<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q/A
[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)
----------------
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.
THIS DOCUMENT CONTAINS 51 PAGES.
THE EXHIBIT INDEX IS ON PAGE 49.
================================================================================
<PAGE> 2
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, SEPTEMBER 30, 1998
----------------
CONTENTS
<TABLE>
<CAPTION>
ITEM NUMBER PAGE
- ----------- ----
<S> <C>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets:
September 30, 1998 and December 31, 1997.................. 3
Condensed Consolidated Statements of Operations:
Three and nine months ended September 30, 1998 and 1997... 4
Condensed Consolidated Statements of Cash Flows:
Nine months ended September 30, 1998 and 1997............. 5
Notes to Condensed Consolidated Financial Statements......... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................... 23
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.............................................. 46
ITEM 2. CHANGES IN SECURITIES........................................... 46
ITEM 5. OTHER INFORMATION............................................... 47
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................ 47
SIGNATURES............................................................... 48
EXHIBIT INDEX............................................................ 49
</TABLE>
2
<PAGE> 3
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
(AS RESTATED NOTE 2.)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................. $ 363,839 $ 157,031
Marketable securities ................................. 133,098 151,580
Accounts receivable, net of allowances for
doubtful accounts of $7,842 and $5,107 at
September 30, 1998 and December 31, 1997 .............. 226,362 156,197
Prepaid expenses, taxes and other current assets ...... 57,337 72,971
---------- ----------
Total current assets .......................... 780,636 537,779
Marketable securities ................................... 146,804 109,184
Fixed assets, net ....................................... 58,281 48,328
Deferred taxes .......................................... 93,471 16,173
Intangibles and other assets ............................ 330,229 93,886
---------- ----------
Total assets .................................. $1,409,421 $ 805,350
========== ==========
LIABILITIES
Current liabilities:
Accounts payable ...................................... $ 34,333 $ 26,444
Accrued liabilities ................................... 172,409 152,772
Deferred taxes ........................................ 41,704 1,413
Deferred revenue ...................................... 125,794 109,029
Long term debt, current portion ....................... 3,540 310
---------- ----------
Total current liabilities ..................... 377,780 289,968
Deferred taxes, less current portion .................. 20,969 2,135
Deferred revenue, less current portion ................ 56,656 18,393
Long term debt and other liabilities .................. 363,420 2,353
---------- ----------
Total liabilities ............................. 818,825 312,849
---------- ----------
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
128,435,232 shares at December 31, 1997 ............... 1,344 1,281
Additional paid-in capital ............................. 450,866 332,519
Retained earnings ....................................... 138,386 158,701
---------- ----------
Total stockholders' equity .................... 590,596 492,501
---------- ----------
Total liabilities and stockholders' equity .... $1,409,421 $ 805,350
========== ==========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
<PAGE> 4
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(AS RESTATED NOTE 2.)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenue ............................................ $ 242,444 $ 188,407 $ 717,854 $ 537,566
Operating costs and expenses:
Cost of net revenue .................................. 44,556 34,012 137,695 97,410
Research and development ............................. 33,077 26,534 102,217 74,032
Marketing and sales .................................. 66,007 54,061 210,189 155,479
General and administrative ........................... 16,022 21,269 65,195 60,613
Amortization of intangibles .......................... 11,216 2,775 27,946 8,621
Acquisition and other related costs .................. 63,399 5,234 135,616 24,738
--------- --------- --------- ---------
Total operating costs and expenses ........... 234,277 143,885 678,858 420,893
--------- --------- --------- ---------
Income from operations ....................... 8,167 44,522 38,996 116,673
Interest and other income and expense, net ............. 4,099 6,481 13,946 16,144
--------- --------- --------- ---------
Income before provision for income taxes...... 12,266 51,003 52,942 132,817
Provision for income taxes ............................. 26,710 22,221 73,189 61,854
--------- --------- --------- ---------
Net income (loss) ............................ $ (14,444) $ 28,782 $ (20,247) $ 70,963
========= ========= ========= =========
Net income (loss) per share -- basic .................. $ (0.11) $ 0.23 $ (0.15) $ 0.56
========= ========= ========= =========
Shares used in per share calculation -- basic ....... 133,531 127,100 131,973 126,128
========= ========= ========= =========
Net income (loss) per share -- diluted ................. $ (0.11) $ 0.22 $ (0.15) $ 0.54
========= ========= ========= =========
Shares used in per share calculation -- diluted...... 133,531 132,436 131,973 132,429
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
<PAGE> 5
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS RESTATED (NOTE 2.)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ....................................... $ (20,247) $ 70,963
Adjustments to reconcile net income to net cash
provided from operating activities:
Acquired in-process research and development ....... 49,843 43,192
Depreciation and amortization ...................... 53,703 25,966
Write down of owned facility ....................... 1,177 --
Interest on convertible notes ...................... 11,055 --
Unrealized gain (loss) on investments .............. 2,252 (1,947)
Deferred taxes ..................................... 13,025 (3,653)
Changes in assets and liabilities:
Accounts receivable .............................. (63,354) (40,390)
Prepaid expenses, taxes and other ................ (22,462) (5,297)
Accounts payable and accrued liabilities ......... (24,838) 10,457
Deferred revenue ................................. 35,392 30,370
Other ............................................ -- (197)
--------- ---------
Net cash provided by operating activities ..... 35,546 129,464
Cash flows from investing activities:
Purchase of investment securities, net ................ (19,138) (23,576)
Additions to fixed assets ............................. (33,453) (33,217)
Acquisition of CyberMedia ............................. (119,958) --
Acquisition of Magic Solutions, Inc. .................. (109,717) --
Acquisition of Compusul ............................... -- (2,709)
Acquisition of 3DV Technology, Inc. ................... -- (20,000)
Acquisition of Cinco .................................. -- (25,079)
Other ................................................. -- (922)
--------- ---------
Net cash used in investing activities ......... (282,266) (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 ................................ 92,052 35,262
Tax benefit from exercise of nonqualified stock options 25,154 35,128
Exercise of warrants .................................. 463 --
Repurchase of common stock ............................ -- (39,738)
--------- ---------
Net cash provided by financing activities ..... 453,528 30,192
--------- ---------
Net increase in cash and cash equivalents ............... 206,808 54,153
Cash and cash equivalents at beginning of period ........ 157,031 159,170
--------- ---------
Cash and cash equivalents at end of period .............. $ 363,839 $ 213,323
========= =========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
<PAGE> 6
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
During the nine months ended September 30, 1998, the Company completed the
acquisitions of Trusted Information Systems ("TIS"), Dr. Solomon's Group PLC
("Dr Solomon's"), Anyware Seguridad Informatica S.A. ("Anyware"), QA Information
Security Holding AB ("QA"), Syscon (Proprietary) Limited ("Syscon"), Nordic
Lantools OY and Nordic Lantools AB (together "Nordic"), Secure Networks, Inc.
("Secure") and CSB Consulenza Software di Base S.r.l. ("CSB"). All of these
acquisitions were accounted for under the pooling of interests method of
accounting. Financial data of the Company has been restated to reflect these
acquisitions for all periods presented.
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. RESTATEMENT
After discussions with the Staff of the Securities and Exchange Commission
(the "SEC"), the Company has restated the accompanying consolidated financial
statements as of September 30, 1998 and for the three and nine month periods
ended September 30, 1998. The financial statements have been restated to reflect
a change in the purchase price allocation and related amortization of
intangibles for acquisitions accounted for by the purchase method of accounting
in 1997 (Cinco Networks, Inc., and Pretty Good Privacy, Inc.) and 1998 (Magic
Solutions, Inc., and CyberMedia, Inc.), as well as two smaller acquisitions in
1995 and 1996 (AIM Technology and Vycor Corporation, respectively). The Company
has also revised the original accounting for several previously reported small
acquisitions accounted for under the poolings of interests method of accounting
and for certain other adjustments to the Acquisition and other related costs
charge taken in the fourth quarter of 1997. The following schedules summarize
these restatements.
6
<PAGE> 7
NETWORKS ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------------------------------
AS PREVIOUSLY
REPORTED OTHER AS RESTATED
------------- ----------- -----------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents ................................. $ 360,729 $ 3,110 $ 363,839
Short term marketable securities .......................... 133,098 -- 133,098
Accounts receivable, net of allowance for doubtful accounts
of $7,842 ......................................... 225,232 1,130 226,362
Prepaid expenses, taxes and other current assets .......... 59,324 (1,987) 57,337
----------- ----------- -----------
Total current assets .............................. 778,383 2,253 780,636
Long term marketable securities ............................. 146,804 -- 146,804
Fixed assets, net ........................................... 64,513 (6,232) 58,281
Deferred taxes .............................................. 93,471 -- 93,471
Intangible and other assets ................................. 100,330 229,899 330,229
----------- ----------- -----------
Total assets ...................................... $ 1,183,501 $ 225,920 $ 1,409,421
=========== =========== ===========
LIABILITIES
Current liabilities:
Accounts payable .......................................... $ 34,333 $ -- 34,333
Accrued liabilities ....................................... 184,876 (12,467) 172,409
Deferred taxes ............................................ 41,704 -- 41,704
Deferred revenue .......................................... 125,794 -- 125,794
Long term debt, current portion ........................... 3,540 -- 3,540
----------- ----------- -----------
Total current liabilities ......................... 390,247 (12,467) 377,780
Deferred taxes, less current portion ...................... 20,969 -- 20,969
Deferred revenue, less current portion .................... 56,656 -- 56,656
Long term debt and other liabilities ...................... 363,420 -- 363,420
----------- ----------- -----------
Total liabilities ................................. 831,292 (12,467) 818,825
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value:
Authorized: 5,000,000 shares;
Issued and outstanding: one share
Common stock, $.01 par value:
Authorized: 350,000,000 shares;
Issued and outstanding: 134,378,883 shares ................ 1,344 1,344
Additional paid-in capital .................................. 450,866 450,866
Retained earnings ........................................... (100,001) 238,387 138,386
----------- ----------- -----------
Total stockholders' equity ........................ 352,209 238,387 590,596
----------- ----------- -----------
Total liabilities and stockholders' equity ........ $ 1,183,501 $ 225,920 $ 1,409,421
=========== =========== ===========
</TABLE>
7
<PAGE> 8
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30, 1998
---------------------------------------------
AS PREVIOUSLY
REPORTED OTHER AS RESTATED
------------- --------- -------------
<S> <C> <C> <C>
Net revenue ............................................. $ 242,444 $ -- $ 242,444
Operating costs and expenses:
Cost of net revenue ................................... 44,556 -- 44,556
Research and development .............................. 33,077 -- 33,077
Marketing and sales ................................... 66,007 -- 66,007
General and administrative ............................ 16,022 -- 16,022
Amortization of intangibles ........................... 3,392 7,824 11,216
Acquisition and other related costs ................... 188,862 (125,463) 63,399
--------- --------- ---------
Total operating costs and expenses ............... 351,916 (117,639) 234,277
--------- --------- ---------
Income from operations ........................ (109,472) 117,639 8,167
Interest and other income, net .......................... 4,099 4,099
--------- --------- ---------
Income before provision for income taxes ...... (105,373) 117,639 12,266
Provision for income taxes .............................. 26,710 26,710
--------- ---------
Net income (loss) ............................. $(132,083) $ 117,639 $ (14,444)
========= ========= =========
Net income (loss) per share - basic ..................... $ (0.99) $ (0.11)
========= =========
Shares used in per share calculation - basic ............ 133,531 133,531
========= =========
Net income (loss) per share - diluted .................. $ (0.99) $ (0.11)
========= =========
Shares used in per share calculation - diluted..... 133,531 133,531
========= =========
</TABLE>
8
<PAGE> 9
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
--------------------------------------------------------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
------------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Net revenue .......................................... $ 699,850 $ 18,004 $ -- $ 717,854
Operating costs and expenses:
Cost of revenue .................................... 132,245 5,450 -- 137,695
Research and development ........................... 95,202 7,015 -- 102,217
Marketing and sales ................................ 198,677 4,194 7,318 210,189
General and administrative ......................... 53,557 6,638 5,000 65,195
Amortization of intangibles ........................ 9,932 503 17,511 27,946
Acquisition and other related costs ................ 339,772 -- (204,156) 135,616
--------- --------- --------- ---------
Total operating costs and expenses ............ 829,385 23,800 (174,327) 678,858
--------- --------- --------- ---------
Income from operations ..................... (129,535) (5,796) 174,327 38,996
Interest and other income, net ....................... 13,689 257 -- 13,946
--------- --------- --------- ---------
Income before provision for income taxes.... (115,846) (5,539) 174,327 52,942
Provision for income taxes ........................... 77,241 271 (4,323) 73,189
--------- --------- --------- ---------
Net income (loss) .......................... $(193,087) $ (5,810) 178,650 $ (20,247)
========= ========= ========= =========
Net income (loss) per share - basic .................. $ (1.47) $ (0.15)
========= =========
Shares used in per share calculation - basic ......... 131,428 545 131,973
========= ========= =========
Net income (loss) per share - diluted ............... $ (1.47) $ (0.15)
========= =========
Shares used in per share calculation - diluted ....... 131,428 545 131,973
========= ========= =========
</TABLE>
9
<PAGE> 10
NETWORKS ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------------------------------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
------------- -------------- -------- -----------
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents ............................ $155,391 $ 1,640 $ -- $157,031
Short term marketable securities ..................... 151,042 538 -- 151,580
Accounts receivable, net of allowance for
doubtful accounts of $5,107 ........................ 163,779 2,718 (10,300) 156,197
Prepaid expenses, taxes and other current assets ..... 35,789 5,768 31,414 72,971
-------- -------- -------- --------
Total current assets ......................... 506,001 10,664 21,114 537,779
Long term marketable securities ........................ 109,184 -- -- 109,184
Fixed assets, net ...................................... 46,845 1,483 -- 48,328
Deferred taxes ......................................... 46,262 -- (30,089) 16,173
Intangible and other assets ............................ 45,128 44 48,714 93,886
-------- -------- -------- --------
Total assets ................................. $753,420 $ 12,191 $ 39,739 $805,350
======== ======== ======== ========
LIABILITIES
Current liabilities:
Accounts payable ..................................... $ 24,920 $ 1,524 $ -- $ 26,444
Accrued liabilities .................................. 164,377 3,795 (15,400) 152,772
Deferred taxes ....................................... -- 1,724 (311) 1,413
Deferred revenue ..................................... 108,718 -- 311 109,029
Long term debt, current portion ...................... 153 157 -- 310
-------- -------- -------- --------
Total current liabilities .................... 298,168 7,200 (15,400) 289,968
Deferred taxes, less current portion ................. 2,117 18 -- 2,135
Deferred revenue, less current portion ............... 18,393 -- -- 18,393
Long term debt and other liabilities ................. 2,353 -- -- 2,353
-------- --------
Total liabilities ............................ 321,031 7,218 (15,400) 312,849
-------- -------- -------- --------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value:
Authorized: 5,000,000 shares;
Issued and outstanding: one share
Common stock, $.01 par value:
Authorized: 350,000,000 shares;
Issued and outstanding: 128,435,232 shares at
December 31, 1997 ...................................... 1,273 8 -- 1,281
Additional paid-in capital ............................. 331,800 719 -- 332,519
Retained earnings ...................................... 99,316 4,246 55,139 158,701
-------- -------- -------- --------
Total stockholders' equity ................... 432,389 4,973 55,139 492,501
-------- -------- -------- --------
Total liabilities and stockholders' equity.... $753,420 $ 12,191 $ 39,739 $805,350
======== ======== ======== ========
</TABLE>
10
<PAGE> 11
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30, 1997
-------------------------------------------------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
------------- ------------ -------- -----------
<S> <C> <C> <C> <C>
Net revenue .......................................... $182,041 $ 6,366 $ -- 188,407
Operating costs and expenses:
Cost of revenue .................................... 32,600 1,412 -- 34,012
Research and development ........................... 25,920 614 -- 26,534
Marketing and sales ................................ 52,076 1,985 -- 54,061
General and administrative ......................... 20,201 1,068 -- 21,269
Amortization of intangibles ........................ 1,013 -- 1,762 2,775
Acquisition and other related costs ................ 23,688 -- (18,454) 5,234
-------- -------- -------- --------
Total operating costs and expenses ............ 155,498 5,079 (16,692) 143,885
-------- -------- -------- --------
Income from operations ..................... 26,543 1,287 16,692 44,522
Interest and other income, net ....................... 6,356 125 -- 6,481
-------- -------- -------- --------
Income before provision for income taxes.... 32,899 1,412 16,692 51,003
Provision for income taxes ........................... 21,423 798 -- 22,221
-------- -------- -------- --------
Net income ................................. $ 11,476 $ 614 $ 16,692 $ 28,782
======== ======== ======== ========
Net income per share - basic ......................... $ 0.09 $ 0.23
======== ========
Shares used in per share calculation - basic ......... 125,339 1,761 127,100
======== ======== ========
Net income per share - diluted ....................... $ 0.09 $ 0.22
======== ========
Shares used in per share calculation - diluted ....... 130,675 1,761 132,436
======== ======== ========
</TABLE>
11
<PAGE> 12
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1997
----------------------------------------------------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
------------- ------------ --------- -----------
<S> <C> <C> <C> <C>
Net revenue .......................................... $ 518,468 $ 19,098 $ -- $ 537,566
Operating costs and expenses:
Cost of revenue .................................... 93,174 4,236 -- 97,410
Research and development ........................... 72,190 1,842 -- 74,032
Marketing and sales ................................ 149,524 5,955 -- 155,479
General and administrative ......................... 57,412 3,201 -- 60,613
Amortization of intangibles ........................ 4,359 -- 4,262 8,621
Acquisition and other related costs ................ 43,192 -- (18,454) 24,738
--------- --------- --------- ---------
Total operating costs and expenses ............ 419,851 15,234 (14,192) 420,893
--------- --------- --------- ---------
Income from operations ..................... 98,617 3,864 14,192 116,673
Interest and other income, net ....................... 15,769 375 -- 16,144
--------- --------- --------- ---------
Income before provision for income taxes.... 114,386 4,239 14,192 132,817
Provision for income taxes ........................... 59,460 2,394 -- 61,854
--------- --------- --------- ---------
Net income ................................. $ 54,926 $ 1,845 $ 14,192 $ 70,963
========= ========= ========= =========
Net income per share - basic ......................... $ 0.44 $ 0.56
========= =========
Shares used in per share calculation - basic ......... 124,367 1,761 126,128
========= ========= =========
Net income per share - diluted ....................... $ 0.42 $ 0.54
========= =========
Shares used in per share calculation - diluted ....... 130,668 1,761 132,429
========= ========= =========
</TABLE>
DESCRIPTION OF ADJUSTMENTS
RESTATEMENT FOR POOLING TRANSACTIONS - NOT PREVIOUSLY RECORDED
The above adjustments reflect the acquisitions of Anyware, QA, Syscon,
Nordic, Secure, CSB and Helix Software Company (acquired in December 1997), for
all periods presented. The Company originally included the financial statements
of the acquired entities only in the quarter in which they were acquired, with
an adjustment to retained earnings for prior periods. At the request of the SEC,
the Company has restated all periods to reflect the historical financial
statements of all these acquisitions.
In addition, the Company's original restatement of the nine months ended
September 30, 1998 for the acquisition of Dr. Solomon's included Dr. Solomon's
results for the two pre-acquisition fiscal quarters ended February 28, 1998 and
May 31, 1998 together with its post-acquisition fiscal quarter ended September
30, 1998. As previously disclosed, the results of operations of Dr. Solomon's
for the month of June were not included in the consolidated results for the nine
months ended September 30, 1998 and were separately disclosed in the Company's
Form 10-Q for such period. The above adjustments include the June 1998 results
of operations for Dr. Solomon's and, as a result, include the results of Dr.
Solomon's for a ten-month period. Revenue and net loss for Dr. Solomon's for
June 1998 was $7.3 million and $3.8 million, respectively.
RESTATEMENT FOR ACQUISITION AND OTHER RELATED COSTS:
In-process research and development charges:
During 1997 and 1998, the Company completed a number of acquisitions in
transactions accounted for by the purchase method. Purchase price allocations
performed at the time of these acquisitions resulted in substantial allocations
to in-process research and development for projects underway by the acquired
companies which had not reached technological feasibility and which had no
12
<PAGE> 13
alternative future use. These allocations were performed following methods
generally in use by technology companies based on appraisals at the time. Recent
guidance published by the SEC has resulted in a general re-evaluation of the
methodology used in such appraisals. Following a review of its Form 10-Q for the
nine months ended September 30, 1998 and its Form 10-K for the year ended
December 31, 1997 by the SEC and subsequent discussions with the SEC, the
Company has re-evaluated its allocations for purchase transactions in 1997 and
1998. The restatements included above reflect the adjustments to the in-process
research and development write-offs resulting from such re-evaluations as
follows:
<TABLE>
<CAPTION>
As Additional
Originally As Restated Amount
Reported Capitalized
$'000 $'000 $'000
---------- ----------- -----------
<S> <C> <C> <C>
Magic Solutions $ 97,001 $ 27,014 $ 69,987
(acquired by Network Associates in 1998)
CyberMedia 122,228 22,830 99,398
(acquired by Network Associates in 1998)
Cinco 23,688 5,234 18,454
(acquired by Network General in 1997)
Pretty Good Privacy 30,878 3,937 26,941
(acquired by Network Associates in 1997)
Vycor 7,800 -- 7,800
(acquired by McAfee in 1996)
AIM 7,200 -- 7,200
(acquired by Network General in 1995)
</TABLE>
Restatements relating to other acquisition charges:
The Company has also made a number of other adjustments relating to its
Acquisition and other related costs recorded during the nine months ended
September 30, 1998 and to Amortization of intangibles recorded as a result of
the in-process research and development related restatements. The table below
shows these adjustments together with the adjustments to acquired in-process
research and development:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
NINE MONTHS THREE MONTHS
DESCRIPTION OF RECLASSIFICATION ENDED ENDED
------------------------------- SEPTEMBER 30, SEPTEMBER 30,
1998 1998
--------------------------------------------------------------------------------------------------------------
$'000 $'000
--------- ---------
<S> <C> <C>
Reclassification of severance and benefits for terminated employees of
companies acquired in transactions accounted for by the purchase
method of accounting to goodwill, previously charged to earnings in
the period of acquisition. This adjustment increased intangible and
other assets by the same amount $ (7,729) $ (5,319)
Reclassification of facility cost write downs and reserves relating to
facilities and assets of companies acquired in transactions accounted
for by the purchase method of accounting to goodwill, previously
charged to earnings in the period of acquisition. This adjustment
increased intangible and other assets by the same amount (14,321) (8,025)
Reversal of excess acquisition and other related costs reserves (12,721) (12,721)
Restatement of acquired in-process research and development
This adjustment increased intangible and other assets by the
same amount (169,385) (99,398)
--------- ---------
------------------------------------------------------------------------------------------------------------
</TABLE>
13
<PAGE> 14
<TABLE>
<S> <C> <C>
------------------------------------------------------------------------------------------------------------
$(204,156) $(125,463)
========= =========
Total adjustments to Acquisition and other related costs $ 5,000 --
=========
Reclassification of the write-off of uncollectable receivables associated
with the acquisition of Network General to general and administrative
expenses.
Reclassification of TV advertising costs incurred in 1998
related to the Network General merger and related name change,
previously charged to acquisition and other related costs in 1997, to
marketing expense in 1998. 4,825 --
Reclassification of TV advertising costs incurred in 1998
related to the Network General merger and related name change,
previously charged to acquisition and other related costs in the quarter
ended March 31, 1998, to marketing expense in 1998. 2,493 --
---------
Total adjustments to Marketing and sales expense $ 7,318
=========
Additional amortization resulting adjustments to purchase price
allocations. This adjustment reduced intangible and other assets. $ 17,511 $ 7,824
========= =========
------------------------------------------------------------------------------------------------------------
</TABLE>
The net increase to Intangible and other assets of $229.9 million is
comprised of the above reclassifications of severance and benefits and
facilities and asset write downs of $22.0 million, adjustments to in-process
research and development for 1998 acquisitions of $173.4 million, adjustments
for prior year acquisitions of $60.4 million reduced by the total accumulated
amortization of $29.1 million plus capitalization of trademark costs of $3.2
million.
The Company reclassified $3.1 million from retained earnings to cash in
connection with the acquisition of a foreign subsidiary.
As a result of the re-evaluations of the purchase transactions above,
amortization of goodwill and other intangibles resulting from these acquisitions
for the three and nine months ended September 30, 1998 was increased from
amounts previously reported by $7.8 million and $17.5 million respectively, and
future amortization will be increased for the next 7 years as follows:
<TABLE>
<CAPTION>
Year Ended
December 31, Amount $'000
------------ ------------
<S> <C>
Q4 1998 $ 9,908
1999 37,680
2000 37,030
2001 37,030
2002 36,585
2003 30,042
2004 27,930
2005 13,694
</TABLE>
3. 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.
14
<PAGE> 15
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.
In March 1998, the AICPA issued an Exposure Draft for Statement of Position
No. 98-9 ("SOP 98-9") "Modification of SOP 97-2, Software Revenue Recognition,
With Respect to Certain Transactions" which clarifies guidance regarding VSOE
and multiple element arrangements. SOP 98-9 which is expected to be issued by
December 1998, amends SOP 98-4 to extend the deferral of guidance in SOP 97-2 as
it relates to these matters through fiscal years beginning after March 15, 1999.
The adoption of SOP 97-2, as amended by SOP 98-4, in the first quarter of 1998
did not have a material effect on the Company's revenue recognition practices.
The Company has evaluated the amendments expected to be issued under SOP 98-9
and does not expect their adoption will have a material effect on its revenue
recognition practices.
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.
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.
4. NET INCOME (LOSS) PER SHARE
In accordance with the disclosure requirements of SFAS 128, a reconciliation
of the numerator and denominator of basic and diluted net income (loss) per
share calculations is provided as follows (in thousands, except per share
amounts):
15
<PAGE> 16
<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) ............................ $ (14,444) $ 28,782 $ (20,247) $ 70,963
========= ========= ========= =========
Numerator -- diluted
Net income (loss) ............................ $ (14,444) $ 28,782 $ (20,247) $ 70,963
Interest on convertible debentures, net of tax -- -- -- --
--------- --------- --------- ---------
Net income (loss) available to
common stockholders .......................... $ (14,444) $ 28,782 $ (20,247) $ 70,963
========= ========= ========= =========
Denominator -- basic
Basic weighted average common shares
outstanding .................................. 133,531 127,100 131,973 126,128
========= ========= ========= =========
Denominator -- diluted
Basic weighted average common shares
outstanding .................................. 133,531 127,100 131,973 126,128
Effect of dilutive securities:
Common stock options ......................... -- 5,336 -- 6,301
--------- --------- --------- ---------
Diluted weighted average shares .............. 133,531 132,436 131,973 132,429
========= ========= ========= =========
Net income (loss) per share -- basic ......... $ (0.11) $ 0.23 $ (0.15) $ 0.56
========= ========= ========= =========
Net income (loss) per share -- diluted ....... $ (0.11) $ 0.22 $ (0.15) $ 0.54
========= ========= ========= =========
</TABLE>
5. 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 stockholders 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 $130.4
million. The transaction was accounted for as a purchase transaction. The total
purchase price including transaction costs and assumed net liabilities was
approximately $174.3 million. As the Company had assessed and formulated its
plans to terminate certain CyberMedia employees and close certain CyberMedia
facilities as of the acquisition date, the total purchase price includes related
liabilities of $13.3 million. Of the total purchase price, $22.8 million was
allocated to in-process research and development. In addition, $12.2 million was
allocated to existing technology and other intangibles and $139.3 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 $22.8 million being assigned
to in-process research and development projects which had not yet reached
technological feasibility and did not have alternative future use.
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
16
<PAGE> 17
and the aggregation of the unaudited quarterly statements of operations of Dr.
Solomon's for the years ended November 31, 1997, 1996 and 1995. The 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 31,
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>
Year Ended December 31, Six Months Ended June 30,
------------------------ ----------------------------------------
1997 1996 1995 1998 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Networks Associates $ 656,322 $ 478,587 $ 314,051 $ 419,512 $ 313,992
Dr. Solomon's 79,370 44,275 23,335 55,898 35,167
--------- --------- --------- --------- ---------
Combined $ 735,692 $ 522,862 $ 337,386 $ 475,410 $ 349,159
========= ========= ========= ========= =========
Net income (loss)
Networks Associates $ 10,635 $ 67,447 $ 52,890 $ (6,305) $ 44,145
Dr. Solomon's 4 (56,736) 862 502 3,678
--------- --------- --------- --------- ---------
Combined $ 10,639 $ 10,711 $ 53,752 $ (5,803) $ 47,823
========= ========= ========= ========= =========
Net income (loss) per
share - diluted
Networks Associates $ 0.09 $ 0.59 $ 0.48 $ (0.05) $ 0.38
========= ========= ========= ========= =========
Dr. Solomon's $ 0.00 $ (6.34) $ 0.10 $ 0.03 $ 0.24
========= ========= ========= ========= =========
Combined $ 0.08 $ 0.09 $ 0.45 $ (0.04) $ 0.36
========= ========= ========= ========= =========
</TABLE>
Secure Networks, Inc.
On May 15, 1998, the Company acquired Secure Networks, Inc. ("Secure"). The
aggregate consideration payable in the acquisition was 567,000 shares of the
Company's Common Stock. 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 Secure for all periods presented. Secure is a
developer and licensor of network security auditing software based in Canada.
Trusted Information Systems
On April 28, 1998, the Company acquired Trusted Information Systems ("TIS"),
a publicly-held provider of comprehensive security systems for computer
networks. 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 TIS for all periods presented. In the acquisition, a wholly owned
subsidiary of the Company merged with and into TIS; TIS became a wholly owned
subsidiary of the Company; and all outstanding common stock of TIS was converted
into approximately 6.8 million shares of Common Stock of the Company, at an
exchange ratio of 0.4845. The Company also assumed all outstanding options and
other rights to acquire TIS capital stock.
Magic Solutions International, Inc.
On April 1, 1998, the Company acquired all of the outstanding capital stock
and options of Magic Solutions International, Inc. ("Magic Solutions"), a
privately held provider of internal help desk and asset management solutions,
for approximately $109.8 million in cash. The acquisition was accounted for
using the purchase method of accounting and the total purchase price was $140.3
million, including transaction costs and assumed net liabilities. As the Company
had assessed and formulated its plans to terminate certain Magic Solutions
employees and close the Magic Solutions facilities as of the acquisition date,
the total purchase price includes related liabilities of $8.7 million.
Approximately $27.0 million of the total purchase price was expensed as
purchased in-process research and development. The remaining excess of the
purchase price over the net assets acquired was $113.3 million of which, $20.3
million has been recorded as purchased technology and trademarks and $92.9
million as goodwill which are being amortized on a straight-line basis over 5
and 7
17
<PAGE> 18
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 $27.0 million being assigned to in-process research and
development projects which had not yet reached technological feasibility and did
not have alternative future use.
As of September 30, 1998 the purchase price allocation is final.
The following summary, prepared on a pro forma basis, combines the results of
operations as if CyberMedia and Magic Solutions had been acquired as of the
beginning of the periods presented, after including the impact of certain
adjustments, such as amortization of intangibles, the write-off of in-process
technology and the related income tax effects (dollars in thousands, except per
share amounts):
<TABLE>
<CAPTION>
Nine Months Ended
September 30
-------------------------
1998 1997
--------- ---------
(unaudited)
<S> <C> <C>
Revenue ............................... $ 731,445 $ 627,542
Net income (loss) ..................... (99,241) 14,051
Net income (loss) per share ........... $ (0.75) $ 0.11
</TABLE>
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition had been in effect for the entire periods
presented. In addition, they are not intended to be a projection of future
results and do not reflect any synergies that might be achieved from combined
operations.
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 Company's financial statements have been restated for
these poolings, the effect of which was not material.
In connection with the acquisitions accounted for as a pooling of interests,
the Company incurred direct transaction costs and other restructuring and
related charges in the amount of $40.6 million and $85.8 million in the three
and nine months ended September 30, 1998. In connection with the acquisitions
accounted for as purchase transactions, the Company incurred charges of $22.8
million and $49.8 million in the three and nine months ended September 30, 1998,
consisting principally of the write off of in-process research and development
acquired. The following is a summary of these charges for the nine months ended
September 30, 1998 together with charges for certain restructuring activities
taken by the Company ($ 000's):
18
<PAGE> 19
<TABLE>
<CAPTION>
Direct Lease Costs
Transaction Severance and Asset In-Process
Costs & Benefits Write downs R&D Other Total
----------- ---------- ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
TIS $ 15,023 $ 3,818 $ 4,414 $ (924) $ 22,331
Dr. Solomon's 19,898 11,425 18,312 0 49,635
Secure 500 500 1,200 100 2,300
Magic 27,014 27,014
CyberMedia 22,830 22,830
Restructuring Costs-Q2 11,318 8,644 610 20,572
Restructuring Costs-Q3 -- 3,285 370 -- -- 3,655
Reversal of excess reserves (6,750) (2,276) (3,909) -- 214 (12,721)
--------- --------- --------- --------- --------- ---------
Total Charges $ 28,671 $ 28,070 $ 29,031 $ 49,844 $ -- $ 135,616
--------- --------- --------- --------- --------- ---------
</TABLE>
Direct transaction costs included $18.0 million in investment banking fees,
$9.2 million in legal and accounting fees, and $1.5 million in filing fees,
travel and other costs. Lease costs and asset writedowns include the costs of
closing approximately 33 facilities throughout the world ($12.2 million), the
disposal of excess and obsolete assets (generally computer equipment which did
not comply with the Company's standards ($12.0 million), and the write-off of
goodwill and intangibles associated with discontinued Dr. Solomon's products
($4.8 million). The Dr. Solomon's write-off related to two minor
products--NetOctopus (a software distribution product for MacIntosh computers)
and Audit (an asset inventory product). These products were duplications of
existing Company products and had limited sales subsequent to the Dr. Solomon's
acquisition. The Company has not and does not plan to incorporate these products
into its products. The following table summarizes the activity in the reserves
for severance and benefits, lease costs and asset write downs established in the
second and third quarters of 1998 ($000's):
<TABLE>
<CAPTION>
Direct
Transaction Severance Asset
Costs & Benefits Lease Costs Write Downs Other Total
----------- ---------- ----------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Charged in Three Months
ended June 30, 1998 $ 15,523 $ 15,636 $ 6,485 $ 7,773 $ (214) $ 45,203
Paid Out or Charged against
the related assets (5,254) (9,053) (596) (1,310) -- (16,213)
-------- -------- -------- -------- -------- --------
Balance, June 30, 1998 10,269 6,583 5,889 6,463 (214) 28,990
Charged in three months
ended September 30, 1998 19,898 14,710 5,764 12,918 53,290
Paid Out or charged against
the related assets (9,363) (10,334) (5,904) (11,067) (36,668)
Reversal of excess reserves (6,750) (2,276) -- (3,909) 214 (12,721)
-------- -------- -------- -------- -------- --------
Balance, September 30, 1998 $ 14,054 $ 8,683 $ 5,749 $ 4,405 $ -- $ 32,891
-------- -------- -------- -------- -------- --------
</TABLE>
The severance and benefits charges for the nine months ended September 30,
1998 related to company-wide reductions in force following the Company's major
acquisitions in the second and third quarters of approximately 784 employees of
which 107 were in research and development functions, 302 were in sales and
marketing functions and the remainder were in administrative and other support
functions. Substantially all terminated employees left the Company in the period
the related accounting charge was recorded. A limited number of employees from
each acquisition were retained for short transition periods. The cost of these
employees was charged to operating expenses during the transition period.
The lease costs represent an estimate of lease expenses during the period
prior to re-leasing the property together with losses on sub-leases, if any. The
leased facilities were substantially vacated in the period in which the related
accounting charges were recorded. The costs related to any facilities which were
used by the Company during this period were charged to operations, however, such
charges were not material. Other asset write downs, exclusive of the intangible
assets of Dr. Solomon described above, comprised $5.6 million in losses on
Company owned buildings (which were written down to estimated values determined
by appraisals) and $10.3 million in net losses of computer and other
miscellaneous assets. In general, this equipment was discarded or sold for
nominal value. Due to the immediate consolidation of facilities, depreciation
allocable to these facilities and the related assets, during the transition
period, was not material. Of the facilities acquired in its 1998 acquisitions
identified for closure, the Company has 17 facilities worldwide which have not
been disposed of or subleased (16 leased; 1 owned). These facilities are
insignificant to the Company's operations and, other than a portion of a leased
facility which the Company has decided to retain, each is intended for disposal
or sublease in 1999.
19
<PAGE> 20
The following table summarizes the activity in the reserves for severance and
benefits, lease costs and asset and write downs established in the year ended
December 31, 1997 ($000's):
<TABLE>
<CAPTION>
Asset
Transaction Severance Lease Write
Costs & Benefits Costs Downs Other Total
------------ ---------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 8,050 $ 10,697 $ 3,842 $ 1,865 $ 2,893 $ 27,347
Paid Out or Charged
against the related assets (8,083) (6,725) (2,853) (4,381) (2,521) (24,563)
Adjustment to liability -- (3,000) -- 3,000 -- --
-------- -------- -------- -------- -------- --------
Balance, September 30, 1998 $ (33) $ 972 $ 989 $ 484 $ 372 $ 2,784
======== ======== ======== ======== ======== ========
</TABLE>
The Company believes that the reserve balances remaining at September 30,
1998 are adequate to cover any additional benefits or losses yet to be paid or
realized. Any reserves not used will be recorded as a credit to Acquisition and
Related Charges in future periods.
6. CONVERTIBLE DEBENTURES
On February 13, 1998, the Company completed a private placement of zero
coupon convertible subordinated Debentures due in 2018 (the "Debentures"). The
Debentures, with an aggregate face amount at maturity of $885.5 million,
generated net proceeds to the Company of approximately $337.6 million. The
initial price to the public for the Debentures was $391.06 per $1,000 of face
amount at maturity, which equates to a yield to maturity over the term of the
bonds of 4.75% (on a semi-annual bond equivalent basis). The debentures are
convertible into Common Stock at the rate of 8.538 shares per $1,000 of face
amount at maturity, which equates to an initial conversion price of $45.80 per
share. The Debentures are subordinated in right of payment to all existing and
future Senior Indebtedness (as defined) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the Company's subsidiaries.
The Debentures may be redeemed for cash at the option of the Company beginning
on February 13, 2003. At the option of the holder, the Company will purchase the
Debentures on February 13, 2003, February 13, 2008 and February 13, 2013 at
purchase prices (to be paid in cash or Common Stock or any combination thereof,
at the election of the Company and subject to certain conditions) equal to the
initial issue price plus accrued original issue discount to such dates. The
Debentures may also be redeemed at the option of the holder if there is a
Fundamental Change (as defined) at a price equal to the issue price plus accrued
original issue discount to the date of redemption, subject to adjustment.
7. 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
20
<PAGE> 21
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.
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,
21
<PAGE> 22
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.
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.
8. 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.
22
<PAGE> 23
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 PGP TOTAL NETWORK SNIFFER TOTAL NETWORK MCAFEE TOTAL SERVICE
VIRUS 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 - Self Service Desk Suite
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.
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
23
<PAGE> 24
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:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net revenue ................................. 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Cost of net revenue ....................... 18.4 18.1 19.2 18.1
Research and development .................. 13.6 14.1 14.2 13.8
Marketing and sales ....................... 27.3 28.6 29.3 28.9
General and administrative ................ 6.6 11.3 9.1 11.3
Amortization of intangibles ............... 4.6 1.5 3.9 1.6
Acquisition and other related costs ....... 26.1 2.8 18.9 4.6
------ ------ ------ ------
Total operating costs and expenses ..... 96.6 76.4 94.6 78.3
------ ------ ------ ------
Income (loss) from operations ..... 3.4 23.6 5.4 21.7
Interest and other income and expense net ... 1.7 3.5 2.0 3.0
------ ------ ------ ------
Income (loss) before provision
for income taxes ................ 5.1 27.1 7.4 24.7
Provision for income taxes .................. 11.1 11.8 10.2 11.5
------ ------ ------ ------
Net income (loss) ................ (6.0)% 15.3% (2.8)% 13.2%
====== ====== ====== ======
</TABLE>
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
24
<PAGE> 25
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 29%
from $188.4 million in the three months ended September 30, 1997. In the nine
months ended September 30, 1998, net revenue was $717.9 million, an increase of
34% from $537.6 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 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% and 36% of net revenue
for the three months ended September 30, 1998 and 1997, respectively. The
percentage of international net revenue was 36% and 34%, 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.
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
25
<PAGE> 26
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 31% from $34.0 million in the three months ended September 30, 1997.
For the nine months ended September 30, 1998, cost of revenue was $137.7
million, an increase of 41% from $97.4 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.
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 25% from $26.5 million in the three
months ended September 30, 1997. In the nine months ended September 30, 1998
research and development expenses were $102.2 million, an increase of 38% from
$74.0 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 14.1% in the three months ended September 30, 1997 and increased to
14.2% in the nine months ended September 30, 1998 from 13.8% 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 22% from $54.1 million in the three months ended September 30,
1997. In the nine months ended September 30, 1998 marketing and sales expenses
were $210.2 million, an increase of 35% from $155.5 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 28.7% in the three month periods ended September 30, 1998
and 1997 and 29.3% and 28.9% in the nine month periods ended September 30, 1998
and 1997. The decrease, quarter over quarter 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 25% from $21.3 million in
the three months ended September 30, 1997. In the nine months ended September
30, 1998 general and administrative costs were $65.2 million, an increase of 8%
from $60.6 million for the same period in 1997. The decrease quarter over
quarter is a result of the continued consolidation of staffing both domestically
and internationally, including
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
26
<PAGE> 27
elimination of duplicate staff arising from the acquisition of Dr. Solomon's.
The increase in the nine month period over the prior year is due largely to the
write-off of uncollectable receivables associated with the acquisition of
Network General. As a percentage of net revenue, general and administrative
expenses were 6.6% and 11.3% in the three months periods ended September 30,
1998 and 1997 and 9.1% and 11.3% 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.*
Amortization of Intangibles. The Company expensed $11.2 million and $2.8
million of amortization related to intangibles in the three months ended
September 30, 1998 and 1997, respectively and $27.9 million and $8.6 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 in 1998 accounted for as a pooling of
interests, the Company incurred direct transaction costs and other restructuring
and related charges in the amount of $40.6 million and $85.8 million in the
three and nine months ended September 30, 1998. In connection with the
acquisitions accounted for as purchase transactions, the Company incurred
charges of $22.8 million and $49.8 million in the three and nine months ended
September 30, 1998, consisting principally of the write-off of acquired
in-process research & development. The following is a summary of these charges
together with charges for certain restructuring activities taken by the Company
during the nine months ended September 30, 1998 ($ 000's):
<TABLE>
<CAPTION>
Direct Lease Costs
Transaction Severance and Asset In-Process
Costs & Benefits Write downs R&D Other Total
----------- ---------- ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
TIS $ 15,023 $ 3,818 $ 4,414 $ (924) $ 22,331
Dr. Solomon's 19,898 11,425 18,312 0 49,635
Secure 500 500 1,200 100 2,300
Magic 27,014 27,014
CyberMedia 22,830 22,830
Restructuring Costs-Q2 11,318 8,644 610 20,572
Restructuring Costs-Q3 -- 3,285 370 -- -- 3,655
Reversal of excess reserves (6,750) (2,276) (3,909) -- 214 (12,721)
--------- --------- --------- --------- --------- ---------
Total Charges $ 28,671 $ 28,070 $ 29,031 $ 49,844 $ -- $ 135,616
--------- --------- --------- --------- --------- ---------
</TABLE>
Direct transaction costs included $18.0 million in investment banking fees,
$9.2 million in legal and accounting fees, and $1.5 million in filing fees,
travel and other costs. Lease costs and asset write downs include the costs of
closing approximately 33 facilities throughout the world ($12.2 million), the
disposal of excess and obsolete assets (generally computer equipment which did
not comply with the Company's standards ($12.0 million)), and the write-off of
goodwill and intangibles associated with discontinued Dr. Solomon's products
($4.8 million). The Dr. Solomon's write-off related to two minor products which
were discontinued by the Company and which had no sales subsequent to the Dr.
Solomon's acquisition. The following table summarizes the activity in the
reserves for severance and benefits and facilities write downs established in
the second and third quarters ($000's):
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
27
<PAGE> 28
<TABLE>
<CAPTION>
Transaction Severance Asset
Costs & Benefits Lease Costs Write Downs Other Total
----------- ---------- ----------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Charged in Three Months
ended June 30, 1998 $ 15,523 $ 15,636 $ 6,485 $ 7,773 $ (214) $ 45,203
Paid Out or Charged against
the related assets (5,254) (9,053) (596) (1,310) -- (16,213)
-------- -------- -------- -------- -------- --------
Balance, June 30, 1998 10,269 6,583 5,889 6,463 (214) 28,990
Charged in three months
ended September 30, 1998 19,898 14,710 5,764 12,918 53,290
Paid Out or charged against
the related assets (9,363) (10,334) (5,904) (11,067) (36,668)
Reversal of excess reserves (6,750) (2,276) -- (3,909) 214 (12,721)
-------- -------- -------- -------- -------- --------
Balance, September 30, 1998 $ 14,054 $ 8,683 $ 5,749 $ 4,405 $ -- $ 32,891
-------- -------- -------- -------- -------- --------
</TABLE>
The severance and benefits charges related to company-wide reductions in
force following the Company's major acquisitions in the second and third
quarters of approximately 784 employees of which 107 were in research and
development functions, 302 were in sales and marketing functions and the
remainder were in administrative and other support functions. Substantially all
terminated employees left the Company in the period the related accounting
charge was recorded. A limited number of employees from each acquisition were
retained for short transition periods. The cost of these employees was charged
to operating expenses during the transition period
The lease costs represent an estimate of lease expense during the period
prior to re-leasing the property together with losses on subleases if any. The
leased facilities were substantially vacated in the period in which the related
accounting charges were recorded. The costs related to any facilities which were
used by the Company during this period were charged to operations. However, such
charges were not material. Asset write downs, exclusive of the intangible assets
of Dr. Solomon's described above, comprised $5.6 million in losses on Company
owned buildings (which were written down to estimated values ) and $10.3 million
in net losses of computer and other miscellaneous assets. In general, this
equipment was discarded or sold for nominal value. Due to the immediate
consolidation of facilities, depreciation allocable to these facilities and the
related assets, during the transition period, was not material. Of the
facilities acquired in its 1998 acquisitions identified for closure, the Company
has 17 facilities worldwide which have not been disposed of or subleased (16
leased; 1 owned). These facilities are insignificant to the Company's operations
and, other than a portion of a leased facility which the Company has decided to
retain, each is intended for disposal or sublease in 1999.
The following table summarizes the activity in the reserves for severance and
benefits and facilities write downs established in the year ended December 31,
1997 ($000's):
<TABLE>
<CAPTION>
Asset
Transaction Severance Lease Write
Costs & Benefits Costs Downs Other Total
------------ ---------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 8,050 $ 10,697 $ 3,842 $ 1,865 $ 2,893 $ 27,347
Paid Out or Charged
against the related assets (8,083) (6,725) (2,853) (4,381) (2,521) (24,563)
Adjustment to liability -- (3,000) -- 3,000 -- --
-------- -------- -------- -------- -------- --------
Balance, September 30, 1998 $ (33) $ 972 $ 989 $ 484 $ 372 $ 2,784
======== ======== ======== ======== ======== ========
</TABLE>
The Company believes that the balances remaining at September 30, 1998 are
adequate to cover any additional benefits or losses yet to be paid or realized.
Any reserves not used will be recorded as a credit to Acquisition and Related
Charges in future periods.
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
28
<PAGE> 29
The in-process research and development costs comprise approximately $22.8
million and $27.0 million 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. The following is a summary of the
projects acquired and the assumptions used in determining the value of the
in-process research and development costs.
CyberMedia:
The ongoing projects at CyberMedia at the time of the purchase included
upgrade versions of four products (First Aid 6.0 and 7.0, UnInstaller 6.0, Guard
Dog 3.0, and Oil Change 3.0) as well as work on technologies to be used in two
of the Companies projects (a replacement product for PC Medic and McAfee
Office). These upgrades will include new interfaces with the Internet, enhanced
use of Active-X controls and Java and enhanced user interfaces. At the date we
acquired CyberMedia, the Company estimated that, on average, 42% of the
development effort had been completed and that the remaining 58% of the
development effort would take approximately 12 months to complete and would cost
$2.7 million. The efforts required to complete the development of these projects
principally relate to additional design efforts to integrate the technologies
into the Company's suite of products, finalization of coding, and completion of
prototyping, verification, and testing activities required to establish that
products associated with the technologies can be successfully introduced. The
value of the in-process technologies was determined by estimating the projected
net cash flows related to products, including costs to complete the development
of the technologies or products, and the future net revenues that may be earned
from the products, excluding the value attributed to integration with the
Company's products or that may have been achieved due to efficiencies resulting
from the combined sales force or the use of the Company's more effective
distribution channel. In conformity with the SEC's revised guidelines, these
cash flows were discounted back to their net present value using a discount rate
of 28% (which represents a premium of approximately 5% over the Company's
average weighted cost of capital) and excluding the value attributable to the
use of the in-process technologies in future products. If the Company does not
deploy commercially accepted products based on the acquired in-process
technologies, operating results could be adversely affected in future periods.
Additionally, the failure of any particular project would impair the value of
other intangibles, particularly goodwill, acquired from CyberMedia.
Magic Solutions:
The ongoing projects at Magic Solutions at the time of the purchase comprised
an upgrade version of Support Magic 4.0, Magic Solutions current product. This
upgrade, known as Merlin Enterprise, represents new technologies with
significant enhanced functionality, including increased scalability, a 32-bit
browser-based technology, an enhanced user interface and integrated management
features. At the date the Company acquired Magic Solutions, the Company
estimated that, on average, 80% of the development effort had been completed and
that the remaining 20% of the development effort would take approximately 12
months to complete and would cost $1.8 million. The efforts required to complete
the development of these projects principally relate to additional design
efforts to integrate the technologies into the Company's suite of products,
finalization of coding, and completion of prototyping, verification, and testing
activities required to establish that products associated with the technologies
can be successfully introduced. The value of the in-process technologies was
determined by estimating the projected net cash flows related to products,
including costs to complete the development of the technologies or products, and
the future net revenues that may be earned from the products, excluding the
value attributed to integration with the Company's products or that may have
been achieved due to efficiencies resulting from the combined sales force or the
use of the Company's more effective distribution channel. In conformity with the
SEC's revised guidelines, these cash flows were discounted back to their net
present value using a discount rate of 28% (which represents a premium of
approximately 5% over the Company's average weighted cost of capital) and
excluding the value attributable to the use of the in-process technologies in
future products. If the Company does not deploy commercially accepted products
based on the acquired in-process technologies, operating results could be
adversely affected in future periods. Additionally, the failure of any
particular project would impair the value of other intangibles, particularly
goodwill, acquired from Magic Solutions.
Other Acquisitions:
In addition to the above transactions, the Company acquired Cinco Networks,
Inc. and Pretty Good Privacy, Inc. in 1997 which, in conformity with the SEC's
revised guidelines, resulted in in-process research charges of $5.2 million and
$3.9 million respectively. As of September 30, 1998, the projects related to the
acquisitions of Cinco and PGP were substantially complete.
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
29
<PAGE> 30
Finally, in conformity with the SEC's revised guidelines, Acquisition and
other related costs for the nine months ended September 30, 1997 consisted of
$19.5 million and $5.2 million of acquired in-process technology in connection
with the acquisitions of 3DV and Cinco, respectively. Subsequent to the Network
General merger in December 1997, all 3DV projects were terminated.
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 $6.5 million in the three months ended September 30, 1997. Interest and
other income and expense decreased from $13.9 million in the nine months ended
September 30, 1998 from $16.1 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, before
acquisition and other related costs, was 35% and 40% for the three month periods
ended September 30, 1998 and 1997, respectively, and 39% for the nine month
periods ended September 30, 1998 and 1997. The reduction in the effective tax
rate quarter over quarter is the result of the implementation of various
domestic and international tax strategies. The Company's effective tax rate for
the three month periods ended September 30, 1998 and 1997 was 31% and 38%,
respectively, and for the nine month periods ended September 30, 1998 and 1997
was 30% and 34%, respectively, excluding the effect of one-time non-deductible
in-process research and development, merger and other acquisition costs and
amortization of intangibles.
Liquidity and Capital Resources
At September 30, 1998, the Company had $363.8 million in cash and cash
equivalents and $279.9 million in marketable securities, for a combined total of
$643.7 million.
Net cash provided by operating activities was $35.5 million and $129.5
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 and deferred
taxes which were offset primarily by an increase in accounts receivable and
prepaid and other assets and a decrease in accounts payable and accrued
liabilities. 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 and
accounts payable and accrued liabilities, offset primarily by increases in
accounts receivable, prepaid and other assets 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.
Net cash used in investing activities was $282.3 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.
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
30
<PAGE> 31
Net cash provided by financing activities was $453.5 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.
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
- --------
* 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 33 for a discussion
of certain factors that could affect future performance.
31
<PAGE> 32
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 33 for a discussion
of certain factors that could affect future performance.
32
<PAGE> 33
RISK FACTORS
The following risk factors should be considered in conjunction with the
information in this Report on Form 10-Q/A.
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.
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
33
<PAGE> 34
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.
34
<PAGE> 35
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.
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
35
<PAGE> 36
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.
36
<PAGE> 37
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
37
<PAGE> 38
provide the necessary software and support capabilities. In addition, to the
extent that the Company is successful in developing its Net Tools suite of
products designed around a centralized management and administration console for
the Windows NT platform, the Company will likely compete with large computer
systems management companies such as Tivoli Systems (TME) and Computer
Associates (Unicenter). There can be no assurance that the Company will continue
to compete effectively against existing and potential competitors, many of whom
have substantially greater financial, technical, marketing and support resources
and name recognition than the Company. In addition, there can be no assurance
that software vendors who currently use traditional distribution methods will
not in the future decide to compete more directly with the Company by utilizing
electronic software distribution.
The competitive environment for anti-virus software internationally is
similar to that in North America, although local competitors in specific foreign
markets often present stronger competition and shareware authors control a more
significant portion of the European market. The international market for network
management software has developed more slowly than the North American market,
although larger competitors such as Intel and Symantec have begun to penetrate
European markets. Asian markets have lagged significantly behind North America
and Europe in their adoption of networking technology. There can be no assurance
that the Company will be able to compete successfully in international markets.
Need to Develop Enterprise and 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.
38
<PAGE> 39
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.
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
39
<PAGE> 40
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 7 to the Notes to the Condensed Consolidated Financial Statements.
In addition, as the Company may acquire a portion of software included in its
products from third parties, its exposure to infringement actions may increase
because it must rely upon such third parties as to the origin and ownership of
any software being acquired. Similarly, exposure to infringement claims exists
and will increase to the extent that the Company employs or hires additional
software engineers previously employed by competitors, notwithstanding measures
taken by them to prevent usage by such
40
<PAGE> 41
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 36%, 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.
41
<PAGE> 42
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.
42
<PAGE> 43
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.
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,
43
<PAGE> 44
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.
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
44
<PAGE> 45
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.
45
<PAGE> 46
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, SEPTEMBER 30, 1998
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
Information with respect to this item is incorporated by reference to Note 7
of the Notes to the Consolidated Financial Statements included herein on page 20
of this Report on Form 10-Q/A.
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.
46
<PAGE> 47
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.
47
<PAGE> 48
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, 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 amended 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: April 15, 1999
48
<PAGE> 49
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, SEPTEMBER 30, 1998
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<S> <C> <C>
2.1 Agreement and Plan of Reorganization, dated 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 Registrant, 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, 1998, by and between the Registrant and 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 Participating 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)................................................
</TABLE>
49
<PAGE> 50
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<S> <C> <C>
4.11 Registration Rights Agreement, dated June 29, 1998, by and between the Registrant and
certain stockholders of CSB Consulenza Software di Base S.r.l. ("CSB").(11) .................
4.12 Registration Rights Agreement, dated July 30, 1998, by and between the Registrant and
certain stockholders of Anyware Seguridad Informatica S.A.(11) .............................
4.13 Registration Rights Agreement, dated August 31, 1998, by and between the Registrant and
certain stockholders of QA Information Security Holding AB.(24) ............................
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 Agreement, dated as of April 14, 1997 by and among McAfee Associates,
Inc. and McAfee Do Brasil Ltda., Compusul-Consultoria E Comercio De Informatica Ltda.,
and the stockholders of Compusul-Consultoria E Comercio 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 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 dated April 18,
1996.(19)...................................................................................
10.27* Change in control agreement between the Company and Zachary Nelson, dated May 12,
1998.(20)...................................................................................
27.1 Financial Data Sheet........................................................................
</TABLE>
50
<PAGE> 51
- ----------
(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 from the Registrant's Report on Form 8-K filed
with the Commission on December 11, 1997.
(6) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on March 25, 1998.
(7) Incorporated by reference from the Registrant's Report on Form 8-K 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 May 26, 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 Corporation'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 Report 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.
(24) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1998, filed with the Commission on
November 13, 1998.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
51
<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> 363,839
<SECURITIES> 279,902
<RECEIVABLES> 234,204
<ALLOWANCES> 7,842
<INVENTORY> 0
<CURRENT-ASSETS> 780,636
<PP&E> 58,281
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,409,421
<CURRENT-LIABILITIES> 377,780
<BONDS> 0
0
0
<COMMON> 1,344
<OTHER-SE> 589,252
<TOTAL-LIABILITY-AND-EQUITY> 1,409,421
<SALES> 717,854
<TOTAL-REVENUES> 717,854
<CGS> 137,695
<TOTAL-COSTS> 137,695
<OTHER-EXPENSES> 678,858
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 52,942
<INCOME-TAX> 73,189
<INCOME-CONTINUING> (20,247)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (20,247)
<EPS-PRIMARY> (0.15)<F1>
<EPS-DILUTED> (0.15)
<FN>
<F1>For Purposes of this Exhibit, Primary means Basic.
</FN>
</TABLE>
