<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1 TO
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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)
<TABLE>
<S> <C>
DELAWARE 77-0316593
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
</TABLE>
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
------------------------
2805 BOWERS AVENUE
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 [ ]
114,732,687 shares of the registrant's common stock, $0.01 par value, were
outstanding as of April 30, 1998 (after giving effect to a 3:2 stock split to be
effected by a stock dividend payable on or about May 29, 1998).
THIS DOCUMENT CONTAINS 34 PAGES.
THE EXHIBIT INDEX IS ON PAGE 32.
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NETWORKS ASSOCIATES, INC.
FORM 10-Q, MARCH 31, 1998
------------------------
CONTENTS
<TABLE>
<CAPTION>
ITEM NUMBER PAGE
----------- ----
<S> <C>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets:
March 31, 1998 and December 31, 1997......... 3
Condensed Consolidated Statements of Income:
Three months ended March 31, 1998 and 1997... 4
Condensed Consolidated Statements of Cash Flows:
Three months ended March 31, 1998 and 1997... 5
Notes to Condensed Consolidated Financial
Statements...................................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................. 11
PART II: OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................... 30
SIGNATURES.................................................. 31
EXHIBIT INDEX............................................... 32
</TABLE>
2
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 190,983 $123,494
Marketable securities..................................... 436,474 123,882
Accounts receivable, net of allowances for doubtful
accounts and returns of $4,129 and $3,662 at March 31,
1998 and December 31, 1997............................. 139,624 125,284
Prepaid expenses, taxes and other......................... 74,555 57,612
---------- --------
Total current assets.............................. 841,636 430,272
Marketable securities....................................... 155,001 109,184
Fixed assets, net........................................... 37,241 28,570
Deferred taxes.............................................. 12,633 16,173
Intangibles and other assets................................ 16,925 17,732
---------- --------
Total assets...................................... $1,063,436 $601,931
========== ========
LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 22,682 $ 18,439
Accrued liabilities....................................... 129,374 141,083
Deferred revenue.......................................... 77,420 69,464
---------- --------
Total current liabilities......................... 229,476 228,986
Deferred revenue and taxes, less current portion.......... 14,512 13,186
Long term debt and other liabilities...................... 354,663 --
---------- --------
Total liabilities................................. 598,651 242,172
---------- --------
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:
107,504,225 shares at March 31, 1998 and 104,881,325
shares at December 31, 1997............................... 1,075 1,049
Additional paid-in capital.................................. 253,396 190,643
Retained earnings........................................... 210,314 168,067
---------- --------
Total stockholders' equity........................ 464,785 359,759
---------- --------
Total liabilities and stockholders' equity........ $1,063,436 $601,931
========== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Net revenue................................................. $188,415 $141,362
Operating costs and expenses:
Cost of net revenue....................................... 34,163 25,514
Research and development.................................. 25,525 17,908
Marketing and sales....................................... 56,556 40,613
General and administrative................................ 11,172 9,534
Amortization of intangibles............................... 792 104
Acquisition and other related costs....................... -- 19,504
-------- --------
Total operating costs and expenses................ 128,208 113,177
-------- --------
Income from operations............................ 60,207 28,185
Interest and other income and expense, net.................. 4,765 2,897
-------- --------
Income before provision for income taxes.......... 64,972 31,082
Provision for income taxes.................................. 23,390 17,811
-------- --------
Net income........................................ $ 41,582 $ 13,271
======== ========
Net income per share -- basic............................... $ 0.39 $ 0.13
-------- --------
Shares used in per share calculation -- basic............... 106,952 101,450
======== ========
Net income per share -- diluted............................. $ 0.37 $ 0.12
======== ========
Shares used in per share calculation -- diluted............. 116,084 108,899
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1998 1997
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income.................................................. $ 41,582 $ 13,271
Adjustments to reconcile net income to net cash provided
from operating activities:
Acquired in-process research and development........... -- 19,504
Depreciation and amortization.......................... 3,958 4,602
Interest on convertible notes.......................... 2,498 --
Unrealized gain on investments......................... -- (242)
Deferred taxes......................................... 1,457 (3,307)
Changes in assets and liabilities:
Accounts receivable.................................. (14,340) (11,187)
Prepaid expenses, taxes and other.................... (13,268) 5,415
Accounts payable and accrued liabilities............. (7,384) 4,425
Deferred revenue..................................... 13,623 8,604
Other................................................ 730 (197)
--------- --------
Net cash provided by operating activities......... 28,856 40,888
--------- --------
Cash flows from investing activities:
Purchase of intangibles................................... 371 (9)
Purchases of investment securities, net................... (358,408) (17,587)
Additions to fixed assets................................. (12,328) (9,740)
--------- --------
Net cash used in investing activities............. (370,365) (27,336)
--------- --------
Cash flows from financing activities:
Effect of exchange rate fluctuations...................... (1,045) (250)
Sale of convertible debentures............................ 346,284 --
Stock option exercises.................................... 42,761 14,839
Tax benefit from exercise of nonqualified stock options... 20,998 13,825
Repurchase of common stock................................ -- (16,378)
--------- --------
Net cash provided by financing activities......... 408,998 12,036
--------- --------
Net increase in cash and cash equivalents................... 67,489 25,588
Cash and cash equivalents at beginning of period............ 123,494 118,528
--------- --------
Cash and cash equivalents at end of period.................. $ 190,983 $144,116
========= ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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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 months ended March 31, 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 are 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 to be provided 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 quarter 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.
6
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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.
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
MARCH 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Numerator -- basic
Net income.................................................. $41,582 $13,271
======= =======
Numerator -- diluted
Net income.................................................. $41,582 $13,271
Interest on convertible debentures, net of tax.............. 1,594 --
------- -------
Net income available to common stockholders................. $43,176 $13,271
======= =======
Denominator -- basic
Basic weighted average common shares outstanding............ 106,952 101,450
======= =======
Denominator -- diluted
Basic weighted average common shares outstanding............ 106,952 101,450
Effect of dilutive securities:
Common stock options........................................ 9,132 7,449
------- -------
Diluted weighted average shares............................. 116,084 108,899
======= =======
Net income per share -- basic............................... $ 0.39 $ 0.13
======= =======
Net income per share -- diluted............................. $ 0.37 $ 0.12
======= =======
</TABLE>
4. CONVERTIBLE DEBENTURES
On February 13, 1998, the Company completed a private placement of zero
coupon convertible subordinated debentures due in 2018 (the "Debentures"). The
debentures, with an aggregate face amount at maturity of $885.5 million,
generated net proceeds to the Company of approximately $346.3 million. The
initial price to the public for the debentures was $391.06 per $1,000 of face
amount at maturity, which equates to a yield to maturity over the term of the
bonds of 4.75% (on a semi-annual bond equivalent basis). The debentures are
convertible into Common Stock at the rate of 8.538 shares per $1,000 of face
amount at maturity, which equates to an initial conversion price of $45.80 per
share. The Debentures are subordinated in right of payment to all existing and
future Senior Indebtedness (as defined) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the Company's subsidiaries.
The Debentures may be redeemed for cash at the option of the Company beginning
on February 13, 2003. At the option of the holder, the Company will purchase the
Debentures on February 13, 2003 and February 13, 2013 at purchase prices (to be
paid in cash or Common Stock or any combination thereof, at the election of the
Company and subject to certain conditions) equal to the initial issue price plus
accrued original issue discount to such dates.
7
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The Debentures may also be redeemed at the option of the holder if there is a
Fundamental Change (as defined) at a price equal to the issue price plus accrued
original issue discount to the date of redemption, subject to adjustment.
5. ACQUISITIONS
On February 28, 1998, the Company acquired two distributors, Nordic
Lantools OY, a Finnish company and Syscon, a South African company. Both
companies have been accounted for as pooling of interest transactions; however
prior periods have not been restated as the effect is not material.
6. LITIGATION
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 February 11, 1998,
Symantec filed another motion seeking leave to again amend its complaint to
include 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 Company employees of proprietary Symantec
customer information. The Company will move to dismiss the RICO claim. Symantec
also filed a motion for a preliminary injunction relating to these new
allegations, and has scheduled both motions for hearing on June 5, 1998. Trial
is currently set for September 1998.
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. Trend and
Symantec have stated that they have settled the case between them, although no
formal dismissal notice has been received by the Company.
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
8
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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. The arbitration
proceedings are in the preliminary stages.
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.
A status conference is scheduled for September 14, 1998, at which time RSA may
ask the court to lift the stay if the case has not been arbitrated or settled by
that time. On April 15, 1998, RSA filed a third lawsuit on the same patent
against the Company. Counsel for the Company intend to ask the Court to stay
this action also.
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, 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. The Court had originally set a fact discovery
cut-off date of July 15, 1998 and an expert discovery cut-off date of September
15, 1998, with a status conference on September 22, 1998. Because of a recent
change in its counsel, the Company intends to ask the Court to continue those
dates. No trial date has been set.
The Company has changed its legal name to "Networks Associates, Inc." and
has begun conducting business as "Network Associates." Four companies (Network
Associates Corporation and The Network Associates in California; Network
Associates, Inc. in Kansas; and Network Associates, Inc. in Oregon) have made
claims (including various trademark claims) or demands with respect to the
Company's use of the name Network Associates. Network Associates Corporation
filed suit in Superior Court of California for the county of Santa Clara on
February 25, 1998, seeking among other things, a preliminary and permanent
injunction restraining the Company from using in California, the name "Network
Associates" or "Network Associates, Inc." and unspecified compensatory and
punitive damages. A preliminary injunction hearing is scheduled for June 4,
1998, but the parties have reached an agreement in principle to settle the
matter.
While there can be no assurance that the above litigation will not have a
material adverse effect on the Company, management does not expect that the
ultimate costs to resolve these matters will have a material adverse effect on
the Company's consolidated financial position, results of operations, or cash
flow.
7. SUBSEQUENT EVENTS
Magic Solutions, Inc.
On April 1, 1998, the Company acquired all of the outstanding capital stock
and options of Magic Solutions, Inc. ("Magic Solutions"), a privately held
provider of internal help desk and asset management solutions, for approximately
$110 million in cash. The acquisition will be accounted for using the purchase
method of accounting and the Company expects that a substantial portion of this
price will be expensed as purchased in-process research and development in the
quarter ended June 30, 1998.
9
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Trusted Information Systems
On April 28, 1998, the Company completed the acquisition of 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.
The TIS acquisition will be accounted for as a pooling of interests;
however, historical results have not been restated to reflect the TIS
acquisition. TIS results for the year ended December 31, 1997 were: Revenue,
$42.2 million; Net loss, $8.6 million; and Total assets, $53.8 million. In the
second quarter, retained earnings as of March 31, 1998 will be adjusted to
reflect TIS' retained earnings to date.
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 will be distributed on or about May 29, 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.
10
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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 PGP TOTAL NETWORK SNIFFER TOTAL NETWORK MCAFEE TOTAL SERVICE
DEFENSE SECURITY VISIBILITY DESK
- ------------------------- -------------------- -------------------------------- --------------------------------
<S> <C> <C> <C>
- - VirusScan Security - PGP Desktop Suite - Sniffer Portable Analysis - McAfee Help Desk Suite
Suite - PGP Server Suite Suite - Zero Administration Client
- - Net Shield Security - CyberCop - Sniffer Distributed Analysis Suite
Suite Suite
- - Internet Security Suite
</TABLE>
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
11
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NETWORKS ASSOCIATES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 ended March 31, 1998 and 1997:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
----------------
1998 1997
------ ------
<S> <C> <C>
Net revenue................................................. 100.0% 100.0%
Operating costs and expenses:
Cost of net revenue....................................... 18.1 18.0
Research and development.................................. 13.6 12.7
Marketing and sales....................................... 30.0 28.7
General and administrative................................ 5.9 6.7
Amortization of intangibles............................... 0.4 0.1
Acquisition and other unusual costs....................... -- 13.8
----- -----
Total operating costs and expenses..................... 68.0 80.0
----- -----
Income from operations............................ 32.0 20.0
Other income................................................ 2.5 2.0
----- -----
Income before income taxes........................ 34.5 22.0
Provision for income taxes.................................. 12.4 12.6
----- -----
Net income........................................ 22.1% 9.4%
===== =====
</TABLE>
Net Revenue. Net revenue includes product, 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
33% to $188.4 million in the three months ended March 31, 1998 from $141.4
million in the three months ended March 31, 1997. The increase was primarily due
to increases in the licensing of anti-virus software products to new customers,
renewing expiring anti-virus licenses, continued acceptance of the Company's
Sniffer products, continued acceptance of the Company's consulting and support
services as well as the growth of the installed customer base and the resulting
renewal of maintenance contracts. The increase is also attributable to
12
<PAGE> 13
NETWORKS ASSOCIATES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
a lessor extent to the licensing of products (other than anti-virus and Sniffer
products) to new and existing customers as well as expansion into indirect
product distribution channels and international markets.
Although the Company has had significant growth in net revenue and net
income (before acquisition and other related charges), the Company's growth rate
has slowed in recent periods. 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 32% and 27% of net
revenue for the three months ended March 31, 1998 and 1997, 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
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 uses non-leveraged forward currency contracts.
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 34% to $34.2 million in the three months ended March 31,
1998 from $25.5 million in the
- ---------------
* This statement is a forward looking statement reflecting current expectations.
There can be no assurance
that Networks' actual future performance will meet Networks' current
expectations. See the Risk Factors on
page 17 for a discussion of certain factors that could affect future
performance.
13
<PAGE> 14
NETWORKS ASSOCIATES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
three months ended March 31, 1997. This increase is due to an increase in net
revenue (particularly product revenues) as well as the initial investment in the
anti-virus professional services organization.
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, 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 43% to $25.5 million
in the three months ended March 31, 1998 from $17.9 million in the three months
ended March 31, 1997. This increase was primarily a result of the expansion of
the Company's product development and technical support staff and, to a lesser
extent, the increased use of independent contractors. As a percentage of net
revenue, research and development expenses increased to 14% in the three months
ended March 31, 1998 from 13% in the three months ended March 31, 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 39% to $56.6 million in the three months ended March
31, 1998 from $40.6 million in the three months ended March 31, 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 30% in
the three months ended March 31, 1998 and 29% in the three months ended March
31, 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 increased 17% to $11.2 million
in the three months ended March 31, 1998 from $9.5 million in the three months
ended March 31, 1997. The increase is largely a result of a increased staffing
to support operations both domestically and internationally and to accommodate
the growth in revenue. As a percentage of net revenue, general and
administrative expenses were 6% in the three months ended March 31, 1998 and 7%
in the three months ended March 31, 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.*
- ---------------
* This statement is a forward looking statement reflecting current expectations.
There can be no assurance
that Networks' actual future performance will meet Networks' current
expectations. See the Risk Factors on
page 17 for a discussion of certain factors that could affect future
performance.
14
<PAGE> 15
NETWORKS ASSOCIATES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Acquisition and Other Related Costs. In March 1997, the Company wrote off
$19.5 million of acquired in-process technology in connection with the
acquisition of 3DV Technology, Inc.
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 incurrence of significant
acquisition related charges to earnings. For example, in the three months ended
June 30, 1998, the Company expects to take significant acquisition related
charges in connection with the TIS Acquisition and the Magic Solutions
acquisition which were both consummated in the second quarter. 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 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 increased to $4.8 million in the three months ended March 31, 1998 from
$2.9 million in the three months ended March 31, 1998. This increase was due to
the investment of cash generated from operating activities and the issuance, in
February 1998, of Debentures with net proceeds of approximately $337.6 million.
Interest expense increased to $2.5 million in the three months ended March 31,
1998 from zero in the three months ended March 31, 1997. Interest expense
relates to the Debentures issued in February 1998.
Provision for Income Taxes. The Company's effective tax rate was 36% and
57% for the three months ended March 31, 1998 and 1997, respectively. Excluding
the one time charge for the write off of in-process research and development,
the Company's effective tax rate in the three months ended March 31, 1997 would
have been 35%.
Liquidity and Capital Resources
At March 31, 1998, the Company had $191.0 million in cash and cash
equivalents and $591.5 million in marketable securities, for a combined total of
$782.5 million.
Net cash provided by operating activities was $28.1 million and $41.1
million in the three months ended March 31, 1998 and 1997, respectively. Net
cash provided by operating activities in the three months ended March 31, 1998,
consisted primarily of net income and an increase in deferred revenue which were
offset primarily by an increase in accounts receivable, prepaid and other assets
and accounts payable and accrued liabilities. In the three months ended March
31, 1997, net cash provided by operating activities consisted primarily of net
income before acquisition costs, plus increases in deferred revenue and prepaid
and other assets, offset primarily by increases in accounts receivable and
deferred taxes.
The Company expects its accounts receivable balance as a percentage of
sales to increase due to the Company's increased emphasis on international sales
(typically having longer payment terms) and the
- ---------------
* This statement is a forward looking statement reflecting current expectations.
There can be no assurance
that Networks' actual future performance will meet Networks' current
expectations. See the Risk Factors on
page 17 for a discussion of certain factors that could affect future
performance.
15
<PAGE> 16
NETWORKS ASSOCIATES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Company's emphasis on licensing its network security and management product
suites to enterprise customers (which complex products may require longer
installation and implementation cycles, in turn resulting in potentially longer
payment cycles). Increased licensing through the indirect channel may also
impact the Company's receivable collection experience due to the longer payment
cycle for VARs and system integrators. To address this increase in accounts
receivable and to improve cash flow, the Company may, among other things, take
actions to encourage earlier payment of receivables or sell receivables. To the
extent that the Company's receivable balance increases, the Company will be
subject to greater general credit risks with respect thereto.
Net cash used in investing activities was $369.6 million and $27.5 million
in the three months ended March 31, 1998 and 1997, respectively, primarily
reflecting purchases of marketable securities and additions to fixed assets and
intangible assets.
Net cash provided by financing activities was $409.9 million in the three
months ended March 31, 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 $12.0 million in the three months ended March 31, 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.
- ---------------
* This statement is a forward looking statement reflecting current expectations.
There can be no assurance
that Networks' actual future performance will meet Networks' current
expectations. See the Risk Factors on
page 18 for a discussion of certain factors that could affect future
performance.
16
<PAGE> 17
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's growth rate has slowed in recent periods. 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 in the future. 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 March 31, 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
17
<PAGE> 18
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 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 recent acquisitions (including the acquisitions of 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 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; 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 expects to incur
additional non-recurring charges associated with the acquisitions of TIS and
Magic Solutions. 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 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 -- meaning that the Company would no longer sell
the hardware
18
<PAGE> 19
components contained in these 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.
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 security products (such as its recently
acquired PGP encryption products, Network General CyberCop product and TIS
firewall products) into a marketable suite of products 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 TIS and Magic 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
19
<PAGE> 20
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
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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
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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 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, the Dr. Solomon Group 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.
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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 the separate 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 training about, and
knowledge of, product attributes for the Company's suite of products. 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.
The Company does not have an extensive indirect sales channel for its
Network Sniffer products or its PGP 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.
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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.
Need to Expand and Develop An Effective Professional Services Organization;
Risks Related to Third-Party Professional Services. As the Company's products
and computer networks become more complex, customers will increasingly require
greater professional assistance in the design, installation, configuration and
implementation 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, 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 and growth in indirect channel business, will
require it to attract, train, motivate and manage new employees successfully, to
effectively integrate new employees into its operations 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
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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." Four companies
(Network Associates Corporation and The Network Associates in California;
Network Associates, Inc. in Kansas; and Network Associates, Inc. in Oregon) have
made claims (including various trademark claims) or demands with respect to
Network Associates' use of the name Network Associates. Network Associates
Corporation filed suit in Superior Court of California for the county of Santa
Clara on February 25, 1998, seeking among other things, a preliminary and
permanent injunction restraining Network Associates from using in California,
the name "Network Associates" or "Network Associates, Inc." and unspecified
compensatory and punitive damages. A preliminary injunction hearing is scheduled
for June 4, 1998, but the parties have reached an agreement in principle to
settle the matter.
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 (including a pending unfair
trade practice case and a patent infringement case involving Symantec and Trend
Micro Inc., respectively). 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.
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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 March
31, 1998, net revenue from international licenses represented approximately 32%
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. 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
uses non-leveraged forward currency contracts. 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 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 PGP and TIS
security 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 anti-virus
software market, the Company has been a target of computer "hackers" who have
created viruses to sabotage its products. While to date these viruses have been
discovered quickly and their dissemination has been limited, there can be no
assurance that similar viruses will not be created 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.
Risk of False Detection of Viruses. 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.
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.
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Failure to obtain the required licenses or the costs of compliance could have a
material adverse effect on the Company's international revenues.
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 anti-virus 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. 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
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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."
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 products and systems are Year 2000 compliant, the Company
utilizes third-party equipment and software 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
28
<PAGE> 29
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.
29
<PAGE> 30
NETWORKS ASSOCIATES, INC.
FORM 10-Q, MARCH 31, 1998
PART II: OTHER INFORMATION
ITEM 3. 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
9 of this Report on Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) The Company filed the following reports on Form 8-K:
April 28, 1998 related to the acquisition of TIS.
April 3, 1998 and March 25, 1998 related to the acquisition of Magic
Solutions, Inc.
February 25, 1998 related to the acquisition of PGP.
February 12, 1998 related to the issuance of the Debentures.
February, 1998 related to the press release for the fourth quarter and
the year ended December 31, 1997.
(b) Exhibits. The exhibits listed in the accompanying Exhibit Index are
filed or incorporated by reference as part of this Report.
30
<PAGE> 31
NETWORKS ASSOCIATES, INC.
FORM 10-Q, MARCH 31, 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: May 15, 1998
31
<PAGE> 32
NETWORKS ASSOCIATES, INC.
FORM 10-Q, MARCH 31, 1998
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<C> <S> <C>
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, incorporated
by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on October 31, 1997......
2.2 Combination Agreement dated August 16, 1996 among the
Registrant, FSA Combination Corp., FSA Corporation and
Daniel Freedman.(1).........................................
2.3 Stock Exchange Agreement dated January 13, 1996 among the
Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and
the shareholders of Jade.(2)................................
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.,
incorporated by reference to the Report on Form 8-K of the
Registrant as filed with the Securities and Exchange
Commission on December 11, 1997 (the "December 11, 1997 Form
8-K").......................................................
2.6 Agreement and Plan of Reorganization dated February 22,
1998, between the Registrant, TIS and Thor Acquisition
Corp., incorporated by reference to the Report on Form S-4
of the Registrant as filed with the Securities and Exchange
Commission on March 25, 1998. ..............................
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.
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
Securities and Exchange Commission on April 2, 1998 (the
"April 2, 1998 Form 8-K"). .................................
3.1 Second Restated Certificate of Incorporation of Networks
Associates, Inc., as amended on December 1, 1997,
incorporated by reference to the Registrant's Registration
Statement on Form S-4, filed with the Commission on March
25, 1998....................................................
3.2 Restated Bylaws of Networks Associates, Inc., incorporated
by reference to the Registrant's Registration Statement on
Form S-4, filed with the Commission on March 25, 1998.......
3.3 Certificate of Designation of Series A Preferred Stock of
Networks Associates, Inc., incorporated by reference to
Exhibit 3.3 of the Registrant's Form 10-Q for the Quarter
ended September 30, 1996....................................
4.1 Registration Rights Agreement, dated January 13, 1996
between the Registrant an all shareholders of Jade.(2)......
4.2 Registration Rights Agreement dated August 30, 1996 between
the Registrant and Daniel Freedman.(1)......................
4.3 Registration Rights Agreement dated February 27, 1997
between the Registrant and the shareholders of Schuijers,
incorporated by reference from Exhibit 10.50 to the
Registrant's Report on Form 10-K for the year ended December
31, 1996....................................................
4.4 Registration Rights Agreement dated December 1, 1997 between
the Registrant and the shareholders of Helix.(4)............
</TABLE>
32
<PAGE> 33
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<C> <S> <C>
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, incorporated by reference to Exhibit 4.6 of
the Company's Registration Statement on Form S-3 filed with
the Securities and Exchange Commission on May 6, 1998 (the
"May 6, Form S-3")..........................................
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, incorporated by reference to
the May 6, Form S-3.........................................
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., which is incorporated
by reference to Exhibit 10.3 of Network General's Annual
Report on Form 10-K for the year ended March 31, 1992
("Network General 1992 From 10-K").(3)......................
10.2 First Amendment to Lease dated June 10, 1992, between
Network General and Menlo Parks Partners, L.P., which is
incorporated by reference to Exhibit 10.3 of Network
General's Annual Report on Form 10-K for the year ended
March 31, 1992 ("Network General 1992 Form 10-K").(3).......
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., which is incorporated
by reference to Exhibit 10.4 of the Network General 1992
Form 10-K.(3)...............................................
10.4 First Amendment to Lease dated June 18, 1992, between
Network General and Menlo Oaks Partners, L.P., which is
incorporated by reference to Exhibit 10.5 of the Network
General 1992 Form 10-K.(3)..................................
10.5 Lease dated March 31, 1992, between Network General and
Equitable Life Assurance Society of the United States, which
is incorporated by reference to Exhibit 10.4 of the Network
General 1992 Form 10-K.(3)..................................
10.6 Second Amendment to Lease dated February 1, 1995, between
Network General and Menlo Oaks Partners, L.P., which is
incorporated by reference to Exhibit 10.2 of Network
General's Quarterly Report on Form 10-Q for the quarter
ended December 31, 1994 ("Network General December 1994 From
10-Q").(3)..................................................
10.7 Third amendment to Lease dated February 1, 1995 between
Network General and Menlo Oaks Partners L.P., which is
incorporated by reference to Exhibit 10.23 of the Network
General December 1994 Form 10-Q.(3).........................
10.8 Fourth Amendment to Lease dated May 31, 1995, between
Network General and Menlo Oaks Partners, L.P., which is
incorporated by reference to Exhibit 10.27 of Network
General's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995 ("Network General June 1995 Form
10-Q").(3)..................................................
10.9 Fifth Amendment to Lease dated June 13, 1995, between
Network General and Menlo Oaks Partners, L.P., which is
incorporated by reference to Exhibit 10.28 of the Network
General June 1995 Form 10-Q.(3).............................
10.10 Lease dated July 3, 1996 between Network General and
Campbell Avenue Associates, which is incorporated by
reference to Exhibit 10.21 of Network General's Quarterly
Report on Form 10-Q for the quarter ended June 30,
1996.(3)....................................................
10.11 Sixth Amendment to Lease dated November 29, 1996, between
Network General and Menlo Oaks Partners, L.P., which is
incorporated by reference to Exhibit 10.22 of Network
General's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1996.(3).....................................
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, incorporated by reference to Exhibit 10.51 of
the Form 10-Q of McAfee Associates, Inc. for the Quarter
ended June 30, 1997.........................................
</TABLE>
33
<PAGE> 34
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<C> <S> <C>
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.,
incorporated by reference to Exhibit 10.52 of the Form 10-Q
of McAfee Associates, Inc. for the Quarter ended June 30,
1997. ......................................................
10.18* 1997 Stock Incentive Plan, incorporated by reference to
Exhibit 4.1 to the Registration Statement on Form S-8 of
McAfee Associates, Inc., filed with the Securities and
Exchange Commission on August 8, 1997. .....................
10.19* Change in control agreement between the Company and Dennis
Cline dated April 14, 1995 incorporated by reference to
Exhibit 10.2 of the Company's Registration Statement No.
33-93296 on Form S-4 (the "S-4"). ..........................
10.20* Change in control agreement between the Company and Peter
Watkins May 1, 1995 incorporated by reference to Exhibit
10.6 of the S-4. ...........................................
10.21* Change in control agreement between the Company and William
S. Larson dated April 14, 1995 incorporated by reference to
Exhibit 10.7 of the S-4. ...................................
10.22* Change in control agreement between the Company and Prabhat
K. Goyal incorporated by reference to Exhibit 10.43 of the
Company's Form 10-Q for the quarter ended June 30, 1996. ...
10.27 Change in control agreement between the Company and Zach
Nelson, dated May 12, 1998. ................................
27.1 Financial Data Sheet........................................
</TABLE>
- ---------------
(1) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on September 24, 1996.
(2) Incorporated by reference from the Registrants Current Report on Form 8-K
filed with the Commission on March 14, 1997.
(3) Network General's filings with the Commission were made under File Number
0-17431
(4) Incorporated by reference from the Registrant's Registration Statement on
Form S-3, filed with the Commission on February 12, 1998.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
34
<PAGE> 1
EXHIBIT 10.27
May 12, 1998
Mr. Zachary T. Nelson
Networks Associates, Inc.
2805 Bowers Avenue
Santa Clara, CA 95051
RE: CHANGE IN CONTROL ARRANGEMENT
Dear Zach:
Pursuant to our recent discussions, this letter sets forth the terms of
your change in control arrangement (the "AGREEMENT") with Networks Associates,
Inc. (the "COMPANY").
A. TRANSFER OF CONTROL.
1. Definition. A "TRANSFER OF CONTROL" shall be deemed
to have occurred in the event any of the following occurs with respect to the
Company.
a. The direct or indirect sale or exchange by the
stockholders of the Company of all or substantially all of the voting stock of
the Company wherein the stockholders of the Company immediately before such sale
or exchange do not retain in substantially the same proportions as their
ownership of shares of the Company's voting stock immediately before such event,
directly or indirectly (including, without limitation, through their ownership
of shares of the voting stock of a corporation which, as a result of such sale
or exchange, owns the Company either directly or indirectly or through one or
more subsidiaries), at least a majority of the beneficial interest in the voting
stock of the Company immediately after such sale or exchange;
b. a merger or consolidation wherein the stockholders
of the Company immediately before such merger or consolidation do not retain in
substantially the same proportions as their ownership of shares of the Company's
voting stock immediately before such event, directly or indirectly (including,
without limitation, through their ownership of shares of the voting stock of a
corporation which, as a result of such merger or consolidation, owns the Company
either directly or indirectly or through one or more subsidiaries), at least a
majority of the beneficial interest in the voting stock of the Company
immediately after such merger or consolidation;
c. the sale, exchange, or transfer of all or
substantially all of the assets of the Company (other than a sale, exchange, or
transfer to one or more corporations (the "TRANSFEREE CORPORATION(S)")) wherein
the stockholders of the Company immediately before such sale,
<PAGE> 2
exchange, or transfer retain in substantially the same proportions as their
ownership of shares of the Company's voting stock immediately before such event,
directly or indirectly (including, without limitation, through their ownership
of shares of the voting stock of a corporation which owns the Transferee
Corporation(s) either directly or through one or more subsidiaries), as least a
majority of the beneficial interest in the voting stock of the Transferee
Corporation(s) immediately after such event); or
d. a liquidation or dissolution of the Company.
2. Effect on Options. Notwithstanding any provisions to
the contrary contained in any stock option agreement between the Company and
you, in the event of a Transfer of Control all options held by you shall be
vested in full and immediately exercisable, to the extent such stock options
remain outstanding and unexercised, as of the date ten (10) days prior to the
date of the Transfer of Control whether or not the acquiring corporation has
agreed to assume or substitute substantially equivalent options for the
acquiring corporation's stock for such outstanding options. The exercise or
vesting of any option that was permissible solely by reason of this Section 6
shall be conditioned upon the consummation of the Transfer of Control.
Notwithstanding the foregoing, shares acquired upon exercise of an option prior
to the Transfer of Control and any consideration received pursuant to the
Transfer of Control with respect to such shares shall continue to be subject to
all applicable provisions of the option agreement evidencing such option except
as otherwise provided in such option agreement.
B. INTERPRETATION: This Agreement shall be interpreted in accordance
with and governed by the laws of the State of California.
C. ASSIGNMENT: In view of the personal nature of the services to be
performed under this Agreement by you, you shall not have the right to assign or
transfer any of your rights, obligations or benefits under this Agreement.
D. MODIFICATION: This Agreement may only be modified or amended by a
supplemental written agreement signed by you and an authorized member of the
Board.
-2-
<PAGE> 3
Please sign this letter on the space provided below to acknowledge your
acceptance of the terms of this Agreement.
Sincerely,
NETWORKS ASSOCIATES, INC.
By: /s/ WILLIAM L. LARSON
-------------------------------------------
William L. Larson, President and
Chief Executive Officer
I agree to and accept the terms and conditions set forth in this Agreement.
Date: May 12, 1998
---------------------
/s/ ZACHARY T. NELSON
-----------------------------------------------
Zachary T. Nelson
-3-
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 190,983
<SECURITIES> 591,475
<RECEIVABLES> 139,624
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 841,636
<PP&E> 76,573
<DEPRECIATION> (39,332)
<TOTAL-ASSETS> 1,063,436
<CURRENT-LIABILITIES> 229,476
<BONDS> 0
0
0
<COMMON> 716
<OTHER-SE> 273,545
<TOTAL-LIABILITY-AND-EQUITY> 1,063,436
<SALES> 188,415
<TOTAL-REVENUES> 188,415
<CGS> 34,163
<TOTAL-COSTS> 128,208
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 64,972
<INCOME-TAX> 0
<INCOME-CONTINUING> 64,972
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 41,582
<EPS-PRIMARY> 0.39<F1>
<EPS-DILUTED> 0.37
<FN>
<F1>For Purposes of this Exhibit, Primary means Basic.
</FN>
</TABLE>
