMedia Common Stock at a net price of
$9.50 per share in cash for an aggregate purchase price of approximately
$130 million. Following completion of the tender offer, the Company's
subsidiary will be merged into CyberMedia in a transaction in which any
CyberMedia shares not tendered will be converted into the right to
receive the same per share cash price paid in the tender offer.
Completion of the tender offer is subject to customary conditions,
including the tender of a majority of the CyberMedia shares, receipt of
necessary governmental approvals and the expiration of applicable
waiting periods under the Hart-Scott-Rodino Act. The transaction will
be accounted for as a purchase transaction.
<PAGE>
NETWORKS ASSOCIATES, INC.
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
The Company is a leading developer and provider of network security
and management software products. The Company has historically derived a
significant majority of its revenues from the licensing of its flagship
McAfee anti-virus products and Sniffer network fault and performance
management products. The Company is currently focusing its efforts on
broadening its revenue base by providing network security and management
solutions to enterprise customers, targeting in particular the Windows
NT/Intel platform. In furtherance of this strategy, the Company recently
organized its products into four product suites - McAfee Total Virus
Defense and PGP Total Network Security (together comprising "Net Tools
Secure") and Sniffer Total Network Visibility and McAfee Total Service
Desk (together comprising "Net Tools Manager"). These four product
suites together form an integrated solution called "Net Tools".
The following table depicts the Company's product suites:
NET TOOLS
<TABLE>
<CAPTION>
NET TOOLS SECURE NET TOOLS MANAGER
- --------------------------------------------------------------- ------------------------------------------------------------------
MCAFEE TOTAL VIRUS TOTAL NETWORK SNIFFER TOTAL NETWORK MCAFEE TOTAL SERVICE
DEFENSE (TVD) SECURITY (TNS) VISIBILITY (TNV) DESK (TSD)
- ---------------------------- --------------------------------- ------------------------------------ ----------------------------
<S> <C> <C> <C>
- -- VirusScan Security Suite - PGP Encryption Suite - Sniffer Portable Analysis Suite - McAfee Help Desk Suite
- -- Net Shield Security Suite - Gauntlet Active Firewall Suite - Sniffer Distributed Analysis Suite - Zero Administration Client
- -- Internet Security Suite - CyberCop Intrusion Protection - Sniffer Service Desk Suite Suite
Suite - Self Service Desk Suite
</TABLE>
Net Tools Secure is designed to protect the enterprise from viruses,
hackers, thefts, lost data and threats to data security at all points of
entry. McAfee Total Virus Defense is a multi-tiered approach to virus
protection covering the client, server and Internet gateway; and PGP
Total Network Security combines security products with desktop
encryption software and key management tools. Net Tools Manager is a
network management and service desk solution designed to make computer
networks more efficient and users more productive. Sniffer Total Network
Visibility is a comprehensive set of products and services for network
fault and performance management (also known as analysis and
monitoring); and McAfee Total Service Desk is designed to integrate
robust help desk applications with asset management software. The
Company also provides product support, education and consulting
services.
Many of the Company's network security and management products,
including its industry-leading network security products for anti-virus
protection and Sniffer software-based fault and performance solutions
for managing computer networks, are also available as stand-alone
products or as part of smaller product suites. The Company is also a
leader in electronic software distribution, which is the principal means
by which it markets its products and one of the principal ways it
distributes its software products to its customers. The Company
generally utilizes a two-year subscription model for licensing its non-
Sniffer products to corporate clients and is in the process of
developing a two-year subscription model for licensing its Sniffer
products as well.
The Company's results of operations can fluctuate significantly on a
quarterly basis. Causes of such fluctuations may include the volume and
timing of new orders and renewals, the introduction of new products,
distributor inventory levels and return rates, Company inventory levels,
product upgrades or updates released by the Company or its competitors,
changes in product prices, the impact of competitive pricing or
products, timely availability and acceptance of new products, changes in
product mix, changes in the market for anti-virus or network management
software, inclusion of network security or management software
functionality in system software, failure to manage growth and/or
potential acquisitions, seasonality, trends in the computer industry,
general economic conditions, extraordinary events such as acquisitions
or litigation and the occurrence of unexpected events. Historically,
renewals have accounted for a significant portion of the Company's net
revenue, however, there can be no assurance that the Company will be
able to sustain current renewal rates in the future. In addition,
revenue generated through distribution channels tends to be non-linear
and this may cause the Company's revenue to fluctuate in the future. The
Company's results for any given period should not be relied upon as
indicative of future performance. See "Risk Factors - Variability of
Quarterly Operating Results."
The Company's future earnings and stock price may be subject to
volatility in any period. Any shortfall in various operating results,
including licensing activity, product sales, net revenue, operating
income, net income or net income per share from historical levels or
expectations of securities analysts may have significant adverse effects
on the trading price of the Company's stock. Furthermore, other factors
such as acquisitions or unforeseen events in the technology or software
industry or in the Company's day to day activities can have a material
adverse effect on the Company's stock performance. See "Risk Factors -
Volatility of Stock Price" and "Risk Factors - Risks Associated with
Failure to Manage Growth; Potential Future Acquisitions."
Results of Operations
The following table sets forth, for the periods indicated, the
percentage of net revenue represented by certain items in the Company's
statements of operations for the three months and six months ended June
30, 1998 and 1997:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenue....................... 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Cost of net revenue............. 18.3% 16.8% 18.5% 17.5%
Research and development........ 13.0% 15.2% 13.5% 14.4%
Marketing and sales............. 27.6% 31.5% 30.5% 30.4%
General and administrative...... 5.9% 9.5% 5.7% 9.3%
Amortization of intangibles..... 1.3% 0.1% 0.9% 0.1%
Acquisition and other related
costs......................... 71.0% 0.0% 36.9% 6.5%
---------- ---------- ---------- ----------
Total operating costs and
expenses................... 137.1% 73.1% 106.0% 78.2%
---------- ---------- ---------- ----------
Income (loss) from
operations................. -37.1% 26.9% -6.0% 21.8%
Interest and other income and
expense, net.................... 1.5% 3.3% 2.0% 2.8%
---------- ---------- ---------- ----------
Income (loss) before
provision for income taxes. -35.6% 30.2% -4.0% 24.6%
Provision for income taxes........ 12.0% 11.4% 12.0% 11.4%
---------- ---------- ---------- ----------
Net income (loss)............ -47.6% 18.8% -16.0% 13.2%
========== ========== ========== ==========
</TABLE>
Net Revenue. Net revenue includes product revenues, revenues from
software support, maintenance contracts, education and consulting
services as well as revenues from those warranty, customer support and
maintenance contracts which are deferred and recognized over the related
service period. Net revenue increased 39% to $212.5 million in the three
months ended June 30, 1998 from $152.8 million in the three months ended
June 30, 1997. For the six month period ended June 30, 1998, net revenue
increased 36% to $408.8 million from $301.3 million in the same period
in 1997. The increase in net revenues is due to increases in the
licensing of anti-virus and network security software products to new
customers, renewing expiring anti-virus and network security licenses,
continued acceptance of the Company's Network Visibility and Service
Desk product suites as well as the growth of the installed customer base
and the resulting renewal of maintenance contracts.
Although the Company has had significant growth in net revenue and
net income (before acquisition and other related charges), the Company's
historic growth rate will be difficult to sustain or exceed. The Company
has experienced increased price competition for its products and the
Company expects competition to increase in the near-term, which may
result in reduced average selling prices for the Company's products.*
Due to these and factors such as a maturing anti-virus market and an
increasingly higher base from which to grow, the historic revenue growth
rate will be difficult to sustain or increase.* To the extent these
trends continue, the Company's results of operations could be materially
adversely affected. Renewals have historically accounted for a
significant portion of the Company's net revenue; however, there can be
no assurance that the Company will be able to sustain historic renewal
rates for its products in the future.* Risks related to the Company's
change in business strategies, including its newly introduced suite
pricing model and its development of a two- year subscription licensing
model for the Company's Sniffer products and a software only version of
the Company's Sniffer products, could also cause fluctuations in the
Company's operating results and could make comparisons with historic
operating results and balances difficult.* To more effectively service
its customer's evolving needs, the Company also intends to significantly
expand and develop its worldwide professional service organization. The
Company expects that it will have lower profit margins on its service
revenues relative to licensing revenues.* See "Risk Factors -
Variability of Quarterly Operating Results," "- Risks Related to Certain
Business Strategies" and "- Need to Expand and Develop An Effective
Professional Services Organization; Risks * Related to Third-Party
Professional Services".
International revenue accounted for approximately 31% and 25% of net
revenue for the three months ended June 30, 1998 and 1997, respectively.
For the six month periods ended June 30, 1998 and 1997, the percentage
of net revenue from international licenses was approximately 31% and
26%, respectively. The increase in international net revenue as a
percentage of net revenue was due primarily to increased acceptance of
the Company's products in international markets and the continued
investment in international operations. The Company expects that
international revenue will continue to account for a significant
percentage of net revenue, particularly in light of the recent Dr
Solomon's acquisition. The Company also expects that a significant
portion of such international revenue will be denominated in local
currencies. To reduce the impact of foreign currency fluctuations, the
Company engages in financial risk management activities. However, there
can be no assurance that the Company's future results of operations will
not be adversely affected by such fluctuations or by costs associated
with currency risk management strategies. Other risks inherent in
international revenue generally include the impact of longer payment
cycles, greater difficulty in accounts receivable collection, unexpected
changes in regulatory requirements, seasonality due to the slowdown in
European business activity during the third quarter, tariffs and other
trade barriers, uncertainties relative to regional economic
circumstances (such as the current economic turbulence in Asia),
political instability in emerging markets and difficulties in staffing
and managing foreign operations. There can be no assurance that these
factors will not have a material adverse affect on the Company's future
international license revenue. Further, in countries with a high
incidence of software piracy, the Company may experience a higher rate
of piracy of its products.* There are a number of additional risks
related to the export of the Company's PGP and TIS security products.
Cost of Revenue. Cost of revenue is comprised of cost of product
revenue and cost of services and support revenue. Cost of product
revenue consists primarily of the cost of media, manuals and packaging
for products distributed through traditional channels, royalties and,
with respect to certain Sniffer products, computer platforms and other
hardware components. Cost of services and support revenue consists
principally of salaries and benefits related to employees providing
customer support and consulting and education services. Cost of revenue
increased 52% to $38.9 million in the three months ended June 30, 1998
from $25.6 million in the three months ended June 30, 1997. For the six
months ended June 30, 1998, cost of revenue increased 44% to $75.8
million from $52.6 million for the six months ended June 30, 1997.
These increases are due to an increase in net revenue (particularly
product revenues) as well as the continued investment in the
professional services organization. To the extent that the product mix
fluctuates from quarter to quarter, the cost of revenue will increase or
decrease accordingly.
The Company continued to expand its professional services
organization which is expected to cause the cost of services and support
revenue to increase in absolute dollars and may cause such expenses as a
percentage of net revenue to increase. To the extent that the percentage
of the Company's net revenue which is generated through traditional
distribution channels increases, the Company's cost of net revenue will
increase and, accordingly, gross margins will decrease.* In addition, to
the extent that the Company increases its reliance on retail
distribution (including through the pending CyberMedia acquisition), it
may encounter problems related to product returns and limited shelf
space availability.*
Research and Development. Research and development expenses consist
primarily of salary and benefits for the Company's development and
technical support staff. Research and development expenses increased 19%
to $27.6 million in the three months ended June 30, 1998 from $23.3
million in the three months ended June 30, 1997. For the six months
ended June 30, 1998 research and development expenses increased 27% to
$55.1 million from $43.3 million in the six months ended June 30, 1997.
These increases were primarily a result of the expansion of the
Company's product development and technical support staff. As a
percentage of net revenue, research and development expenses decreased
to 13.0% in the three months ended June 30, 1998 from 15.2% in the three
months ended June 30, 1997 and decreased to 13.5% in the six months
ended June 30, 1998 from 14.4% in the six months ended June 30, 1997.
The Company anticipates that research and development expenses will
continue to increase in absolute dollars, but may fluctuate as a
percentage of net revenue.*
The Company believes that its ability to maintain its competitiveness
will depend in large part upon its ability to enhance existing products,
develop and acquire new products and develop and integrate acquired
products. The market for computer software is characterized by low
barriers to entry and rapid technological change, and is highly
competitive with respect to timely product introductions. The timing and
amount of research and development expenses may vary significantly based
upon the number of new products and significant upgrades under
development and products acquired during a given period.*
Marketing and Sales. Marketing and sales expenses consist primarily
of salary, commissions and benefits for marketing, sales and customer
support personnel and costs associated with advertising and promotions.
Marketing and sales expenses increased 22% to $58.7 million in the three
months ended June 30, 1998 from $48.1 million in the three months ended
June 30, 1997. For the six months ended June 30, 1998 marketing and
sales expenses increased 36% to $124.5 million from $91.7 million in the
six months ended June 30, 1997. This increase was primarily the result
of an increase in marketing and sales personnel and, to a lesser extent,
increased advertising and promotional activities required to support
increased sales volumes and expanding product lines. As a percentage of
net revenue, marketing and sales expense was 27.6% and 31.5% in the
three month periods ended June 30, 1998 and 1997 and 30.5% and 30.4% in
the six month periods ended June 30, 1998 and 1997. The Company is
seeking to expand the breadth and depth of its product suites. Such
expansion, together with the Company's efforts to build brand identity
under its new corporate name are expected to contribute to a further
increase in marketing and sales expenses in absolute dollars, which, may
cause expenses to fluctuate as a percentage of net revenue.
General and Administrative. General and administrative expenses
consist principally of salary and benefit costs for administrative
personnel and general operating costs. General and administrative costs
decreased 14% to $12.4 million in the three months ended June 30, 1998
from $14.5 million in the three months ended June 30, 1997. For the six
months ended June 30, 1998 general and administrative costs decreased
16% to $23.6 million from $28.1 million in the six months ended June 30,
1998. The decrease is a result of the consolidated staffing both
domestically and internationally. As a percentage of net revenue,
general and administrative expenses were 5.9% and 9.5% in the three
months periods ended June 30, 1998 and 1997 and 5.7% and 9.3% in the six
month periods ended June 30, 1998 and 1997. The Company intends to
continue to make investments in its finance and administrative
infrastructure, and, as a result, expects general and administrative
expenses will increase in absolute dollars, but may fluctuate as a
percentage of net revenue.*
Amortization of Intangibles. The Company expensed $2.8 million and
$213,000 of amortization related to intangibles in the three months
ended June 30, 1998 and 1997, respectively and $3.5 million and $317,000
in the six months ended June 30, 1998 and 1997, respectively.
Intangibles consist of purchased goodwill and certain technology
acquired through acquisitions. The increases are due to the
acquisitions of PGP and Magic Solutions.
Acquisition and Other Related Costs. In connection with the
acquisitions of TIS, Magic Solutions and Secure in the three months
ended June 30, 1998, the Company incurred direct transaction costs of
approximately $15.5 million consisting of fees for investment bankers,
attorneys, accountants, financial printing and other related charges.
The Company also incurred restructuring costs of approximately $38.4
million which relate to the closure and elimination of duplicate
facilities, the write-off of impaired assets and severance costs related
to terminated employees. In addition, $97 million was expensed as
acquired in-process technology in connection with the acquisition of
Magic Solutions. In the six months ended June 30, 1997, the Company
wrote off $19.5 million of acquired in-process technology in connection
with the acquisition of 3DV. Similarly , in connection with the recent
Dr Solomon's acquisition and the pending CyberMedia acquisition, during
the three months ended September 30, 1998, the Company expects to incur
non-recurring direct transaction costs and other costs associated with
integrating the companies and significant charges related to the
acquisitions and in-process research and development (in the case of
CyberMedia). As a result of these and the Company's previous
acquisition charges, the Company currently expects that at September 30,
1998 its retained earnings balances will be negative.* The Company does
not expect this negative balance to affect its financial condition or
results of operations.
The software industry has experienced and is expected to continue to
experience a significant amount of consolidation. In addition, it is
expected that the Company will grow internally and through strategic
acquisitions in order, among other things, to expand the breadth and
depth of its product suites and to build its professional services
organization. The Company continually evaluates potential acquisitions
of complementary businesses, products and technologies. Any acquisition,
depending on its size, could result in the use of a significant portion
of the Company's available cash or, if such acquisition is made
utilizing the Company's securities, could result in significant dilution
to the Company's stockholders, and could result in the Company incurring
significant acquisition related charges to earnings. Acquisitions by the
Company may result in the Company incurring or assuming liabilities,
including liabilities that are unknown or not fully known at the time of
acquisition, which could have a material adverse effect on the Company.
Furthermore, there can be no assurance that any products acquired in
connection with any acquisition will gain acceptance in the Company's
markets or that the Company will obtain the anticipated or desired
benefits of such transactions.* See "Risk Factors - Risks Associated
with Recent Acquisitions" and "- Risks Associated with Acquisitions
Generally."
Interest and Other Income and Expense, Net. Interest and other income
and expense decreased to $3.3 million in the three months ended June 30,
1998 from $5.1 million in the three months ended June 30, 1997. Interest
and other income and expense was $8.4 million in the six months ended
June 30, 1998 and 1997. The decrease from quarter to quarter was
primarily due to the increase of interest expense to $4.1 million in the
three months ended June 30, 1998 from zero in the three months ended
June 30, 1997, partially offset by increased interest income from the
increased funds invested. Interest expense relates to the Company's Zero
Coupon Convertible Subordinated Debentures (the "Debentures"), issued in
February 1998.
Provision for Income Taxes. The Company's effective tax rate was 34%
and 38% for the three months ended June 30, 1998 and 1997, respectively,
and 36% and 37% for the six months ended June 30, 1998 and 1997,
respectively.
Liquidity and Capital Resources
At June 30, 1998, the Company had $101.6 million in cash and cash
equivalents and $574.2 million in marketable securities, for a combined
total of $675.8 million.
Net cash provided by operating activities was $11.2 million and $66.9
million in the six months ended June 30, 1998 and 1997, respectively.
Net cash provided by operating activities in the six months ended June
30, 1998, consisted primarily of net income before acquisition costs
plus increases in deferred revenue and deferred taxes which were offset
primarily by an increase in accounts receivable, prepaid and other
assets and accounts payable and accrued liabilities. In the six months
ended June 30, 1997, net cash provided by operating activities consisted
primarily of net income before acquisition costs, plus increases in
deferred revenue, accounts payable and accrued liabilities and prepaid
and other assets, offset primarily by increases in accounts receivable
and deferred taxes.
The Company expects that its accounts receivable balances as a
percentage of sales will increase in the foreseeable future due to
various factors, including its recent and pending acquisitions of
companies with longer payment cycles (particularly its acquisitions
of Dr Solomon's and CyberMedia) and its increased emphasis on
international sales, typically having longer payment terms.* In
addition, the longer payment cycles associated with licensing
enterprise-wide network security and management product suites and with
licensing products through indirect channels, such as systems
integrators and VARs, are also expected to contribute to an increase in
the Company's receivables balances.* Lastly, development of a two-year
subscription license model for the Company's Sniffer products, which as
compared to product sales typically results in lower current revenue
and a corresponding increase in deferred revenue, is expected to result
in an increase in accounts receivable balances as a percentage of sales.*
To address the increased level of the Company's accounts receivables and
to improve cash flow, the Company continuously evaluates available
options, including actions to encourage earlier payment of receivables
and receivable sales.* To the extent the Company's receivable balances
increase, the Company will be subject to increased general credit risks
with respect thereto.* There can be no assurance that the Company will
be successful in mitigating the impact which such increased receivable
levels may have on its financial conditions and operating results.
Net cash used in investing activities was $464.2 million in the six
months ended June 30, 1998 consisting primarily of the purchase of
marketable securities, additions to fixed assets and the acquisition of
Magic Solutions. Net cash used in investing activities was $61.0
million in the six months ended June 30, 1997, primarily reflecting the
acquisitions of Compusul and 3DV Technology, purchases of marketable
securities and additions to fixed assets and intangible assets.
Net cash provided by financing activities was $429.9 million in the
six months ended June 30, 1998, consisting primarily of net proceeds
from the issuance of the Debentures, and the proceeds and tax benefits
associated with the exercise of non-qualified stock options. Net cash
provided by financing activities was $21.7 million in the six months
ended June 30, 1997, consisting primarily of the proceeds and tax
benefits associated with the exercise of non-qualified stock options
partially offset by the repurchase of common stock under the Network
General stock repurchase program.
The Company believes that its available cash and anticipated cash
flow from operations will be sufficient to fund the Company's working
capital and capital expenditure requirements for at least the next
twelve months.
Financial Risk Management
As a result of the continued expansion of the Company's business in
Europe, the Company expects to see an increase over time in exposures
related to nonfunctional currency denominated sales in several European
currencies. Currently, the Company hedges only those currency exposures
associated with certain assets and liabilities denominated in
nonfunctional currencies and does not generally hedge anticipated
foreign currency cash flows. The hedging activity undertaken by the
Company is intended to offset the impact of currency fluctuations on
certain non-functional currency assets and liabilities. The success of
this activity depends upon forecasts of transaction activity denominated
in various currencies, primarily the Canadian dollar, Australian dollar
and certain European currencies. To the extent that these forecasts are
over or understated during periods of currency volatility, the Company
could experience unanticipated currency gains or losses.
Year 2000
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. These
date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, many companies'
software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. Although the Company
believes that its current products and systems are Year 2000 compliant,
the Company utilizes third-party equipment and software that may not be
Year 2000 compliant and the Company may acquire third-party equipment
and software products that may not be Year 2000 compliant. Failure of
such third-party equipment or software to operate properly with regard
to the Year 2000 and thereafter could require the Company to incur
unanticipated expenses to remedy any problems, which could have a
material adverse effect on the Company's business, operating results and
financial condition. The business, operating results and financial
condition of the Company's customers could be adversely affected to the
extent that they utilize third-party software products which are not
Year 2000 compliant. Furthermore, the purchasing patterns of customers
or potential customers may be affected by Year 2000 issues as companies
expend significant resources to correct their current systems for Year
2000 compliance. These expenditures may result in reduced funds
available to purchase products and services such as those offered by the
Company, which could have a material adverse effect on the Company's
business, operating results and financial condition.
* This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual performance
will meet the Company's current expectations. See the Risk Factors for a
discussion of certain factors that could affect future performance.
<PAGE>
RISK FACTORS
The following risk factors should be considered in conjunction with
the information in this Report on Form 10-Q.
Variability of Quarterly Operating Results. The Company's results of
operations have been subject to significant fluctuations, particularly
on a quarterly basis, and the Company's future results of operations
could fluctuate significantly from quarter to quarter and from year to
year. Causes of such fluctuations may include the volume and timing of
new orders and renewals, distributor inventory levels and return rates,
Company inventory levels, the introduction of new products, product
upgrades or updates by the Company or its competitors, changes in
product mix, changes in product prices and pricing models, seasonality,
trends in the computer industry, general economic conditions (such as
the recent economic turbulence in Asia), extraordinary events such as
acquisitions or litigation and the occurrence of unexpected events. The
operating results of many software companies reflect seasonal trends,
and the Company's business, financial condition and results of
operations may be affected by such trends in the future. Such trends may
include higher net revenue in the fourth quarter as many customers
complete annual budgetary cycles, and lower net revenue in the summer
months when many businesses experience lower sales, particularly in the
European market.
Although the Company has experienced significant growth in net
revenue and net income (before acquisition and other related costs) in
absolute terms, the Company has experienced increased price competition
for its products and the Company expects competition to increase in the
near-term, which may result in reduced average selling prices for the
Company's products. Due to these and other factors (such as a maturing
anti-virus market and an increasingly higher base from which to grow),
the Company's historic revenue growth rate will be difficult to sustain
or increase. To the extent these trends continue, the Company's results
of operations could be materially adversely affected. Renewals have
historically accounted for a significant portion of the Company's net
revenue; however, there can be no assurance that the Company will be
able to sustain historic renewal rates for its products in the future.
Risks related to the Company's recent change in business strategies
could also cause fluctuations in operating results and could make
comparisons with historic operating results and balances difficult or
not meaningful. See "- Risks Related to Certain Business Strategies."
The timing and amount of the Company's revenues are subject to a
number of factors that make estimating operating results prior to the
end of a quarter uncertain. The Company does not expect to maintain a
significant level of backlog and, as a result, product revenues in any
quarter will be dependent on contracts entered into or orders booked and
shipped in that quarter. During the three months ended June 30, 1998 and
the year ended December 31, 1997, the Company generally experienced a
trend toward higher order receipts toward the end of the last month of a
quarter, resulting in a higher percentage of revenue shipments during
the corresponding period in the prior year, which makes predicting
revenues more difficult. The timing of closing larger orders increases
the risks of quarter-to-quarter fluctuation. To the extent that the
Company is successful in licensing larger product suites under the Net
Tools umbrella (particularly to large enterprise and national accounts),
the size of its orders and the length of its sales cycle are likely to
increase. If orders forecasted for a specific customer for a particular
quarter are not realized or revenues are not otherwise recognized in
that quarter, the Company's operating results for that quarter could be
materially adversely affected. See "Potentially Longer Sales and
Implementation Cycles for Certain Products."
The trading price of the Company's Common Stock has historically been
subject to wide fluctuations, with factors such as earnings
announcements, acquisition announcements and litigation developments
contributing to this volatility. Failure to achieve periodic revenue,
earnings and other operating and financial results as forecasted or
anticipated by brokerage firms, industry analysts or investors could
result in an immediate and adverse effect on the market price of the
Company's Common Stock. The Company may not discover, or be able to
confirm, revenue or earnings shortfalls until the end of a quarter,
which could result in an immediate and adverse effect on the price of
the Company's Common Stock.
Risk of Inclusion of Network Management and Security Functionality in
Hardware and Other Software. In the future, vendors of hardware and of
operating system software or other software (such as firewall or
electronic mail software) may continue to enhance their products or
bundle separate products to include functionality that currently is
provided primarily by network security and management software. Such
enhancements may be achieved through the addition of functionality to
operating system software or other software or the bundling of network
security and management software with operating system software or other
products. For example, Cisco Systems, Inc. ("Cisco") recently
incorporated a firewall in certain of its hardware products and
Microsoft introduced limited anti-virus functionality into its MS-DOS
versions in 1993. The widespread inclusion of the functionality of the
Company's products as standard features of computer hardware or of
operating system software or other software could render the Company's
products obsolete and unmarketable, particularly if the quality of such
functionality were comparable to that of the Company's products.
Furthermore, even if the network security and/or management
functionality provided as standard features by hardware providers or
operating systems or other software is more limited than that of the
Company's products, there can be no assurance that a significant number
of customers would not elect to accept such functionality in lieu of
purchasing additional software. If the Company were unable to develop
new network security and management products to further enhance
operating systems or other software and to replace successfully any
obsolete products, the Company's business, financial condition and
results of operations would be materially adversely affected.
Risks Associated with Pending and Recent Acquisitions. In addition to
risks described under "- Risks Associated with Acquisitions Generally,"
the Company faces significant risks associated with its recent
combination with Network General and other pending and recent
acquisitions (including the acquisitions of Dr Solomon's, CyberMedia,
TIS, Magic Solutions, Pretty Good Privacy, Inc. ("PGP") and Helix
Software Company ("Helix")). There can be no assurance that the Company
will realize the desired benefits of these transactions. In order to
successfully integrate these companies, the Company must, among other
things, continue to attract and retain key management and other
personnel; integrate, both from an engineering and a sales and marketing
perspective, the acquired products (including Dr Solomon's anti-virus
products, TIS' firewall products, Magic Solutions' helpdesk products,
Network General's Sniffer and CyberCop products, PGP's encryption
products and Helix's utilities products) into its suite of product
offerings; integrate and develop a cohesive focused direct and indirect
sales force for its product offerings; consolidate duplicate facilities;
implement standardized accounting and reporting systems and develop name
recognition for its new name. The diversion of the attention of
management from the day-to-day operations of the Company, or
difficulties encountered in the integration process, could have a
material adverse effect on the Company's business, financial condition
and results of operations. See "- Need to Develop Enterprise and
National Accounts Sales Force and Security Products Sales Force; Risks
Related to Direct Sales Force" and "- Use of Indirect Sales Channels;
Need to Develop Indirect Sales Channel for Sniffer and PGP Security
Products."
During 1997, the Company incurred significant non-recurring charges
associated with the Network General combination and the acquisitions of
PGP and Helix. During the second quarter of 1998, the Company to
incurred additional significant non-recurring charges associated with
the acquisitions of TIS and Magic Solutions. In the third quarter of
1998, the Company expects to incur additional significant non-recurring
charges associated with the acquisitions of Dr Solomon's and CyberMedia.
There can be no assurance that the Company will not incur additional
material charges in subsequent quarters to reflect additional costs
associated with these transactions and with respect to its name change
and the marketing of its products under the "Network Associates" name.
Risks Related to Certain Business Strategies. The Company has
historically derived a significant majority of its revenues from the
licensing of its flagship anti-virus products and Sniffer products. See
"- Dependence on Revenue from Flagship Anti-Virus and Sniffer Products."
The Company is currently focusing its efforts on broadening its revenue
base by providing network security and management solutions to
enterprise customers, targeting in particular the Windows NT/Intel
platform. In furtherance of this strategy, the Company recently
organized its products into four product suites - McAfee Total Virus
Defense, PGP Total Network Security, and Sniffer Total Network
Visibility and McAfee Total Virus Defense. These four product suites
together form an integrated solution called "Net Tools" which utilizes a
new pricing model. There can be no assurance that potential customers
(including the installed customer base of acquired companies) will
respond favorably to the modified pricing structure and the lack of a
favorable response could materially adversely affect the Company's
operating results. Although the Company will continue to offer perpetual
licenses with annual support and maintenance contracts for its Sniffer
products, it is currently developing a subscription licensing model for
those products. In addition, in an effort to increase total Sniffer unit
sales, the Company intends to develop software only versions of certain
of its Sniffer products. There can be no assurance that the Company can
produce a software only Sniffer product on a timely basis or at all,
that customers will not continue to require that the Company provide the
associated hardware platform and components, that total unit licenses of
Sniffer products will increase over previous levels or that customers
will react favorably to the subscription pricing model for Sniffer
products. To the extent that customers do license Sniffer products on a
two-year subscription basis or license significant amounts of software
only Sniffer products, the Company's operating results and financial
condition would likely be affected. In the case of subscription
licenses, the Company would, among other things, expect an increase in
deferred revenues related to the service portion of the two-year Sniffer
license that would be capitalized on the Company's balance sheet. In the
initial year of the license, the corresponding revenue would be lower
than if the license were perpetual. In the case of the software only
Sniffer product, for any individual license, the Company would expect
lower total revenues and a higher overall gross margin related to the
transaction, as the Company would not be selling the corresponding
hardware component. Currently, the hardware component has a lower gross
margin than the total product gross margin. Furthermore, the increase
in subscription revenue as a percentage of revenue will have a negative
impact on the Company's receivable balance as a percentage of sales, due
to more revenue being deferred with no impact on the related
receivables.
The Company has been acquiring (and is continuing to investigate the
acquisition of) existing independent agents and distributors of its
products in certain strategic markets or has been converting these
independent agents into resellers who must purchase Company products
from Company approved distributors. These actions may require, among
other things, that the Company provide the technical support to
customers that was previously provided by such agents and distributors.
There can be no assurance that the Company can provide such support as
effectively or on a timely basis or at all, that the Company will
operate any acquired distributor or agent as successfully as the
previous operators, that the acquisition of any distributor or agent or
the conversion of any agent into a reseller will result in the desired
increased foreign revenues or that the Company will be able to identify
and retain suitable distributors in any market in which it converts an
independent agent. See "- Risks Associated with Acquisitions Generally"
and "- Risks Related to International Revenue and Activities."
As part of the Net Tools concept, the Company is in the process of
designing a centralized console from which the various component suites
can be operated, administered and maintained utilizing a common look and
feel. The Company faces significant engineering challenges related to
these efforts. In addition, the Company faces significant engineering
and other challenges related to the integration of its various products
(such as its recently acquired PGP encryption products, Network General
CyberCop product and TIS firewall products) into marketable product
suites and the development of a software only Sniffer product. Success
of the Company's Net Tools suite strategy will also depend, in part,
upon successful development and coordination of the Company's sales
force; on successful development of a national accounts sales force and
an effective indirect sales channel for the Company's Sniffer and
PGP/TIS security products; and on the development and expansion of an
effective professional services organization. See "- Risks Associated
with Recent Transactions," "- Risks Associated with Acquisitions
Generally," "- Need to Develop Enterprise and National Accounts Sales
Force and Security Products Sales Force; Risks Related to Direct Sales
Force," "- Use of Indirect Sales Channels; Need to Develop Indirect
Sales Channel for Sniffer and PGP Security Products" and "- Need to
Expand and Develop An Effective Professional Services Organization."
The foregoing factors, individually or in the aggregate, could
materially adversely affect the Company's operating results and could
make comparison of historic operating results and balances difficult or
not meaningful.
Risks Associated with Acquisitions Generally. The software industry
has experienced and is expected to continue to experience a significant
amount of consolidation. In addition, it is expected that the Company
will grow internally and through strategic acquisitions in order, among
other things, to expand the breadth and depth of its product suites and
to build its professional services organization. The Company continually
evaluates potential acquisitions of complementary businesses, products
and technologies. In addition to the acquisitions of Dr Solomon's in
August 1998, Anyware in July 1998 and TIS and Magic Solutions in April
1998, the Company has consummated a series of significant acquisitions
since 1994, including the combination with Network General in December
1997, the acquisitions of PGP and Helix in December 1997, Cinco
Networks, Inc. in August 1997, 3DV Technology, Inc. in March 1997, FSA
Corporation of Canada in August 1996, Vycor Corporation in February
1996, Saber Software Corporation, Inc. in August 1995 and ProTools, Inc.
in January 1994. In addition, since 1995 the Company has acquired a
number of its international distributors, including distributors in
Australia, Brazil, Finland, Japan, South Africa and The Netherlands and
is currently investigating acquisitions of additional foreign
distributors. Past acquisitions have consisted of, and future
acquisitions will likely include, acquisitions of businesses, interests
in businesses and assets of businesses. Any acquisition, depending on
its size, could result in the use of a significant portion of the
Company's available cash or, if such acquisition is made utilizing the
Company's securities, could result in significant dilution to the
Company's stockholders, and could result in the incurrence of
significant acquisition related charges to earnings. Acquisitions by the
Company may result in the incurrence or the assumption of liabilities,
including liabilities that are unknown or not fully known at the time of
acquisition, which could have a material adverse effect on the Company.
Furthermore, there can be no assurance that any products acquired in
connection with any such acquisition will gain acceptance in the
Company's markets or that the Company will obtain the anticipated or
desired benefits of such transactions.
Achieving the anticipated benefits of an acquisition will depend, in
part, upon whether the integration of the acquired business, products or
technology is accomplished in an efficient and effective manner, and
there can be no assurance that this will occur. Moreover, successful
acquisitions in the high technology industry may be more difficult to
accomplish than in other industries. Combining a merged or acquired
company requires, among other things, integration of product offerings
and coordination of sales and marketing and research and development
efforts. There can be no assurance that such an integration can be
accomplished smoothly or successfully. The difficulties of such
integration may be increased by the necessity of coordinating
geographically separated organizations, the complexity of the
technologies being integrated, and the necessity of integrating
personnel with disparate business backgrounds and combining two
different corporate cultures. The integration of operations following an
acquisition requires the dedication of management resources that may
distract attention from the day-to-day business, and may disrupt key
research and development, marketing or sales efforts. The inability of
management to successfully integrate any acquisition could have a
material adverse effect on the business, operating results and financial
condition of the Company. In addition, as commonly occurs, during the
pre-acquisition and integration phases of technology company
acquisitions, aggressive competitors may undertake initiatives to
attract customers and to recruit key employees through various
incentives.
Rapid Technological Change; Risks Associated with Product
Development. The network security and management market is highly
fragmented and is characterized by ongoing technological developments,
evolving industry standards and rapid changes in customer requirements.
The Company's success depends upon its ability to offer a broad range of
network security and management software products, to continue to
enhance existing products, to develop and introduce in a timely manner
new products that take advantage of technological advances, and to
respond promptly to new customer requirements. While the Company
believes that it offers one of the broadest product lines in the network
management and security market, this market is continuing to evolve and
customer requirements are continuing to change. As the market evolves
and competitive pressures increase, the Company believes that it will
need to further expand its product offerings. There can be no assurance
that the Company will be successful in developing and marketing, on a
timely basis, enhancements to its existing products or new products, or
that such enhancements or new products will adequately address the
changing needs of the marketplace.
In addition, from time to time, the Company or its competitors may
announce new products with new or additional capabilities or
technologies. Such announcements of new products could have the
potential to replace, or shorten the life cycles of, the Company's
existing products and to cause customers to defer or cancel purchases of
the Company's existing products.
The Company has in the past experienced delays in software
development, and there can be no assurance that the Company will not
experience delays in connection with its current or future product
development activities. Complex software products such as those offered
by the Company may contain undetected errors or version compatibility
issues, particularly when first introduced or when new versions are
released, resulting in loss of or delay in market acceptance. For
example, the Company experienced compatibility issues in connection with
its recent NetShield upgrade, and the Company's anti-virus software
products have in the past falsely detected viruses that did not actually
exist. See "- Risk of False Detection of Viruses." Delays and
difficulties associated with new product introductions, performance or
enhancements could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company's development efforts are impacted by the adoption or
evolution of industry standards related to its products and the
environments in which they operate. For example, no uniform industry
standard has developed in the market for encryption security products.
As industry standards are adopted or evolve, the Company may be required
to modify existing products or develop and support new versions of
existing products. In addition, to the extent that no industry standard
develops, the Company's products and those of its competitors may be
incompatible if they use competing standards, which could prevent or
significantly delay overall development of the market for a particular
product or products. The failure of the Company's products to comply, or
delays in compliance, with existing or evolving industry standards could
have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's long-term success will depend on its ability on a
timely and cost effective basis to develop upgrades and updates to its
existing product offerings, to modify and enhance acquired products, and
to introduce new products which meet the needs of current and potential
customers. Future upgrades and updates may, among other things, include
additional functionality, respond to user problems or address issues of
compatibility with changing operating systems and environments. The
Company believes that the ability to provide these upgrades and updates
to users frequently and at a low cost is a key to success. For example,
the proliferation of new and changing viruses makes it imperative to
update anti-virus products frequently in order for the products to avoid
obsolescence. Failure to release such upgrades and updates on a timely
basis could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance
that the Company will be successful in these efforts. In addition,
future changes in Windows 95, Windows NT, NetWare or other popular
operating systems may result in compatibility problems with the
Company's products. Further, delays in the introduction of future
versions of operating systems or lack of market acceptance of future
versions of operating systems would result in a delay or a reduction in
the demand for the Company's future products and product versions which
are designed to operate with such future versions of operating systems.
The Company's failure to introduce in a timely manner new products that
are compatible with operating systems and environments preferred by
desktop computer users would have a material adverse effect on the
Company's business, financial condition and results of operations.
Dependence on Revenue from Flagship Anti-Virus and Sniffer Products.
In recent years, the Company has derived a substantial majority of its
net revenue from its flagship McAfee anti-virus software products and
Sniffer network fault and performance management products. These
products are expected to continue to account for a significant portion
of the Company's net revenue for the foreseeable future. Because of this
concentration of revenue, a decline in demand for, or in the prices of,
these anti-virus and network management products as a result of
competition, technological change, a change in the Company's pricing
model for such products, the inclusion of anti-virus or network
management and analysis functionality in system hardware or operating
system software or other software or otherwise, or a maturation in the
respective markets for these products could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Dependence on Emergence of Network Management and Network Security
Markets. The markets for the Company's network management and network
security products are evolving, and their growth depends upon broader
market acceptance of network management and network security software,
including help desk software. Although the number of LAN-attached
personal computers ("PCs") has increased dramatically, the network
management and network security markets continue to be emerging markets
and there can be no assurance that such markets will continue to develop
or that further market development will be rapid enough to benefit the
Company significantly. In addition, there are a number of potential
approaches to network management and network security, including the
incorporation of management and security tools into network operating
systems. Therefore, even if network management and network security
tools gain broader market acceptance, there can be no assurance that the
Company's products will be chosen by organizations which acquire network
management and network security tools. Furthermore, to the extent that
either the network management or network security market does continue
to develop, the Company expects that competition will increase. See "-
Competition" and "- Risk of Inclusion of Network Security and Management
Functionality in Hardware and Other Software."
Competition. The markets for the Company's products are intensely
competitive and the Company expects competition to increase in the near-
term. The Company believes that the principal competitive factors
affecting the markets for its products include performance,
functionality, quality, customer support, breadth of product line,
frequency of upgrades and updates, integration of products,
manageability of products, brand name recognition, company reputation
and price. Certain of the criteria upon which the performance and
quality of the Company's anti-virus software products compete include
the number and types of viruses detected, the speed at which the
products run and ease of use. Certain of the Company's competitors have
been in the network management market longer than the Company, and other
competitors, such as Symantec Corporation ("Symantec"), Intel
Corporation ("Intel"), Seagate Technology, Inc. ("Seagate") and Hewlett-
Packard Company ("HP"), are larger and have greater name recognition
than the Company. The Company will also need to develop name recognition
for its new name, "Network Associates." In addition, certain larger
competitors such as Intel, Microsoft and Novell, Inc. ("Novell") have
established relationships with hardware vendors related to their other
product lines. These relationships may provide them with a competitive
advantage in penetrating the OEM market with their network security and
management products. As is the case in many segments of the software
industry, the Company has been encountering, and expects to further
encounter, increasing competition. This increased competition is due in
part to the Company's recent increased size and visibility. Increased
competition could reduce average selling prices and, therefore, profit
margins. Competitive pressures could result not only in sustained price
reductions but also in a decline in sales volume, which events would
materially adversely affect the Company's business, financial condition
and results of operations. In addition, competitive pressures may make
it difficult for the Company to maintain or exceed its growth rate.
Although there is a trend toward consolidation in the network
security and management market, the market is currently highly
fragmented with products offered by many vendors. The Company's
principal competitor is the Peter Norton Group of Symantec in the
network security market and Intel's LanDesk in the network management
market. The Company's other competitors include Computer
Associates/Cheyenne Software, IBM, Seagate and Trend Micro, Inc., as
well as numerous smaller companies and shareware authors that may in the
future develop into stronger competitors or be consolidated into larger
competitors. In the encryption portion of the security market, the
Company's principal competitors are Security Dynamics Technologies,
Inc., Cylink Corporation, Entrust Technologies and VeriSign, Inc. The
Company's principal competitors in the help desk market are Remedy
Corporation and Software Artistry (recently acquired by Tivoli
Systems/IBM). The Company's principal competitor in the software-based
network fault and performance management market is HP, with other
competitors including Azure Technologies Incorporated, Concord
Communications, DeskTalk Systems, Kaspia Systems, Shomiti Systems, Inc.
and Wandel & Goltermann, Inc. The Company also faces competition in the
security market from Cisco, Security Dynamics Technologies, Inc.,
Checkpoint Software and other vendors in the encryption/firewall market.
In addition, the Company faces competition from large and established
software companies such as Microsoft, Intel, Novell and HP which offer
network management products as enhancements to their network operating
systems. As the network management market develops, the Company may face
increased competition from these large companies, as well as other
companies seeking to enter the market. The trend toward enterprise-wide
network management and security solutions may result in a consolidation
of the network management and security market around a smaller number of
vendors who are able to provide the necessary software and support
capabilities. In addition, to the extent that the Company is successful
in developing its Net Tools suite of products designed around a
centralized management and administration console for the Windows NT
platform, the Company will likely compete with large computer systems
management companies such as Tivoli Systems (TME) and Computer
Associates (Unicenter). There can be no assurance that the Company will
continue to compete effectively against existing and potential
competitors, many of whom have substantially greater financial,
technical, marketing and support resources and name recognition than the
Company. In addition, there can be no assurance that software vendors
who currently use traditional distribution methods will not in the
future decide to compete more directly with the Company by utilizing
electronic software distribution.
The competitive environment for anti-virus software internationally
is similar to that in North America, although local competitors in
specific foreign markets often present stronger competition and
shareware authors control a more significant portion of the European
market. The international market for network management software has
developed more slowly than the North American market, although larger
competitors such as Intel and Symantec have begun to penetrate European
markets. Asian markets have lagged significantly behind North America
and Europe in their adoption of networking technology. There can be no
assurance that the Company will be able to compete successfully in
international markets.
Need to Develop Enterprise and National Accounts Sales Force and
Security Products Sales Force; Risks Related to Direct Sales Force. In
connection with its recent acquisitions and as part of its evolving
strategy of offering product suites under the Net Tools umbrella, the
Company has recently reorganized its direct sales force into three
tiers. The first tier focuses on the sale of the full product suite
under the Net Tools umbrella to enterprise and national account
customers. The second tier consists of four separate sales groups
focused on the sale of the individual product suites (i.e., McAfee Total
Virus Defense; PGP Total Network Security; Sniffer Total Network
Visibility; or McAfee Total Service Desk) to the departmental level. The
third tier consists of four separate outbound corporate telesales forces
who actively market the Company's individual product suites to customers
with less than 1,000 nodes. The Company historically has not had a large
enterprise or national accounts sales force and only recently developed
a direct sales group focused on these larger accounts. In addition, the
Company has not historically had a separate sales force focused on the
sale of its suite of security products (many of which were only recently
acquired and are currently being engineered into a common suite). To
succeed in the direct sales channel for the enterprise and national
accounts market and for the sale of its various product suites,
(including its security product suite), the Company will be required to
build a significant direct sales organization and will be required to
attract and retain qualified personnel, which personnel will require
continuous training about, and knowledge of, product attributes for the
Company's suite of products. The need for continuous product training
results, in part, from new developments and enhancements (including
those products acquired in the Company's various acquisitions). There
can be no assurance that the Company will be successful in building the
necessary sales organization or in attracting, retaining or training
these individuals. Historically, the Company has sold its products at
the departmental level. To succeed in the enterprise and national
accounts market will require, among other things, establishing
relationships and contacts with senior technology officers at these
accounts. There can be no assurance that the Company or its sales force
will be successful in these efforts.
The Company's sales organization structure may result in multiple
customer contacts by different Company sales representatives
(particularly in circumstances where the customer has multiple
facilities and offices), a lack of coordination between the Company's
various sales organizations and a lack of focus by the individual sales
representatives on their designated customers or products. The
occurrence of these events could lead to customer confusion, disputes in
the sales force and lost revenue opportunities which could have a
material adverse effect on the Company's business, financial condition
and results of operations. In addition, while the development of a
direct sales channel reduces the Company's dependence on resellers and
distributors, it may lead to conflicts for the same customers and
further customer confusion, pressure by current and prospective
customers for price reductions on products and, consequently, in
reductions in the Company's gross margin and operating profit.
Use of Indirect Sales Channels; Need to Develop Indirect Sales
Channel for Sniffer and PGP Security Products. The Company markets a
significant portion of its products to end-users through distributors,
resellers and VARs. The Company's distributors sell other products that
are complementary to, or compete with, those of the Company. While the
Company encourages its distributors to focus on its products through
market and support programs, there can be no assurance that these
distributors will not give greater priority to products of other
suppliers, including competitors. In addition, to the extent the
Company is successful in building its professional services
organization, its ability to establish and maintain relationships with
distributors, resellers and VARs who market their services along with
third party products may be adversely impacted.
The Company does not have an extensive indirect sales channel for its
Network Sniffer products or its PGP and TIS security products. To
succeed in the indirect sales channel, the Company will be required to
build a more extensive network of distributors, resellers and VARs who
will support and market these products. These indirect channel
participants will require significant training about, and knowledge of,
product attributes for these products and the related product suites.
There can be no assurance that the Company can successfully establish
such an indirect channel on a timely basis or at all or that such a
channel, once established, can be maintained.
The Company's agreements with its distributors provide for a right of
return. This right of return may be triggered by a number of events,
including returns to distributors by end users, inaccurate estimates of
end user demand by distributors, increased purchases by distributors in
response to sales incentives or transitions to new products or versions
of products. As a result of this right of return, revenue recognized by
the Company upon sales to distributors is subject to a reserve for
returns. Returns could exceed reserves as a result of distributors
holding excessive Company product inventory. There can be no assurance
that current or future reserves established by the Company will be
adequate.
No customer accounted for more than 10% of net revenue during the
years ended December 31, 1997, 1996 and 1995. In the quarter ended June
30, 1998, Ingram Micro Devices accounted for 16% of net revenue. No
other customers accounted for more than 10% of net revenue during the
quarter ended June 30, 1998.
Need to Expand and Develop An Effective Professional Services
Organization; Risks Related to Third-Party Professional Services. As
computer networks become more complex and as the Company's products
become more complex and are more broadly targeted at the enterprise and
at mission-critical applications, customers will increasingly require
greater professional assistance in the design, installation,
configuration, implementation and support of their networks and acquired
products. To date, the Company has relied on its limited professional
services capabilities and increasingly on outside professional service
providers (including its distributors, resellers and system
integrators). There can be no assurance that third party service
providers can or will continue to be willing to provide adequate levels
(both in terms of time and quality) of professional services. Moreover,
reliance on these third parties reduces the Company's control over the
provision of support services for its products and places a greater
burden on these third parties, which, in turn, could delay the Company's
recognition of product revenue, could harm the Company's relationships
or reputation with such third parties or the end users of its products
and could result in decreased future sales of, or prices for, its
products.
To more effectively service its customer's evolving needs (including
the need for product support), the Company intends to significantly
expand and develop its worldwide professional service organization.
There can be no assurance that the Company will be successful in its
efforts to expand and develop an effective professional services
organization. This will require that the Company hire and train
additional service professional who must be continually trained and
educated to ensure that they possess sufficient technical skills and
product knowledge. In particular, the market for qualified professionals
is intensely competitive, making hiring and retention difficult. The
Company expects significant competition in this market from existing
providers of professional services and future entrants. The Company must
also properly price its services to attract customers, while maintaining
sufficient margins for its services. The Company expects that it will
have lower profit margins on its service revenues. The failure to
develop an effective professional services organization could have a
material adverse effect on the Company's business, financial condition
and results of operations.
Reliance on Microsoft Technology. Although the Company intends to
support other operating systems, the Company's mission is to be the
leading supplier of network security and management products for Windows
NT/Intel based networks. Sales of the Company's products would be
materially and adversely affected by market developments which are
adverse to the Windows operating environments, including the failure of
users and application developers to accept Windows NT. In addition, the
Company's ability to develop products using the Windows operating
environments is substantially dependent on its ability to gain timely
access to, and to develop expertise in, current and future developments
by Microsoft, of which there can be no assurance.
Risks Associated with Failure to Manage Growth. The Company's growth
internally and through its numerous acquisitions has placed, and any
further expansion would continue to place, a significant strain on its
limited personnel, management and other resources. In the future, the
Company's ability to manage any growth, particularly with the
anticipated expansion of the Company's international business, growth in
indirect channel business and increased focus on the enterprise and
mission critical applications, will require it to attract, train,
motivate and manage new employees successfully, to effectively integrate
new employees into its operations, provide adequate levels of product
support and to continue to improve its operational, financial,
management and information systems and controls. The failure to
effectively manage any further growth could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Proprietary Technology and Rights; Litigation. The Company's success
is heavily dependent upon proprietary software technology. The Company
relies on a combination of contractual rights, trademarks, trade secrets
and copyrights to establish and protect proprietary rights in its
software. There can be no assurance these protections will be adequate
or that competitors will not independently develop technologies or
products that are substantially equivalent or superior to the Company's
products.
Network Associates has changed its legal name to "Networks
Associates, Inc." and has begun conducting business as "Network
Associates." Two companies, (Network Associates, Inc. in Kansas ("NAI-
Kansas"); and Network Associates, Inc. in Oregon ("NAI-Oregon")) and
Ronald L. Meyers ("Meyers"), a California resident doing business as The
Network Associates, have made unresolved claims (including various
trademark claims) or demands with respect to Network Associates' use of
the name Network Associates. On March 26, 1998, Network Associates
commenced a declaratory judgement action in the United States District
Court, Northern District of California against all three of the above-
cited claimants. Network Associates seeks a declaration that its use of
the NETWORK ASSOCIATES title does not violate the federal, state or
common law rights of any of the defendants. Defendants NAI-Oregon and
NAI-Kansas have since been granted extensions of time in which to
respond to the Complaint; defendant Meyers has not yet been served. NAI
Kansas has moved to dismiss the claims against it for lack of personal
jurisdiction.
The Company does not typically obtain signed license agreements from
its corporate, government and institutional customers who license
products directly from it. The Company includes an electronic version of
a "shrink-wrap" license in all of its electronically distributed
software and a printed license in the box for its products distributed
through traditional distribution channels in order to protect its
copyrights and trade secrets in those products. Since none of these
licenses are signed by the licensee, many authorities believe that such
licenses may not be enforceable under the laws of many states and
foreign jurisdictions. In addition, the laws of some foreign countries
either do not protect proprietary rights or offer only limited
protection for those rights. There can be no assurance that the steps
taken by the Company to protect its proprietary software technology will
be adequate to deter misappropriation of this technology. For example,
the Company is aware that a substantial number of users of its anti-
virus products have not paid any registration or license fees to the
Company. Changing legal interpretations of liability for unauthorized
use of the Company's software, or lessened sensitivity by corporate,
government or institutional users to avoiding copyright infringement,
could have a material adverse effect on the Company's business,
financial condition and results of operations.
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 has in the past been, and currently
is, subject to litigation related to its intellectual property. There
can be no assurance that there will be no developments arising out of
such pending litigation or any other litigation to which the Company is
or may become party which could have a material adverse effect on the
Company's business, financial condition and results of operation. See
Note 6 to the Notes to the Condensed Consolidated Financial Statements.
In addition, as the Company may acquire a portion of software
included in its products from third parties, its exposure to
infringement actions may increase because it must rely upon such third
parties as to the origin and ownership of any software being acquired.
Similarly, exposure to infringement claims exists and will increase to
the extent that the Company employs or hires additional software
engineers previously employed by competitors, notwithstanding measures
taken by them to prevent usage by such software engineers of
intellectual property used or developed by them while employed by a
competitor. In the future, litigation may be necessary to enforce and
protect trade secrets and other intellectual property rights owned by
the Company. The Company may also be subject to litigation to defend it
against claimed infringement of the rights of others or to determine the
scope and validity of the proprietary rights of others. Any such
litigation could be costly and cause diversion of management's
attention, either of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
Adverse determinations in such litigation could result in the loss of
the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or
prevent the Company from manufacturing or selling its products, any one
of which could have a material adverse effect on the Company's business,
financial condition and results of operations. Furthermore, there can be
no assurance that any necessary licenses will be available on reasonable
terms, or at all.
Risks Related to International Revenue and Activities. In 1997, 1996
and 1995, net revenue from international licenses represented
approximately 28%, 24% and 25%, respectively, of the Company's net
revenue. In the quarter ended June 30, 1998, net revenue from
international licenses represented approximately 31% of the Company's
net revenue. Historically, the Company has relied primarily upon
independent agents and distributors to market its products
internationally. The Company expects that international revenues will
continue to account for a significant percentage of net revenue, with
that percentage increasing as a result of the recent Dr Solomon's
acquisition. The Company also expects that a significant portion of such
international revenue will be denominated in local currencies. To reduce
the impact of foreign currency fluctuations, the Company has engaged in
various financial risk management activities. However, there can be no
assurance that the Company's future results of operations will not be
adversely affected by such fluctuations or by costs associated with
financial risk management strategies. Other risks inherent in
international revenue generally include the impact of longer payment
cycles, greater difficulty in accounts receivable collection, unexpected
changes in regulatory requirements, seasonality due to the slowdown in
European business activity during the third quarter, tariffs and other
trade barriers, uncertainties relative to regional economic
circumstances (such as the current economic turbulence in Asia),
political instability in emerging markets and difficulties in staffing
and managing foreign operations. There can be no assurance that these
factors will not have a material adverse effect on the Company's future
international license revenue. Further, in countries with a high
incidence of software piracy, the Company may experience a higher rate
of piracy of its products. There are a number of additional risks
related to the export of the Company's encryption products. See "- Risks
Relating to Cryptography Technology."
In addition, a portion of the Company's international revenue is
expected to continue to be generated through independent agents. Since
these agents will not be employees of the Company and will not be
required to offer the Company's products exclusively, there can be no
assurance that they will continue to market the Company's products.
Also, the Company is likely to have limited control over its agents,
limited access to the names of the customers to whom the agents sell its
products and limited knowledge of the information provided by, or
representations made by, these agents to its customers.
Risk of Sabotage. Given the Company's high profile in the security
software market, the Company has been a target of computer "hackers" who
have, among other things, created viruses to sabotage its products or
otherwise attack the Company's products. While to date these efforts
have been discovered quickly and their adverse impact has been limited,
there can be no assurance that similar viruses or efforts will not be
created or replicated in the future, that they will not cause damage to
users' computer systems and that demand for the Company's software
products will not suffer as a result. In addition, since the Company
does not control diskette duplication by distributors or its independent
agents, there can be no assurance that diskettes containing the
Company's software will not be infected with viruses.
Risk of False Detection of Viruses and of Actual or Perceived
Security Breaches. The Company's anti-virus software products have in
the past and may at times in the future falsely detect viruses that do
not actually exist. Such "false alarms," while typical in the industry,
may impair the perceived reliability of the Company's products and may
therefore adversely impact market acceptance of the Company's products.
In addition, the Company has in the past been subject to litigation
claiming damages related to a false alarm, and there can be no assurance
that similar claims will not be made in the future. Similarly, while a
well-publicized actual or perceived breach of network or computer
security could trigger a heightened awareness of computer abuse
(resulting in a potential increase in demand for security products), an
actual or perceived breach of network or computer security at one of the
Company's customers, regardless of whether such breach is attributable
to the Company's products, could adversely affect the market's
perception of such products.
Risks Relating to Cryptography Technology. Certain of the Company's
PGP and TIS network security products, technology and associated
assistance are subject to export restrictions administered by the U.S.
Department of State and the U.S. Department of Commerce, which permit
the export of encryption products only with the required level of export
license. In addition, these U.S. export laws prohibit the export of
encryption products to a number of countries deemed hostile by the U.S.
government. U.S. export regulations regarding the export of encryption
technology require either a transactional export license or the granting
of Department of Commerce Commodity jurisdiction. As result of this
regulatory regime, foreign competitors facing less stringent controls on
their products may be able to compete more effectively than the Company
in the global market. While the Company has obtained approval from the
Department of Commerce to export to certain end users, there can be no
assurance that the U.S. government will approve pending or future export
license requests. Further, there can be no assurance that the list of
products and countries for which export approval is required, and the
regulatory policies with respect thereto, will not be revised from time
to time. Failure to obtain the required licenses or the costs of
compliance could have a material adverse effect on the Company's
international revenues.
Certain of the Company's PGP and TIS network security products are
dependent on the use of public key cryptography technology, which
depends in part on the application of certain mathematical principles
known as "factoring." The security afforded by public key cryptography
technology is predicated on the assumption that the factoring of the
composite of large prime numbers is difficult. Should an easy factoring
method be developed, then the security afforded by encryption products
utilizing public key cryptography technology would be reduced or
eliminated. Furthermore, any significant advance in techniques for
attacking cryptographic systems could also render some or all of the
Company's existing products and services obsolete or unmarketable. There
can be no assurance that such developments will not occur. Moreover,
even if no breakthroughs in factoring or other methods of attacking
cryptographic systems are made, factoring problems can theoretically be
solved by computer systems significantly faster and more powerful than
those presently available. If such improved techniques for attacking
cryptographic systems are ever developed, it could have a material
adverse effect on the Company's business, operating results and
financial condition.
Product Liability. The Company's security and network management
software products are used to protect and manage computer systems and
networks that may be critical to organizations and, as a result, the
sale and support of these products by the Company may entail the risk of
product liability and related claims. The Company's license agreements
with its customers typically contain provisions designed to limit the
Company's exposure to potential product liability claims. It is
possible, however, that the limitation of liability provisions contained
in these license agreements may not be effective under the laws of
certain jurisdictions, particularly in circumstances involving unsigned
licenses. A product liability claim brought against the Company could
have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence upon Key Personnel. The success of the Company will depend
to a significant extent upon a number of key technical and management
employees. While employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, Company
employees are generally not otherwise subject to employment agreements
or to noncompetition covenants. The loss of the services of any key
employees could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company
does not maintain life insurance policies on its key employees. The
ability of the Company to achieve its revenue and operating performance
objectives will depend in large part on its ability to attract and
retain technically qualified and highly skilled sales, consulting,
technical, marketing and management personnel. Competition for such
personnel is intense and is expected to remain so for the foreseeable
future. There can be no assurance the Company will be successful in
retaining its existing key personnel and in attracting and retaining the
personnel it requires, and failure of the Company to retain and grow its
key employee population could adversely affect the Company's business
and operating results. In April, 1998, Messers. Leslie Denend, David
Carver and John Stringer resigned from their positions as executive
officers of the Company. Mr. Denend will remain a director of the
Company. Additions of new personnel and departures of existing
personnel, particularly in key positions, can be disruptive and can
result in departures of existing personnel, which could have a material
adverse effect upon the Company's business, operating results and
financial condition.
Customer Purchase Decisions; Potentially Longer Sales and
Implementation Cycles for Certain Products Suites. The products offered
by the Company may be considered to be capital purchases by certain
customers or prospective customers. Capital purchases are often
considered discretionary and, therefore, are canceled or delayed if the
customer experiences a downturn in its business or prospects or as a
result of economic conditions in general. Any such cancellation or delay
could adversely affect the Company's results of operations. In addition,
as the Company proceeds with its strategy of selling product suites
under the Net Tools umbrella (particularly to larger enterprise and
national accounts), its sales cycle is likely to lengthen. Such sales
may involve a lengthy education process and a significant technical
evaluation and commitment of capital and other resources and may be
subject to the risk of delays associated with customers' internal budget
and other procedures for approving large capital expenditures, deploying
new technologies within their networks and testing and accepting new
technologies that affect key operations. Because of the potentially
lengthy sales cycle and the potentially large size of such orders, if
orders forecasted for a specific customer for a particular quarter are
not realized or revenues are not otherwise recognized in that quarter,
the Company's operating results for that quarter could be materially
adversely affected. See "-Variability of Quarterly Operating Results"
and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Risks of Doing Business with the U.S. Government. As a result of its
recent acquisition of TIS, the Company expects that, in the near term, a
meaningful portion of its revenues will result from existing and future
research and development contracts with agencies of the U.S. government.
Network Associates believes that the awarding to it of future government
contracts will in part be dependent upon the continued favorable
reaction of government agencies to the Company's research, development
and consulting capabilities. There can be no assurance that Network
Associates will be able to procure additional government contracts.
Minimum fee awards for government contracts are usually 3% to 7% of the
contract costs, but may be as low as 1% of the contracts costs, and the
contracts are subject to cancellation for the convenience of the
governmental agencies. Although the Company has been awarded contract
fees of more than 1% in the past and there have been no terminations of
its government contracts in the past, there can be no assurance that
minimum fee awards or cancellations will not occur in the future.
Reductions or delays in federal funds available for projects the Company
is performing could also have an adverse impact on its government
business. Contracts involving the U.S. government are also subject to
the risks of disallowance of costs upon audit, changes in government
procurement policies, the necessity to participate in competitive
bidding and, with respect to contracts involving prime contractors or
government-designated subcontractors, the inability of such parties to
perform under their contracts. Any of the foregoing events could have a
material adverse effect on the Company's financial condition or results
of operations.
Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date
code field. These date code fields will need to accept four digit
entries to distinguish 21st century dates from 20th century dates. As a
result, many companies' software and computer systems may need to be
upgraded or replaced in order to comply with such "Year 2000"
requirements. Although the Company believes that its current products
and systems are Year 2000 compliant, the Company utilizes third-party
equipment and software that may not be Year 2000 compliant and the
Company may acquire third-party equipment and software products that may
not be Year 2000 compliant. Failure of such third-party equipment or
software to operate properly with regard to the Year 2000 and thereafter
could require the Company to incur unanticipated expenses to remedy any
problems, which could have a material adverse effect on the Company's
business, operating results and financial condition. The business,
operating results and financial condition of the Company's customers
could be adversely affected to the extent that they utilize third-party
software products which are not Year 2000 compliant. Furthermore, the
purchasing patterns of customers or potential customers may be affected
by Year 2000 issues as companies expend significant resources to correct
their current systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase products and services such
as those offered by the Company, which could have a material adverse
effect on the Company's business, operating results and financial
condition.
Supplier Dependence; Third Party Manufacturing. Certain of the
Company's products contain critical components supplied by a single or a
limited number of third parties. The Company has been required to
purchase and inventory certain of the computer platforms around which it
designs its network fault and performance management products to ensure
an available supply of the product for its customers. Any significant
shortage of these platforms or other components or the failure of the
third party supplier to maintain or enhance these products could lead to
cancellations of customer orders or delays in placement of orders which
could materially adversely affect the Company's results of operations.
If the Company's purchase of such components or platforms exceeds
demand, the Company could incur losses or other charges in disposing of
excess inventory, which could also materially adversely affect the
Company's results of operations.
The Company's manufacturing operations consist primarily of final
assembly, testing and quality control of materials, components,
subassemblies and systems for its Sniffer based products. The Company
intends to outsource these manufacturing operations in 1998. There can
be no assurance that the Company will be able to qualify and secure on
commercially acceptable terms satisfactory third party manufacturers on
a timely basis or at all. In addition, reliance on third party
manufacturers will involve a number of risks, including the lack of
direct control over the manufacturing process, the absence or
unavailability of adequate capacity and reduced control over delivery
schedules, quality control and costs. In the event that, once initially
secured, the Company's third party manufacturers are unable or unwilling
to continue to manufacture the Sniffer based products in required
volumes, on a cost effective basis, in a timely manner or at all, the
Company will have to secure additional manufacturing capacity. Even if
such additional capacity is available at commercially acceptable terms,
the qualification process could be lengthy and could create delay in
product shipments.
Possible Price Volatility of Common Stock. The trading price of the
Company's Common Stock has historically been, and is expected to be,
subject to wide fluctuations. The market price of the Common Stock may
be significantly impacted by quarterly variations in financial
performance, shortfalls in revenue or earnings from levels forecast by
securities analysts, changes in estimates by such analysts, market
conditions in the computer software or hardware industries, product
introductions by the Company or its competitors, announcements of
extraordinary events such as acquisitions or litigation or general
economic conditions. Statements or changes in opinions, ratings, or
earnings estimates made by brokerage firms or industry analysts relating
to the market in which the Company does business or relating to the
Company specifically could result in an immediate and adverse effect on
the market price of the Common Stock. In addition, in recent years the
stock market has experienced extreme price and volume fluctuations.
These fluctuations have had a substantial effect on the market prices
for many high technology and emerging growth companies, often unrelated
to the operating performance of the specific companies. There can be no
assurances that the market price of the Common Stock will not decline
below the levels prevailing at the time of this offering. Securities
class action lawsuits are often brought against companies following
periods of volatility in the market price of their securities. Any such
litigation against the Company could result in substantial costs and a
diversion of resources and management attention.
Effect of Certain Provisional Anti-Takeover Effects of Certificate of
Incorporation, Bylaws and Delaware Law. The board of directors of the
Company has the authority to issue up to 5,000,000 shares of Preferred
Stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any
further vote or action by its stockholders. The rights of the holders of
Company Common Stock will be subject to, and may be adversely affected
by, the rights of the holders of any Preferred Stock that may be issued
in the future. The issuance of Preferred Stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult
for a third party to acquire a majority of the outstanding voting stock.
Further, certain provisions of Delaware law and the Company's
Certificate of Incorporation and Bylaws, such as a classified board,
could delay or make more difficult a merger, tender offer or proxy
contest involving the Company. While such provisions are intended to
enable the Company's Board to maximize stockholder value, they may have
the effect of discouraging takeovers which could be in the best interest
of certain stockholders. There is no assurance that such provisions will
not have an adverse effect on the market value of the Company's Common
Stock.
NETWORKS ASSOCIATES, INC.
FORM 10-Q, June 30, 1998
PART II: OTHER INFORMATION
Item 1. Legal Proceedings:
Information with respect to this item is incorporated by reference to
Note 6 of the Notes to the Consolidated Financial Statements included
herein on page 8 of this Report on Form 10-Q.
Item 2. Changes in Securities
On June 29, 1998, the Company acquired CSB Consulenza Software di
Base S.r.l. ("CSB"). In connection therewith, the Company issued an
aggregate of 9,815 shares of Company Common Stock to the shareholders of
CSB. The transaction was exempt from registration requirements of
Section 5 of the Securities Act pursuant to Section 4(2) thereof and
Regulation S promulgated thereunder. The recipients of the securities
represented their intentions to acquire the securities for investment
only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate
access to information regarding the Company. In addition, the offer and
sale of such securities by the Company occurred outside of the United
States.
On May 15, 1998, the Company acquired Secure Networks, Inc.
("Secure"). In connection therewith, the Company issued an aggregate of
567,000 shares of Company Common Stock to the shareholders of Secure.
The transaction was exempt from registration requirements of Section 5
of the Securities Act pursuant to Section 4(2) thereof and Regulation S
promulgated thereunder. The recipients of the securities represented
their intentions to acquire the securities for investment only and not
with a view to or for sale in connection with any distribution thereof
and appropriate legends were affixed to the share certificates issued in
such transaction. All recipients had adequate access to information
regarding the Company.
On March 30, 1998, the Company acquired (subject to right of
repurchase) a percentage interest in Nordic Lantools AB ("Nordic AB").
In connection therewith, the Company issued an aggregate of 3,063
shares of Company Common Stock to the shareholders of Nordic AB. The
transaction was exempt from registration requirements of Section 5 of
the Securities Act pursuant to Section 4(2) thereof and Regulation S
promulgated thereunder. The recipients of the securities represented
their intentions to acquire the securities for investment only and not
with a view to or for sale in connection with any distribution thereof
and appropriate legends were affixed to the share certificates issued in
such transaction. All recipients had adequate access to information
regarding the Company. In addition, the offer and sale of such
securities by the Company occurred outside of the United States.
On February 27, 1998, the Company acquired Nordic Lantools OY
("Nordic OY"). In connection therewith, the Company issued an aggregate
of 27,445 shares of Company Common Stock to the shareholders of Nordic
OY. The transaction was exempt from registration requirements of
Section 5 of the Securities Act pursuant to Section 4(2) thereof and
Regulation S promulgated thereunder. The recipients of the securities
represented their intentions to acquire the securities for investment
only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate
access to information regarding the Company. In addition, the offer and
sale of such securities by the Company occurred outside of the United
States.
On February 26, 1998, the Company acquired Syscon (Proprietary)
Limited ("Syscon"). In connection therewith, the Company issued an
aggregate of 1,230 shares of Company Common Stock to the shareholders
of Syscon. The transaction was exempt from registration requirements of
Section 5 of the Securities Act pursuant to Section 4(2) thereof and
Regulation S promulgated thereunder. The recipients of the securities
represented their intentions to acquire the securities for investment
only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate
access to information regarding the Company. In addition, the offer and
sale of such securities by the Company occurred outside of the United
States.
Item 4. Submission of Matters to a Vote of Security Holders:
At the Annual Meeting of Stockholders of the Company on May 29, 1998, the
following matters were acted upon by the stockholders of the Company:
1. The election of William L. Larson as the sole Class III director of the
Company to hold office for a three-year term, until a successor is elected
and qualified:
Shares in Favor 62,488,800
Shares Withheld 687,514
2. The approval of an amendment to the Company's 1997 Stock Incentive Plan,
to increase the number of shares of the Company's Common Stock reserved for
issuance thereunder by 3,000,000 shares (after giving effect to the
Company's recent 3-for-2 Common Stock split):
Shares in Favor 43,524,911
Shares Against 19,527,645
Shares Abstained 123,758
No Vote 0
3. The approval of an amendment to the Company's 1994 Employee Stock
Purchase Plan (as amended on January 20, 1997), to increase the number of
shares of the Company's Common Stock reserved for issuance thereunder by
1,500,000 shares (after giving effect to the Company's recent 3-for-2
Common Stock split):
Shares in Favor 61,545,112
Shares Against 1,508,856
Shares Abstained 122,346
No Vote 0
4. The ratification of the appointment of PriceWaterhouseCoopers L.L.P.
(formerly Coopers & Lybrand L.L.P.) as the independent accountants of the
Company for the fiscal year ending December 31, 1998:
Shares in Favor 63,044,360
Shares Against 51,759
Shares Abstained 80,195
No Vote 0
The number of shares of Common Stock outstanding and entitled to vote
at the Annual Meeting was 71,790,355 and 63,176,314 shares were
represented in person or by proxy. Unless otherwise noted above, share
numbers provided in this Item 4. Do not reflect the effect of the
Company's recent 3-for-2 Common Stock Split.
Item 6. Exhibits and Reports on Form 8-K:
(a) The Company filed the following reports on Form 8-K:
In a report on Form 8-K filed with the Commission on June 16,
1998, the Company reported the agreement as to the terms of a
proposed acquisition of Dr Solomon's Group PLC, a corporation duly
organized and existing under the laws of England and Wales. The
Company filed an amended Report on Form 8-K on July 1, 1998, which
included certain exhibits in connection with such proposed
acquisition.
In a report on Form 8-K filed with the Commission on April 28,
1998, the Company reported the closing and principal terms of the
acquisition of Trusted Information Systems, Inc., a Delaware
Corporation, which acquisition was consummated on April 28, 1998.
In a report on Form 8-K filed with the Commission on April 3,
1998, the Company reported the closing and the principal terms of
the acquisition of Magic Solutions International, Inc., a Delaware
Corporation, which acquisition was consummated on April 1, 1998.
(b) Exhibits. The exhibits listed in the accompanying Exhibit Index
are filed or incorporated by reference as part of this Report.
<PAGE>
NETWORKS ASSOCIATES, INC.
FORM 10-Q, June 30, 1998
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 report to be signed on its behalf by the undersigned
thereunto duly authorized.
NETWORKS ASSOCIATES, INC.
/s/ PRABHAT K. GOYAL
Name: Prabhat K. Goyal
Title: Vice President
Administration,
Chief Financial Officer
and Secretary
Date: August 14, 1998
<PAGE>
NETWORKS ASSOCIATES, INC.
Form 10-Q, June 30, 1998
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT TITLE
- ----------- ------------------------------------------------------------
2.1 Agreement and Plan of Reorganization, dated as of October
13, 1997, among McAfee Associates, Inc., Mystery Acquisition
Corp. and Network General Corporation, as amended by the
First Amendment dated as of October 22, 1997.(1)
2.2 Combination Agreement dated August 16, 1996 among the
Registrant, FSA Combination Corp., FSA Corporation and
Daniel Freedman.(2)
2.3 Stock Exchange Agreement dated January 13, 1996 among the
Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and
the shareholders of Jade.(3)
2.4 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, Helix Software Company an DNA
Acquisition Corp.(4)
2.5 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, PGP and PG Acquisition Corp.(5)
2.6 Agreement and Plan of Reorganization dated February 22, 1998,
between the Registrant, TIS and Thor Acquisition Corp.(6)
2.7 Agreement and Plan of Reorganization by and among the
Company, Magic Solutions International, Inc., Merlin
Acquisition Corp. and Igal Lichtman, Amendment Agreement by
and among the Registrant, Magic Solutions International,
Inc., Merlin Acquisition Corp., and Igal Lichtman dated
March 24, 1998. Second Amendment Agreement by and among the
Registrant, Magic Solutions International, Inc., Merlin
Acquisition Corp., and Igal Lichtman dated April 1, 1998.(7)
2.8 Stock Purchase Agreement, dated as of February 26, 1998, by and
between FSA Combination Corp., and Brenda Joyce Cook.(8)
2.9 Share Purchase Agreement, dated as of March 30, 1998, among FSA
Combination Corp., and Irina Karlsson and Jarmo Rouvinen.(8)
2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA
Combination Corp., and Secure Networks, Inc.(8)
3.1 Second Restated Certificate of Incorporation of Networks
Associates, Inc., as amended on December 1, 1997.(6)
3.2 Restated Bylaws of Networks Associates, Inc.(6)
3.3 Certificate of Designation of Series A Preferred Stock of
Networks Associates, Inc.(9)
4.2 Registration Rights Agreement dated August 30, 1996 between
the Registrant and Daniel Freedman.(1)
4.5 Registration Rights Agreement dated December 9, 1997 between
the Registrant and certain shareholders of PGP.(4)
4.6 Registration Rights Agreement, dated as of February 13,
1998, by and between the Registrant and Morgan Stanley & Co.
Incorporated.(10)
4.7 Indenture dated as of February 13, 1998 between the
Registrant and State Street Bank and Trust Company of
California, N.A., as Trustee.(10)
4.10 Registration Rights Agreement dated May 8, 1998, by and between the
Registrant and the stockholders of Secure Networks, Inc.(8)
4.11 Registration Rights Agreement, dated June 29, 1998, by and between
the Registrant and certain stockholders of CSB Consulenza Software
di Base S.r.l. ("CSB").(11)
4.12 Registration Rights Agreement, dated July 30, 1998, by and between
the Registrant and certain stockholders of Anyware Seguridad
Informatica S.A.(11)
10.1 Standard Business Lease (Net) for Network General's
principal facility dated June 19, 1991, between Network
General and Menlo Oaks Partners, L.P.(12)
10.2 First Amendment to Lease dated June 10, 1992, between
Network General and Menlo Parks Partners, L.P.(12)
10.3 Standard Business Lease (Net) for Network General's
principal facility dated March 11, 1992, between Network
General and Menlo Oaks Partners L.P.(13)
10.4 First Amendment to Lease dated June 18, 1992, between
Network General and Menlo Oaks Partners, L.P.(12)
10.5 Lease dated March 31, 1992, between Network General and
Equitable Life Assurance Society of the United States.(12)
10.6 Second Amendment to Lease dated February 1, 1995, between
Network General and Menlo Oaks Partners, L.P.(13)
10.7 Third amendment to Lease dated February 1, 1995 between
Network General and Menlo Oaks Partners L.P.(13)
10.8 Fourth Amendment to Lease dated May 31, 1995, between
Network General and Menlo Oaks Partners, L.P.(14)
10.9 Fifth Amendment to Lease dated June 13, 1995, between
Network General and Menlo Oaks Partners, L.P.(14)
10.10 Lease dated July 3, 1996 between Network General and
Campbell Avenue Associates.(15)
10.11 Sixth Amendment to Lease dated November 29, 1996, between
Network General and Menlo Oaks Partners, L.P.(15)
10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa
Clara, California, dated as of February 20, 1997, by and
between McAfee Associates, Inc. and National Semiconductor
Corporation.(16)
10.13 Lease Agreement dated November 17, 1997 for facility at 3965
Freedom Circle, Santa Clara, California by and between
Informix Corporation and McAfee Associates, Inc.(4)
10.14 Consent to Assignment Agreement dated December 19, 1997 by
and among Birk S. McCandless, LLC, Guaranty Federal Bank,
F.S.B., Informix Corporation and Networks Associates,
Inc.(4)
10.15 Subordination, Nondisturbance and Attornment Agreement dated
December 18, 1997, between Guaranty Federal Bank, F.S.B.,
Networks Associates, Inc. and Birk S. McCandless, LLC.(4)
10.16 Lease dated November 22, 1996 by and between Birk S.
McCandless, LLC and Informix Corporation for facility at
3965 Freedom Circle, Santa Clara, California.(4)
10.17 Quota Purchase Assignment Agreement, dated as of April 14, 1997 by
and among McAfee Associates, Inc. and McAfee Do Brasil Ltda.,
Compusul-Consultoria E Comericio De Informatica Ltda., and the
stockholders of Compusul-Consultoria E Comericio De Informatica
Ltda.(17)
10.18* 1997 Stock Incentive Plan.(17)
10.19* Stock Option Plan for Outside Directors.(18)
10.20* Change in control agreement between the Company and Dennis
Cline dated April 14, 1995.(17)
10.21* Change in control agreement between the Company and Peter
Watkins dated May 1, 1995.(17)
10.22* Change in control agreement between the Company and William
S. Larson dated April 14, 1995.(17)
10.23* Change in control agreement between the Company and Prabhat
K. Goyal.(19)
10.27* Change in control agreement between the Company and Zach
Nelson, dated May 12, 1998.(20)
27.1 Financial Data Sheet
- ----------------
(1) Incorporated by reference from the Registrant's Registration
Statement on Form S-4 filed with the Commission on October 31, 1997.
(2) Incorporated by reference from the Registrant's Current Report on
Form 8-K filed with the Commission on September 24, 1996.
(3) Incorporated by reference from the Registrants Current Report on
Form 8-K filed with the Commission on March 14, 1997.
(4) Incorporated by reference from the Registrant's Registration
Statement on Form S-3, filed with the Commission on February 12, 1998.
(5) Incorporated by reference to the Report on Form 8-K of the Registrant
as filed with the Commission on December 11, 1997.
(6) Incorporated by reference to the Report on Form S-4 of the
Registrant as filed with the Commission on March 25, 1998.
(7) Incorporated by reference to Exhibits 2.1, 2.2 and 2.3 of the Report
on Form 8-K of the Registrant as filed with the Commission on April
2, 1998.
(8) Incorporated by reference from the Registrant's Registration
Statement on Form S-3 filed with the Commission on April 2, 1998.
(9) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended September 30, 1996, filed with the Commission
on November 4, 1997.
(10) Incorporated by reference from the Registrant's Registration
Statement on Form S-3 filed with the Commission on May 6, 1998.
(11) Incorporated by reference from the Registrant's Registration
Statement on Form S-3 filed with the Commission on August 5, 1998.
(12) Incorporated by reference from the Network General Corporation's
Report on Form 10-K for the year ended March 31, 1992. Network
General's filings with the Commission were made under File Number
0-17431.
(13) Incorporated by reference from the Network General Corporation's
Report on Form 10-Q for the quarter ended December 31, 1994.
Network General's filings with the Commission were made under File
Number 0-17431.
(14) Incorporated by reference from the Network General Corp.oration's
Report on Form 10-Q for the quarter ended June 30, 1995. Network
General's filings with the Commission were made under File Number
0-17431.
(15) Incorporated by reference from the Network General Corporation's
Report on Form 10-Q for the quarter ended June 30, 1996. Network
General's filings with the Commission were made under File Number
0-17431.
(16) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended June 30, 1997, filed with the Commission on
August 14, 1997.
(17) Incorporated by reference from the Registrant's Registration
Statement on Form S-4 filed with the Commission on July 31, 1995.
(18) Incorporated by reference from the Registrant's Registration
Statement on Form S-8 filed with the Commission on December 2, 1997.
(19) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended June 30, 1996, filed with the Commission on
August 13, 1996.
(20) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended March 31, 1998, filed with the Commission on
May 15, 1998.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE ACCOMPANYING CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 101,634
<SECURITIES> 451,794
<RECEIVABLES> 168,924
<ALLOWANCES> 6,086
<INVENTORY> 0
<CURRENT-ASSETS> 780,666
<PP&E> 49,238
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,083,941
<CURRENT-LIABILITIES> 252,410
<BONDS> 0
0
0
<COMMON> 1,158
<OTHER-SE> 427,096
<TOTAL-LIABILITY-AND-EQUITY> 1,083,941
<SALES> 408,785
<TOTAL-REVENUES> 408,785
<CGS> 75,763
<TOTAL-COSTS> 75,763
<OTHER-EXPENSES> 357,692
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (16,288)
<INCOME-TAX> 49,034
<INCOME-CONTINUING> (65,322)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (65,322)
<EPS-PRIMARY> ($0.57) <F1>
<EPS-DILUTED> ($0.57)
<FN>
<F1>For Purposes of this Exhibit, Primary means Basic.
</FN>
</TABLE>
