UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from _______ to _______
COMMISSION FILE NUMBER 0-20558
------------------------
NETWORKS ASSOCIATES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0316593
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
------------------------
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)
------------------------
Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
135,090,442 shares of the registrant's common stock, $0.01 par value, were
outstanding as of October 31, 1998.
================================================================================
<PAGE> 1
NETWORKS ASSOCIATES, INC.
FORM 10-Q, SEPTEMBER 30, 1998
------------------------
CONTENTS
ITEM NUMBER
--------
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets:
September 30, 1998 and December 31, 1997................
Condensed Consolidated Statements of Operations:
Three and nine months ended September 30, 1998 and 1997.
Condensed Consolidated Statements of Cash Flows:
Nine months ended September 30, 1998 and 1997...........
Notes to Condensed Consolidated Financial
Statements..............................................
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings.............................................
ITEM 2. Changes in Securities.........................................
ITEM 5. Other Information.............................................
ITEM 6. Exhibits and Reports om Form 8-K..............................
SIGNATURES.............................................................
EXHIBIT INDEX..........................................................
<PAGE> 2
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------- -----------
(unaudited) (unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................... $360,729 $155,391
Marketable securities............................. 133,098 151,042
Accounts receivable, net of allowances for
doubtful accounts and returns of $7,842 and
$5,107 at September 30, 1998 and December 31, 1997 225,232 163,779
Prepaid expenses, taxes and other................. 59,324 35,789
----------- -----------
Total current assets........................ 778,383 506,001
Marketable securities............................... 146,804 109,184
Fixed assets, net................................... 64,513 46,845
Deferred taxes...................................... 93,471 46,262
Intangibles and other assets........................ 100,330 45,128
----------- -----------
Total assets................................ $1,183,501 $753,420
=========== ===========
LIABILITIES
Current liabilities:
Accounts payable.................................. 34,333 24,920
Accrued liabilities............................... 184,876 164,377
Deferred taxes.................................... 41,704 --
Deferred revenue.................................. 125,794 108,718
Long-term debt, current portion................... 3,540 153
----------- -----------
Total current liabilities................... 390,247 298,168
Deferred taxes, less current portion.............. 20,969 2,117
Deferred revenue, less current portion............ 56,656 18,393
Long-term debt and other liabilities.............. 363,420 2,353
----------- -----------
Total liabilities........................... 831,292 321,031
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; authorized:
5,000,000 shares -- --
Common stock, $.01 par value; authorized:
350,000,000 shares; issued and outstanding:
134,378,883 shares at September 30, 1998 and
127,292,918 shares at December 31, 1997........... 1,344 1,273
Additional paid-in capital.......................... 450,866 331,800
Retained earnings................................... (100,001) 99,316
----------- -----------
Total stockholders' equity.................. 352,209 432,389
----------- -----------
Total liabilities and stockholders' equity.. $1,183,501 $753,420
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE> 3
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenue....................... $242,444 $182,041 $699,850 $518,468
Operating costs and expenses:
Cost of net revenue............. 44,556 32,600 132,245 93,174
Research and development........ 33,077 25,920 95,202 72,190
Marketing and sales............. 66,007 52,076 198,677 149,524
General and administrative...... 16,022 20,201 53,557 57,412
Amortization of intangibles..... 3,392 1,013 9,932 4,359
Acquisition and other related
costs......................... 188,862 23,688 339,772 43,192
---------- ---------- ---------- ----------
Total operating costs and
expenses................... 351,916 155,498 829,385 419,851
---------- ---------- ---------- ----------
Income (loss) from
operations................. (109,472) 26,543 (129,535) 98,617
Interest and other income and
expense, net.................... 4,099 6,356 13,689 15,769
---------- ---------- ---------- ----------
Income (loss) before
provision for income taxes. (105,373) 32,899 (115,846) 114,386
Provision for income taxes........ 26,710 21,423 77,241 59,460
---------- ---------- ---------- ----------
Net income (loss)............ ($132,083) $11,476 ($193,087) $54,926
========== ========== ========== ==========
Net income (loss) per share --
basic........................... ($0.99) $0.09 ($1.47) $0.44
========== ========== ========== ==========
Shares used in per share
calculation -- basic............ 133,531 125,339 131,428 124,367
========== ========== ========== ==========
Net income (loss) per share --
diluted......................... ($0.99) $0.09 ($1.47) $0.42
========== ========== ========== ==========
Shares used in per share
calculation -- diluted.......... 133,531 130,675 131,428 130,668
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE> 4
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)........................................ ($193,087) $54,926
Adjustments to reconcile net income to net cash provided
from operating activities:
Acquired in-process research and development........ 219,229 43,192
Depreciation and amortization....................... 35,333 21,704
Write down of owned property........................ 1,177 --
Interest on convertible notes....................... 11,055 --
Unrealized gain (loss) on investments............... 2,252 (1,947)
Deferred taxes...................................... 17,023 (3,653)
Changes in assets and liabilities:
Accounts receivable............................... (66,541) (40,390)
Prepaid expenses, taxes and other................. (16,167) 8,895
Accounts payable and accrued liabilities.......... 4,817 10,457
Deferred revenue.................................. 52,168 30,370
Other............................................. (541) (197)
----------- -----------
Net cash provided by operating activities...... 66,718 123,357
----------- -----------
Cash flows from investing activities:
Purchases of investment securities, net................ (18,437) (23,576)
Additions to fixed assets.............................. (42,206) (33,217)
Acquisition of CyberMedia. ............................ (120,691) --
Acquisition of Magic Solutions......................... (136,843) --
Acquisition of Compusul................................ -- (2,709)
Acquisition of 3DV Technology, Inc. ................... -- (20,000)
Acquisition of Secure Networks, Inc. .................. 8,497 --
Acquisition of Cinco................ .................. -- (25,079)
Other ................................................. 2,580 (922)
----------- -----------
Net cash used in investing activities.......... (307,100) (105,503)
----------- -----------
Cash flows from financing activities:
Effect of exchange rate fluctuations................... (3,827) (1,333)
Issuance of common stock............................... 2,248 --
Proceeds from borrowing under line of credit........... -- 990
Repayments of notes payable............................ (186) (117)
Sale of convertible debentures......................... 337,624 --
Stock option exercises................................. 84,244 35,262
Tax benefit from exercise of nonqualified stock options 25,154 35,128
Exercise of warrans.................................... 463 --
Repurchase of common stock............................. -- (39,738)
----------- -----------
Net cash provided by financing activities...... 445,720 30,192
----------- -----------
Net increase in cash and cash equivalents................ 205,338 48,046
Cash and cash equivalents at beginning of period......... 155,391 155,665
----------- -----------
Cash and cash equivalents at end of period............... 360,729 203,711
=========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
<PAGE> 5
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation:
On April 28, 1998, and August 13, 1998, the Company completed the
acquisitions of Trusted Information Systems ("TIS") and Dr. Solomon's
Group PLC ("Dr Solomon's"), respectively. Both acquisitions were
accounted for under the pooling of interests method of accounting.
Financial data of the Company has been restated to reflect the
acquisition of TIS as if it had occurred on January 1, 1997 and the
acquisition of Dr Solomon's as if had occurred on January 1, 1995.
The unaudited consolidated financial statements have been prepared by
the Company without audit in accordance with instructions to Form 10-Q
and Article 10 of Regulation S-X. The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiaries.
All significant intercompany accounts and transactions have been
eliminated. In the opinion of management, all adjustments, consisting
only of normal recurring adjustments considered necessary for a fair
presentation, have been included. The results of operations for the
three and nine month periods ended September 30, 1998 are not
necessarily indicative of the results to be expected for the full year
or for any future periods.
2. Recent Accounting Pronouncements
In October 1997, the AICPA issued Statement of Position No. 97-2
("SOP 97-2") "Software Revenue Recognition," which the Company has
adopted for transactions entered into during the year beginning January
1, 1998. SOP 97-2 provides guidance for recognizing revenue on software
transactions and supersedes previous guidance provided by SOP 91-1,
"Software Revenue Recognition." Under SOP 97-2, revenue from product
licenses is recognized when a signed agreement or other persuasive
evidence of an arrangement exists, the software or system has been
shipped (or software has been electronically delivered), the license fee
is fixed and determinable, and collection of the resulting receivable is
probable. For contracts with multiple elements/obligations, (e.g.
software products, upgrades/enhancements, maintenance and services),
revenue is allocated to each element of the arrangement based on the
Company's evidence of fair value as determined by the amount charged
when the element is sold separately. Maintenance revenue for providing
product updates and customer support is deferred and recognized ratably
over the service period. Revenue on rental units under operating leases
and service agreements is recognized over the term of the rental
agreement or the period during which services are expected to be
performed. Revenue generated from products sold through traditional
channels where the right of return exists is reduced by reserves for
estimated sales returns.
In March 1998, the AICPA issued Statement of Position No. 98-4 ("SOP
98-4"), "Deferral of the Effective Date of a Provision of SOP 97-2,
Software Revenue Recognition." SOP 98-4 defers, for one year, the
application of certain passages in SOP 97-2, which limit what is
considered vendor-specific objective evidence ("VSOE") necessary to
recognize revenue for software licenses in multiple-element arrangements
when undelivered elements exist. Additional guidance is expected prior
to adoption of any resulting final amendments related to the deferred
provisions of SOP 97-2. Because of the uncertainties related to the
outcome of these proceedings, the impact, if any, on future financial
results of the Company is not currently determinable. Adoption of the
remaining provisions of SOP 97-2, as amended, did not have a material
impact on revenue recognition during the first three quarters of 1998.
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income,"
effective January 1, 1998. This statement requires the disclosure of
comprehensive income and its components in a full set of general-purpose
financial statements. Comprehensive income is defined as net income plus
revenues, expenses, gains and losses that, under generally accepted
accounting principles, are excluded from net income. The components of
comprehensive income, which are excluded from net income, are not
significant individually or in aggregate, and therefore, no separate
statement of comprehensive income has been presented.
In July 1997, the Financial Accounting Standards Board issued
Statement of Financial 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.
<PAGE> 6
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 (SFAS 133),
"Accounting for Derivative Instruments and Hedging Activities". SFAS
133 requires the Company to recognize all derivatives on the balance
sheet at fair value. Derivatives that are not hedges must be adjusted
to fair value through net income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of the
derivative are either offset against the change in fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. SFAS 133 is effective for years
beginning after June 15, 1999, but companies can early adopt as of the
beginning of any fiscal quarter that begins after June 1998. The
Company is evaluating the requirements of SFAS 133, but does not expect
this pronouncement to materially impact the Company's results of
operations.
3. NET INCOME PER SHARE
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted net income
per share calculations is provided as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator -- basic
Net income (loss)................. ($132,083) $11,476 ($193,087) $54,926
========== ========== ========== ==========
Numerator -- diluted
Net income (loss)................. ($132,083) $11,476 ($193,087) $54,926
Interest on convertible
debentures, net of tax.......... -- -- -- --
---------- ---------- ---------- ----------
Net income (loss) available
to common stockholders.......... ($132,083) $11,476 ($193,087) $54,926
========== ========== ========== ==========
Denominator -- basic
Basic weighted average common
shares outstanding.............. 133,531 125,339 131,428 124,367
========== ========== ========== ==========
Denominator -- diluted
Basic weighted average common
shares outstanding.............. 133,531 125,339 131,428 124,367
Effect of dilutive securities:
Common stock options.............. -- 5,336 -- 6,301
---------- ---------- ---------- ----------
Diluted weighted average shares... 133,531 130,675 131,428 130,668
========== ========== ========== ==========
Net income (loss) per share --
basic........................... ($0.99) $0.09 ($1.47) $0.44
========== ========== ========== ==========
Net income (loss) per share --
diluted......................... ($0.99) $0.09 ($1.47) $0.42
========== ========== ========== ==========
</TABLE>
4. Acquisitions
CyberMedia, Inc.
On September 9, 1998, the Company obtained control of CyberMedia,
Inc. ("CyberMedia"), a provider of desktop utility software solutions,
when CyberMedia's stockholder's tendered approximately 97% of the
outstanding shares to the Company for $9.50 per share in cash. On
September 10, 1998, a subsidiary of the Company merged into CyberMedia
in a transaction in which CyberMedia shares not tendered were converted
into the right to receive the same per share cash price paid in the
tender offer. Total cash paid to stockholders was $131.0 million. The
transaction was accounted for as a purchase transaction. The total
purchase price including transaction costs and assumed net liabilities
was approximately $160.9 million. Of this amount, $122.2 million was
allocated to in-process research and development. In addition, $12.2
million was allocated to existing technology and other intangibles and
$26.5 million to goodwill, to be amortized over 3 and 7 years,
respectively. To determine the value of the in-process research and
development, the Company considered, among other factors, the stage of
development of each project at the time of acquisition, the time and
cost needed to complete each project, expected income from the projects,
and the projected incremental cash flows from the projects when
completed and any associated risks. Associated risks include the
inherent difficulties and uncertainties in completing a project and
thereby achieving technological feasibility and risks related to the
impact of potential changes in future target markets. This analysis
resulted in $122.2 million being assigned to in-process research and
development projects which had not yet reached technological feasibility
and did not have alternative future use. Pro forma results of
operations have not been presented as CyberMedia's historical operations
are not material.
<PAGE> 7
Dr Solomon's Group PLC
On August 13, 1998, the Company acquired Dr Solomon's Group PLC ("Dr
Solomon's"), (the "Acquisition"), a European-based publicly-held
provider of anti-virus software products for approximately 15.3 million
shares of the Company's Common Stock (including 1.7 million shares held
in trust pending the exercise of certain outstanding and fully vested Dr
Solomon's options). In the Acquisition, each outstanding ordinary share
of Dr Solomon's was exchanged for 0.27625 shares of Common Stock of the
Company. The Company assumed all outstanding options to acquire Dr
Solomon's ordinary shares.
The Acquisition was accounted for as a pooling of interests and
therefore all prior period financial statements have been restated to
include the results of Dr Solomon's for all periods presented.
Financial statements for the years ended December 31, 1997, 1996 and
1995, reflect the combination of the statements of operations of the
Company for the years ended December 31, 1997, 1996 and 1995 and the
aggregation of the unaudited quarterly statements of operations of Dr
Solomon's for the years ended November 31, 1997, 1996 and 1995.
Restated financial statements for the nine months ended September 30,
1998 reflect the statements of operations of the Company for the nine
months ended September 30, 1998 and the statements of operations of Dr
Solomon's for the six months ended May 31, 1998 and the three months
ended September 30, 1998. Revenue and net loss of Dr Solomon's for the
month ended June 30, 1998 were $7.3 million and $3.8 million,
respectively. The results of operations for the nine months ended
September 30, 1997 reflect the results of operations of the Company for
the nine months ended September 30, 1997 and the results of operations
of Dr Solomon's for the nine months ended August 30, 1997.
Separate and combined results of operations for the periods prior to
the merger are as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Six Months Ended
Year Ended December 31, June 30,
------------------------------- -------------------
1997 1996 1995 1998 1997
---------- --------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Networks Associates......... $647,859 $421,794 $278,910 $408,786 $301,260
Dr Solomon's................ 79,370 44,275 23,335 48,620 35,167
---------- --------- ---------- --------- ---------
Combined.................... $727,229 $466,069 $302,245 $457,406 $336,427
========== ========= ========== ========= =========
Net income (loss):
Networks Associates......... ($36,919) $64,110 $42,341 ($65,321) $39,772
Dr Solomon's................ 4 (56,736) 862 4,317 3,678
---------- --------- ---------- --------- ---------
Combined.................... ($36,915) $7,374 $43,203 ($61,004) $43,450
========== ========= ========== ========= =========
Net income (loss) per share --
diluted:
Networks Associates......... ($0.34) $0.59 $0.41 ($0.57) $0.34
========== ========= ========== ========= =========
Dr Solomon's................ $0.00 ($6.34) $0.10 $0.28 $0.24
========== ========= ========== ========= =========
Combined.................... ($0.30) $0.06 $0.39 ($0.47) $0.33
========== ========= ========== ========= =========
</TABLE>
Other Acquisitions
On August 31, 1998, the Company acquired QA Information Security
Holding AB ("QA"). The consideration payable in the acquisition was
305,557 shares of the Company's Common Stock in a transaction accounted
for as a pooling of interests. QA, based in Sweden, is a distributor of
network security products. On July 30, 1998, the Company acquired
Anyware Seguridad Informatica S.A. ("Anyware"). The aggregate
consideration payable in the acquisition was 228,204 shares of the
Company's Common Stock in a transaction accounted for as a pooling of
interests. Anyware, based in Madrid, Spain, is a developer and
distributor of anti-virus software products. The effect of these
acquisitions was not material.
<PAGE> 8
In connection with the acquisitions of Dr Solomon's, CyberMedia, TIS,
Magic Solutions and Secure Networks, Inc. ("Secure"), the Company
incurred direct transaction costs of approximately $35 million
consisting of fees for investment bankers, attorneys, accountants,
financial printing and other related charges. $20 million of these
costs were charged to operations in the three months ended September 30,
1998. In connection with the acquisitions of Dr Solomon's, CyberMedia,
QA, TIS, Anyware, Magic Solutions and Secure, the Company incurred
restructuring charges of approximately $86 million. Of these charges,
approximately $39 million related to severance costs for terminated
employees and $47 million related to closure and elimination of
duplicate facilities and the write-off of impaired long-lived assets.
Of these costs, $21 million and $27 million, respectively, were charged
to operations in the three months ended September 30, 1998. In
addition, $122 million and $97 million were expensed as acquired in-
process technology in connection with the acquisitions of CyberMedia in
the three months ended September 30, 1998 and Magic Solutions in the
three months ended June 30, 1998, respectively. In the nine months
ended September 30, 1997, the Company wrote off $19.5 million and $23.7
million of acquired in-process technology in connection with the
acquisitions of 3DV and Cinco, respectively.
5. Litigation
In December 1997, the Company changed its legal name to "Networks
Associates, Inc." and has since been conducting business as "Network
Associates." Network Associates, Inc. in Oregon ("NAI-Oregon") and
Ronald L. Myers ("Myers"), a California resident doing business as The
Network Associates, have made unresolved claims (including various
trademark claims) or demands with respect to the Company's use of the
name Network Associates. On March 26, 1998, the Company commenced a
declaratory judgement action in the United States District Court,
Northern District of California against the above-cited claimants. The
Company seeks a declaration that its use of the Network Associates title
does not violate the federal, state or common law rights of any of the
defendants. Defendant NAI-Oregon has not yet answered the complaint;
defendant Myers has not yet been served.
On April 24, 1997, the Company was served by Symantec Corporation
("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 CrashGuard
or an approximately 100-line routine found in a Symantec DLL. The
Court's order expressly stated that "the court is not enjoining the sale
or distribution of [McAfee's] current product." On December 19, 1997,
the Court denied Symantec's motion to enjoin sale or distribution of the
Company's current PC Medic product. On April 1, 1998, Symantec filed an
amended complaint including additional allegations of trade secret
misappropriation, unfair competition, interference with economic
advantage and contractual relations and violations of the Racketeer
Influenced and Corrupt Organization Act ("RICO"), in connection with the
alleged use by Company employees of a proprietary Symantec customer
database. On June 9, 1998, the Court dismissed Symantec's RICO claims
without prejudice and dismissed Symantec's unfair competition claims
relating to alleged use of source code with prejudice. On June 15, 1998,
the Court entered a stipulated preliminary injunction prohibiting the
Company from making use of any Symantec customer list data. On September
4, 1998, Symantec's time for amending its complaint expired; Symantec
did not re-file its RICO claims. On October 8, 1998, the Court granted
partial summary judgment in the Company's favor dismissing with
prejudice Symantec's claims for interference with economic and
contractual relations, Symantec's trade secret claims relating to
alleged misappropriation of source code and portions of Symantec's
copyright claims.
In September 1998, the Company acquired CyberMedia. On October 22,
the Court consolidated the above case for purposes of trial with an
action originally brought on February 4, 1998 by CyberMedia against
Symantec (described below) and the action brought by Symantec against
the Company on September 4, 1998 (described below). There is currently
no trial date set for the consolidated case. The Court will hold a
status conference on the matter on November 19, 1998.
On September 4, 1998, Symantec filed suit in United States District
Court for the Northern District of California, San Jose Division,
against the Company, alleging copyright infringement, unfair
competition, and trade secret misappropriation. Symantec alleges that
an unidentified Company employee copied and transported to the Company
certain proprietary Symantec files, including files containing Norton
Antivirus software. Symantec also alleges that another unidentified
Company employee located in Canada copied and transported to the Company
certain other unidentified files containing Symantec confidential
information. Symantec has not yet served the Company in this case.
<PAGE> 9
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
was 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 were to proceed separately. Symantec has since settled out
of the lawsuit. The Court held a patent claim interpretation hearing on
September 1, 1998. The Court has not yet issued a ruling on claim
interpretation. At a case management conference held on October 2,
1998, the Court set a new trial date of November 8, 1999. In addition,
Trend filed a supplemental complaint on October 5, 1998, adding the
Gauntlet product to the products accused of infringing Trend's patent.
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. Discovery is presently scheduled to be completed by January
1999. A trial date has been set for June 1999.
On July 30, 1998, CyberMedia, the Company and certain of
CyberMedia's officers and directors were named as defendants in a
purported class action entitled Schneider v. Patil, et al., No. 16565NC
(Del. Ch.). The complaint, in a subsequent amendment, alleges that the
individual defendants breached their fiduciary duties by failing to
obtain an adequate price for CyberMedia in the Network
Associates/CyberMedia transaction. The complaint also alleged that the
relevant merger documents failed to disclose material information. The
complaint sought injunctive relief. As of the date of this Form 10-Q,
it appears plaintiffs will not pursue this action.
On August 10, 1998, CyberMedia and two of its officers were named as
defendants in a purported securities class action entitled Daugherty v.
CyberMedia, Inc. et al., No. BC195733 (Los Angeles Cty. Superior Ct.).
The complaint alleges that defendants violated California state
securities laws and common law by artificially deflating the price of
CyberMedia stock to the detriment of a purported class of investors who
sold CyberMedia stock between March 13, 1998 and July 28, 1998. The
complaint does not specify damages. Defendants filed a demurrer to the
complaint on September 25, 1998. The hearing on the demurrer is
scheduled for December 8, 1998. Defendants also have filed a motion to
stay discovery pending resolution of the demurrer and class
certification. The motion to stay discovery is scheduled to be heard on
December 8, 1998.
On September 14, 1998, CyberMedia and certain of its former officers
and directors were named as defendants in a consolidated amended
securities class action complaint filed in the United States District
Court for the Central District of California. The consolidated amended
complaint consolidated the following previously filed cases: Ong v.
CyberMedia, Inc., et al., No. 98-1811 CBM (Ex), filed on March 12, 1998,
St. John v. CyberMedia, Inc., et al., No. 98-2085 MRP (SHx), filed on
March 24, 1998, Zier v. CyberMedia, Inc., et al., No. 98-2210 CM (MCx),
filed on March 26, 1998, Liu v. CyberMedia, Inc., et al., No. 98-2617,
filed on April 8, 1998, Kerr, et al. v. CyberMedia, Inc., et al., No.
98-3104 RJK (Anx), filed on April 23, 1998, and Barker v. CyberMedia,
Inc., et al., No. SA CV98-401 AHS (ANx), filed on May 6, 1998. The
consolidated amended complaint alleges that the defendants violated
federal securities laws by artificially inflating the price of
CyberMedia stock to the detriment of a purported class of investors who
purchased or otherwise acquired CyberMedia stock between March 31, 1997
and March 12, 1998. The consolidated amended complaint does not specify
damages. In light of ongoing settlement negotiations, the parties have
entered into a stipulation extending defendants' time to file a
responsive pleading to and including November 16, 1998.
CyberMedia and certain of its former officers and directors were
named as defendants in three securities class action lawsuits filed in
the Superior Court of Los Angeles County. Such complaints have been
ordered consolidated, although a consolidated amended complaint has not
yet been filed. The consolidated complaints include: Brown v.
CyberMedia, Inc., et al., No. B C187898, filed on March 19, 1998, Smith
v. CyberMedia, Inc., et al. No. B C188527, filed on March 31, 1998, and
Stockwell v. CyberMedia, Inc., et al., No. B C189020, filed on April 8,
1998. The complaints allege that defendants violated California state
securities laws and common law by artificially inflating the price of
CyberMedia stock to the detriment of a purported class of investors who
purchased or otherwise acquired CyberMedia stock between March 31, 1997
and March 13, 1998. The complaints do not specify damages. There is
currently no schedule for the filing of a consolidated amended
complaint.
<PAGE> 10
On February 4, 1998, CyberMedia filed a lawsuit against Symantec in
United States District Court for the Northern District of California.
Also named as defendants in the complaint are ZebraSoft, Inc.
("ZebraSoft") and three individual officers and directors of ZebraSoft.
The complaint alleges that the defendants violated federal copyright
laws and misappropriated CyberMedia's trade secrets in developing and
distributing a computer software program, known as Norton Uninstall
Deluxe, that is competitive with CyberMedia's UnInstaller program. The
complaint seeks money damages and injunctive relief against the
defendants.
Although the Company intends to defend itself vigorously against the
claims asserted against it (and its subsidiary CyberMedia) in the
foregoing actions or matters, there can be no assurance that such
pending litigation will not have a material adverse effect on the
Company's business, financial condition or operating results. The
litigation process is subject to inherent uncertainties and no assurance
can be given that the Company will prevail in any such matters, or will
be able to obtain licenses, on commercially reasonable terms, or at all,
under any patents or other intellectual property rights that may be held
valid or infringed by the Company or its products. Uncertainties
inherent in the litigation process involve, among other things, the
complexity of the technologies involved, potentially adverse changes in
the law and discovery of facts unfavorable to the Company.
6. Subsequent Events
On October 19, 1998, pursuant to a Preferred Shares Rights Agreement
between the Company and BankBoston, N.A. as Rights Agent, the Board of
Directors of the Company announced that it had declared a dividend
distribution of one preferred share purchase right (a "Right") on each
outstanding share of the Company's Common Stock. Each right will
entitle stockholders to buy one-one thousandth of a share of the
Company's Series B Participating Preferred Stock at an exercise price of
$200.00. The Rights will become exercisable following the tenth day
after a person or group announces the acquisition of 15% or more of the
Company's Common Stock or announces commencement of a tender or exchange
offer, the consummation of which would result in ownership by the person
or group of 15% or more of the Common Stock of the Company. The Company
will be entitled to redeem the Rights at $0.01 per Right at any time on
or before the tenth day following acquisition by a person or group of
15% or more of the Company's Common Stock. The dividend distribution
was made on November 3, 1998, payable to the stockholders of record on
November 3, 1998. The Rights will expire on October 20, 2008.
<PAGE> 11
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. The Company has 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 (TVD) SECURITY (TNS) VISIBILITY (TNV) DESK (TSD)
- ---------------------------- --------------------------------- ------------------------------------ ----------------------------
<S> <C> <C> <C>
- -- Total Virus Defense Suite - Total Network Security Suite - Total Network Visibility Suite - Total Service Desk Suite
- -- GroupShield Security Suite - PGP Enterprise Security Suite - Sniffer Portable Analysis Suite - McAfee Help Desk Suite
- Gauntlet Active Firewall Suite - Sniffer Distributed Analysis Suite - Zero Administration Client
- CyberCop Intrusion Protection - Sniffer Service Desk Suite Suite
Suite - Self Service Desk Suite
- Support Magic SQL Suite
</TABLE>
Net Tools Secure is designed to protect the enterprise from viruses,
hackers, thefts, lost data and threats to data security at all points of
entry. McAfee Total Virus Defense is a multi-tiered approach to virus
protection covering the client, server and Internet gateway; and PGP
Total Network Security combines security products with desktop
encryption software and key management tools. Net Tools Manager is a
network management and service desk solution designed to make computer
networks more efficient and users more productive. Sniffer Total Network
Visibility is a comprehensive set of products and services for network
fault and performance management (also known as analysis and
monitoring); and McAfee Total Service Desk is designed to integrate
robust help desk applications with asset management software. The
Company also provides product support, education and consulting
services.
<PAGE> 12
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 licensing model for its
products to corporate clients. The Company also markets as a subset of
its products to retail customers; McAfee Office combines ten PC
diagnostic and utility tools into one integrated software package.
The Company's results of operations can fluctuate significantly on a
quarterly basis. Causes of such fluctuations may include the volume and
timing of new orders and renewals, the introduction of new products,
distributor inventory levels and return rates, Company inventory levels,
product upgrades or updates released by the Company or its competitors,
changes in product prices, the impact of competitive pricing or
products, timely availability and acceptance of new products, changes in
product mix, changes in the market for anti-virus or network management
software, inclusion of network security or management software
functionality in system software, failure to manage growth and/or
potential acquisitions, seasonality, changes in customer budgets related
to information technology spending, 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. More recently, the Company has adopted a strategy of up-
selling existing licenses to higher level product suites. There can be
no assurance that the Company will be able to sustain current renewal
and/or up-selling rates in the future. In addition, revenue generated
through distribution channels tends to be non-linear and this may cause
the Company's revenue to fluctuate in the future. The Company's results
for any given period should not be relied upon as indicative of future
performance. See "Risk Factors - Variability of Quarterly Operating
Results."
The Company's future earnings and stock price may be subject to
volatility in any period. Any shortfall in various operating results,
including licensing activity, product sales, net revenue, operating
income, net income or net income per share from historical levels or
expectations of securities analysts may have significant adverse effects
on the trading price of the Company's stock. Furthermore, other factors
such as acquisitions or unforeseen events in the technology or software
industry or in the Company's day to day activities can have a material
adverse effect on the Company's stock performance. See "Risk Factors -
Volatility of Stock Price" and "Risk Factors - Risks Associated with
Failure to Manage Growth; Potential Future Acquisitions."
Results of Operations
The following table sets forth, for the periods indicated, the
percentage of net revenue represented by certain items in the Company's
statements of operations for the three months and nine months ended
September 30, 1998 and 1997:
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 and nine months ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenue....................... 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Cost of net revenue............. 18.4% 17.9% 18.9% 18.0%
Research and development........ 13.6% 14.2% 13.6% 13.9%
Marketing and sales............. 27.2% 28.6% 28.4% 28.8%
General and administrative...... 6.7% 11.1% 7.7% 11.2%
Amortization of intangibles..... 1.4% 0.6% 1.4% 0.8%
Acquisition and other related
costs......................... 77.9% 13.0% 48.5% 8.3%
---------- ---------- ---------- ----------
Total operating costs and
expenses................... 145.2% 85.4% 118.5% 81.0%
---------- ---------- ---------- ----------
Income (loss) from
operations................. -45.2% 14.6% -18.5% 19.0%
Interest and other income and
expense, net.................... 1.7% 3.5% 1.9% 3.1%
---------- ---------- ---------- ----------
Income (loss) before
provision for income taxes. -43.5% 18.1% -16.6% 22.1%
Provision for income taxes........ 11.0% 11.8% 11.0% 11.5%
---------- ---------- ---------- ----------
Net income (loss)............ -54.5% 6.3% -27.6% 10.6%
========== ========== ========== ==========
</TABLE>
Net Revenue. Net revenue includes product revenues, revenues from
software support, maintenance contracts, education and consulting
services as well as revenues from those warranty, customer support and
maintenance contracts which are deferred and recognized over the related
service period. Net revenue was $242.4 million in the three months ended
September 30, 1998, an increase of 33% from $182.0 million in the three
months ended September 30, 1997. In the nine months ended September 30,
1998, net revenue was $699.9 million, an increase of 35% from $518.5
million in the same period in 1997. The increase in net revenues is due
to an increase in the breadth of product offerings largely due to the
expansion of both the Net Tools Secure and Net Tools
<PAGE> 13
Manager product suites, and an increase in brand recognition, resulting
in the growth of the installed customer base and the resulting renewal
of maintenance contracts.
Although the Company has had significant growth in net revenue and
net income (before acquisition and other related charges), the Company's
historic growth rate will be difficult to sustain or exceed.* The
Company has experienced increased price competition for its products and
the Company expects competition to increase in the near-term, which may
result in reduced average selling prices for the Company's products.*
Due to these and factors such as a maturing anti-virus market and an
increasingly higher base from which to grow, the historic revenue growth
rate will be difficult to sustain or increase.* To the extent these
trends continue, the Company's results of operations could be materially
adversely affected. Historically, renewals have accounted for a
significant portion of the Company's net revenue. More recently, the
Company has adopted a strategy of up-selling existing licenses to higher
level product suites. There can be no assurance that the Company will
be able to sustain current renewal and/or up-selling rates for its
products in the future.* Risks related to the Company's change in
business strategies, including its newly introduced suite pricing model,
two-year licensing model for the Company's Sniffer products and a
software only version of the Company's Sniffer products, as well as up-
selling and cross-selling new product suites to existing TNV and
VirusScan customers, 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.* In addition, to the extent
that companies incur costs related to Y2K issues, they may reassign
budgets away from capital spending and the Company's products, which
could have a material adverse impact on the Company's revenue or revenue
growth in the future. 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 34% of net revenue
for the three months ended September 30, 1998 and 1997. The percentage
of international net revenue was 34% and 33%, respectively for the nine
month periods ended September 30, 1998 and 1997. The increase in
international net revenue as a percentage of net revenue between the
nine month periods ended September 30, 1998 and 1997 was due primarily
to increased acceptance of the Company's products in international
markets and the continued investment in international operations,
including the recent acquisition of Dr Solomon's. The Company expects
that international revenue 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 engages in financial risk management activities. However, there
can be no assurance that the Company's future results of operations will
not be adversely affected by such fluctuations or by costs associated
with currency risk management strategies. Other risks inherent in
international revenue generally include the impact of longer payment
cycles, greater difficulty in accounts receivable collection, unexpected
changes in regulatory requirements, seasonality due to the slowdown in
European business activity during the third quarter, tariffs and other
trade barriers, uncertainties relative to regional economic
circumstances, 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 revenue. In addition, there can be
no assurance that the macroeconomic issues currently being experienced
in Asia will not spread to Europe, the U.S. or Latin America, and/or
have a material adverse impact on the Company's revenue or revenue
growth in the future. 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 outside of the United States 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
was $44.6 million in the three months ended September 30, 1998, an
increase of 37% from $32.6 million in the three months ended September
30, 1997. For the nine months ended September 30, 1998, cost of revenue
was $132.2 million, an increase of 42% from $93.2 million in the same
period in 1997. These increases are due to an increase in net revenue
(particularly product revenues) as well as the continued investment in
the professional services organization. To the extent that the product
mix fluctuates from quarter to quarter, the cost of revenue will
increase or decrease accordingly.
<PAGE> 14
The Company continues 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 retail distribution
(including through the recent CyberMedia acquisition), it will
experience greater media, manual and packaging costs and 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 were $33.1
million in the three months ended September 30, 1998, an increase of 28%
from $25.9 million in the three months ended September 30, 1997. In the
nine months ended September 30, 1998 research and development expenses
were $95.2 million, an increase of 32% from $72.2 million in the same
period in 1997. These increases were primarily a result of the general
expansion of the Company's product development and technical support
staff. As a percentage of net revenue, research and development
expenses decreased to 13.6% in the three months ended September 30, 1998
from 14.2% in the three months ended September 30, 1997 and decreased to
13.6% in the nine months ended September 30, 1998 from 13.9% in the nine
months ended September 30, 1997. The Company anticipates that research
and development expenses will continue to increase in absolute dollars,
but may fluctuate as a percentage of net revenue.*
The Company believes that its ability to maintain its competitiveness
will depend in large part upon its ability to enhance existing products
and develop 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 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 were $66.0 million in the three months
ended September 30, 1998, an increase of 27% from $52.1 million in the
three months ended September 30, 1997. In the nine months ended
September 30, 1998 marketing and sales expenses were $198.7 million, an
increase of 33% from $149.5 million for the same period in 1997. This
increase was primarily the result of an increase in advertising and
promotional activities required to support increased sales volumes and
expanding product lines. As a percentage of net revenue, marketing and
sales expense was 27.2% and 28.6% in the three month periods ended
September 30, 1998 and 1997 and 28.4% and 28.8% in the nine month
periods ended September 30, 1998 and 1997. The decrease, period over
period is due to the consolidation of staffing both domestically and
internationally, including eliminating duplicate staff arising from the
acquisition of Dr Solomon's. The Company is continuing to build brand
identity under its new corporate name, which is expected to contribute
to a further increase in marketing and sales expenses in absolute
dollars, and 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
were $16.0 million in the three months ended September 30, 1998, a
decrease of 21% from $20.2 million in the three months ended September
30, 1997. In the nine months ended September 30, 1998 general and
administrative costs were $53.6 million, a decrease of 7% from $57.4
million for the same period in 1997. The decrease is a result of the
continued consolidation of staffing both domestically and
internationally, including elimination of duplicate staff arising from
the acquisition of Dr Solomon's. As a percentage of net revenue, general
and administrative expenses were 6.7% and 11.1% in the three months
periods ended September 30, 1998 and 1997 and 7.7% and 11.2% in the nine
month periods ended September 30, 1998 and 1997. The decrease as a
percentage of net revenue is also due in part to the significant
increase in net revenue. To the extent that the Company makes future
investments in its worldwide general and administrative infrastructure,
general and administrative expenses will increase in absolute dollars
but may fluctuate as a percentage of net revenue.*
<PAGE> 15
Amortization of Intangibles. The Company expensed $3.4 million and
$1.0 million of amortization related to intangibles in the three months
ended September 30, 1998 and 1997, respectively and $9.9 million and
$4.4 million in the nine months ended September 30, 1998 and 1997,
respectively. Intangibles consist of purchased goodwill and certain
technology acquired through acquisitions. The increases are due to the
acquisitions of Pretty Good Privacy, Inc. ("PGP"), Magic Solutions, Inc.
("Magic Solutions") and CyberMedia, as well as the acquisitions of the
Virex and NetOctopus products by Dr Solomon's.
Acquisition and Other Related Costs. In connection with the
acquisitions of Dr Solomon's, CyberMedia, TIS, Magic Solutions and
Secure, the Company incurred direct transaction costs of approximately
$35 million consisting of fees for investment bankers, attorneys,
accountants, financial printing and other related charges. $20 million
of these costs were charged to operations in the three months ended
September 30, 1998. In connection with the acquisitions of Dr
Solomon's, CyberMedia, QA, TIS, Anyware, Magic Solutions and Secure
Networks, Inc. ("Secure"), the Company incurred restructuring charges of
approximately $86 million. Of these charges, approximately $39 million
related to severance costs for terminated employees and $47 million
related to closure and elimination of duplicate facilities and the
write-off of impaired long-lived assets. $21million and $27 million,
respectively, of these costs were charged to operations in the three
months ended September 30, 1998. In addition, $122 million and $97
million were expensed as acquired in-process technology in connection
with the acquisitions of CyberMedia in the three months ended September
30, 1998 and Magic Solutions in the three months ended June 30, 1998,
respectively. In the nine months ended September 30, 1997, the Company
wrote off $19.5 million and $23.7 million of acquired in-process
technology in connection with the acquisitions of 3DV and Cinco,
respectively.
Interest and Other Income and Expense, Net. Interest and other income
and expense decreased to $4.1 million in the three months ended
September 30, 1998 from $6.4 million in the three months ended September
30, 1997. Interest and other income and expense decreased from $13.7
million in the nine months ended September 30, 1998 from $15.8 million
in the nine months ended September 30, 1997. The decrease from quarter
to quarter was primarily due to the increase of interest expense to $4.2
million in the three months ended September 30, 1998 from zero in the
three months ended September 30, 1997, primarily as a result of the
Company's Zero Coupon Convertible Subordinated Debentures (the
"Debentures"), issued in February 1998, partially offset by increased
interest income from the increased funds invested.
Provision for Income Taxes. The Company's effective tax rate was 32%
and 38% for the three month periods ended September 30, 1998 and 1997,
respectively, and 34% and 38% for the nine month periods ended September
30, 1998 and 1997, respectively. The reduction in the effective tax
rate is the result of the implementation of various domestic and
international tax strategies.
Liquidity and Capital Resources
At September 30, 1998, the Company had $360.7 million in cash and
cash equivalents and $279.9 million in marketable securities, for a
combined total of $640.6 million.
Net cash provided by operating activities was $66.7 million and
$123.4 million in the nine months ended September 30, 1998 and 1997,
respectively. Net cash provided by operating activities in the nine
months ended September 30, 1998, consisted primarily of net income
before acquisition costs and depreciation and amortization, plus
increases in deferred revenue, deferred taxes and accounts payable and
accrued liabilities which were offset primarily by an increase in
accounts receivable and prepaid and other assets. In the nine months
ended September 30, 1997, net cash provided by operating activities
consisted primarily of net income before acquisition costs and
depreciation and amortization, plus increases in deferred revenue,
accounts payable and accrued liabilities and prepaid and other assets,
offset primarily by increases in accounts receivable and deferred taxes.
The Company expects that its accounts receivable balances as a
percentage of sales will increase in the foreseeable future due to
various factors, including its recent acquisitions of companies with
longer payment cycles (particularly its acquisitions of Dr Solomon's and
CyberMedia) and its increased emphasis on international sales, typically
having longer payment terms.* In addition, the longer payment cycles
associated with licensing enterprise-wide network security and
management product suites and with licensing products through indirect
channels, such as systems integrators and VARs, are also expected to
contribute to an increase in the Company's receivables balances.*
Lastly, development of a two-year licensing model for the Company's
Sniffer products, which as compared to product sales typically results
in lower current revenue and a corresponding increase in deferred
revenue, is expected to result in an increase in accounts receivable
balances as a percentage of sales.* To address the increased level of
the Company's accounts receivables and to improve cash flow, the Company
continuously evaluates available options, including actions to encourage
earlier payment of receivables and receivable sales.* To the extent the
Company's receivable balances increase, the Company will be subject to
increased general credit risks with respect thereto.* There can be no
assurance that the Company will be successful in mitigating the impact
which such increased receivable levels may have on its financial
conditions and operating results.
<PAGE> 16
Net cash used in investing activities was $307.1 million in the nine
months ended September 30, 1998 consisting primarily of the purchase of
marketable securities, additions to fixed assets and the acquisition of
Magic Solutions and CyberMedia. Net cash used in investing activities
was $105.5 million in the nine months ended September 30, 1997,
primarily reflecting the acquisitions of Compusul, 3DV Technology and
Cinco, purchases of marketable securities and additions to fixed assets.
Net cash provided by financing activities was $445.7 million in the
nine months ended September 30, 1998, consisting primarily of net
proceeds from the issuance of the Debentures, and the proceeds and tax
benefits associated with the exercise of non-qualified stock options.
Net cash provided by financing activities was $30.2 million in the nine
months ended September 30, 1997, consisting primarily of the proceeds
and tax benefits associated with the exercise of non-qualified stock
options partially offset by the repurchase of common stock under the
Network General stock repurchase program.
The Company believes that its available cash and anticipated cash
flow from operations will be sufficient to fund the Company's working
capital and capital expenditure requirements for at least the next
twelve months.*
Financial Risk Management
As a result of the continued expansion of the Company's business in
Europe, the Company expects to see an increase over time in exposures
related to nonfunctional currency denominated sales in several European
currencies.* Currently, the Company hedges only those currency
exposures associated with certain assets and liabilities denominated in
nonfunctional currencies and does not generally hedge anticipated
foreign currency cash flows. The hedging activity undertaken by the
Company is intended to offset the impact of currency fluctuations on
certain non-functional currency assets and liabilities. The success of
this activity depends upon forecasts of transaction activity denominated
in various currencies, primarily the Canadian dollar, Australian dollar
and certain European currencies.* To the extent that these forecasts
are over or understated during periods of currency volatility, the
Company could experience unanticipated currency gains or losses.*
Year 2000
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. These
date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, many companies'
software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" or "Y2K" requirements.
The Company has established a corporate-wide program to address the
Y2K issue. This program encompasses commercial product, internal
systems and technology, supplier and business partner and facilities and
life safety compliance. The project is comprised of identification of
risks, assessment of risks, development of remediation or contingency
plans and implementation and testing.
Based on the assessments to date, all products currently under
development and the majority of products released are Y2K compliant. For
any released products which are not Y2K compliant, the Company is
working with its customers to provide migration paths for those
products. The Company's internal systems and technology are relatively
new and as a result the majority are already Y2K compliant. The Company
is in the process of upgrading systems and technology that are not
currently Y2K compliant, and expects to have this process completed by
the third quarter of 1999. In addition, the Company is working with its
suppliers and business partners to identify at what stage they are at in
the process of identifying and addressing the Y2K issue and to assess
the resulting risks and develop appropriate contingency plans. The
Company will continue to perform compliance reviews and tests to ensure
compliance on an ongoing basis. In connection with the resolution of
Y2K issues, the Company has not to date incurred material costs and does
not anticipate that such costs will be material in the future.
<PAGE> 17
Although the Company has established and commenced its program to
address Y2K issues, the failure of the Company's current or prior
products to operate properly with regard to the Year 2000 requirements
could (i) cause the Company to incur unanticipated expenses to remedy
any problems, (ii) cause a reduction in sales and (iii) expose the
Company to related litigation by its customers, each of which could have
a material adverse effect on the Company's business, operating results
and financial condition. In addition, the Company and third parties
with whom it conducts business may utilize equipment or software that
may not be Y2K compliant. Failure of the Company's or any such third
party software to operate properly with regard to the Year 2000
requirements could cause, among other things, the Company or any such
third party to incur unanticipated expenses or efforts to remedy any
problems, which could have a material adverse effect on its or their
respective business, operation results and financial condition.
Furthermore, the purchasing patterns of customers or potential customers
may be affected by Y2K issues as companies expend significant resources
to evaluate and to correct their equipment or software for Y2K
compliance and as they simultaneously evaluate the preparedness of the
third parties with whom they deal. These expenditures may result in
reduced funds available to purchase products and services such as those
offered by the Company, which could have a material adverse effect on
the Company's business, operating results and financial condition.
*This statement is a forward looking statement reflecting current
expectations. There can be no assurance that the Company's actual
performance will meet the Company's current expectations. See the Risk
Factors on page 19 for a discussion of certain factors that could affect
future performance.
<PAGE> 18
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,
changes in customer budgets related to information technology spending,
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. In addition, there can be no assurance that the
macroeconomic issues currently being experienced in Asia will not spread
to Europe, the U.S. or Latin America, and/or have a material adverse
impact on the Company's revenue or revenue growth in the future.
Further, to the extent that companies incur costs related to Y2K issues,
they may reassign budgets away from capital spending and the Company's
products, which could have a material adverse impact on the Company's
revenue or revenue growth in the future.
Although the Company has experienced significant growth in net
revenue and net income (before acquisition and other related costs) in
absolute terms, the Company has experienced increased price competition
for its products and the Company expects competition to increase in the
near-term, which may result in reduced average selling prices for the
Company's products. Due to these and other factors (such as a maturing
anti-virus market and an increasingly higher base from which to grow),
the Company's historic revenue growth rate will be difficult to sustain
or increase. To the extent these trends continue, the Company's results
of operations could be materially adversely affected. Historically,
renewals have accounted for a significant portion of the Company's net
revenue. More recently, the Company has adopted a strategy of up-
selling existing licenses to higher level product suites. There can be
no assurance that the Company will be able to sustain current renewal
and/or up-selling 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 nine months ended September 30, 1998
and the year ended December 31, 1997, the Company generally experienced
a trend toward higher order receipt, and therefore a higher percentage
of revenue shipments, toward the end of the last month of a quarter,
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.
<PAGE> 19
Risk of Inclusion of Network Management and Security Functionality in
Hardware and Other Software. In the future, vendors of hardware and of
operating system software or other software (such as firewall or
electronic mail software) may continue to enhance their products or
bundle separate products to include functionality that currently is
provided primarily by network security and management software. Such
enhancements may be achieved through the addition of functionality to
operating system software or other software or the bundling of network
security and management software with operating system software or other
products. For example, Cisco Systems, Inc. ("Cisco") recently
incorporated a firewall in certain of its hardware products and
Microsoft introduced limited anti-virus functionality into its MS-DOS
versions in 1993. The widespread inclusion of the functionality of the
Company's products as standard features of computer hardware or of
operating system software or other software could render the Company's
products obsolete and unmarketable, particularly if the quality of such
functionality were comparable to that of the Company's products.
Furthermore, even if the network security and/or management
functionality provided as standard features by hardware providers or
operating systems or other software is more limited than that of the
Company's products, there can be no assurance that a significant number
of customers would not elect to accept such functionality in lieu of
purchasing additional software. If the Company were unable to develop
new network security and management products to further enhance
operating systems or other software and to replace successfully any
obsolete products, the Company's business, financial condition and
results of operations would be materially adversely affected.
Risks Associated with Recent Acquisitions. In addition to risks
described under "- Risks Associated with Acquisitions Generally," the
Company faces significant risks associated with its recent acquisitions
(including the acquisitions of Dr Solomon's, CyberMedia, Secure, TIS,
Magic Solutions, Network General, PGP and Helix Software Company
("Helix")). There can be no assurance that the Company will realize the
desired benefits of these transactions. In order to successfully
integrate these companies, the Company must, among other things,
continue to attract and retain key management and other personnel;
integrate, both from an engineering and a sales and marketing
perspective, the acquired products (including Dr Solomon's anti-virus
products, TIS' firewall products, Magic Solutions' helpdesk products,
Network General's Sniffer and CyberCop products, PGP's encryption
products and CyberMedia and Helix's utilities products) into its suite
of product offerings; integrate and develop a cohesive focused direct
and indirect sales force for its product offerings; consolidate
duplicate facilities; implement standardized accounting and reporting
systems and develop name recognition for its new name. The diversion of
the attention of management from the day-to-day operations of the
Company, or difficulties encountered in the integration process, could
have a material adverse effect on the Company's business, financial
condition and results of operations. See "- Need to Develop Enterprise
and Major Accounts Sales Expertise and Security Products Sales
Expertise; Risks Related to Direct Sales Force" and "- Use of Indirect
Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and
TIS 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 and third quarters of 1998, the Company
incurred additional significant non-recurring charges associated with
the acquisitions of TIS, Magic Solutions, Dr Solomon's and CyberMedia.
There can be no assurance that the Company will not incur additional
material charges in subsequent quarters to reflect additional costs
associated with these transactions and with respect to its name change
and the marketing of its products under the "Network Associates" name.
Risks Related to Certain Business Strategies. The Company has
historically derived a significant majority of its revenues from the
licensing of its flagship anti-virus products and Sniffer products. See
"- Dependence on Revenue from Flagship Anti-Virus and Sniffer Products."
The Company is currently focusing its efforts on broadening its revenue
base by providing network security and management solutions to
enterprise customers, targeting in particular the Windows NT/Intel
platform. In furtherance of this strategy, the Company recently
organized its products into four product suites - McAfee Total Virus
Defense, PGP Total Network Security, and Sniffer Total Network
Visibility and McAfee Total Virus Defense. These four product suites
together form an integrated solution called "Net Tools" which utilizes a
new pricing model. There can be no assurance that potential customers
(including the installed customer base of acquired companies) will
respond favorably to the modified pricing structure and the lack of a
favorable response could materially adversely affect the Company's
operating results. Although the Company will continue to offer perpetual
licenses with annual support and maintenance contracts for its Sniffer
products, it is recently developed a licensing model for those products.
In addition, in an effort to increase total Sniffer unit sales, the
Company has developed software only versions of certain of its Sniffer
products. To the extent that customers do license Sniffer products on a
two-year 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 licenses, the Company would, among
other things, expect an increase in deferred revenues related to the
service portion of the two-year Sniffer license that would be
capitalized on the Company's balance sheet. In the initial year of the
license, the corresponding revenue would be lower than if the license
were perpetual. In the case of the software only Sniffer product, for
any individual license, the Company would expect lower total revenues
and a higher overall gross margin related to the transaction, as the
Company would not be selling the corresponding hardware component.
Currently, the hardware component has a lower gross margin than the
total product gross margin. Furthermore, the increase in license
revenue as a percentage of revenue will have a negative impact on the
Company's receivable balance as a percentage of sales, due to more
revenue being deferred with no impact on the related receivables.
<PAGE> 20
The Company has been acquiring (and is continuing to investigate the
acquisition of) existing independent agents and distributors of its
products in certain strategic markets or has been converting these
independent agents into resellers who must purchase Company products
from Company approved distributors. These actions may require, among
other things, that the Company provide the technical support to
customers that was previously provided by such agents and distributors.
There can be no assurance that the Company can provide such support as
effectively or on a timely basis or at all, that the Company will
operate any acquired distributor or agent as successfully as the
previous operators, that the acquisition of any distributor or agent or
the conversion of any agent into a reseller will result in the desired
increased foreign revenues or that the Company will be able to identify
and retain suitable distributors in any market in which it converts an
independent agent. See "- Risks Associated with Acquisitions Generally"
and "- Risks Related to International Revenue and Activities."
As part of the Net Tools concept, the Company is in the process of
designing a centralized console from which the various component suites
can be operated, administered and maintained utilizing a common look and
feel. The Company faces significant engineering challenges related to
these efforts. In addition, the Company faces significant engineering
and other challenges related to the integration of its various products
(such as its recently acquired Dr Solomon's anti-virus products, PGP
encryption products, Network General CyberCop product and TIS firewall
products) into marketable 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 Major Accounts Sales Expertise and Security Products
Sales Expertise; Risks Related to Direct Sales Force," "- Use of
Indirect Sales Channels; Need to Develop Indirect Sales Channel for
Sniffer and TIS 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 CyberMedia in
September 1998, Dr Solomon's in August 1998 and TIS and Magic Solutions
in April 1998, the Company has consummated a series of significant
acquisitions since 1994, including the combination with Network General
in December 1997, the acquisitions of PGP and Helix in December 1997,
Cinco Networks, Inc. in August 1997, 3DV Technology, Inc. in March 1997,
FSA Corporation of Canada in August 1996, Vycor Corporation in February
1996, Saber Software Corporation, Inc. in August 1995 and ProTools, Inc.
in January 1994. In addition, since 1995 the Company has acquired a
number of international distributors, including distributors in
Australia, Brazil, Finland, Japan, South Africa, Sweden 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.
<PAGE> 21
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's anti-virus software products have in the past
falsely detected viruses that did not actually exist. See "- Risk of
False Detection of Viruses." Delays and difficulties associated with new
product introductions, performance or enhancements could have a material
adverse effect on the Company's business, financial condition and
results of operations.
The Company's development efforts are impacted by the adoption or
evolution of industry standards related to its products and the
environments in which they operate. For example, no uniform industry
standard has developed in the market for encryption security products.
As industry standards are adopted or evolve, the Company may be required
to modify existing products or develop and support new versions of
existing products. In addition, to the extent that no industry standard
develops, the Company's products and those of its competitors may be
incompatible if they use competing standards, which could prevent or
significantly delay overall development of the market for a particular
product or products. The failure of the Company's products to comply, or
delays in compliance, with existing or evolving industry standards could
have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's long-term success will depend on its ability on a
timely and cost effective basis to develop upgrades and updates to its
existing product offerings, to modify and enhance acquired products, and
to introduce new products which meet the needs of current and potential
customers. Future upgrades and updates may, among other things, include
additional functionality, respond to user problems or address issues of
compatibility with changing operating systems and environments. The
Company believes that the ability to provide these upgrades and updates
to users frequently and at a low cost is a key to success. For example,
the proliferation of new and changing viruses makes it imperative to
update anti-virus products frequently in order for the products to avoid
obsolescence. Failure to release such upgrades and updates on a timely
basis could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance
that the Company will be successful in these efforts. In addition,
future changes in Windows 95 and 97, Windows NT, NetWare, the
introduction of Windows 2000 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.
<PAGE> 22
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 anti-virus software products and Sniffer
network fault and performance management products. These products are
expected to continue to account for a significant portion of the
Company's net revenue for the foreseeable future. Because of this
concentration of revenue, a decline in demand for, or in the prices of,
these anti-virus and network management products as a result of
competition, technological change, a change in the Company's pricing
model for such products, the inclusion of anti-virus or network
management and analysis functionality in system hardware or operating
system software or other software or otherwise, or a maturation in the
respective markets for these products could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Dependence on Emergence of Network Management and Network Security
Markets. The markets for the Company's network management and network
security products are evolving, and their growth depends upon broader
market acceptance of network management and network security software,
including help desk software. Although the number of LAN-attached
personal computers ("PCs") has increased dramatically, the network
management and network security markets continue to be emerging markets
and there can be no assurance that such markets will continue to develop
or that further market development will be rapid enough to benefit the
Company significantly. In addition, there are a number of potential
approaches to network management and network security, including the
incorporation of management and security tools into network operating
systems. Therefore, even if network management and network security
tools gain broader market acceptance, there can be no assurance that the
Company's products will be chosen by organizations which acquire network
management and network security tools. Furthermore, to the extent that
either the network management or network security market does continue
to develop, the Company expects that competition will increase. See "-
Competition" and "- Risk of Inclusion of Network Security and Management
Functionality in Hardware and Other Software."
Competition. The markets for the Company's products are intensely
competitive and the Company expects competition to increase in the near-
term. The Company believes that the principal competitive factors
affecting the markets for its products include performance,
functionality, quality, customer support, breadth of product line,
frequency of upgrades and updates, integration of products,
manageability of products, brand name recognition, company reputation
and price. Certain of the criteria upon which the performance and
quality of the Company's anti-virus software products compete include
the number and types of viruses detected, the speed at which the
products run and ease of use. Certain of the Company's competitors have
been in the network management market longer than the Company, and other
competitors, such as Symantec Corporation ("Symantec"), Intel
Corporation ("Intel") and Hewlett-Packard Company ("HP"), are larger
and/or have greater name recognition than the Company. The Company will
also need to develop name recognition for its new name, "Network
Associates." In addition, certain larger competitors such as Intel,
Microsoft and Novell, Inc. ("Novell") have established relationships
with hardware vendors related to their other product lines. These
relationships may provide them with a competitive advantage in
penetrating the OEM market with their network security and management
products. As is the case in many segments of the software industry, the
Company has been encountering, and expects to further encounter,
increasing competition. This increased competition is due in part to the
Company's recent increased size and visibility. Increased competition
could reduce average selling prices and, therefore, profit margins.
Competitive pressures could result not only in sustained price
reductions but also in a decline in sales volume, which events would
materially adversely affect the Company's business, financial condition
and results of operations. In addition, competitive pressures may make
it difficult for the Company to maintain or exceed its growth rate.
Although there is a trend toward consolidation in the network
security and management market, the market is currently highly
fragmented with products offered by many vendors. The Company's
principal competitor is the Peter Norton Group of Symantec in the
network security market and Intel's LanDesk in the network management
market. The Company's other competitors include Computer
Associates/Cheyenne Software, IBM, Axent Technologies, Inc. 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., ISS Group, Inc. 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.
<PAGE> 23
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 Major Accounts Sales Expertise and
Security Products Sales Expertise; 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 major account customers.
The second tier consists of geographically aligned sales groups focused
on the sale of the NetTools and 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 outbound corporate telesales forces who actively
market the Company's individual product suites to customers with less
2,500 nodes. The Company historically has not had a large enterprise or
major 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 major accounts market and
for the sale of its various product suites, (including its security
product suite), the Company will be required to build a significant
direct sales organization and will be required to attract and retain
qualified personnel, which personnel will require continuous training
about, and knowledge of, product attributes for the Company's suite of
products. The need for continuous product training results, in part,
from new developments and enhancements (including those products
acquired in the Company's various acquisitions). There can be no
assurance that the Company will be successful in building the necessary
sales organization or in attracting, retaining or training these
individuals. Historically, the Company has sold its products at the
departmental level. To succeed in the enterprise and major 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 TIS and PGP Security Products. The Company
markets a significant portion of its products to end-users through
distributors, resellers, system integrators, OEMs and VARs. The
Company's distributors sell other products that are complementary to, or
compete with, those of the Company. While the Company encourages its
distributors to focus on its products through market and support
programs, there can be no assurance that these distributors will not
give greater priority to products of other suppliers, including
competitors. In addition, to the extent the Company is successful in
building its professional services organization, its ability to
establish and maintain relationships with distributors, resellers,
systems integrators, OEMs and VARs who market their services along with
third party products may be adversely impacted.
<PAGE> 24
The Company does not have an extensive indirect sales channel for its
Network Sniffer products or its PGP and TIS security products. To
succeed in the indirect sales channel, the Company will be required to
build a more extensive network of distributors, resellers, system
integrators, OEMs and VARs who will support and market these products.
These indirect channel participants will require significant training
about, and knowledge of, product attributes for these products and the
related product suites. There can be no assurance that the Company can
successfully establish such an indirect channel on a timely basis or at
all or that such a channel, once established, can be maintained.
The Company's agreements with its distributors provide for a right of
return. This right of return may be triggered by a number of events,
including returns to distributors by end users, inaccurate estimates of
end user demand by distributors, increased purchases by distributors in
response to sales incentives or transitions to new products or versions
of products. As a result of this right of return, revenue recognized by
the Company upon sales to distributors is subject to a reserve for
returns. Returns could exceed reserves as a result of distributors
holding excessive Company product inventory. There can be no assurance
that current or future reserves established by the Company will be
adequate. The Company has historically sold a significant portion of
its anti-virus and other products through distributors indirectly into
the retail channel. With the acquisitions of Dr Solomon's, CyberMedia
and Helix, the amount of products sold into the retail channel has and
is expected to continue to increase in absolute dollars, although not as
a percentage of net revenue. Retailers of the Company's products
typically have a limited amount of shelf space and promotional
resources, and there is intense competition for high quality and
adequate levels of shelf space and promotional support from retailers.
There can be no assurance that retailers will continue to purchase the
Company's products or provide the Company's products with adequate
levels of shelf space and promotional support, the lack of which could
have a material adverse impact on the Company's business, financial
condition and results of operations. The Company recently introduced
its retail product suites, including McAfee Office, which combines ten
PC diagnostic and utility tools into one integrated software package.
There can be no assurance that these suites will gain acceptance in the
market place and/or that the Company will obtain the anticipated
revenues.
No customer accounted for more than 10% of net revenue during the
years ended December 31, 1997, 1996 and 1995. In the quarter ended
September 30, 1998, Ingram Micro Devices accounted for 17% of net
revenue. No other customers accounted for more than 10% of net revenue
during the quarter ended September 30, 1998.
Need to Expand and Develop An Effective Professional Services
Organization; Risks Related to Third-Party Professional Services. As
computer networks become more complex and as the Company's products
become more complex and are more broadly targeted at the enterprise and
at mission-critical applications, customers will increasingly require
greater professional assistance in the design, installation,
configuration, implementation and support of their networks and acquired
products. To date, the Company has relied on its limited professional
services capabilities and increasingly on outside professional service
providers (including its distributors, resellers and system
integrators). There can be no assurance that third party service
providers can or will continue to be willing to provide adequate levels
(both in terms of time and quality) of professional services. Moreover,
reliance on these third parties reduces the Company's control over the
provision of support services for its products and places a greater
burden on these third parties, which, in turn, could delay the Company's
recognition of product revenue, could harm the Company's relationships
or reputation with such third parties or the end users of its products
and could result in decreased future sales of, or prices for, its
products.
To more effectively service its customer's evolving needs (including
the need for product support), the Company intends to significantly
expand and develop its worldwide professional service organization.
There can be no assurance that the Company will be successful in its
efforts to expand and develop an effective professional services
organization. This will require that the Company hire and train
additional service professional who must be continually trained and
educated to ensure that they possess sufficient technical skills and
product knowledge. In particular, the market for qualified professionals
is intensely competitive, making hiring and retention difficult. The
Company expects significant competition in this market from existing
providers of professional services and future entrants. The Company must
also properly price its services to attract customers, while maintaining
sufficient margins for its services. The Company expects that it will
have lower profit margins on its service revenues. The failure to
develop an effective professional services organization could have a
material adverse effect on the Company's business, financial condition
and results of operations.
<PAGE> 25
Reliance on Microsoft Technology. Although the Company intends to
support other operating systems, the Company's mission is to be the
leading supplier of network security and management products for Windows
NT/Intel based networks. Sales of the Company's products would be
materially and adversely affected by market developments which are
adverse to the Windows operating environments, including the failure of
users and application developers to accept Windows NT. In addition, the
Company's ability to develop products using the Windows operating
environments is substantially dependent on its ability to gain timely
access to, and to develop expertise in, current and future developments
by Microsoft, of which there can be no assurance.
Risks Associated with Failure to Manage Growth. The Company's growth
internally and through its numerous acquisitions has placed, and any
further expansion would continue to place, a significant strain on its
limited personnel, management and other resources. In the future, the
Company's ability to manage any growth, particularly with the
anticipated expansion of the Company's international business, growth in
indirect channel business and increased focus on the enterprise and
mission critical applications, will require it to attract, train,
motivate and manage new employees successfully, to effectively integrate
new employees into its operations, provide adequate levels of product
support and to continue to improve its operational, financial,
management and information systems and controls. The failure to
effectively manage any further growth could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Given the Company's current size and growth rate, the Company will
need to make investments in its general and administrative
infrastructure to maintain adequate controls and systems and meet
worldwide statutory reporting requirements. Failure to make sufficient
investment in the general and administrative infrastructure could have a
material adverse effect on the Company's business, financial condition
and results of operations.
Proprietary Technology and Rights; Litigation. The Company's success
is heavily dependent upon proprietary software technology. The Company
relies on a combination of contractual rights, trademarks, trade secrets
and copyrights to establish and protect proprietary rights in its
software. There can be no assurance these protections will be adequate
or that competitors will not independently develop technologies or
products that are substantially equivalent or superior to the Company's
products.
In December 1997, the Company changed its legal name to "Networks
Associates, Inc." and has since been conducting business as "Network
Associates." Network Associates, Inc. in Oregon ("NAI-Oregon") and
Ronald L. Myers ("Myers"), a California resident doing business as The
Network Associates, have made unresolved claims (including various
trademark claims) or demands with respect to the Company's use of the
name Network Associates. On March 26, 1998, the Company commenced a
declaratory judgement action in the United States District Court,
Northern District of California against the above-cited claimants. The
Company seeks a declaration that its use of the Network Associates title
does not violate the federal, state or common law rights of any of the
defendants. Defendant NAI-Oregon has not yet answered the complaint;
defendant Myers has not yet been served.
The Company does not typically obtain signed license agreements from
its corporate, government and institutional customers who license
products directly from it. The Company includes an electronic version of
a "shrink-wrap" license in all of its electronically distributed
software and a printed license in the box for its products distributed
through traditional distribution channels in order to protect its
copyrights and trade secrets in those products. Since none of these
licenses are signed by the licensee, many authorities believe that such
licenses may not be enforceable under the laws of many states and
foreign jurisdictions. In addition, the laws of some foreign countries
either do not protect proprietary rights or offer only limited
protection for those rights. There can be no assurance that the steps
taken by the Company to protect its proprietary software technology will
be adequate to deter misappropriation of this technology. For example,
the Company is aware that a substantial number of users of its anti-
virus products have not paid any registration or license fees to the
Company. Changing legal interpretations of liability for unauthorized
use of the Company's software, or lessened sensitivity by corporate,
government or institutional users to avoiding copyright infringement,
could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company's principal assets are its intellectual property, and the
Company competes in an increasingly competitive market. There has been
substantial litigation regarding intellectual property rights of
technology companies. The Company has in the past been, and currently
is, subject to litigation related to its intellectual property. There
can be no assurance that there will be no developments arising out of
such pending litigation or any other litigation to which the Company is
or may become party which could have a material adverse effect on the
Company's business, financial condition and results of operation. See
Note 5 to the Notes to the Condensed Consolidated Financial Statements.
<PAGE> 26
In addition, as the Company may acquire a portion of software
included in its products from third parties, its exposure to
infringement actions may increase because it must rely upon such third
parties as to the origin and ownership of any software being acquired.
Similarly, exposure to infringement claims exists and will increase to
the extent that the Company employs or hires additional software
engineers previously employed by competitors, notwithstanding measures
taken by them to prevent usage by such software engineers of
intellectual property used or developed by them while employed by a
competitor. In the future, litigation may be necessary to enforce and
protect trade secrets and other intellectual property rights owned by
the Company. The Company may also be subject to litigation to defend it
against claimed infringement of the rights of others or to determine the
scope and validity of the proprietary rights of others. Any such
litigation could be costly and cause diversion of management's
attention, either of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
Adverse determinations in such litigation could result in the loss of
the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or
prevent the Company from manufacturing or selling its products, any one
of which could have a material adverse effect on the Company's business,
financial condition and results of operations. Furthermore, there can be
no assurance that any necessary licenses will be available on reasonable
terms, or at all.
Risks Related to International Revenue and Activities. In 1997, 1996
and 1995, international net revenue represented 33%, 31% and 31%,
respectively, of the Company's net revenue. In the quarter ended
September 30, 1998, international net revenue represented approximately
34% of the Company's net revenue. Historically, the Company has relied
primarily upon independent agents and distributors to market its
products internationally. The Company expects that international
revenues will continue to account for a significant percentage of net
revenue, with that percentage increasing as a result of the recent Dr
Solomon's acquisition. The Company also expects that a significant
portion of such international revenue will be denominated in local
currencies. To reduce the impact of foreign currency fluctuations, the
Company has engaged in various financial risk management activities.
However, there can be no assurance that the Company's future results of
operations will not be adversely affected by such fluctuations or by
costs associated with financial risk management strategies. Other risks
inherent in international revenue generally include the impact of longer
payment cycles, greater difficulty in accounts receivable collection,
unexpected changes in regulatory requirements, seasonality due to the
slowdown in European business activity during the third quarter, tariffs
and other trade barriers, uncertainties relative to regional economic
circumstances, 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. In addition,
there can be no assurance that the macroeconomic issues currently being
experienced in Asia will not spread to Europe, the U.S. or Latin
America, and/or have a material adverse impact on the Company's revenue
or revenue growth in the future. Further, in countries with a high
incidence of software piracy, the Company may experience a higher rate
of piracy of its products. There are a number of additional risks
related to the export of the Company's encryption products. See "- Risks
Relating to Cryptography Technology."
In addition, a portion of the Company's international revenue is
expected to continue to be generated through independent agents. Since
these agents will not be employees of the Company and will not be
required to offer the Company's products exclusively, there can be no
assurance that they will continue to market the Company's products.
Also, the Company is likely to have limited control over its agents,
limited access to the names of the customers to whom the agents sell its
products and limited knowledge of the information provided by, or
representations made by, these agents to its customers.
Risk of Sabotage. Given the Company's high profile in the security
software market, the Company has been a target of computer "hackers" who
have, among other things, created viruses to sabotage its products or
otherwise attack the Company's products. While to date these efforts
have been discovered quickly and their adverse impact has been limited,
there can be no assurance that similar viruses or efforts will not be
created or replicated in the future, that they will not cause damage to
users' computer systems and that demand for the Company's software
products will not suffer as a result. In addition, since the Company
does not control diskette duplication by distributors or its independent
agents, there can be no assurance that diskettes containing the
Company's software will not be infected with viruses.
Risk of False Detection of Viruses and of Actual or Perceived
Security Breaches. The Company's anti-virus software products have in
the past and may at times in the future falsely detect viruses that do
not actually exist. Such "false alarms," while typical in the industry,
may impair the perceived reliability of the Company's products and may
therefore adversely impact market acceptance of the Company's products.
In addition, the Company has in the past been subject to litigation
claiming damages related to a false alarm, and there can be no assurance
that similar claims will not be made in the future. Similarly, while a
well-publicized actual or perceived breach of network or computer
security could trigger a heightened awareness of computer abuse
(resulting in a potential increase in demand for security products), an
actual or perceived breach of network or computer security at one of the
Company's customers, regardless of whether such breach is attributable
to the Company's products, could adversely affect the market's
perception of such products.
<PAGE> 27
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 a result of this
regulatory regime, foreign competitors facing less stringent controls on
their products may be able to compete more effectively than the Company
in the global market. While the Company has obtained approval from the
Department of Commerce to export to certain end users, there can be no
assurance that the U.S. government will approve pending or future export
license requests. Further, there can be no assurance that the list of
products and countries for which export approval is required, and the
regulatory policies with respect thereto, will not be revised from time
to time. Failure to obtain the required licenses or the costs of
compliance could have a material adverse effect on the Company's
international revenues. See "- Risks Associated with the Export or
Import of Technology."
Certain of the Company's PGP and TIS network security products are
dependent on the use of public key cryptography technology, which
depends in part on the application of certain mathematical principles
known as "factoring." The security afforded by public key cryptography
technology is predicated on the assumption that the factoring of the
composite of large prime numbers is difficult. Should an easy factoring
method be developed, then the security afforded by encryption products
utilizing public key cryptography technology would be reduced or
eliminated. Furthermore, any significant advance in techniques for
attacking cryptographic systems could also render some or all of the
Company's existing products and services obsolete or unmarketable. There
can be no assurance that such developments will not occur. Moreover,
even if no breakthroughs in factoring or other methods of attacking
cryptographic systems are made, factoring problems can theoretically be
solved by computer systems significantly faster and more powerful than
those presently available. If such improved techniques for attacking
cryptographic systems are ever developed, it could have a material
adverse effect on the Company's business, operating results and
financial condition.
Risks Associated with the Export or Import of Technology. The
Company is a developer and distributor of technologies subject the
export or import rules and regulations of the United States government
and other foreign jurisdictions. Given the continuous development of
new technologies and products, and the evolving worldwide rules and
regulations regarding the export or import of high-technology software
products, the Company is subject to continued scrutiny and review of the
development and distribution of its products. There can be no assurance
that the Company will continually be in compliance with the evolving and
complex United States and foreign governments import or export laws, and
such failure of compliance could result in a material adverse effect on
the Company's business, financial condition and results of operations.
See "- Risks Relating to Cryptography Technology."
Product Liability. The Company's security and network management
software products are used to protect and manage computer systems and
networks that may be critical to organizations and, as a result, the
sale and support of these products by the Company may entail the risk of
product liability and related claims. The Company's license agreements
with its customers typically contain provisions designed to limit the
Company's exposure to potential product liability claims. It is
possible, however, that the limitation of liability provisions contained
in these license agreements may not be effective under the laws of
certain jurisdictions, particularly in circumstances involving unsigned
licenses. A product liability claim brought against the Company could
have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence upon Key Personnel. The success of the Company will depend
to a significant extent upon a number of key technical and management
employees. While employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, Company
employees are generally not otherwise subject to employment agreements
or to noncompetition covenants. The loss of the services of any key
employees could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company
does not maintain life insurance policies on its key employees. The
ability of the Company to achieve its revenue and operating performance
objectives will depend in large part on its ability to attract and
retain technically qualified and highly skilled sales, consulting,
technical, marketing and management personnel. Competition for such
personnel is intense and is expected to remain so for the foreseeable
future. There can be no assurance the Company will be successful in
retaining its existing key personnel and in attracting and retaining the
personnel it requires, and failure of the Company to retain and grow its
key employee population could adversely affect the Company's business
and operating results. 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.
<PAGE> 28
Customer Purchase Decisions; Potentially Longer Sales and
Implementation Cycles for Certain Products Suites. The products offered
by the Company may be considered to be capital purchases by certain
customers or prospective customers. Capital purchases are often
considered discretionary and, therefore, are canceled or delayed if the
customer experiences a downturn in its business or prospects or as a
result of economic conditions in general. Any such cancellation or delay
could adversely affect the Company's results of operations. In addition,
as the Company proceeds with its strategy of selling product suites
under the Net Tools umbrella (particularly to larger enterprise and
national accounts), its sales cycle is likely to lengthen. Such sales
may involve a lengthy education process and a significant technical
evaluation and commitment of capital and other resources and may be
subject to the risk of delays associated with customers' internal budget
and other procedures for approving large capital expenditures, deploying
new technologies within their networks and testing and accepting new
technologies that affect key operations. Because of the potentially
lengthy sales cycle and the potentially large size of such orders, if
orders forecasted for a specific customer for a particular quarter are
not realized or revenues are not otherwise recognized in that quarter,
the Company's operating results for that quarter could be materially
adversely affected. See "-Variability of Quarterly Operating Results"
and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Risks of Doing Business with the U.S. Government. As a result of its
recent acquisition of TIS, the Company expects that, in the near term, a
meaningful portion of its revenues will result from existing and future
research and development contracts with agencies of the U.S. government.
Network Associates believes that the awarding to it of future government
contracts will in part be dependent upon the continued favorable
reaction of government agencies to the Company's research, development
and consulting capabilities. There can be no assurance that Network
Associates will be able to procure additional government contracts.
Minimum fee awards for government contracts are usually 3% to 7% of the
contract costs, but may be as low as 1% of the contracts costs, and the
contracts are subject to cancellation for the convenience of the
governmental agencies. Although the Company has been awarded contract
fees of more than 1% in the past, there can be no assurance that minimum
fee awards will not occur in the future. Reductions or delays in federal
funds available for projects the Company is performing could also have
an adverse impact on its government business. Contracts involving the
U.S. government are also subject to the risks of disallowance of costs
upon audit, changes in government procurement policies, the necessity to
participate in competitive bidding, de-funding of government contracts
and, with respect to contracts involving prime contractors or
government-designated subcontractors, the inability of such parties to
perform under their contracts. Any of the foregoing events could have a
material adverse effect on the Company's financial condition or results
of operations.
Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date
code field. These date code fields will need to accept four digit
entries to distinguish 21st century dates from 20th century dates. As a
result, many companies' software and computer systems may need to be
upgraded or replaced in order to comply with such "Year 2000" or "Y2K"
requirements.
The Company has established a corporate-wide program to address the
Y2K issue. This program encompasses commercial product, internal
systems and technology, supplier and business partner and facilities and
life safety compliance. The project is comprised of identification of
risks, assessment of risks, development of remediation or contingency
plans and implementation and testing.
Based on the assessments to date, all products currently under
development and the majority of products released are Y2K compliant. For
any released products which are not Y2K compliant, the Company is
working with its customers to provide migration paths for those
products. The Company's internal systems and technology are relatively
new and as a result the majority are already Y2K compliant. The Company
is in the process of upgrading systems and technology that are not
currently Y2K compliant, and expects to have this process completed by
the third quarter of 1999. In addition, the Company is working with its
suppliers and business partners to identify at what stage they are at in
the process of identifying and addressing the Y2K issue and to assess
the resulting risks and develop appropriate contingency plans. The
Company will continue to perform compliance reviews and tests to ensure
compliance on an ongoing basis. The Company will continue to perform
compliance reviews and tests to ensure compliance on an ongoing basis.
In connection with the resolution of Y2K issues, the Company has not to
date incurred material costs and does not anticipate that such costs
will be material in the future.
<PAGE> 29
Although the Company has established and commenced its program to
address Y2K issues, the failure of the Company's current or prior
products to operate properly with regard to the Year 2000 requirements
could (i) cause the Company to incur unanticipated expenses to remedy
any problems, (ii) cause a reduction in sales and (iii) expose the
Company to related litigation by its customers, each of which could have
a material adverse effect on the Company's business, operating results
and financial condition. In addition, the Company and third parties
with whom it conducts business may utilize equipment or software that
may not be Y2K compliant. Failure of the Company's or any such third
party software to operate properly with regard to the Year 2000
requirements could cause, among other things, the Company or any such
third party to incur unanticipated expenses or efforts to remedy any
problems, which could have a material adverse effect on its or their
respective business, operation results and financial condition.
Furthermore, the purchasing patterns of customers or potential customers
may be affected by Y2K issues as companies expend significant resources
to evaluate and to correct their equipment or software for Y2K
compliance and as they simultaneously evaluate the preparedness of the
third parties with whom they deal. 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.
Historically, the Company's manufacturing operations consisted
primarily of final assembly, testing and quality control of materials,
components, subassemblies and systems for its Sniffer based products.
The Company outsourced these manufacturing operations in 1998. There can
be no assurance that the Company will be able to continue to qualify and
secure on commercially acceptable terms satisfactory third party
manufacturers on a timely basis or at all. In addition, reliance on
third party manufacturers will involve a number of risks, including the
lack of direct control over the manufacturing process, the absence or
unavailability of adequate capacity and reduced control over delivery
schedules, quality control and costs. In the event that, once initially
secured, the Company's third party manufacturers are unable or unwilling
to continue to manufacture the Sniffer based products in required
volumes, on a cost effective basis, in a timely manner or at all, the
Company will have to secure additional manufacturing capacity. Even if
such additional capacity is available at commercially acceptable terms,
the qualification process could be lengthy and could create delay in
product shipments.
Possible Price Volatility of Common Stock. The trading price of the
Company's Common Stock has historically been, and is expected to be,
subject to wide fluctuations. The market price of the Common Stock may
be significantly impacted by quarterly variations in financial
performance, shortfalls in revenue or earnings from levels forecast by
securities analysts, changes in estimates by such analysts, market
conditions in the computer software or hardware industries, product
introductions by the Company or its competitors, announcements of
extraordinary events such as acquisitions or litigation or general
economic conditions. Statements or changes in opinions, ratings, or
earnings estimates made by brokerage firms or industry analysts relating
to the market in which the Company does business or relating to the
Company specifically could result in an immediate and adverse effect on
the market price of the Common Stock. In addition, in recent years the
stock market has experienced extreme price and volume fluctuations.
These fluctuations have had a substantial effect on the market prices
for many high technology and emerging growth companies, often unrelated
to the operating performance of the specific companies. There can be no
assurances that the market price of the Common Stock will not decline
below the levels prevailing at the time of this offering. Securities
class action lawsuits are often brought against companies following
periods of volatility in the market price of their securities. Any such
litigation against the Company could result in substantial costs and a
diversion of resources and management attention.
<PAGE> 30
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. In this regard, on October
19, 1998, the Board of Directors of the Company declared a dividend of
one Preferred Share Purchase Right on each outstanding share of Company
Common Stock which was paid to stockholders of record on November 3,
1998. 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.
<PAGE> 31
NETWORKS ASSOCIATES, INC.
Form 10-Q, September 30, 1998
PART II: OTHER INFORMATION
Item 1. Legal Proceedings:
Information with respect to this item is incorporated by reference to
Note 5 of the Notes to the Consolidated Financial Statements included
herein on page 9 of this Report on Form 10-Q.
Item 2. Changes in Securities
Preferred Shares Purchase Rights
On October 19, 1998, the Network Associates Board of Directors
declared a dividend distribution of one preferred share purchase right
(a "Right") on each outstanding share of the Company's Common Stock.
Each Right entitles the record holder to buy one-one thousandth of a
share of the Company's Series B Participating Preferred Stock, $0.01 par
value per share, at an exercise price of $200.00. The Rights will
become exercisable following the tenth day after a person or group
announces acquisition of 15% or more of the Company's Common Stock or
announces commencement of a tender or exchange offer the consummation of
which would result in ownership by the person or group of 15% or more of
the Common Stock. The Company will be entitled to redeem the Rights at
$0.01 per Right at any time on or before the tenth day following
acquisition by a person or group of 15% or more of the Company's Common
Stock. The dividend distribution was paid on November 3, 1998, to
stockholders of record on that day. The Rights will expire on October
20, 2008.
Issuances of Securities
On August 31, 1998, the Company acquired QA Information Security
Holding AB ("QA"). In connection therewith, the Company issued an
aggregate of 305,557 shares of Company Common Stock to the shareholders
of QA. The transaction was exempt from the registration requirements of
Section 5 of the Securities Act pursuant to Section 4(2) thereof and
Regulation S promulgated thereunder. The recipients of the securities
represented their intentions to acquire the securities for investment
only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate
access to information regarding the Company. In addition, the offer and
sale of such securities by the Company occurred outside of the United
States.
On August 13, 1998, the Company acquired Dr Solomon's Group Plc ("Dr
Solomon's"). In connection therewith, the Company issued approximately
15.3 million shares of Company Common Stock (including approximately 1.7
million shares held in trust pending the exercise of certain outstanding
and fully vested Dr Solomon's options) to the shareholders of Dr
Solomon's. The securities were exempt from the registration
requirements of Section 5 of the Securities Act pursuant to Section
3(a)(10) thereof. The High Court of Justice of England and Wales
approved the fairness of such acquisition.
On July 30, 1998, the Company acquired Anyware Seguridad Informatica
S.A. ("Anyware"). In connection therewith, the Company issued an
aggregate of 228,204 shares of Company Common Stock to the shareholders
of Anyware. The transaction was exempt from the registration
requirements of Section 5 of the Securities Act pursuant to Section 4(2)
thereof and Regulation S promulgated thereunder. The recipients of the
securities represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with
any distribution thereof and appropriate legends were affixed to the
share certificates issued in such transaction. All recipients had
adequate access to information regarding the Company. In addition, the
offer and sale of such securities by the Company occurred outside of the
United States.
<PAGE> 32
Item 5. Other Information
Pursuant to Rule 14a-4(c)(1) under the Securities Exchange Act of
1934, the proxies provided to management would allow management to use
its discretionary voting authority with respect to any non-Rule 14a-8
stockholder proposal (i.e., a stockholder proposal not included in a
company's proxy) raised at the Company's annual meeting of stockholders,
without any discussion of the matter in the proxy statement, unless the
stockholder has notified the Company of such proposal at least 45 days
prior to the month and day on which the Company mailed its prior year's
proxy statement. Since the Company mailed its proxy statement for the
1998 annual meeting of stockholders on May 8, 1998, the deadline for
receipt of any such non-Rule 14a-8 stockholder proposal for the 1999
annual meeting of stockholders is March 24, 1999.
Item 6. Exhibits and Reports on Form 8-K:
(a) The Company filed the following reports on Form 8-K:
In a report on Form 8-K filed with the Commission on October 22,
1998, the Company reported the declaration of a dividend
distribution of a Preferred Share Purchase Right. The dividend
distribution is expected to be made on November 3, 1998.
In a report on Form 8-K filed with the Commission on August 4,
1998, the Company reported the closing and principal terms of the
acquisition of Dr Solomon's Group Plc, a corporation duly
organized and existing under the laws of England and Wales, which
acquisition was consummated on August 12, 1998.
In a report on Form 8-K/A filed with the Commission on July 1,
1998, the Company reported the agreement as to terms of the
proposed acquisition of Dr Solomon's Group Plc, a corporation duly
organized and existing under the laws of England and Wales, which
agreement was executed on June 9, 1998.
(b) Exhibits. The exhibits listed in the accompanying Exhibit Index
are filed or incorporated by reference as part of this Report.
<PAGE> 33
NETWORKS ASSOCIATES, INC.
Form 10-Q, September 30, 1998
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
and the results and regulations promulgated thereunder, the registrant
has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETWORKS ASSOCIATES, INC.
/s/ PRABHAT K. GOYAL
Name: Prabhat K. Goyal
Title: Vice President Administration,
Chief Financial Officer and Secretary
Date: November 13, 1998
<PAGE> 34
NETWORK ASSOCIATES, INC.
Form 10-Q, September 30, 1998
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT TITLE
- ----------- ------------------------------------------------------------
2.1 Agreement and Plan of Reorganization, dated as of October
13, 1997, among McAfee Associates, Inc., Mystery Acquisition
Corp. and Network General Corporation, as amended by the
First Amendment dated as of October 22, 1997.(1)
2.2 Combination Agreement dated August 16, 1996 among the
Registrant, FSA Combination Corp., FSA Corporation and
Daniel Freedman.(2)
2.3 Stock Exchange Agreement dated January 13, 1996 among the
Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and
the shareholders of Jade.(3)
2.4 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, Helix Software Company an DNA
Acquisition Corp.(4)
2.5 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, PGP and PG Acquisition Corp.(5)
2.6 Agreement and Plan of Reorganization dated February 22, 1998,
between the Registrant, TIS and Thor Acquisition Corp.(6)
2.7 Agreement and Plan of Reorganization by and among the
Company, Magic Solutions International, Inc., Merlin
Acquisition Corp. and Igal Lichtman, Amendment Agreement by
and among the Registrant, Magic Solutions International,
Inc., Merlin Acquisition Corp., and Igal Lichtman dated
March 24, 1998. Second Amendment Agreement by and among the
Registrant, Magic Solutions International, Inc., Merlin
Acquisition Corp., and Igal Lichtman dated April 1, 1998.(7)
2.8 Stock Purchase Agreement, dated as of February 26, 1998, by and
between FSA Combination Corp., and Brenda Joyce Cook.(8)
2.9 Share Purchase Agreement, dated as of March 30, 1998, among FSA
Combination Corp., and Irina Karlsson and Jarmo Rouvinen.(8)
2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA
Combination Corp., and Secure Networks, Inc.(8)
2.11 Transaction Agreement, dated June 9, 1888, by and between the
Registrant an Dr Solomon's Group Plc (21)
2.12 Agreement and Plan of Merger, dated July 28, 1998, by and between
the Registrant and CyberMedia, Inc. (22)
3.1 Second Restated Certificate of Incorporation of Networks
Associates, Inc., as amended on December 1, 1997.(6)
3.2 Restated Bylaws of Networks Associates, Inc.(6)
3.3 Certificate of Designation of Series A Preferred Stock of
Networks Associates, Inc.(9)
3.4 Certificate of Designation of Series B Preferred Stock of
the Registrant (23)
4.2 Registration Rights Agreement dated August 30, 1996 between
the Registrant and Daniel Freedman.(1)
4.5 Registration Rights Agreement dated December 9, 1997 between
the Registrant and certain shareholders of PGP.(4)
4.6 Registration Rights Agreement, dated as of February 13,
1998, by and between the Registrant and Morgan Stanley & Co.
Incorporated.(10)
4.7 Indenture dated as of February 13, 1998 between the
Registrant and State Street Bank and Trust Company of
California, N.A., as Trustee.(10)
4.10 Registration Rights Agreement dated May 8, 1998, by and between the
Registrant and the stockholders of Secure Networks, Inc.(8)
4.11 Registration Rights Agreement, dated June 29, 1998, by and between
the Registrant and certain stockholders of CSB Consulenza Software
di Base S.r.l. ("CSB").(11)
<PAGE> 35
4.12 Registration Rights Agreement, dated July 30, 1998, by and between
the Registrant and certain stockholders of Anyware Seguridad
Informatica S.A.(11)
4.13 Registration Rights Agreement, dated August 31, 1998, by and between
the Registrant and certain stockholders of QA Informatica Security
Holding AB.
10.1 Standard Business Lease (Net) for Network General's
principal facility dated June 19, 1991, between Network
General and Menlo Oaks Partners, L.P.(12)
10.2 First Amendment to Lease dated June 10, 1992, between
Network General and Menlo Parks Partners, L.P.(12)
10.3 Standard Business Lease (Net) for Network General's
principal facility dated March 11, 1992, between Network
General and Menlo Oaks Partners L.P.(13)
10.4 First Amendment to Lease dated June 18, 1992, between
Network General and Menlo Oaks Partners, L.P.(12)
10.5 Lease dated March 31, 1992, between Network General and
Equitable Life Assurance Society of the United States.(12)
10.6 Second Amendment to Lease dated February 1, 1995, between
Network General and Menlo Oaks Partners, L.P.(13)
10.7 Third amendment to Lease dated February 1, 1995 between
Network General and Menlo Oaks Partners L.P.(13)
10.8 Fourth Amendment to Lease dated May 31, 1995, between
Network General and Menlo Oaks Partners, L.P.(14)
10.9 Fifth Amendment to Lease dated June 13, 1995, between
Network General and Menlo Oaks Partners, L.P.(14)
10.10 Lease dated July 3, 1996 between Network General and
Campbell Avenue Associates.(15)
10.11 Sixth Amendment to Lease dated November 29, 1996, between
Network General and Menlo Oaks Partners, L.P.(15)
10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa
Clara, California, dated as of February 20, 1997, by and
between McAfee Associates, Inc. and National Semiconductor
Corporation.(16)
10.13 Lease Agreement dated November 17, 1997 for facility at 3965
Freedom Circle, Santa Clara, California by and between
Informix Corporation and McAfee Associates, Inc.(4)
10.14 Consent to Assignment Agreement dated December 19, 1997 by
and among Birk S. McCandless, LLC, Guaranty Federal Bank,
F.S.B., Informix Corporation and Networks Associates,
Inc.(4)
10.15 Subordination, Nondisturbance and Attornment Agreement dated
December 18, 1997, between Guaranty Federal Bank, F.S.B.,
Networks Associates, Inc. and Birk S. McCandless, LLC.(4)
10.16 Lease dated November 22, 1996 by and between Birk S.
McCandless, LLC and Informix Corporation for facility at
3965 Freedom Circle, Santa Clara, California.(4)
10.17 Quota Purchase Assignment Agreement, dated as of April 14, 1997 by
and among McAfee Associates, Inc. and McAfee Do Brasil Ltda.,
Compusul-Consultoria E Comericio De Informatica Ltda., and the
stockholders of Compusul-Consultoria E Comericio De Informatica
Ltda.(17)
10.18* 1997 Stock Incentive Plan.(17)
10.19* Stock Option Plan for Outside Directors.(18)
10.20* Change in control agreement between the Company and Dennis
Cline dated April 14, 1995.(17)
10.21* Change in control agreement between the Company and Peter
Watkins dated May 1, 1995.(17)
10.22* Change in control agreement between the Company and William
S. Larson dated April 14, 1995.(17)
10.23* Change in control agreement between the Company and Prabhat
K. Goyal.(19)
10.27* Change in control agreement between the Company and Zach
Nelson, dated May 12, 1998.(20)
27.1 Financial Data Sheet
- ----------------
<PAGE> 36
(1) Incorporated by reference from the Registrant's Registration
Statement on Form S-4 filed with the Commission on October 31, 1997.
(2) Incorporated by reference from the Registrant's Current Report on
Form 8-K filed with the Commission on September 24, 1996.
(3) Incorporated by reference from the Registrants Current Report on
Form 8-K filed with the Commission on March 14, 1997.
(4) Incorporated by reference from the Registrant's Registration
Statement on Form S-3, filed with the Commission on February 12, 1998.
(5) Incorporated by reference to the Report on Form 8-K of the Registrant
as filed with the Commission on December 11, 1997.
(6) Incorporated by reference to the Report on Form S-4 of the
Registrant as filed with the Commission on March 25, 1998.
(7) Incorporated by reference to Exhibits 2.1, 2.2 and 2.3 of the Report
on Form 8-K of the Registrant as filed with the Commission on April
2, 1998.
(8) Incorporated by reference from the Registrant's Registration
Statement on Form S-3 filed with the Commission on April 2, 1998.
(9) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended September 30, 1996, filed with the Commission
on November 4, 1997.
(10) Incorporated by reference from the Registrant's Registration
Statement on Form S-3 filed with the Commission on May 6, 1998.
(11) Incorporated by reference from the Registrant's Registration
Statement on Form S-3 filed with the Commission on August 5, 1998.
(12) Incorporated by reference from the Network General Corporation's
Report on Form 10-K for the year ended March 31, 1992. Network
General's filings with the Commission were made under File Number
0-17431.
(13) Incorporated by reference from the Network General Corporation's
Report on Form 10-Q for the quarter ended December 31, 1994.
Network General's filings with the Commission were made under File
Number 0-17431.
(14) Incorporated by reference from the Network General Corp.oration's
Report on Form 10-Q for the quarter ended June 30, 1995. Network
General's filings with the Commission were made under File Number
0-17431.
(15) Incorporated by reference from the Network General Corporation's
Report on Form 10-Q for the quarter ended June 30, 1996. Network
General's filings with the Commission were made under File Number
0-17431.
(16) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended June 30, 1997, filed with the Commission on
August 14, 1997.
(17) Incorporated by reference from the Registrant's Registration
Statement on Form S-4 filed with the Commission on July 31, 1995.
(18) Incorporated by reference from the Registrant's Registration
Statement on Form S-8 filed with the Commission on December 2, 1997.
(19) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended June 30, 1996, filed with the Commission on
August 13, 1996.
(20) Incorporated by reference from the Registrant's Report on Form 10-Q
for the quarter ended March 31, 1998, filed with the Commission on
May 15, 1998.
(21) Incorporated by reference from the Registrant's Report on Form 8-K
filed with the Commission on June 16, 1998.
(22) Incorporated by reference from CyberMedia, Inc.'s Schedule 13D filed
by the Registrant with the Commission on August 7, 1998.
CyberMedia, Inc.'s filings with the Commission were made under File
Number 0-21289
(23) Incorporated by reference from the Registrant's Report on Form 8-A
filed with the Commission on October 22, 1998.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
<PAGE> 37
<PAGE>
REGISTRATION RIGHTS AGREEMENT
THIS REGISTRATION RIGHTS AGREEMENT is made as of August 31, 1998,
by and between Networks Associates, Inc., a Delaware corporation (the
"Company"), and the undersigned shareholders of QA Information Security
Holding AB (the "Shareholders").
RECITALS
WHEREAS, concurrent with delivery of this Agreement, the Company,
and the Shareholders are entering into a Stock Purchase Agreement (the
"Purchase Agreement") which provides for the purchase (the "Purchase")
of all of the issued and outstanding shares of QA Information Security
Holding AB by the Company in exchange for shares of Company Common
Stock;
WHEREAS, as an inducement to the Shareholders to enter into the
Purchase Agreement, as of the Closing Date, the shares of Company Common
Stock that are issued to the Shareholders pursuant to the Purchase
Agreement shall be granted registration rights as set forth herein; and
WHEREAS, all terms not otherwise defined herein shall have the
same meanings ascribed to them in the Purchase Agreement;
NOW, THEREFORE, THE PARTIES HEREBY AGREE AS FOLLOWS:
1. Registration Rights. The Company covenants and agrees as
follows:
1.1 Definitions. For purposes of this Section 1:
(a) The term "Act" means the Securities Act of 1933,
as amended.
(b) The term "1934 Act" shall mean the Securities
Exchange Act of 1934, as amended.
(c) The term "register," "registered," and
"registration" refer to a registration effected by preparing
and filing a registration statement or similar document in
compliance with the Act, and the declaration or ordering of
effectiveness of such registration statement or document.
(d) The term "Registrable Securities" means the
Common Stock of the Company ("Common Stock") issued to the
Shareholders in accordance with the terms and conditions of
the Purchase Agreement and any securities of the Company
issued as a dividend on or other distribution with respect
to, or in exchange for or replacement of, such common stock.
(e) The term "SEC" shall mean the Securities and
Exchange Commission.
1.2 Obligations of the Company. Whenever required under
this Section 1 to effect the registration of any Registrable
Securities, the Company shall, as soon as reasonably possible:
(a) Prepare and file with the SEC as soon as
reasonably possible, but in no event later than 60 days
after the Closing Date, a registration statement on Form S-
3, or other available form of registration statement with
respect to such Registrable Securities (hereinafter referred
to as the "Registration Statement") and use its reasonable
best efforts to cause such registration statement to become
effective as soon as reasonably possible thereafter, and,
subject to the provisions below, use its reasonable best
efforts to, keep such registration statement effective for a
period of 360 days or, if earlier, until the Shareholders
have sold all of the Registrable Securities. If at any time
after a registration statement becomes effective, the
Company advises the Shareholders' Agent (defined below) in
writing that due to the existence of material information
that has not been disclosed to the public and included in
the registration statement it is necessary to amend the
registration statement, the Shareholders shall suspend any
further sale of Registrable Securities pursuant to the
Registration Statement until the Company advises the
Shareholders' Agent that the registration statement has been
amended. In such event, the Company shall cause the
registration statement to be amended forthwith, provided
that the Company shall not be required to amend the
registration statement during any time when the Company's
officers and director are prohibited from buying or selling
the Company's Common Stock pursuant to the Company's insider
trading policy. Notwithstanding the foregoing sentence, the
Company shall file any amendment necessary for the
Shareholders to recommence sales under the registration
statement concurrently with the commencement of any period
in which directors and officers of the Company are allowed
to buy or sell Common Stock pursuant to the Company's
insider trading policy. In addition, the Company may
suspend use of the registration statement to the extent the
Company is advised by its legal counsel, such action is
reasonably necessary to comply with federal securities law.
In the event the sales of Registrable Securities of the
Shareholders are suspended as provided above, the 360-day
period during which a registration statement must be kept
effective shall be extended for the total number of days
during which sales are suspended.
(b) Subject to subsection 1.2(a), prepare and file
with the SEC such amendments and supplements to such
Registration Statement and the prospectus used in connection
with such Registration Statement as may be necessary to
comply with the provisions of the Act with respect to the
disposition of all securities covered by such Registration
Statement.
(c) Furnish to Erik Aberg (the "Shareholders'
Agent") such numbers of copies of a prospectus, including a
preliminary prospectus, in conformity with the requirements
of the Act, and such other documents as the Shareholders may
reasonably request in order to facilitate the disposition of
Registrable Securities owned by them.
(d) Use its best efforts to register and qualify the
securities covered by such registration statement under such
other (U.S.) securities or Blue Sky laws of such
jurisdictions as shall be reasonably requested by the
Shareholders, provided that the Company shall not be
required in connection therewith or as a condition thereto
to qualify to do business or to file a general consent to
service of process in any such states or jurisdictions,
unless the Company is already subject to service in such
jurisdiction and except as may be required by the Act.
(e) The Company may include securities issued in
connection with any acquisition not otherwise registered on
an S-4 Registration Statement in the registration pursuant
to this Agreement.
1.3 Information from Shareholders. It shall be a
condition precedent to the obligations of the Company to take any
action pursuant to this Section 1 with respect to the Registrable
Securities of the Shareholders that the Shareholders shall furnish
to the Company such information regarding themselves, the
Registrable Securities held by them, and the intended method of
disposition of such securities, as shall be required to effect the
registration of the Registrable Securities.
1.4 Expenses of Registration. All expenses of the
Shareholders, including (without limitation) all registration,
filing and qualification fees, printers' and accounting fees, fees
and disbursements of counsel for the Company shall be borne by the
Company; provided, however, that the Company shall not be required
to pay any professional fees of the Shareholders other than the
fees of one counsel to the Shareholders' Agent (not to exceed
$10,000).
1.5 Indemnification. In the event any Registrable
Securities are included in the Registration Statement under this
Section 1:
(a) The Company will indemnify and hold harmless the
Shareholders, each of their directors, officers, trustees or
beneficiaries, if applicable and each person, if any, who
controls a non-individual shareholder within the meaning of
the Act against any losses, claims, damages, or liabilities
(joint or several) to which the Shareholders may become
subject under the Act, or the 1934 Act or other federal or
state law, insofar as such losses, claims, damages, or
liabilities (or actions in respect thereof) arise out of or
are based upon any of the following statements, omissions or
violations (collectively a "Violation"): (i) any untrue
statement or alleged untrue statement of a material fact
contained in the Registration Statement, including any
preliminary prospectus or final prospectus contained therein
or any amendments or supplements thereto, (ii) the omission
or alleged omission to state therein a material fact
required to be stated therein, or necessary to make the
statements' therein not misleading, or (iii) any violation
or alleged violation by the Company of the Act, the 1934
Act, or any rule or regulation promulgated under the Act, or
the 1934 Act; and the Company will pay to the Shareholders
as incurred any legal or other expenses reasonably incurred
by the Shareholders in connection with investigating or
defending any such loss, claim, damage, liability, or
action; provided, however, that the indemnity agreement
contained in this subsection 1.5(a) shall not apply to
amounts paid in settlement of any such loss, claim, damage,
liability, or action if such settlement is effected without
the consent of the Company, which consent shall not be
unreasonably withheld, nor shall the Company be liable in
any such case for any such loss, claim, damage, liability,
or action to the extent that it arises out of or is based
upon a Violation which occurs in reliance upon and in
conformity with information furnished in writing expressly
for use in connection with such registration by the
Shareholders seeking indemnification hereunder. In
addition, the Company shall not be liable for any untrue
statement or omission in any prospectus if a supplement or
amendment thereto correcting such untrue statement or
omission was delivered to the Shareholders' Agent prior to
the pertinent sale or sales by the Shareholders.
(b) Each Shareholder will indemnify and hold
harmless the Company, each of its directors, each of its
officers who has signed the Registration Statement, each
person, if any, who controls the Company within the meaning
of the Act, any other shareholder selling securities in such
Registration Statement and any controlling person of any
such shareholder, against any losses, claims, damages, or
liabilities (joint or several) to which any of the foregoing
persons may become subject, under the Act, or the 1934 Act
or other federal or state law, insofar as such losses,
claims, damages, or liabilities (or actions in respect
thereto) arise out of or are based upon any Violation, in
each case to the extent (and only to the extent) that such
Violation occurs in reliance upon and in conformity with
written information furnished by such Shareholder expressly
for use in connection with such registration; and such
Shareholder will pay, as incurred, any legal or other
expenses reasonably incurred by any person intended to be
indemnified pursuant to this subsection 1.5(b), in
connection with investigating or defending any such loss,
claim, damage, liability, or action; provided, however, that
the indemnity agreement contained in this subsection 1.5(b)
shall not apply to amounts paid in settlement of any such
loss, claim, damage, liability or action if such settlement
is effected without the consent of such Shareholder, which
consent shall not be unreasonably withheld; provided, that,
in no event shall any indemnity under this subsection 1.5(b)
by such Shareholder exceed the gross proceeds from the
offering received by such Shareholder.
(c) Promptly after receipt by an indemnified party
under this Section 1.5 of notice of the commencement of any
action (including any governmental action), such indemnified
party will, if a claim in respect thereof is to be made
against any indemnifying party under this Section 1.5,
deliver to the indemnifying party a written notice of the
commencement thereof and the indemnifying party shall have
the right to participate in, and, to the extent the
indemnifying party so desires, jointly with any other
indemnifying party similarly noticed, to assume the defense
thereof with counsel mutually satisfactory to the parties;
provided, however, that an indemnified party (together with
all other indemnified parties which may be represented
without conflict by one counsel) shall have the right to
retain one separate counsel, with the fees and expenses to
be paid by the indemnifying party, if representation of such
indemnified party by the counsel retained by the
indemnifying party would be inappropriate due to actual or
potential differing interests between such indemnified party
and any other party represented by such counsel in such
proceeding. The failure to deliver written notice to the
indemnifying party within a reasonable time of the
commencement of any such action, if prejudicial to its
ability to defend such action, shall relieve such
indemnifying party of any liability to the indemnified party
under this Section 1.5, but the omission so to deliver
written notice to the indemnifying party will not relieve it
of any liability that it may have to any indemnified party
otherwise than under this Section 1.5.
(d) If the indemnification provided for in this
Section 1.5 is held by a court of competent jurisdiction to
be unavailable to an indemnified party with respect to any
loss, liability, claim, damage, or expense referred to
therein, then the indemnifying party, in lieu of
indemnifying such indemnified party hereunder, shall
contribute to the amount paid or payable by such indemnified
party as a result of such loss, liability, claim, damage, or
expense in such proportion as is appropriate to reflect the
relative fault of the indemnifying party on the one hand and
of the indemnified party on the other in connection with the
statements or omissions that resulted in such loss,
liability, claim, damage, or expense as well as any other
relevant equitable considerations. The relative fault of
the indemnifying party and of the indemnified party shall be
determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the
omission to state a material fact relates to information
supplied by the indemnifying party or by the indemnified
party and the parties' relative intent, knowledge, access to
information, and opportunity to correct or prevent such
statement or omission.
(e) The obligations of the Company, and the
Shareholders under this Section 1.5 shall survive the
completion of any offering of Registrable Securities in a
registration statement under this Section 1, and otherwise.
1.6 Reports Under the Securities Exchange Act. The
Company agrees to file with the SEC in a timely manner all reports
and other documents and information required of the Company under
the 1934 Act, and take such other actions as may be necessary to
assure the availability of Form S-3 for use in connection with the
registration rights provided in this Agreement.
1.7 Rules 144 and 144A. The Company shall use
commercially reasonable efforts to file the reports required to be
filed by it under the Act and the 1934 Act in a timely manner and,
if at any time the Company is not required to file such reports,
it will, upon the written request of the Shareholders' Agent, make
publicly available other information so long as necessary to
permit sales of the Shareholders' securities pursuant to Rule 144
and 144A. The Company covenants that it will take such further
action as the Shareholders may reasonably request, all to the
extent required from time to time to enable the Shareholders to
sell securities without registration under the Act within the
limitation of the exemptions provided by Rules 144 and 144A
(including the requirements of Rule 144A(d)(4)).
2. Miscellaneous.
2.1 Notices. Notice to the Shareholders' Agent shall
constitute notice to all the shareholders party hereto. All
notices and other communications hereunder shall be in
writing and shall be deemed given if delivered personally or
by commercial delivery service, or mailed by registered or
certified mail (return receipt requested) or sent via
facsimile (with acknowledgment of complete transmission) to
the parties at the following addresses (or at such other
address for a party as shall be specified by like notice) :
(1) if to the Company:
Networks Associates, Inc.
3965 Freedom Circle
Santa Clara, CA 95054, USA
Attention: Richard Hornstein, Esq.
Facsimile No.: +1 (408) 346-3038
with a copy to:
Wilson Sonsini Goodrich & Rosati, P.C.
650 Page Mill Road
Palo Alto, California 94304-1050, USA
Attention: Jeffrey D. Saper, Esq.
Kurt J. Berney, Esq.
Facsimile No.: +1 (650) 493-6811
(2) if to the Shareholders' Agent, to
Erik Aberg
Ostanvagen 14
SE-177 71 Jarfalla, Sweden
Facsimile No.: +46 (8) 580 353 04
with a copy to:
Advokatfirman Vinge
Box 1703
SE-111 97 Stockholm, Sweden
Attention: Christer Soderlund
Facsimile No.: +46 (8) 614 31 90
2.2 Interpretation. The words "include," "includes" and
"including" when used herein shall be deemed in each case to be
followed by the words "without limitation." The table of contents
and headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
2.3 Counterparts. This Agreement may be executed in one
or more counterparts, all of which shall be considered one and the same
agreement and shall become effective when one or more counterparts have
been signed by each of the parties and delivered to the other party, it
being understood that all parties need not sign the same counterpart.
2.4 Entire Agreement; Assignment. This Agreement and
the documents and instruments and other agreements among the parties
hereto referenced herein: (a) constitute the entire agreement among the
parties with respect to the subject matter hereof and supersede all
prior agreements and understandings, both written and oral, among the
parties with respect to the subject matter hereof; (b) are not intended
to confer upon any other person (including, without limitation, those
persons listed on any exhibits hereto) any rights or remedies hereunder;
and (c) without the prior written consent of each party shall not
be assigned by operation of law or otherwise, except that the Company
may assign its rights and obligations hereunder to an affiliate of the
Company provided that the Company shall remain liable for all its
obligations hereunder notwithstanding such assignment. Any assignment
of rights or delegation of duties under this Agreement by a party
without the prior written consent of the other parties, if such consent
is required hereby, shall be void.
2.5 Severability. In the event that any provision of
this Agreement or the application thereof, becomes or is declared by a
court of competent jurisdiction to be illegal, void or unenforceable,
the remainder of this Agreement will continue in full force and effect
and the application of such provision to other persons or circumstances
will be interpreted so as reasonably to effect the intent of the parties
hereto. The parties further agree to replace such void or unenforceable
provision of this Agreement with a valid and enforceable provision that
will achieve, to the extent possible, the economic, business and other
purposes of such void or unenforceable provision.
2.6 Other Remedies. Except as otherwise provided
herein, any and all remedies herein expressly conferred upon a party
will be deemed cumulative with and not exclusive of any other remedy
conferred hereby, or by law or equity upon such party, and the exercise
by a party of any one remedy will not preclude the exercise of any other
remedy.
2.7 Governing Law. This Agreement shall be governed by
and construed in accordance with the laws of the State of Delaware,
regardless of the laws that might otherwise govern under applicable
principles of conflicts of laws thereof.
* * * *
IN WITNESS WHEREOF, the parties have executed this Registration
Rights Agreement as of the date first above written.
NETWORKS ASSOCIATES, INC.
By: /S/ PRABHAT K. GOYAL
Prabhat K. Goyal,
Chief Financial Officer,
Vice President of
Finance and Administration
Address: 3965 Freedom Circle
Santa Clara, California 95054
SHAREHOLDERS
/S/ ERIK ABERG
___________________________________________
Erik Aberg
/S/ MIKAEL LARSSON
___________________________________________
Mikael Larsson
/S/ PER KARLSSON
___________________________________________
Per Karlsson
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE ACCOMPANYING CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 360,729
<SECURITIES> 133,098
<RECEIVABLES> 217,390
<ALLOWANCES> 7,842
<INVENTORY> 0
<CURRENT-ASSETS> 778,383
<PP&E> 64,513
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,183,501
<CURRENT-LIABILITIES> 436,151
<BONDS> 0
0
0
<COMMON> 1,322
<OTHER-SE> 350,887
<TOTAL-LIABILITY-AND-EQUITY> 1,183,501
<SALES> 699,850
<TOTAL-REVENUES> 699,850
<CGS> 132,245
<TOTAL-COSTS> 132,245
<OTHER-EXPENSES> 697,140
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (115,846)
<INCOME-TAX> 77,241
<INCOME-CONTINUING> (193,087)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (193,087)
<EPS-PRIMARY> ($1.47) <F1>
<EPS-DILUTED> ($1.47)
<FN>
<F1>For Purposes of this Exhibit, Primary means Basic.
</FN>
</TABLE>
