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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 0-20558
--------------------------------
NETWORKS ASSOCIATES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 77-0316593
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
</TABLE>
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
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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 [ ]
139,216,131 shares of the registrant's common stock, $0.01 par value, were
outstanding as of September 30, 1999.
THIS DOCUMENT CONTAINS 45 PAGES.
THE EXHIBIT INDEX IS ON PAGE 42.
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NETWORKS ASSOCIATES, INC.
FORM 10-Q, SEPTEMBER 30, 1999
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CONTENTS
<TABLE>
<CAPTION>
ITEM
NUMBER PAGE
- ------ ----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Operations:
Three and nine months ended September 30, 1999 and 1998..... 3
Condensed Consolidated Balance Sheets:
September 30, 1999 and December 31, 1998.................... 4
Condensed Consolidated Statements of Cash Flows:
Nine months ended September 30, 1999 and 1998............... 5
Notes to Condensed Consolidated Financial Statements........ 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 14
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS........................................... 40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................ 40
SIGNATURES........................................................... 41
EXHIBIT INDEX........................................................ 42
</TABLE>
2
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Net revenues:
Product........................................ $149,141 $203,620 $ 303,351 $607,744
Services & support........................... 46,060 38,824 162,238 110,110
-------- -------- --------- --------
Total revenues....................... 195,201 242,444 465,589 717,854
Cost of revenues:
Product...................................... 23,718 33,047 64,138 106,422
Services & support........................... 9,619 11,509 27,996 31,273
-------- -------- --------- --------
Total cost of revenues............... 33,337 44,556 92,134 137,695
Operating expenses:
Research and development..................... 38,921 33,077 109,833 102,217
Marketing and sales.......................... 88,926 66,007 273,337 210,189
General and administrative................... 24,218 16,022 100,226 65,195
Amortization of intangibles and stock
compensation charge....................... 21,000 11,216 58,194 27,946
Acquisition and related charges.............. (10,373) 63,399 (18,732) 135,616
-------- -------- --------- --------
Total operating expenses............. 162,692 189,721 522,858 541,163
-------- -------- --------- --------
Income (loss) from operations........ (828) 8,167 (149,403) 38,996
Interest and other income and expense, net... 1,909 4,099 5,381 13,946
-------- -------- --------- --------
Income (loss) before provision for
income taxes....................... 1,081 12,266 (144,022) 52,942
Provision for income taxes..................... 1,322 26,710 25,763 73,189
-------- -------- --------- --------
Net loss............................. $ (241) $(14,444) $(169,785) $(20,247)
======== ======== ========= ========
Other comprehensive income (loss):
Unrealized gain (loss) on investments.......... $ 897 $ 2,409 $ (2,412) $ 2,196
Foreign currency translation gain (loss)....... 2,855 (850) (4,531) (3,484)
-------- -------- --------- --------
Comprehensive income (loss).................... $ 3,511 $(12,885) $(176,728) $(21,536)
======== ======== ========= ========
Net loss per share -- basic.................... $ 0.00 $ (0.11) $ (1.23) $ (0.15)
======== ======== ========= ========
Shares used in per share calculation --basic... 139,038 133,531 137,906 131,973
======== ======== ========= ========
Net loss per share -- diluted.................. $ 0.00 $ (0.11) $ (1.23) $ (0.15)
======== ======== ========= ========
Shares used in per share
calculation -- diluted....................... 139,038 133,531 137,906 131,973
======== ======== ========= ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................... $ 249,426 $ 418,899
Marketable securities..................................... 50,138 98,515
Accounts receivable, net of allowances for doubtful
accounts and returns of $128,285 at September 30, 1999
and $97,342 at December 31, 1998....................... 190,829 260,784
Prepaid expenses, income taxes and other current assets... 32,145 59,554
Deferred taxes............................................ 80,965 65,866
---------- ----------
Total current assets.............................. 603,503 903,618
Marketable securities....................................... 352,370 216,457
Fixed assets, net........................................... 47,639 54,489
Deferred taxes.............................................. 46,323 38,205
Intangibles and other assets................................ 291,117 323,952
---------- ----------
Total assets...................................... $1,340,952 $1,536,721
========== ==========
LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 15,485 $ 20,881
Accrued liabilities....................................... 193,229 210,070
Deferred revenue.......................................... 119,124 132,409
Long term debt, current portion........................... 411 3,202
---------- ----------
Total current liabilities......................... 328,249 366,562
Deferred taxes............................................ 11,484 13,000
Deferred revenue, less current portion.................... 29,692 60,189
Long term debt and other liabilities...................... 380,362 374,132
---------- ----------
Total liabilities................................. 749,787 813,883
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; authorized: 5,000,000
shares; Common stock, $.01 par value; authorized:
300,000,000 shares; issued: 139,316,131 shares at
September 30, 1999 and 137,123,562 shares at December 31,
1998...................................................... 1,393 1,371
Treasury stock.............................................. (1,606) --
Additional paid-in capital.................................. 574,503 527,862
Cumulative other comprehensive income -- unrealized loss on
investments and foreign currency translation.............. (8,477) (1,534)
Retained earnings........................................... 25,352 195,139
---------- ----------
Total stockholders' equity........................ 591,165 722,838
---------- ----------
Total liabilities and stockholders' equity........ $1,340,952 $1,536,721
========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................... $(169,785) $ (20,247)
Adjustments to reconcile net loss to net cash provided
(used) from operating activities:
Acquired in-process research and development.............. -- 49,843
Depreciation and amortization............................. 61,551 53,703
Write down of owned facility.............................. -- 1,177
Allowance for doubtful accounts........................... 36,867 6,658
Interest on convertible notes............................. 12,934 11,055
Unrealized gain (loss) on investments..................... (2,412) 2,252
Deferred taxes............................................ (24,733) 13,025
Stock compensation charges................................ 14,806 --
Changes in assets and liabilities:
Accounts receivable.................................... 33,092 (70,012)
Prepaid expenses, taxes and other...................... 16,797 (22,462)
Accounts payable and accrued liabilities............... (28,943) (24,838)
Deferred revenue....................................... (43,782) 35,392
--------- ---------
Net cash provided by (used in) operating
activities...................................... (93,608) 35,546
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of CyberMedia, Inc............................ -- (119,958)
Acquisition of Magic Solutions, Inc....................... -- (109,717)
Purchase of investment securities, net.................... (87,535) (19,138)
Additions to fixed assets................................. (17,778) (33,453)
Proceeds from sale of fixed assets........................ 6,518 --
--------- ---------
Net cash used in investing activities............. (98,795) (282,266)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Effect of exchange rate fluctuations...................... (4,531) (3,827)
Sale of convertible debentures............................ -- 337,624
Repayment of notes payable................................ (2,791) (186)
Issuance of common stock under stock option and stock
purchase plans......................................... 26,149 94,300
Tax benefit from exercise of nonqualified stock options... -- 25,154
Repurchase of common stock................................ (1,606) --
Exercise of warrants...................................... 459 463
Proceeds from sale of put options......................... 5,250 --
--------- ---------
Net cash provided by financing activities......... 22,930 453,528
--------- ---------
Net increase (decrease) in cash and cash equivalents........ (169,473) 206,808
Cash and cash equivalents at beginning of period............ 418,899 157,031
--------- ---------
Cash and cash equivalents at end of period.................. $ 249,426 $ 363,839
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The 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. The Company has two reportable
segments consisting of computer security and management software ("Enterprise"),
and consumer PC security and management software on the Internet ("McAfee.com").
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, 1999 are not necessarily indicative of the results to be expected
for the full year or for any future periods. The accompanying consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements contained in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission on April 15, 1999, as amended by
Form 10-K/A filed on April 30, 1999. The balance sheet at December 31, 1998 has
been derived from the audited financial statements as of and for the year ended
December 31, 1998, but does not include all the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
2. RELATED PARTY TRANSACTIONS
During the first quarter of 1999, the Company agreed to acquire 3,948,199
shares of Series A Preferred Stock of DirectWeb, Inc. for $2.5 million, and
4,615,385 shares of Series B Preferred Stock for $6.0 million. DirectWeb, Inc.
is a subscription-based online service offering a complete turnkey Windows-98
based PC, unlimited Internet access and technical support for a fixed user only
fee. In connection with the formation of DirectWeb, the Company received a
warrant to acquire 3,175,000 shares of Direct Web common stock for total
consideration of $317.50. As of September 30, 1999, on an as converted basis and
excluding shares that may be acquired upon exercise of its warrant, the
Company's total DirectWeb investment represented approximately 12.3% of
DirectWeb's outstanding capital stock. With respect to the balance,
approximately 35.2% is owned by William L. Larson, a DirectWeb founder and the
Company's Chief Executive Officer; 35.4% is owned by Dennis Cline, a DirectWeb
founder and the Company's former Vice President of Worldwide Sales; and 17.1% is
owned by unrelated third party investors who, along with the Company, invested
in DirectWeb's Series A and Series B Preferred Stock.
3. MCAFEE.COM
McAfee.com is an Internet destination dedicated to updating, upgrading, and
managing PCs over the web for single use retail, non-corporate, consumers. In
December 1998, the Company incorporated McAfee.com Corporation in Delaware as a
wholly owned subsidiary. Since January 1, 1999, the Company has contributed
certain assets and liabilities to McAfee.com and has entered into certain
inter-company arrangements including technology, licenses, shared facilities,
functions, services and tax sharing agreements. In September 1999, McAfee.com
filed an S-1 with the Securities and Exchange Commission ("SEC') for an initial
public offering. Upon the completion of the offering, if at all, the Company
will own all of the outstanding Class B common stock, representing approximately
85% of McAfee.com's outstanding common stock, assuming no exercise of the
underwriter's over-allotment option.
In January 1999, executives of Network Associates were granted options to
purchase 1,710,000 shares (after restatement for the effects of a two for one
stock split in June 1999, a reverse 3 for 5 stock split in July 1999, and share
reduction/cancellation in September 1999) of McAfee.com common stock. As of
September 30, 1999, all these options were fully vested. In connection with
these options, the Company recorded total
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
compensation expense for the three and nine months ended September 30, 1999 of
approximately $5.0 million and $6.6 million, respectively.
4. SEGMENT REPORTING
The Company has adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, effective for fiscal years beginning after
December 15, 1997. In fiscal year 1998, the Company determined that it had a
single reporting segment consisting of the development, sale, and support of
computer security and management software. Since then, the Company established
one of its subsidiaries, McAfee.com, as a separate business entity. As of
September 30, 1999, the Company evaluated its product segments in accordance
with SFAS 131 and concluded that its reportable segments are computer security
and management software ("Enterprise"), and consumer PC security and management
software on the Internet ("McAfee.com").
The Enterprise segment is organized into two product suites: Net Tools
Secure and Net Tools Manager. These product suites are marketed and sold through
a direct sales force to distributors, retailers, and end users in the United
States, Europe, Asia Pacific and Latin America.
The McAfee.com segment is a one-stop destination for consumer PC security
and management needs on the Internet. The McAfee.com website provides a suite of
online products and services personalized for the user based on the user's PC
configuration, attached peripherals and resident software.
Summarized pre-tax financial information concerning the Company's
reportable segments is provided as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Enterprise:
Net revenues................... $188,438 $240,762 $ 449,494 $713,586
Segment profit (loss)........ 10,895 (13,404) (147,987) (19,424)
McAfee.com:
Net revenues................. 6,763 1,682 16,095 4,268
Segment loss................. (11,136) (1,040) (21,798) (823)
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Enterprise:
Total assets....................................... $1,330,883 $1,534,283
McAfee.com:
Total assets.................................. 10,069 2,438
</TABLE>
5. STOCK OPTION REPRICING AND STOCK REPURCHASE PLAN
On April 22, 1999, the Company offered to substantially all of its
employees, excluding executive officers, the right to cancel certain outstanding
stock options and receive new options with exercise prices at the current fair
market value of the stock. Options to purchase a total of 10.3 million shares
were canceled and the same number of new options were granted at an exercise
price of $11.063, which was based on the closing price of the Company's common
stock on April 22, 1999. The new options vest at the same rate that they would
have vested under previous option plans. As a result, options to purchase
approximately 3.0 million shares at $11.063 were vested at September 30, 1999,
however the new options cannot be exercised for a period of twelve months
regardless of vesting status.
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In accordance with Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees," the Company incurred an initial stock based
compensation charge in connection with this repricing. This charge was
calculated based on the difference between the exercise price of the new options
and their market value on the date of acceptance by employees. Approximately
$1.6 million and $8.2 million were expensed in the three and nine months ended
September 30, 1999, respectively, and approximately $14.5 million will be
expensed over the remaining vesting period.
On March 31, 1999, the Financial Accounting Standards Board ("FASB") issued
an exposure draft of its Proposed Interpretation, "Accounting for Certain
Transactions involving Stock Compensation -- an interpretation of APB Opinion
No. 25" (the "Proposed Interpretation"). Under the Proposed Interpretation,
stock options repriced after December 15, 1998 will be subject to variable plan
accounting treatment. If adopted, this proposed guidance will require the
Company to remeasure compensation cost for outstanding repriced options each
reporting period based on changes in the market value of the underlying common
stock after the date of adoption. The FASB currently expects to approve the
release of this interpretation in the first quarter of 2000. Depending upon
movements in the market value of the Company's common stock, this proposed
accounting treatment may result in significant additional compensation charges
in future periods.
In May 1999, the Board of Directors authorized the Company to repurchase up
to $100 million of its common stock in the open market. In the quarter ended
September 30, 1999, the Company repurchased 100,000 shares of its common stock
for a total cash outlay of approximately $1.6 million. The timing and size of
any future stock repurchases are subject to market conditions, stock prices, the
Company's cash position and other cash requirements going forward.
On August 3, 1999, Network Associates sold "European style" put options for
1,000,000 shares of the Company's common stock as part of its stock repurchase
plan. European style put options can only be exercised on the expiry date, which
is August 3, 2000. The strike price for these put options is $20.00, and the
Company received total proceeds of $5,250,000 from the sale.
6. RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted Statement of Position
("SOP") No. 97-2, "Software Revenue Recognition" and SOP No. 98-4, "Deferral of
the Effective Date of a Provision of SOP No. 97-2." Prior to 1998, the Company
recognized revenues in accordance with SOP No. 91-1, "Software Revenue
Recognition." In December 1998, the American Institute of Certified Public
Accountants ("AICPA") issued SOP No. 98-9, "Modification of SOP No. 97-2,
Software Revenue Recognition, with Respect to Certain Transactions." SOP No.
98-9 clarifies certain provisions of SOP No. 97-2 that were previously deferred
by SOP No. 98-4, and effectively defers the required adoption of those
provisions until the Company's fiscal year beginning January 1, 2000. The
adoption of SOP No. 98-9 is not expected to have a material impact on the
Company's results of operations, financial position or cash flows.
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,
2000, 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.
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
7. NET LOSS PER SHARE
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted net loss
per share calculations is provided as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Numerator -- basic
Net loss....................................... $ (241) $(14,444) $(169,785) $(20,247)
======== ======== ========= ========
Numerator -- diluted
Net loss....................................... $ (241) $(14,444) $(169,785) $(20,247)
======== ======== ========= ========
Interest on convertible debentures, net of
tax(1)....................................... -- -- -- --
Denominator -- basic
Basic weighted average common shares
outstanding.................................. 139,038 133,531 137,906 131,973
======== ======== ========= ========
Denominator -- diluted
Basic weighted average common shares
outstanding.................................. 139,038 133,531 137,906 131,973
-------- -------- --------- --------
Effect of dilutive securities:
Convertible debt............................. -- -- -- --
Common stock options......................... -- -- -- --
Diluted weighted average shares................ 139,038 133,531 137,906 131,973
======== ======== ========= ========
Net loss per share -- basic.................... $ 0.00 $ (0.11) $ (1.23) $ (0.15)
======== ======== ========= ========
Net loss per share -- diluted.................. $ 0.00 $ (0.11) $ (1.23) $ (0.15)
======== ======== ========= ========
</TABLE>
- ---------------
(1) Convertible debt interest and related as-if converted shares are excluded
from both the 1998 and 1999 calculations as the Company incurred a net loss
for all periods.
8. LITIGATION
On April 7, 1999, a putative securities class action, captioned Knisley v.
Network Associates, Inc., et al., Civil Action No. C-99-1729-SBA, was filed
against Network Associates and several of its officers in the United States
District Court for the Northern District of California. The complaint alleges
violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934,
and seeks unspecified damages on behalf of a purported class of purchasers of
common stock between January 20, 1998 and April 6, 1999. Twenty-four similar
actions asserting virtually identical allegations have been filed by other
plaintiffs. The Court has consolidated these cases. Certain of the plaintiffs
have filed motions seeking to be appointed lead plaintiff. The Company has not
responded to the complaints.
On May 12, 1999, a purported derivative action, captioned Dow Jones
Investment Club v. Network Associates, Inc. et al., Civil Action No. CV-781854,
was filed against nominal defendant Network Associates, Inc. and certain of its
officers and directors in the Superior Court of California, County of Santa
Clara. The complaint alleges violations of Sections 25402 and 1507 of the
California Corporations Code, breach of fiduciary duty, insider trading, gross
negligence, and unjust enrichment. The complaint seeks unspecified damages. Two
similar derivative actions have been filed by other plaintiffs in the Superior
Court of California, County of Santa Clara, including Leighton v. Network
Associates, Inc. et al., Civil Action No. CV-781947, and Katz v. Network
Associates, Inc., Civil Action No. CV-782194. On January 21, 1999, the court
ordered
9
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
these three actions consolidated for pretrial and trial proceedings and deemed
the complaint filed in the Leighton action the operative complaint. Defendants
have filed a motion to dismiss the operative complaint. A similar case,
captioned Gage v. Network Associates, Inc., et al., Civil Action No. B C211552,
has been filed in the Superior Court of California, County of Los Angeles.
Plaintiffs allege violations of Sections 25400 et seq. of the California
Corporations Code, Section 17200 of the California Business and Professions
Code, and breach of fiduciary duty. The parties have stipulated to transfer the
action to Santa Clara County Superior Court.
On April 24, 1997, Network Associates was served by Symantec with a suit
filed in the United States District Court, Northern District of California, San
Jose Division, alleging copyright infringement and unfair competition by Network
Associates. Symantec alleges that Network Associates' 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 Network Associates' "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 Network Associates from shipping any product containing
either an approximately 30-line routine found in Crash Guard or an approximately
100-line routine found in a Symantec DLL. The Court's order expressly stated
that "the court is not enjoining the sale or distribution of [McAfee's] current
product." On December 19, 1997, the Court denied Symantec's motion to enjoin
sale or distribution of Network Associates' current PC Medic product. On April
1, 1998, Symantec filed an amended complaint including additional allegations of
trade secret misappropriation, unfair competition, interference with economic
advantage and contractual relations and violations of the Racketeer Influenced
and Corrupt Organization Act ("RICO"), in connection with the alleged use by
Network Associates employees of 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 Network Associates from making use of any
Symantec customer list data. On September 4, 1998, Symantec's time for amending
its complaint expired; Symantec did not refile its RICO claims. On October 8,
1998, the Court granted partial summary judgment in Network'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.
On October 22, the Court consolidated this case for purposes of trial with
an action originally brought on February 4, 1998 by CyberMedia Inc. (acquired by
Network Associates in September 1998) against Symantec (described below) and the
action brought by Symantec against Network Associates on September 4, 1998
(described below). Trial is currently set for May 22, 2000.
On September 4, 1998, Symantec filed suit in United States District Court
for the Northern District of California, San Jose Division, against Network
Associates, alleging copyright infringement, unfair competition, and trade
secret misappropriation. Symantec alleges that an unidentified Network
Associates employee copied and transported to Network Associates certain
proprietary Symantec files, including files containing Norton Antivirus
software. On January 20, 1999, the Court dismissed those portions of Symantec's
claims relating to Network Associates' PC Medic and VirusScan products. Symantec
also alleges that another unidentified Network Associates employee located in
Canada copied and transported to Network Associates certain other unidentified
files containing Symantec confidential information.
On May 13, 1997, Trend Micro, Inc. ("Trend") filed suit in United States
District Court for the Northern District of California against both Network
Associates and Symantec. Trend alleges that Network Associates' "WebShield,"
"GroupShield," and "Gauntlet Firewall" products infringe a Trend patent, which
10
<PAGE> 11
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
was issued on April 22, 1997. Trend's complaint seeks injunctive relief and
unspecified money damages. On June 6, 1997, Network Associates filed its answer
denying any infringement. Network Associates 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 Network Associates from
its action against Symantec. Network Associates 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 Network Associates' recommendation regarding a joint hearing
on patent claim interpretation. As a result of the Court's decision, Trend's
actions against Network Associates 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 issued a ruling on claim interpretation on or about December 29, 1998.
In addition, Trend filed a supplemental complaint on October 5, 1998, adding the
Gauntlet product to the products accused of infringing Trend's patent. At a case
management conference held on October 2, 1998, the Court set a new trial date of
November 8, 1999. Since then, the parties have stipulated to a postponement of
various dates, including postponement of the trial date until February, 2000.
The parties are still engaged in completing discovery.
On September 15, 1997, Network Associates was named as a defendant in a
patent infringement action filed by Hilgraeve Corporation ("Hilgraeve") in the
United States District Court, Eastern District of Michigan. Hilgraeve alleges
that Network Associates' VirusScan product infringes a Hilgraeve patent, which
was issued on June 7, 1994. Hilgraeve's action seeks injunctive relief and
unspecified money damages. All discovery has been completed. The Court heard
Network Associates' motions for summary judgment of non-infringement on May 20,
1999 and granted the motion in a written opinion dated June 10, 1999. The Court
entered judgment in favor of Network Associates on July 7, 1999. Hilgraeve has
filed an appeal from the judgment to the United States Court of Appeals for the
Federal Circuit. That appeal is pending.
On July 30, 1998, CyberMedia, Network Associates 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 merger. On December 16, 1998,
plaintiffs filed a stipulation of voluntary dismissal.
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 did not specify damages.
Defendants filed a demurrer to the complaint on September 25, 1998. On January
13, 1999, the court (Commissioner Bruce E. Mitchell) sustained Defendants'
demurrer with prejudice and allowed plaintiff to amend its complaint within 30
days only if a new named plaintiff was added. On February 12, 1999, plaintiffs
filed an amended complaint alleging the same causes of action with the same
named plaintiff. On February 26, 1999, Defendants filed an ex parte application
for an order to show cause why plaintiffs should not be held in violation of the
Court's Order. At the hearing on March 8, 1999, the Court dismissed the action
with prejudice.
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.
11
<PAGE> 12
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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. Plaintiffs filed a second consolidated amended complaint on March 8, 1999.
It 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. CyberMedia and certain of its former officers and
directors were also 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. Network Associates has reached
an agreement in principle with plaintiffs to settle the state and federal
securities class actions. The settlement provides for a payment of $11.5 million
plus interest from approximately May 6, 1999, $1.5 million (and interest on that
amount) of which is to be paid by Network Associates and the remainder of which
is to be paid by the Company's insurers. The parties memorialized the agreement
in principle in a Memorandum of Understanding and are negotiating a final
Stipulation of Settlement. Once a final Stipulation of Settlement has been
negotiated and signed, the parties will seek judicial approval of the
settlement. Consummation of the proposed settlement is contingent on a number of
factors including agreement on settlement language and judicial approval.
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.
On September 3, 1998, the United States District Court for the Northern
District of California issued a preliminary injunction preventing the defendants
from manufacturing, marketing or distributing any existing version of their
competing program, and requiring defendants to issue a "Notice of Recall" to all
distributors regarding existing versions of the program. The injunction was
effective throughout the United States. On November 30, 1998, the Court issued a
further order pursuant to an agreement of the parties, prohibiting Symantec from
manufacturing, distributing or advertising Norton Uninstall Deluxe anywhere in
the world.
The defendants have filed counterclaims against CyberMedia for slander,
libel, product disparagement and related state law claims, seeking unspecified
money damages.
On April 27, 1999, Network Associates was served by Symantec with a suit
filed in the Superior Court of California, County of Santa Clara. The suit
alleges malicious prosecution in connection with an earlier suit Network
Associates brought against Symantec for defamation and related claims, and which
was dismissed in December 1997. Symantec has agreed that no response to the
Complaint in this action need be filed until further notice.
12
<PAGE> 13
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
9. FIXED ASSETS SALE-LEASEBACK
On September 20, 1999, the Company sold approximately $6.5 million of fixed
assets to a third party and leased them back under an operating lease. The
initial term of the lease is 12 months, with an option to renew the lease for an
additional 12 months.
13
<PAGE> 14
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 our 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 us on the date hereof,
and we assume no obligation to update any such forward-looking statements. Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of a number of factors, including, but
not limited to, those set forth in "Risk Factors" and elsewhere in this Report
on Form 10-Q.
OVERVIEW
We are a leading developer and provider of software products that address
two of the most important concerns of information technology or IT
professionals: network security and network management. In the network security
arena, the majority of our revenue has historically been derived from our McAfee
anti-virus product line. In the network management arena, the majority of our
revenue has historically been derived from our Sniffer network fault and
performance management product line. These two flagship product lines form the
customer base and product base from which the balance of our product line has
developed.
To continue expanding our revenue base, we have focused our efforts on
building a full line of complementary network security and network management
solutions. On the network security side, during 1998 we strengthened our
anti-virus lineup by adding complementary products in the firewall, intrusion
protection, encryption, and virtual private networking categories. On the
network management side, during 1998 we built upon our Sniffer line by adding
products in the help desk, asset management, network monitoring, and network
reporting categories. We continuously seek to expand our product line. We have
combined complementary products into "suites", offering customers the ability to
license multiple products at the same time. Our products are currently organized
into four primary product suites: McAfee Total Virus Defense and PGP Total
Network Security, which combine to form "Net Tools Secure" and Sniffer Total
Network Visibility and Magic Total Service Desk, which combine to form "Net
Tools Manager". These four product suites together form a single integrated
mega-suite called "Net Tools".
We organize our products for sale to corporate customers into four product
suites:
NET TOOLS
<TABLE>
<CAPTION>
NET TOOLS SECURE
- --------------------------------------------
MCAFEE TOTAL VIRUS PGP TOTAL NETWORK
DEFENSE SECURITY
------------------ ---------------------
<S> <C>
- - Total Virus Defense - Total Network
- - Suite Security Suite
- - VirusScan Security - PGP Virtual Private
Suite Network (VPN)
- - GroupShield Suite
Security Suite - PGP Data Security
Suite
- Gauntlet Active
Firewall Suite
- Cybercop Intrusion
Protection Suite
</TABLE>
<TABLE>
<CAPTION>
NET TOOLS MANAGER
- --------------------------------------------
SNIFFER TOTAL NETWORK MAGIC TOTAL SERVICE
VISIBILITY DESK
- --------------------- ---------------------
<S> <C>
- - Total Network - Total Service
Visibility Suite Desk Suite
- - Sniffer Distributed - Magic HelpDesk
Analysis Suite Suite
- - Sniffer Pro 98 - SupportMagic
Portable Analysis - Zero Admin Client
Suite Suite
- - Network Informant - Zero Admin Client
Suite 2001 Suite
</TABLE>
14
<PAGE> 15
Many of our network security and management products are also available as
stand-alone products or as part of smaller product suites. Electronic software
distribution is one of the principal means by which we distribute our software
products to our customers. We generally license our products to corporate
customers, our primary customer base, under either a one-year or a two-year
product license.
In addition to our corporate customer base, our primary customer base, we
also offer a full range of consumer-oriented security and management software
products to retail customers, both through traditional retail stores and via the
Internet. Products offered to consumers via the Internet are sold by our
subsidiary, McAfee.com.
Our retail products for sale to consumers and small business customers are
organized into three categories:
- Anti-virus;
- Internet security/privacy; and
- Desktop utilities.
Our retail products are available as stand-alone products or bundled
together as part of a suite. For example, our VirusScan anti-virus software is
sold both as a stand-alone product and as part of various product suites, such
as McAfee Office 2000 and McAfee Office Pro. We generally utilize a perpetual or
unlimited license for products sold in the retail channel.
McAfee.com sells our retail products to consumers over the Internet.
Through the McAfee.com web site, consumers can secure, repair, update and
upgrade their PC's online. The web site provides a suite of online products and
services, including the McAfee Clinic, Anti-Virus Center and PC Checkup Center,
personalized for consumers based on their PC configurations, software and
attached peripherals, such as scanners, printers and modems. As of November 2,
1999 McAfee.com had over 100,000 paid subscribers for their McAfee Clinic
service.
15
<PAGE> 16
RESULTS OF OPERATIONS
The following table sets forth, for the period's indicated, the percentage
of net revenues represented by certain items in our statements of operations for
the three months and nine months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
1999 1998 1999 1998
----- ----- ------ -----
<S> <C> <C> <C> <C>
Net revenues:
Product............................................. 76.4 84.0 65.2 84.7
Services & support................................ 23.6 16.0 34.8 15.3
---- ---- ----- ----
Total revenues............................ 100% 100% 100% 100%
Cost of revenues:
Product........................................... 12.2 13.6 13.8 14.8
Services & support................................ 4.9 4.8 6.0 4.4
---- ---- ----- ----
Total cost of revenues.................... 17.1 18.4 19.8 19.2
Operating Expenses:
Research and development.......................... 19.9 13.6 23.6 14.2
Marketing and sales............................... 45.6 27.3 58.7 29.3
General and administrative........................ 12.4 6.6 21.5 9.1
Stock compensation charge......................... 3.4 -- 3.2 --
Amortization of intangibles....................... 7.4 4.6 9.3 3.9
Acquisition and other related costs............... (5.3) 26.1 (4.0) 18.9
---- ---- ----- ----
Total operating expenses.................. 83.3 78.2 112.3 75.4
---- ---- ----- ----
Income (loss) from operations..................... (0.4) 3.4 (32.1) 5.4
Interest and other income and expense, net........ 1.0 1.7 1.1 2.0
---- ---- ----- ----
Income (loss) before provision for income taxes... 0.6 5.1 (30.9) 7.4
Provision for income taxes.......................... 0.7 11.1 5.5 10.2
---- ---- ----- ----
Net loss.......................................... (0.1)% (6.0)% (36.5)% (2.8)%
==== ==== ===== ====
</TABLE>
Net revenues. Net revenues includes product revenues, revenues from
software support, maintenance contracts, education and consulting services as
well as revenues from those customer support and maintenance contracts that are
deferred and recognized over the related service period. Net revenues was $195.2
million in the three months ended September 30, 1999, a decrease of 19.5% from
$242.4 million in the three months ended September 30, 1998. For the nine-month
period ended September 30, 1999, net revenues decreased 35.1% to $465.6 million
from $717.9 million in the same period in 1998. This decrease relates to our
decision to limit distributor orders in an effort to realign channel inventory
levels as a result of Year 2000 concerns and increasing sales cycles for our
products.
International revenue accounted for approximately 35% and 34% of net
revenues for the three months ended September 30, 1999 and 1998, respectively.
For the nine-month periods ended September 30, 1999 and 1998, international
revenue was approximately 40% and 36%, respectively. The increase in
international net revenues as a percentage of net revenues was due primarily to
increased acceptance of our products in international markets and a decrease in
revenue to our distributors, especially in the United States. We expect that
international revenue will continue to account for a significant percentage of
net revenues.* We also expect that a significant portion of our international
revenue will be denominated in local currencies.* To reduce the impact of
foreign currency fluctuations we engage in financial risk management activities.
However, future results of income may be adversely affected by currency
fluctuations or by costs associated
- ---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance
that our actual performance will meet our current expectations. See the Risk
Factors on page 24 for a
discussion of certain factors that could affect future performance.
16
<PAGE> 17
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
our 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 our
revenue or revenue growth in the future. Further, in countries with a high
incidence of software piracy, we may experience a higher rate of piracy of our
products.* There are a number of additional risks related to the export outside
of the United States of our encryption and security products.
Cost of Revenue. Cost of revenue is comprised of cost of product revenue
and cost of services and support revenue. Cost of product revenue consists
primarily of the cost of media, manuals and packaging for products distributed
through traditional channels, royalties and, with respect to certain Sniffer
products, computer platforms and other hardware components. Cost of services and
support revenue consists principally of salaries and benefits related to
employees providing customer support and consulting and education services. Cost
of revenue was $33.3 million in the three months ended September 30, 1999, a
decrease of 25.2% from $44.6 million in the three months ended September 30,
1998. Cost of revenue was $92.1 million in the nine months ended September 30,
1999, a decrease of 33.1% from $137.7 million in the nine months ended September
30, 1998.
Our cost of revenue decreased, in absolute dollars, primarily as a result
of our decrease in revenue. We expect cost of revenue in absolute dollar terms
to increase slightly in Q4 1999, but may fluctuate as a percentage of net
revenues.*
Research and Development. Research and development expenses consist
primarily of salary and benefits for our development and technical support
staff. Research and development expenses were $38.9 million in the three months
ended September 30, 1999, an increase of 17.7% from $33.1 million in the three
months ended September 30, 1998. Research and development expenses were $109.8
million in the nine months ended September 30, 1999, an increase of 7.5% from
$102.2 million in the nine months ended September 30, 1998. As a percentage of
net revenue, research and development expenses were 19.9% and 13.6% in the
three-month periods ended September 30, 1999 and September 30, 1998,
respectively. The increase in actual spending was a result of increased staffing
and equipment expense to support growth in our product and service offerings. We
anticipate that research and development expenses will increase slightly in
absolute dollars in Q4 1999, but may fluctuate as a percentage of net revenues.*
We believe that our ability to maintain our competitiveness will depend in
large part upon our 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 $88.9 million in the three months ended September 30, 1999,
an increase of 34.7% from $66.0 million in the three months ended September 30,
1998. Marketing and sales expenses were $273.3 million in the nine months ended
September 30, 1999, an increase of 30.0% from $210.2 million in the nine months
ended September 30, 1998. As a percentage of net revenues, marketing and sales
expense was 45.6% and 27.3% in the three-month periods ended September 30, 1999
and 1998,
- ---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance
that our actual performance will meet our current expectations. See the Risk
Factors on page 24 for a
discussion of certain factors that could affect future performance.
17
<PAGE> 18
respectively. As a percentage of net revenues, marketing and sales expense was
58.7% and 29.3% in the nine-month periods ended September 30, 1999 and 1998,
respectively. The increase was primarily due to continued investment in the
marketing of our products and services, hiring and training of our enterprise
level sales force, and advertising and promotions for the McAfee.com business
segment. We expect sales and marketing to increase in Q4 1999, particularly as
McAfee.com continues with its efforts to build brand recognition and its
development of strategic relationships with a variety of Internet companies, and
will fluctuate as a percentage of net revenues.*
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 $24.2 million in the
three months ended September 30, 1999, an increase of 51.2% from $16.0 million
in the three months ended September 30, 1998. General and administrative costs
were $100.2 million in the nine months ended September 30, 1999, an increase of
53.7% from $65.2 million in the nine months ended September 30, 1998. As a
percentage of net revenues, general and administrative expenses were 12.4% and
6.6% in the three months periods ended September 30, 1999 and 1998. As a
percentage of net revenues, general and administrative expenses were 21.5% and
9.1% in the nine months periods ended September 30, 1999 and 1998, respectively.
The increase was due to a $31.8 million charge to cover doubtful accounts for
the nine months ended September 30, 1999. Excluding this charge, general and
administrative expenses were $68.4 million in the nine months ended September
30, 1999, which increased slightly from the nine months ended September 30,
1998. This increase was largely due to the development of our E-commerce
business systems, expansion of our IT infrastructure and the implementation of
our new SAP Human Resources module. We expect general and administrative
expenses to remain relatively flat in Q4 1999, but they may fluctuate as a
percentage of net revenues.*
Amortization of Intangibles and Stock Compensation Charges. We expensed
$21.0 million and $11.2 million of amortization related to intangibles and stock
compensation charges in the three months ended September 30, 1999 and 1998,
respectively. We expensed $58.2 million and $27.9 million of amortization
related to intangibles and stock compensation charges in the nine months ended
September 30, 1999 and 1998, respectively. Intangibles consist of purchased
goodwill and certain technology acquired through acquisitions. Stock
compensation charges relate to the repricing of employee stock options and the
issuance of McAfee.com stock options to our executives. We do not expect to
incur charges related these McAfee.com option grants in future periods. The
increase in amortization related to intangibles is due to the acquisitions of
Magic Solutions, Inc. ("Magic Solutions"), CyberMedia and 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, we incurred direct transaction costs and other restructuring and
related charges in the amount of $85.8 million in the year ended December 31,
1998. In connection with the acquisitions accounted for as purchase
transactions, we incurred charges of $49.8 million in the year ended December
31, 1998, consisting principally of the write-off of acquired in-process
research & development.
- ---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance
that our actual performance will meet our current expectations. See the Risk
Factors on page 24 for a
discussion of certain factors that could affect future performance.
18
<PAGE> 19
The following table summarizes the activity during the nine months ended
September 30, 1999, in the reserves for acquisition and other costs established
in the second and third quarters of 1998 (in thousands):
<TABLE>
<CAPTION>
DIRECT ASSET
TRANSACTION SEVERANCE LEASE WRITE
COSTS & BENEFITS COSTS DOWNS OTHER TOTAL
----------- ---------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998........... $ 9,900 $ 8,338 $ 5,508 $ 1,405 $ 2,144 $ 27,295
Paid Out or Charged against the
related assets....................... (5,712) (1,549) (804) (140) (104) (8,309)
Adjustment to liability.............. (4,188) (6,789) (4,704) (1,265) (2,040) (18,986)
------- ------- ------- ------- ------- --------
Balance, September 30, 1999.......... $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
======= ======= ======= ======= ======= ========
</TABLE>
For the nine months ended September 30, 1999, activity with respect to
these reserves consisted principally of the payment of accrued direct
transaction costs and severance benefits, and adjustments to remaining accruals.
All expenditures related to these accruals have been completed and the excess
reserves were credited to Acquisition and related charges.
The following table summarizes the activity during the nine months ended
September 30, 1999, in the reserves for acquisition and other costs established
in the year ended December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
DIRECT ASSET
TRANSACTION SEVERANCE LEASE WRITE
COSTS & BENEFITS COSTS DOWNS OTHER TOTAL
----------- ---------- ---------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998........... $ (36) $ 539 $ (422) $ 484 $ 374 $ 939
Paid Out or Charged against the
related assets....................... (193) (58) (942) 0 0 (1,193)
Adjustment to liability.............. 229 (481) 1,364 (484) (374) 254
------- ------- ------- ------- ------- --------
Balance, September 30, 1999.......... $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
======= ======= ======= ======= ======= ========
</TABLE>
For the nine months ended September 30, 1999, activity with respect to
these reserves consisted principally of expenditures related to accrued lease
termination costs and adjustments to remaining accruals. All expenditures
related to these accruals have been completed and the excess reserves were
credited to Acquisition and related charges.
Interest and Other Income and Expense, Net. Interest and other income and
expense, net, decreased to $1.9 million in the three months ended September 30,
1999 from $4.1 million in the three months ended September 30, 1998. Interest
and other income and expense, net, decreased to $5.4 million in the nine months
ended September 30, 1999 from $13.9 million in the nine months ended September
30, 1998. The decrease was primarily due to the increase of interest expense
related to the Zero Coupon Convertible Subordinated Debentures (the
"Debentures"), issued in February 1998, and a decrease in interest income.
Interest income decreased due to reduced cash balances resulting from the
acquisitions of Magic and CyberMedia and cash used to fund operating activities
during the nine months ended September 30, 1999.
Provision for Income Taxes. Our provision for income taxes of $1.3 million
for the three-month period ended September 30, 1999 and $25.8 million for the
nine-month period ended September 30, 1999 primarily relates to income taxes
currently payable in foreign jurisdictions.
Liquidity and Capital Resources
At September 30, 1999, we had $249.4 million in cash and cash equivalents
and $402.5 million in marketable securities, for a combined total of $651.9
million.
Net cash used in operating activities was $93.6 million in the nine months
ended September 30, 1999 and net cash provided by the operating activities for
nine months ended September 30, 1998 was $35.5 million. Net cash used in
operating activities in the nine months ended September 30, 1999, consisted
primarily of net loss before depreciation and amortization, plus a decrease in
accounts payable and accrued liabilities and deferred revenue, and an increase
in deferred taxes, which were partially offset by a decrease in accounts
19
<PAGE> 20
receivable and prepaid and other assets. In the nine months ended September 30,
1998, net cash provided by operating activities consisted primarily of net
income before depreciation and amortization and acquired in process research and
development, 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.
Our accounts receivable balance as a percentage of sales may increase due
to our increased emphasis on server/enterprise based sales; a higher percentage
of indirect sales through our channel partners and expanding international
sales, both of which typically have longer payment terms. With an increase in
business through indirect channels, our receivable collection experience has
become more dependent on the longer payment cycle for VARs, distributors and
system integrators. To address this increase in accounts receivable and to
improve cash flow, we may from time to time take actions to encourage earlier
payment of receivables and sell receivables. To the extent that our receivable
balance increases, we will be subject to greater general credit risks with
respect thereto.
Net cash used in investing activities was $98.8 million in the nine months
ended September 30, 1999 consisting primarily of the purchase of marketable
securities and additions to fixed assets. 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 acquisitions of Magic Solutions and CyberMedia.
Net cash provided by financing activities was $22.9 million in the nine
months ended September 30, 1999, consisting primarily of the proceeds associated
with the exercise of non qualified stock options and sale of put options, which
was partially offset by the effect of exchange rate fluctuations. 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.
We believe that our available cash and anticipated cash flow from
operations will be sufficient to fund our working capital and capital
expenditure requirements for at least the next twelve months.*
EURO
On January 1, 1999, the "euro" was introduced. On that day, the exchange
ratios of the currencies of the eleven countries participating in the first
phase of the European Economic and Monetary Union were fixed. The euro became a
currency in its own right and the currencies of the participating countries,
while continuing to exist for a three-year transition period, are now fixed
denominations of the euro. The introduction of the euro will have significant
effects on the foreign exchange markets and bond markets and is requiring
significant changes in the operations and systems within the European banking
industry. Our information system is designed to accommodate multi-currency
environments. As a result we have the flexibility to transact business with
vendors and customers in either euro or traditional national currency units.
Financial Risk Management
As a result of the continued expansion of our business in Europe, we expect
to see an increase over time in exposures related to nonfunctional currency
denominated sales in several European currencies.* Currently, we hedge only
those currency exposures associated with certain assets and liabilities
denominated in nonfunctional currencies and we do not generally hedge
anticipated foreign currency cash flows. The hedging activity we have undertaken
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 US dollar, British pound, Canadian dollar, Australian
dollar
- ---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance
that our actual performance will meet our current expectations. See the Risk
Factors on page 24 for a
discussion of certain factors that could affect future performance.
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<PAGE> 21
and New Zealand dollar. To the extent that these forecasts are over or
understated during periods of currency volatility, we could experience
unanticipated currency gains or losses.*
Year 2000
YEAR 2000 ISSUE DESCRIBED
Many currently installed computer systems and software products are coded
to accept, store, or report only two digit entries in date code fields.
Beginning in the Year 2000, these date code fields will need to be enabled to
distinguish 21st century dates from 20th century dates. This is the "Year 2000
issue." As a result, computer systems and/or software used by many companies,
including us, our vendors and our customers, will need to be upgraded to comply
with these Year 2000 requirements. We could be impacted by Year 2000 issues
occurring in our own infrastructure or the infrastructure of our major
distributors, suppliers, customers, vendors and financial service organizations.
These Year 2000 issues could include information errors and significant
information system failures. Any disruption in our operations as a result of
Year 2000 issues could have a material adverse effect on our business, results
of operations and financial conditions.
OUR STATE OF READINESS
Overview. To address Year 2000 readiness, we have implemented a corporate
program to coordinate efforts across all business functions and geographic
areas, including addressing risks associated with business partners and other
third-party relationships. Our internal Year 2000 readiness program is divided
into four program areas: Commercial Product Compliance; Internal Systems and
Technology Compliance; Supplier and Business Partner Compliance; and Facilities
and Safety Compliance. For each of these areas, we are using a four-step
approach that includes: Awareness (ownership and task assignment); Inventory
(listing of all items to be assessed); Assessment (prioritizing inventoried
items, assessing compliance, planning corrective actions, making initial
contingency plans); and Corrective Action (implementing corrective actions,
verifying implementation, and finalizing contingent plans). We have formed a
Year 2000 Steering Team to coordinate this corporate program. We have
substantially completed the assessment phase and corrective actions for all
areas as of September 30, 1999.* There can be no assurance that we will be able
to complete all four phases in a timely manner, if at all, or that the process
will adequately address the Year 2000 Issue.
Commercial Product Compliance. Our currently licensed products are designed
to be Year 2000 compliant. Year 2000 compliant means that our products will
continue to operate substantially in accordance with published documentation on
and after January 1, 2000. We use the British Standards Institute's DISC PD-2000
as our standard for assessing Year 2000 compliance. We have evaluated and tested
all our products for Year 2000 Compliance and believe that all our products
released since November 1998 or currently under development are Year 2000
compliant. For non-compliant products introduced prior to November 1998, we have
identified and provided customer's migration paths in the form of update and
upgrade options. To date, the number of these products and the related cost
associated with our product compliance program have not been significant.
Internal Systems and Technology Compliance.
Core IT Systems. We have implemented the R/3 system from SAP. The R/3
system from SAP is a version of the industry standard SAP enterprise resource
planning system that we have implemented to more fully automate our business
processes and it is certified by SAP as Year 2000 compliant. The implementation
was completed in late 1997 and early 1998 and included most of the major
functional areas of our business. A major upgrade of the R/3 installation was
completed in 1999. Our core web IT infrastructure, which is maintained by
McAfee.com, is substantially Microsoft-based and we have received certificates
of Year 2000 compliance from Microsoft. We have also obtained compliance
certificates from all other significant third
- ---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance
that our actual performance will meet our current expectations. See the Risk
Factors on page 24 for a
discussion of certain factors that could affect future performance.
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party software vendors. Our hardware infrastructure is based on Compaq, Cisco
and HP systems that are less than two years old and which have also been
certified to be Year 2000 compliant.
Other Information Technology Systems. Our other information technology
systems include telephone switches and equipment and software; network, desktop
and server hardware and related operating systems and applications software and
electronic data interchange systems. We have substantially completed our
assessment of these systems and have replaced, upgraded, or planned to replace
or upgrade, those systems that were not Year 2000 compliant. The most
significant non-compliant system was in human resources. We have undertaken to
implement SAP's Human Resources module across all regions of the company to
ensure compliance. All other system compliance projects were substantially
completed as of September 30, 1999. Testing and minor compliance will continue
into the fourth quarter of 1999.*
Facilities and Safety Compliance. Our facilities and safety technology
systems include building systems such as heating, cooling, and air purification,
fire and sprinkler systems, security systems and elevators. Our commitment is to
minimize the business risks attributable to Year 2000 problems in these systems.
We have actively worked with each facilities and safety systems vendor to
identify and resolve any Year 2000 compliance issues and contingency plans have
been formulated for all critical sites, regardless of whether they have been
shown to be compliant or not. Included in these contingency plans are backup web
sites as well as backup organizations, such as call centers. We have
substantially completed the repair or replacement of non-compliant items that
affect our product development, distribution and support operations. All
landlords and facility and safety system providers were included in the Year
2000 compliance assessment.
Supplier and Business Partner Compliance. Our suppliers and business
partners include the sources of the equipment and supplies we use in the conduct
of our business, as well as our financial institutions, and other service
providers. The following steps were taken to determine their Year 2000
compliance:
- we began our vendor, facilities and business partners' Year 2000
validation program in 1998.
- All were assessed to determine their criticality level relating to our
ongoing business. Each vendor was classified as critical, medium or low
importance.
- All of these organizations received and were asked to complete a Year
2000 readiness questionnaire. Approximately 60% responded in writing,
including over 90% of critical vendors.
- All of our critical vendors, or medium importance vendors of highest
priority, regardless of their answers to the questionnaire, were the
subjects of in-depth audits to determine in detail their ability to
support us and our business needs without date-related interruptions.
Every vendor that showed significant flaws or shortcomings in Year 2000
preparedness became the subject of an intensive set of meetings and tests
to ensure each of these organizations brought their programs up to
satisfactory standards. The few organizations that would or could not do
so were replaced with compliant alternate vendors. We have now rated our
critical vendors as Year 2000 compliant.
- All compliance information from these organizations is in writing and on
file at our Year 2000 office.
- Contingency plans have been developed to ensure business operations can
continue and customer support will be available throughout the Year 2000
rollover period.
The Cost to Address Our Year 2000 Issues
Historic or period costs incurred in connection with the resolution of Year
2000 Issues to date have consisted principally of internal labor costs of
compliance planning and assessment and have not been significant. During 1999,
we expect to incur an estimated $4.5 million of compliance related expenditures,
of which approximately $4.0 million has been incurred as of September 30, 1999.*
These expenditures relate primarily to the replacement of certain internal
systems hardware and software, the most significant being new
- ---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance
that our actual performance will meet our current expectations. See the Risk
Factors on page 24 for a
discussion of certain factors that could affect future performance.
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<PAGE> 23
human resource systems. We do not expect expenditures related to Year 2000
compliance in future years to be significant.*
OUR CONTINGENCY PLANS
As part of the four-step process outlined above, specific contingency plans
have been developed in connection with the assessment and resolution of the
risks identified. We are continuing to refine contingency plans for each
specific area of risk associated with the Year 2000 Issue. Staffing models have
been developed and personnel have been identified for on-site and on-call
support. In addition, we have a comprehensive plan to test and ensure each key
office is ready for business in the New Year and after the Leap Year rollover.
THE RISKS OF OUR YEAR 2000 ISSUES
Our expectations as to our efforts to ensure and achieve Year 2000
compliance are forward-looking statements. Actual results may vary materially as
a result of a number of risks and uncertainties, including the following:
- We may not successfully complete our Year 2000 contingency program.
- We may be unable to successfully and timely modify non-Year 2000
compliant products, services and systems.
- Our contingency plans may not address all Year 2000 risks that may
actually arise.
- Our contingency plans will only be effective if timely and properly
implemented.
- We do not have, and do not anticipate obtaining, any insurance policy
providing material coverage for potential injuries or damages related to
or caused by the Year 2000 Issue.
- Actual costs of our Year 2000 compliance efforts may exceed our
estimates.
We have initiated communications with third party suppliers of the major
computers, software, and other equipment used, operated, or maintained by us to
identify and, to the extent possible, to resolve issues involving the Year 2000
problem. However, we have limited or no control over the actions of these third
party suppliers. These suppliers may fail to resolve any or all Year 2000
problems with their respective systems before the occurrence of a material
disruption to our business or any of their other customer's business. Any of the
above risks could have a material adverse effect on our business, results of
operations and financial condition.
Like a number of other enterprise-wide software providers, we have recently
identified and expect a continued slowing or reduction in customer capital
spending as a result of the Year 2000 Issue. If the purchasing patterns of our
current or potential customers, particularly those to whom we market broader
enterprise solutions, are meaningfully impacted by Year 2000 concerns, we could
experience a significant reduction in our net revenues, net income and related
growth.
Lastly, it has been widely predicted that a significant amount of
litigation surrounding business interruptions will arise out of Year 2000
issues. It is uncertain whether, or to what extent, we may be affected by such
litigation. Because our products are able to operate in the Year 2000 and
beyond, we do not anticipate exposure to material product defect or similar
litigation. Any such litigation, however, could have a material adverse effect
on our business, results of operations and financial condition. We also may not
receive any assistance, damages or other relief as a result of our initiation of
any litigation related to the Year 2000 issue. Our inability to implement our
Year 2000 plans or to otherwise address Year 2000 issues in a timely manner
could have a material adverse effect on our business, results of operations and
financial condition.
- ---------------
* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance
that our actual performance will meet our current expectations. See the Risk
Factors on page 24 for a
discussion of certain factors that could affect future performance.
23
<PAGE> 24
RISK FACTORS
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.
OUR QUARTERLY FINANCIAL RESULTS WILL LIKELY FLUCTUATE
Our quarterly operating results have varied greatly in the past and will
likely vary greatly in the future depending upon a number of factors. Many of
these factors are beyond our control. Our revenues, gross margins and operating
results may fluctuate significantly from quarter to quarter due to, among other
things:
- volume, size and timing of new licenses and renewals of existing
licenses;
- our distributor inventory levels and product return rates;
- our inventory levels;
- introduction of new products, product upgrades or updates by us or our
competitors;
- the mix of products we sell;
- the success of our Net Tools product suite and related pricing model;
- our continued evolution as an enterprise-wide software provider and the
related impact on the length of our sales cycle;
- the size and timing of our non-cash stock-based charges;
- changes in product prices by us or our competitors;
- trends in the computer industry;
- delays or reductions in customer software purchases related to their Year
2000 compliance issues;
- costs related to acquisitions of technology or businesses;
- fluctuations in McAfee.com's expenditure levels related to its efforts to
build brand awareness, and establish strategic relationships with various
Internet companies;
- our investment experience related to our strategic minority equity
investments;
- our investment in expanding our European Sniffer organization may not pay
off;
- the effectiveness of our channel strategy and our mix of direct and
indirect revenues;
- pressure on employee wages as competition for skilled employee's
increases; and
- costs related to extraordinary events including litigation and
acquisitions.
Our business is impacted by the seasonal trends and global or regional
macroeconomic trends. For example, our net revenues is typically higher in the
fourth quarter, as many customers complete annual budgetary cycles, and lower in
the summer months when many businesses experience lower sales, particularly in
the European market. Our business in Japan, Asia generally and Latin America has
been adversely impacted by the adverse economic conditions there. If these
conditions were to spread to Europe or the U.S., our business, results of
operations and financial condition would be adversely impacted.
IN THE NEAR-TERM, WE EXPECT LIMITED GROWTH IN NET INCOME AND NET REVENUES
We have historically experienced significant growth in net income (before
acquisition and related costs) and net revenues. However, our rate of growth has
slowed due to increased price competition, a maturing anti-virus market and an
increasingly higher base from which to grow and changes in customer purchasing
patterns related to Year 2000 concerns. Like a number of other enterprise-wide
software providers, we have recently identified and expect a continued slowing
or reduction in customer capital spending related to Year 2000
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compliance issues. Also, our strategy of up-selling existing licenses to higher
level product suites and the increasing complexity of our products has resulted
in longer sales cycles for our products. These factors have caused us to realign
our channel inventory levels, which has caused our revenues to decrease. We
could continue to experience pressure on our net revenues, net income and
related growth as the purchasing patterns of our current or potential customers,
particularly those to whom we market broader enterprise solutions, are
meaningfully impacted by Year 2000 concerns. Our growth rate and net revenues
also depend significantly on renewals of existing orders. If our renewal or
up-sale rates slow or decline, our net revenues and operating results would be
adversely affected.
THE TIMING AND AMOUNT OF OUR REVENUES ARE SUBJECT TO A NUMBER OF FACTORS THAT
MAKE IT DIFFICULT TO ESTIMATE OPERATING RESULTS PRIOR TO THE END OF A QUARTER
We do not expect to maintain a significant level of backlog. As a result,
product revenues in any quarter are dependent on contracts entered into or
orders booked and shipped in that quarter. We have 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. This trend makes
predicting revenues more difficult. The timing of closing larger orders
increases the risk of quarter-to-quarter fluctuation. As we have evolved as an
enterprise-wide software provider and continued with our efforts to license
larger product suites under the Net Tools umbrella, the size of our orders and
the length of our sales cycle have increased and may increase further. If orders
forecasted for a specific customer for a particular quarter are not realized or
revenues are not otherwise recognized in that quarter, our operating results for
that quarter could be materially adversely affected.
OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE
During the first nine months of 1999, our stock price ranged from a
per-share high of $67.50 to a low of $10.06. Announcements, litigation
developments, and our ability to meet the expectations of brokerage firms,
industry analysts or investors with respect to our operating and financial
results may contribute to this volatility. We may not discover, or be able to
confirm, revenue or earnings shortfalls until the end of a quarter, which could
result in an immediate drop in our stock price. In addition, similar events with
respect to McAfee.com and fluctuations in its stock price may also contribute to
the volatility of our stock price. In the past, following periods of volatility
in the market price of a company's securities, securities class action
litigation has often been instituted against companies with public traded
securities. A number of putative class actions were brought against us, our
officers and our directors. See "Note 8 of the Notes to Condensed Consolidated
Financial Statements." This litigation, and any other litigation if instituted,
could result in substantial costs and a diversion of management's attention and
resources.
COMPETITORS MAY INCLUDE PRODUCTS SIMILAR TO OURS IN THEIR HARDWARE OR SOFTWARE
AND RENDER OUR PRODUCTS OBSOLETE
Vendors of hardware and of operating system software or other software
(such as firewall or e-mail software) may enhance their products or bundle
separate products to include network security and management software similar to
our products. For example, Cisco incorporated a firewall in its hardware
products and Microsoft Corporation introduced limited anti-virus functionality
into versions of MS-DOS in 1993. The widespread inclusion of products that
perform the same or similar function as our products within computer hardware or
other software could render our products obsolete and unmarketable. Furthermore,
even if these incorporated products are inferior or more limited than our
products, customers may elect to accept the incorporated products rather than
purchase our products. If we are unable to develop new network security and
management products to further enhance operating systems or other software and
to successfully replace any obsolete products, our business could suffer.
WE EXPECT SIGNIFICANT STOCK BASED COMPENSATION CHARGES
In light of the recent decline in our stock price and in an effort to
retain our employee base, in April 1999, we offered to reprice options held by
all employees, other than directors and executive officers. In exchange for
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<PAGE> 26
their agreeing to not exercise any of the repriced options for a period of
twelve months, the exercise price of all eligible employee options with an
exercise price in excess of $11.0625 was reduced to $11.0625, the closing market
price on the NASDAQ on April 22, 1999. Option holders electing to have their
options repriced were required to acknowledge their acceptance by April 28,
1999. As a result of the increase in price between the date on which the options
were repriced, April 22, 1999, and the date on which the employees elected to
reprice their option grants, April 28, 1999, we have and will continue to incur
a stock-based compensation charge. The total compensation charge expensed for
the three and nine months ended September 30, 1999 was approximately $1.6
million and $8.2 million, respectively, and approximately $14.5 million will be
expensed over the remaining vesting period of the repriced options.
On March 31, 1999, the FASB issued an exposure draft of its Proposed
Interpretation, "Accounting for Certain Transactions involving Stock
Compensation -- an interpretation of APB Opinion No. 25" (the "Proposed
Interpretation"). Under the Proposed Interpretation, stock options repriced
after December 15, 1998 will be subject to variable plan accounting treatment.
If adopted, this proposed guidance will require us to remeasure compensation
cost for outstanding repriced options each reporting period based on changes in
the market value of the underlying common stock after the date of adoption. The
FASB currently expects to approve the interpretation in the fourth quarter of
1999. Depending upon movements in the market value of our common stock, this
accounting treatment may result in significant additional compensation charges
in future periods.
In the first and third quarters of 1999, McAfee.com, our subsidiary,
granted options to individuals, including Network Associates executive officers
and non-executive employees, who are not employed by McAfee.com. The total
compensation charge expensed for the three and nine months ended September 30,
1999 was approximately $5.0 million and $6.6 million, respectively. As these
options are all fully vested, we do not expect to incur, on a consolidated
basis, additional future charges related to these option grants. See
"Management's Discussion and Analysis of Operating Results and Financial
Condition."
WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE TRANSACTIONS
The software industry has experienced, and is expected to continue to
experience, a significant amount of consolidation. As part of our growth
strategy, we may buy or make investments in, complementary companies, products
and technologies. Since 1994 we have completed a large number of significant
acquisitions involving both public and private companies, including:
- CyberMedia in September 1998;
- Dr Solomon's in August 1998;
- Magic Solutions and TIS in April 1998;
- Network General, PGP and Helix Software in December 1997;
- Cinco Networks in August 1997 (acquired by Network General);
- Vycor Corporation in February 1996; and
- Saber Software in August 1995;
We have also completed a number of smaller acquisitions and acquired a
number of our international distributors. Recently, we began making strategic
minority investments in complementary Internet related companies. As of
September 30, 1999, these minority investments totaled $28.5 million. We are
currently investigating acquisitions of additional foreign distributors and
other strategic minority investments.
Our acquisitions and strategic investments involve a number of risks and we
may not realize the expected benefits of these transactions. We may lose all or
a portion of our investment, particularly in the case of our strategic minority
investments.
The integration of transactions involves a complex, time consuming and
expensive process. Prior to any acquisition, each company has its own business,
culture, clients, employees and systems. Following any
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acquisition, we must operate as a combined organization utilizing common
information communication systems, operating procedures, financial controls and
human resource practices. In order to successfully integrate acquired companies,
we must, among other things, successfully:
- attract and retain key management and other personnel;
- integrate, both from an engineering and a sales and marketing
perspective, the acquired products into our suite of product offerings;
- coordinate research and development efforts;
- integrate sales forces; and
- consolidate duplicate facilities.
The difficulties of integrating an acquired company may be worsened by the
geographic distance between the companies, the complexity of the technologies
and operations being integrated, and the disparate corporate cultures being
combined. Successful acquisitions may be more difficult to accomplish in the
high technology industry than in other industries, and will require the
dedication of our management resources. Management's focus on the integration of
operations may distract attention from our day-to-day business, and may disrupt
key research and development, marketing or sales efforts. In addition, it is
common in the technology industry for aggressive competitors to attract
customers and recruit key employees away from companies during the integration
phase of an acquisition. If we cannot successfully integrate any acquisition,
our business could suffer.
In 1997 and 1998, we incurred significant nonrecurring charges associated
with our previous acquisitions. Our available cash and our securities may be
used to buy or invest in companies or products, which could result in
significant acquisition-related charges to earnings and dilution to our
stockholders. Moreover, if we buy a company, we may have to incur or assume that
company's liabilities, including liabilities that are unknown at the time of
acquisition, which may result in a material adverse effect on us.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE
NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT
In connection with our previous acquisitions accounted for under the
purchase method of accounting, in future periods we will experience significant
charges related to the amortization of purchased technology and goodwill. In
addition, if we later determine that this purchased technology and goodwill is
impaired, we will be required to take a related non-recurring charge to
earnings.
WE FACE RISKS RELATED TO OUR NET TOOLS MEGA-SUITE BUSINESS STRATEGY
Historically, a majority of our revenues resulted from the licensing of our
flagship anti-virus products and Sniffer products. Over the last year we have
been focusing our efforts on broadening our revenue base by providing network
security and management solutions to enterprise customers, targeting in
particular the Windows NT/Intel platform. To this end, we organized our products
into four product suites -- McAfee Total Virus Defense, PGP Total Active
Security, Sniffer Total Network Visibility and McAfee Total Service
Desk -- which form our integrated "Net Tools" mega-suite solution. The Net Tools
product suite model involves a modified product pricing structure. Potential
customers may not respond favorably to this modified pricing structure and the
lack of a favorable response could materially adversely affect our operating
results. In addition, as part of the Net Tools concept, we are 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. We face
significant engineering challenges related to these efforts. Success of our Net
Tools suite strategy will also depend, in part, on the following factors:
- successful development and coordination of our enterprise sales force;
- successful development of a national accounts sales force; and
- the development and expansion of an effective professional services
organization.
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WE FACE RISKS RELATED TO OUR SNIFFER PRODUCT STRATEGY
Although we will continue to offer perpetual licenses with annual support
and maintenance contracts for our Sniffer products, we have recently developed a
subscription-licensing model for these products. We are also seeking to increase
our total Sniffer unit sales through recently developed software-only versions
of some of our Sniffer products, which we would mean that we would no longer
sell the hardware components contained in those products. However, there is a
risk that customers will continue to require that we provide the hardware
platform and components currently contained in our Sniffer products. Despite our
efforts, total unit license of Sniffer products may not increase and customers
may not accept the subscription-pricing model for Sniffer products. To the
extent that customers do license Sniffer products on a two-year subscription
basis or license significant amounts of software-only Sniffer products, our
operating results and financial condition would be likely be affected in the
following ways:
- in the case of subscription licenses, we would expect an increase in
deferred revenues related to the service portion of the two-year Sniffer
license that would be capitalized on our balance sheet;
- in the initial year of the subscription license, the corresponding
revenue would be lower than if the license were perpetual; and
- in the case of the software-only Sniffer product license, we would expect
lower total revenues and a higher overall gross margin related to that
license, as we would not be selling the corresponding hardware component
(currently the hardware component generates a lower gross margin than the
total product gross margin).
We recently began investing significant resources to increase the European
Sniffer sales organization in an effort to increase brand awareness in Europe.
There is no guarantee that this investment will produce the desired results.
WE FACE RISKS RELATED TO OUR MCAFEE.COM STRATEGY
In December 1998, we incorporated McAfee.com, our wholly owned subsidiary,
as our Internet destination dedicated to updating, upgrading and managing
personal computers, or PCs, over the Internet for single use retail,
non-corporate, consumers. Effective January 1, 1999, we contributed certain
assets and liabilities to McAfee.com and in connection therewith have entered
into various inter-company arrangements including technology, licenses, shared
facilities, functions, services and tax sharing agreements. In September 1999,
McAfee.com filed a registration statement with the Securities and Exchange
Commission in connection with its proposed initial public offering of 6.25
million shares of its Class A common stock, which is entitled to one vote per
share. We currently own all 36.0 million shares of McAfee.com's Class B common
stock, which is generally entitled to three votes per share and converts to
shares of McAfee.com Class A common stock if sold by us to a third party. The
offering is expected to close, if at all, in the fourth quarter of 1999.
Assuming no exercise of the underwriter's over-allotment option, upon completion
of the offering we will own approximately 85% of McAfee.com's outstanding
capital stock and approximately 95% of its total voting power.
Pursuant to our cross license agreement with McAfee.com, we have licensed
all our technology to McAfee.com for use in the markets specified below and
McAfee.com has licensed its technology to us for our use outside of McAfee.com's
markets. Under our license and other agreements with McAfee.com, among other
things:
- McAfee.com has the exclusive right to use the licensed technology for
providing single-user consumer licenses for our products and services
sold over the Internet or for Internet-based products and licensing the
technology to original equipment manufacturers for sale to individual
consumers;
- we are permitted to continue to sell our consumer products through
non-online channels, such as traditional retail stores, however
McAfee.com's sales of online products and services could significantly
reduce sales of these products;
- we may not offer a product incorporating third party technology if those
products are competitive with products offered by McAfee.com;
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- McAfee.com is required to pay us a license fee of 20% of net revenue
derived from product sales that include the licensed technology
commencing on January 1, 1999 and declining 1.625% per quarter until the
rate is 7% in the quarter beginning January 1, 2001;
- the license agreement is perpetual and may only be terminated by us if
McAfee.com fails to cure a material breach of the license within 30 days
after we notify it of the breach, subject to mandatory dispute resolution
prior to the effectiveness of any proposed termination;
- we are required to indemnify McAfee.com with respect to existing
litigation related to the licensed technology to which we are a party,
including the litigation described in Note 8 of the Notes to the
Consolidated Financial Statements;
- McAfee.com has agreed to provide the infrastructure and technical support
for our web site;
- generally, we are required to cause to be elected at least two
independent directors to the McAfee.com board of directors, which term
would exclude any serving Network Associates officer or director; and
- if, without the prior approval of our continuing directors (being our
current directors and directors approved or not objected to by our
current directors), someone acquires 15% or more of our outstanding
capital stock or our continuing directors cease to constitute a majority
of our board (1) we are required to vote our shares of McAfee.com common
stock and otherwise seek to cause to the McAfee.com board of directors to
consist of at least a majority of independent directors and (2) our
shares of McAfee.com Class B common stock will be entitled to only one
vote per share instead of three.
In addition to selling traditional software licenses and related
maintenance for our consumer products over the Internet, McAfee.com has
developed an application service provider, or ASP, model providing consumers
with online access to PC security and management products and services hosted on
McAfee.com's servers. This web-based model is a relatively new concept, and to
build awareness and demand for subscription products and services, McAfee.com
initially offered its hosted product, McAfee Clinic, for free. On September 2,
1999 McAfee.com began charging a subscription fee for McAfee Clinic. In July
1999, we began a national marketing campaign to build brand awareness for the
McAfee.com web site and McAfee.com products. We expect that the McAfee.com
business will incur significant losses for the foreseeable future. These losses
will be funded by us and will impact our consolidated financial results. The
growth and market acceptance of McAfee.com's online PC security and management
products and services is highly uncertain and subject to a number of factors,
including:
- potential unwillingness of consumers to pay for McAfee.com's subscription
based products and services and its ability to properly price its
products and services to generate the greatest revenue opportunities;
- consumer reluctance to change their software purchasing behavior in favor
of services hosted on the McAfee.com's servers; and
- consumer concerns about whether the Internet is fast and reliable enough
to deliver critical PC security and management functions effectively.
McAfee.com's services are designed to protect consumer privacy by ensuring
that all PC scans are done locally at the PC, all information about the user's
PC is transmitted to it anonymously and no scanned data is stored by it.
However, consumers' misconceptions about this process could prevent McAfee.com's
ASP model from achieving market acceptance.
WE FACE RISKS RELATED TO OUR STRATEGY OF ACQUIRING INDEPENDENT AGENTS AND
DISTRIBUTORS
We have acquired existing independent agents and distributors of our
products in certain strategic markets. We may be required to provide customers
the same level of technical support that was previously provided by the acquired
agents and distributors. We may be unable to provide technical support or
operate any acquired distributor or agent as well as previous operators or at
all. The acquisition of any distributor or agent may not result in increased
foreign revenues.
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OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISKS
ASSOCIATED WITH PRODUCT DEVELOPMENT
The network security and management market is highly fragmented and
characterized by ongoing technological developments, evolving industry standards
and rapid changes in customer requirements. Our success will depend on our
ability to:
- offer a broad range of network security and management software products;
- continue to enhance existing products and expand product offerings;
- develop and introduce in a timely manner new products with technological
advances;
- respond promptly to new customer requirements;
- comply with evolving industry standards without delays in compliance;
- provide upgrades and updates to users frequently and at low cost; and
- remain compatible with popular operating systems such as Windows 95,
Windows NT and NetWare.
We may not be able to successfully develop and market, on a timely basis,
enhancements to our existing products or new products. Our product enhancements
or new products may not adequately address the changing needs of the
marketplace. New products with new technological capabilities could replace or
shorten the life cycle of our products or cause our customers to defer or cancel
purchases of our products.
We may continue to experience delays in software development as we have at
times in the past. Complex software products like ours may contain undetected
errors or version compatibility problems, particularly when first released,
which could delay or cost us our market acceptance. For example, we experienced
compatibility issues in connection with our recent NetShield upgrade, and our
anti-virus software products have in the past falsely detected viruses that did
not actually exist. Difficulties and delays associated with new product
introductions, performance or enhancements could have a material adverse effect
on our business, financial condition and results of operation.
Our product development efforts are impacted by the adoption or evolution
of industry standards. For example, no uniform industry standard has developed
in the market for encryption security products. As industry standards are
adopted or evolve, we may have to modify existing products or develop and
support new versions of existing products. In addition, if no industry standard
develops, our products and our competitors' products could be incompatible,
which could prevent or delay overall development of the market for a particular
product. If our products fail to comply with existing or evolving industry
standards in a timely fashion, our business, results of operation and financial
condition could be materially and adversely affected.
Our long-term success depends on our ability to upgrade and update existing
product offerings, modify and enhance acquired products and introduce new
products, which meet our customers' needs. Future upgrades and updates may
include additional functionality, respond to user problems or address
compatibility problems with changing operating systems and environments. We
believe that our ability to provide these upgrades and updates frequently and at
low costs is key to our success. For example, the proliferation of new and
changing viruses makes it imperative to update anti-virus products frequently to
avoid obsolescence. Failure to release upgrades and updates could have a
material adverse effect on our business, results of operations and financial
condition. We may not be successful in these efforts. In addition, future
changes in Windows 95, Windows NT, NetWare or other popular operating systems
could cause compatibility problems with our products. Further, delays in the
introduction of future versions of operating systems or lack of market
acceptance of these future versions would delay or reduce demand for our future
products which were designed to operate with these future operating systems. Our
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 our business, results of operation and
financial condition.
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WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenues from our
flagship McAfee anti-virus software products and Sniffer network fault and
performance management products. These products are expected to continue to
account for a significant portion of our net revenues for the foreseeable
future. Because of this concentration of revenue, a decline in demand for or in
the prices of these products as a result of competition, technological change, a
change in our pricing model, inclusion of anti-virus or network management and
analysis software as a standard part of hardware or operating system software or
other software, or a maturation in the markets for these products, could harm
our business.
IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE
ANTICIPATE, OUR BUSINESS COULD SUFFER
The markets for our network management and network security products are
evolving, and their growth depends upon broader market acceptance of this
software, including help desk software. Although the number of personal
computers, or PCs, attached to large-area networks has increased dramatically,
the network management and network security markets continue to be emerging
markets. These markets may not continue to develop or may not develop rapidly
enough to benefit our business 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, our products may not be selected by potential purchasers. To
the extent that either the network management or network security market does
continue to develop, we expect that competition will increase.
WE ARE SUBJECT TO INTENSE COMPETITION IN THE NETWORK MANAGEMENT AND SECURITY
MARKETS AND WE EXPECT TO FACE INCREASED COMPETITION IN THE FUTURE
The markets for our products are intensely competitive, and we expect
competition to increase in the near-term. We believe that the principal
competitive factors affecting the markets for our 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.
Performance and quality of our anti-virus software products are measured by
number and type of viruses detected, the speed at which the products run and
ease of use. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors, and/or greater financial, technical and marketing resources.
These factors may provide our competitors with an advantage in penetrating the
original equipment manufacturer, or OEM, market with their network security and
management products. As is the case in many segments of the software industry,
we have been encountering, and we expect to further encounter, increasing
competition. This increased competition could reduce average selling prices and,
therefore, profit margins. Competitive pressures could result not only in
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price reductions but also in a decline in sales volume, which could cause our
business to suffer. In addition, competitive pressures may make it difficult for
us to maintain or exceed our historic 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 companies. Our principal competitors in the anti-virus market
include Symantec, Computer Associates/Cheyenne Software, IBM, and Trend Micro,
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, our principal
competitors are Security Dynamics, Cylink, Entrust Technologies and VeriSign.
Our principal competitors in the help desk market are Remedy and Software
Artistry, recently acquired by Tivoli Systems/ IBM. Our principal competitor in
the software-based network fault and performance management market is
Hewlett-Packard with other competitors including Azure Technologies, Concord
Communications, DeskTalk Systems, Kaspia Systems, Shomiti Systems, and Wandel &
Goltermann. We also face competition in the security market from Cisco, Security
Dynamics, Checkpoint Software, Internet Security Systems and Axent, and other
vendors in the encryption/firewall/intrusion detection market. In addition, we
face 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, we 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 companies who are able to provide the
necessary software and support capabilities. In addition, to the extent that we
are successful in developing our Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
we will likely compete with large computer systems management companies such as
Tivoli Systems and Computer Associates. We may be unable to 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 we do. In addition, software companies who currently use
traditional distribution methods may in the future decide to compete more
directly with us by utilizing electronic software distribution.
OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH COULD
ADVERSELY AFFECT OUR BUSINESS; OUR SALES CYCLE IS LONG, WHICH COULD ADVERSELY
AFFECT OUR QUARTERLY RESULTS
Our products may be considered to be capital purchases by certain customers
or prospective customers. Capital purchases are often 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
cancellation or delay could adversely affect our results of operations.
In addition, as we have continued to evolve as an enterprise-wide software
provider and continue to focus on the sale of product suites under the Net Tools
umbrella, our sales cycle has lengthened and may continue to lengthen. Sales of
large complex products, particularly product suites, frequently require a long
education process and significant technical evaluation and commitment of capital
and other resources. Moreover, these sales 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 network and
testing and accepting new technologies that affect key operations. Because of
these longer sales cycles and the potential large size of such orders, if
anticipated orders are not realized or revenues are not otherwise recognized in
a particular quarter, our operating results for that quarter could suffer.
WE HAVE ONLY RECENTLY DEVELOPED OUR LARGE ACCOUNTS SALES FORCE; WE FACE RISKS
RELATED TO OUR SALES FORCE STRUCTURE
Our North American direct sales force is divided into three tiers. The
first tier focuses on the sale of all of our product suites under the Net Tools
umbrella to enterprise and national account customers. The second tier consists
of two separate sales groups focused on the sale of the two product supersuites
(Net Tools Secure and Net Tools Manager) to the departmental level. The third
tier consists of four separate outbound corporate
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telesales forces that actively market our individual product suites to customers
with less than 1,000 end users. Historically, we have not had a large enterprise
or national account's sales force and only recently developed a direct sales
group focused on these larger accounts.
To succeed in the direct sales channel for the enterprise and national
accounts market and for the sale of the separate security product suite, we must
build a significant direct sales organization and must attract and retain
qualified personnel. These individuals will require training about, and
knowledge of, product attributes for our various product suites. We may not
succeed in building the necessary sales organization or in attracting, retaining
or training these individuals. Historically, we sold our products at the
departmental level. To succeed in the enterprise and national accounts market
requires, among other things, our establishing relationships and contacts with
senior technology officers at these accounts. Our sales force may not succeed in
these efforts.
Our sales organization structure may result in multiple customer contacts
by our different sales representatives, particularly in circumstances where the
customer has multiple facilities and offices. These multiple contacts may likely
result from a lack of coordination between our 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 our business, results of operations and
financial condition. In addition, while the development of a direct sales
channel reduces our 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 our gross margin and operating profit.
WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES, WHO MAY NOT VIGOROUSLY MARKET OUR
PRODUCTS, HAVE RIGHTS OF RETURN OR MAY HAVE DIFFICULTY IN TIMELY PAYING FOR
PURCHASED PRODUCTS
We market a significant portion of our products to end-users through
intermediaries, including distributors, resellers and value-added resellers.
Beginning in 1998, our dependence on these indirect sales channels increased
significantly with the development of a software-only version of our Sniffer
product and the acquisition of CyberMedia in September 1998. The Sniffer product
was previously only a combined software/hardware product with a limited number
of resellers. CyberMedia sold its products only through indirect channels.
Our distributors sell other products that are complementary to, or compete
with, our products. While we encourage our distributors to focus on our products
through market and support programs, these distributors may give greater
priority to products of other suppliers, including competitors. Our agreements
with our distributors generally permit our distributors to return our product to
us in the event of end user returns to the distributor, inaccurate estimates of
end user demand by the distributor, increased purchases by distributors in
response to sales incentives or transitions to new products. We record sales to
distributors as revenue and at the same time establish a reserve for returns.
Returns could exceed reserves as a result of distributors holding excessive
amounts of our product in inventory. Our current or future reserves for returns
could be inadequate which would adversely impact our operating results.
Many of our distributors are experiencing economic difficulties worldwide,
which may adversely impact our collection of accounts receivable. For example,
one of our major European distributors recently experienced significant cash
flow issues. As a result, in the quarter ended June 30, 1999 we recorded a $31.8
million reserve for payment default. We regularly review the collectibility and
credit worthiness of our distributors to determine an appropriate allowance for
doubtful accounts' reserve. Our uncollectible accounts could exceed our current
or future allowance for doubtful accounts' reserve, which would adversely impact
our operating results.
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WE NEED TO EXPAND AND DEVELOP AN EFFECTIVE PROFESSIONAL SERVICES ORGANIZATION;
WE RELY ON THIRD-PARTY PROFESSIONAL SERVICES
As our products and computer networks in general increase in complexity,
customers require greater professional assistance to design, install, configure
and implement our products. To date, we have relied on our limited professional
services capabilities and increasingly on outside professional service
providers, including our distributors, resellers and system integrators. These
third party service providers may provide inadequate levels of professional
services. Moreover, reliance on these third parties both places a greater burden
on them and reduces our ability to control and establish standards for providing
these support services. Our reliance on these third parties could, delay our
recognition of product revenue, harm our relationships or reputation with these
third parties or the end users of our products or result in decreased future
sales of, or prices for, our products.
To more effectively service our customer's evolving needs, we intend to
significantly expand and develop our worldwide professional service
organization. We may not succeed in these efforts. Effectively expanding and
developing our professional services organization will require that we hire and
train more service professionals who must be continually trained and educated to
ensure that they possess sufficient technical skills and product knowledge. The
market for qualified professionals is intensely competitive, making hiring and
retention difficult. We expect significant competition in this market from
existing providers of professional services and future entrants. We must also
properly price our services to attract customers, while maintaining sufficient
margins for these services. We therefore expect that we will have lower profit
margins on our service revenues. The failure to develop an effective
professional services organization could have a material adverse effect on our
business, results of operations and financial condition.
WE RELY ON THE CONTINUED PROMINENCE OF MICROSOFT TECHNOLOGY
Although we intend to support other operating systems, our mission is to be
the leading supplier of network security and management products for Windows
NT/Intel based Network. Sales of our products would be materially and adversely
affected by market developments, which are adverse to the Windows operating
environments, including the failure of users and application developers to
accept Windows NT. In addition, our ability to develop products using the
Windows operating environments is dependent on our ability to gain timely access
to, and to develop expertise in, current and future developments by Microsoft.
We may not be able to gain the necessary access from Microsoft.
WE MUST EFFECTIVELY MANAGE OUR GROWTH
Our business has grown rapidly, both internally and through acquisitions.
This growth has placed, and any future growth would continue to place, a
significant strain on our limited personnel, management and other resources. Our
ability to manage any future growth, particularly with the anticipated expansion
of our international business and growth in distribution business, will require
us to:
- attract, train, retain, motivate and manage new employees successfully;
- effectively integrate new employees into our operations; and
- continue to improve our operational, financial, management and
information systems and controls.
If we continue to grow, our management systems currently in place may be
inadequate or we may not be able to effectively manage this growth. We are
currently investing in our Internet infrastructure in anticipation of expected
growth from the Internet, which may fail to materialize.
WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WHICH OFFER ONLY LIMITED
PROTECTION AGAINST POTENTIAL INFRINGERS; WE MAY FACE LITIGATION RELATED TO OUR
PROPRIETARY TECHNOLOGY AND RIGHTS
Our success depends significantly upon our proprietary software technology.
We rely on a combination of contractual rights, trademarks, trade secrets,
patents and copyrights to establish and protect proprietary rights in our
software. However, these protections may be inadequate or competitors may
independently develop
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technologies or products that are substantially equivalent or superior to our
products. We do not typically obtain signed license agreements from our
corporate, government and institutional customers who license products directly
from us. Rather, we include an electronic version of a shrink-wrap license in
all of our electronically distributed software and a printed license in the box
for our products distributed through traditional distributors in order to
protect our copyrights and trade secrets in those products. Since none of these
licenses are signed by the licensee, many legal 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 these rights at all or offer only limited protection for these rights.
The steps taken by us to protect our proprietary software technology may be
inadequate to deter misuse or theft of this technology. For example, we are
aware that a substantial number of users of our anti-virus products have not
paid any registration or license fees to us. Changing legal interpretations of
liability for unauthorized use of the our software, or lessened sensitivity by
corporate, government or institutional users to avoiding infringement of
intellectual property, could have a material adverse effect on our business,
results of operations and financial condition.
There has been substantial litigation regarding intellectual property
rights of technology companies. In the past we have been, and we currently are,
subject to litigation related to our intellectual property, including a pending
unfair trade practice case and separate patent infringement cases involving each
of Symantec, Hilgraeve and Trend Micro. See "Note 8, Notes to the Condensed
Consolidated Financial Statements." Although we intend to defend ourselves
vigorously against claims asserted against us in the foregoing actions or
matters, developments arising out of this pending litigation or any other
litigation to which we are or may become a party could have a material adverse
effect on our business, results of operation and financial condition. Adverse
determinations in litigation could:
- result in the loss of our proprietary rights;
- subject us to significant liabilities;
- require us to seek licenses from third parties; or
- prevent us from manufacturing or selling our products.
The litigation process is subject to inherent uncertainties and we may not
prevail in these matters, or we may be unable to obtain licenses with respect to
any patents or other intellectual property rights that may be held valid or
infringed upon by us or our 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 us.
In addition, as we may acquire a portion of software included in its
products from third parties, our exposure to infringement actions may increase
because we must rely upon such third parties as to the origin and ownership of
any software being acquired. Similarly, exposure to infringement claims will
increase to the extent that we employ or hire additional software engineers
previously employed by competitors, notwithstanding measures taken by these
competitors to protect their intellectual property. In the future, litigation
may be necessary to enforce and protect trade secrets and other intellectual
property rights that we own. We may also be subject to litigation to defend
against claimed infringement of the rights of others or determine the scope and
validity of the proprietary rights of others. This litigation could be costly
and cause diversion of management's attention, either of which could have a
material adverse effect on our business, results of operations and financial
condition.
OUR INTERNATIONAL OPERATIONS SUBJECT US TO FOREIGN CURRENCY FLUCTUATIONS AND
OTHER INHERENT RISKS RELATED TO DOING BUSINESS IN FOREIGN COUNTRIES
In the first nine months of 1999 and in 1998, 1997 and 1996, net revenues
from international licenses represented approximately 40%, 36%, 36% and 32%,
respectively, of our net revenues. Historically, we have relied upon independent
agents and distributors to market our products internationally. We expect that
international revenues will continue to account for a significant percentage of
net revenues. We also expect that a significant portion of this international
revenue will be denominated in local currencies. To reduce the
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impact of foreign currency fluctuations, we use nonleveraged forward currency
contracts. However, our future results of operations may be adversely affected
by currency 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 activities during
the third quarter;
- tariffs and other trade barriers;
- export restrictions on our encryption and other security products;
- uncertainties relative to regional economic circumstances, including the
current economic turbulence in Asia;
- political instability in emerging markets and difficulties in staffing;
and
- managing foreign operations.
These factors may have a material adverse effect on our future
international license revenue. Further, in countries with a high incidence of
software piracy, we may experience a higher rate of piracy of our products.
In addition, a portion of our international revenue is expected to continue
to be generated through independent agents. Since these agents are not our
employees and are not required to offer our products exclusively, they may
discontinue marketing our products entirely. Also, we may have limited control
over these agents, limited access to the names of the customers to whom these
agents sell its products and limited knowledge of the information provided by,
or representations made by, these agents to its customers.
COMPUTER "HACKERS" MAY DAMAGE OUR PRODUCTS
Given our high profile in the security software market, we have been a
target of computer hackers who have, among other things, created viruses to
sabotage or otherwise attack our products. While to date these efforts have been
discovered quickly and their adverse impact has been limited, similar viruses or
efforts may be created or replicated in the future. In this event, users'
computer systems could be damaged and demand for our software products may
suffer as a result. In addition, since we do not control diskette duplication by
distributors or our independent agents, diskettes containing our software may be
infected with viruses.
FALSE DETECTION OF VIRUSES AND ACTUAL OR PERCEIVED SECURITY BREACHES COULD
ADVERSELY AFFECT OUR BUSINESS
Our anti-virus software products have in the past and may at times in the
future falsely detect viruses that do not actually exist. These false alarms,
while typical in the industry, may impair the perceived reliability of our
products and may therefore adversely impact market acceptance of our products.
In addition, we have 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, an actual or perceived breach of network
or computer security at one of our customers, regardless of whether the breach
is attributable to our products, could adversely affect the market's perception
of our security products. This could adversely effect our business, results of
operations and financial condition.
OUR CRYPTOGRAPHY TECHNOLOGY IS SUBJECT TO EXPORT RESTRICTIONS AND MAY BECOME
OBSOLETE
All of our products are subject to the U.S. Export Administration
Regulations, governed by the U.S. Department of Commerce. Certain of our network
security products, technology and associated technical assistance, particularly
products and technology incorporating encryption, may be subject to export
restrictions. Network Associates may be required to obtain export licenses,
reviews or approvals from the U.S. Government prior to exporting these products
to certain customers. As result of this regulatory regime, foreign competitors
facing less stringent controls may be able to compete more effectively than we
can in the global
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market. While we have obtained approval from the Department of Commerce to
export certain products, the U.S. Government may or may not approve pending or
future export license requests. Further, the list of products and end users for
which export approval is required, and the regulatory policies with respect
thereto, are subject to revision by the U.S. Government at any time. Inability
to obtain the required licenses, the cost of compliance with U.S. and
international export laws, and changes in existing laws could affect our ability
to sell certain products in certain markets, and could have a material adverse
effect on our international revenues. While the U.S. Department of State has
announced its intentions to significantly relax the restrictions on the export
of encryption products, information regarding the pending regulations indicates
that significant restrictions will still exist on exports to certain foreign
customers and to certain foreign jurisdictions
In addition, some of our network security products are dependent on the use
of public key cryptography technology. This technology depends in part upon the
application of certain mathematical principles known as factoring and discrete
logarithms. The security afforded by public key cryptography technology is based
on our belief that the factoring of large prime numbers and solving the discrete
log problem is not computationally practical. Should an easy factoring method be
developed or the discrete log problem be solved, the security afforded by
encryption products using 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 our existing products and
services obsolete or unmarketable. Moreover, the cryptographic algorithms used
in our products can theoretically be solved by computer systems significantly
faster and more powerful than those presently available. If these improved
techniques for attacking cryptographic systems were ever developed, our business
would be adversely affected.
PRODUCT LIABILITY CLAIMS ASSERTED AGAINST US IN THE FUTURE COULD ADVERSELY
AFFECT OUR BUSINESS
Our network security and management software products are used to protect
and manage computer systems and networks that may be critical to organizations.
As a result, our sale and support of these products involves the risk of
potential product liability and related claims. Our license agreements with our
customers typically contain provisions designed to limit our 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 us could
have a material adverse effect on our business, results of operations and
financial condition.
OUR MANAGEMENT AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, THESE
INDIVIDUALS MAY NOT REMAIN WITH US IN THE FUTURE
We rely, and will continue to rely, on a number of key technical and
management employees. While employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, our employees are
generally not otherwise subject to employment agreements or to noncompetition
covenants. If any of our key employees leave, our business, results of
operations and financial condition could suffer. Furthermore, we do not maintain
life insurance policies on our key employees.
Our ability to achieve our revenue and operating performance objectives
will depend in large part on our ability to attract and retain technically
qualified and highly skilled sales, consulting, technical, marketing and
management personnel. Competition for these employees is intense and is expected
to remain so for the foreseeable future. We have seen upward pressure on wages
as a result of this intense competition for employees, which could cause an
increase in our operating expenses. We may not be successful in retaining our
existing key personnel and in attracting and retaining the personnel we require,
and our failure to retain and hire key employees could adversely affect our
business and operating results. For example, in April 1998, Mr. Leslie Denend
resigned from his position as president of the Company, although he remains on
the Company's Board of Directors. Additions of new and departures of existing
employees, particularly in key positions, can be disruptive and can result in
departures of existing employees, which could adversely affect our business.
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WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING
We are currently engaged in several research and development contracts with
agencies of the U.S. government. We believe that the willingness of these
government agencies to enter into future contracts with us will in part be
dependent upon our continued ability to meet their expectations.
Minimum fee awards for companies entering into government contracts are
generally between 3% and 7% of the costs incurred by them in performing their
duties under the related contract. However, these fee awards may be as low as 1%
of the contract costs. Furthermore, these contracts are subject to cancellation
at the convenience of the governmental agencies. Although we have been awarded
contract fees of more than 1% of the contract costs in the past, minimum fee
awards or cancellations may occur in the future. Reductions or delays in federal
funds available for projects we are performing could also have an adverse impact
on our 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, required competitive bidding and, with respect to
contracts involving prime contractors or government-designated subcontractors,
the inability of those parties to perform under their contracts. Any of the
foregoing events could adversely affect our results of operations or financial
conditions.
POTENTIAL YEAR 2000 PROBLEMS COULD ADVERSELY IMPACT OUR BUSINESS
Many currently installed computer systems and software products experience
difficulty in functionality with respect to distinguishing between twenty-first
century dates and twentieth century dates. As a result, many companies' software
and computer systems may need to be upgraded or replaced in order to function
properly in the future.
We have tested our current products for Year 2000 compliance and believe
that they are Year 2000 compliant. However, the failure of our current or prior
products to operate properly with regard to Year 2000 requirements could cause
us to incur unanticipated expenses to remedy any problems, cause a reduction in
sales and expose us to related litigation by our customers, each of which could
harm our business. In addition, we and the third parties with whom we conduct
business may utilize equipment or software that may not be Year 2000 compliant.
Failure of our or any of these third party's equipment or software to operate
properly with regard to the Year 2000 requirements could result in, among other
things, unanticipated expenses or efforts to remedy any problems, which could
harm our or such third party's respective business. Furthermore, the purchasing
patterns of customers, or potential customers, may be affected by Year 2000
issues. Companies may expend significant resources to evaluate and correct their
own equipment or software for Year 2000 compliance while 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 us, which could adversely affect our business.
See Management's Discussion and Analysis of Financial Condition and Results of
Operations.
WE RELY ON A LIMITED NUMBER OF SUPPLIERS AND THIRD-PARTY MANUFACTURERS, WHO MAY
NOT CONSISTENTLY MEET OUR BUSINESS NEEDS
Some of our products contain critical components supplied by a single or a
limited number of third parties. We have been required to purchase certain
computer platforms around which we design our network fault and performance
management products to ensure an available supply of these products for our
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 our results of operations. In addition,
if our purchase of these components or platforms exceeds demand, we could incur
losses or other charges in disposing of excess inventory, which could also
materially adversely affect our results of operations.
Our manufacturing operations consist primarily of assembly, testing and
quality control of materials, components, subassemblies and systems for our
Sniffer based products. We use third party manufacturers for these manufacturing
operations. Reliance on third party manufacturers involves a number of risks,
including the lack of control over the manufacturing process and the absence or
unavailability of adequate capacity. In
38
<PAGE> 39
the event that any third party manufacturers cannot or will not continue to
manufacture the Sniffer based products in required volumes, on a cost effective
basis, in a timely manner or at all, we 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.
DELAWARE LAW, OUR CERTIFICATE OF INCORPORATION AND BYLAWS, OUR ADOPTION OF A
RIGHTS PLAN AND OUR STOCKHOLDERS AGREEMENT WITH MCAFEE.COM MAY INHIBIT POTENTIAL
ACQUISITION BIDS; THIS MAY ADVERSELY AFFECT THE MARKET PRICE FOR OUR COMMON
STOCK AND PREVENT CHANGES IN OUR MANAGEMENT
Our board of directors 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
of action by its stockholders. 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.
In October 1998, our board of directors adopted shareholders rights plan.
Each right under this plan entitles the record holder to buy 1/1000 of a share
of our 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 acquisition of 15% or more of our 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 our common stock.
We are 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 our
common stock.
In October 1999, we entered into a stockholders agreement with McAfee.com.
Under this agreement we agreed that if (1) without the prior approval of our
continuing directors, as defined below, any person acquires or agrees to acquire
15% or more of our outstanding common stock or (2) our continuing directors
cease to constitute a majority of Network Associates serving directors, then for
so long but only for so long as that condition exists:
- our shares of McAfee.com Class B common stock we be entitled to only one
vote per share instead of three votes per share; and
- we will be obligated to vote our McAfee.com shares to cause, and to take
such actions reasonably within our control to cause, and shall seek to
cause the McAfee.com directors appointed by us to cause, our board of
directors to consist of at least a majority of independent directors.
Network Associates continuing directors will consist of our current directors
and any subsequent directors approved or not objected to by a majority of our
then-continuing directors.
Certain provisions of Delaware law and our certificate of incorporation and
bylaws, such as a classified board, could delay or make a merger, tender offer
or proxy contest involving Network Associates more difficult. While these
provisions and our rights plan are intended to enable our board of directors to
maximize stockholder value, and the provisions of the McAfee.com stockholders
agreement are, among other things, intended to preserve McAfee.com's
independence, they may have the effect of discouraging takeovers, which may not
be in the best interest of certain stockholders. Our rights plan and these
provisions could have an adverse effect on the market value of our common stock.
39
<PAGE> 40
NETWORKS ASSOCIATES, INC.
FORM 10-Q, SEPTEMBER 30, 1999
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
Information with respect to this item is incorporated by reference to Note
8 of the Notes to the Consolidated Financial Statements included herein on page
9 of this Report on Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits. The exhibits listed in the accompanying Exhibit Index are
filed or incorporated by reference as part of this Report.
(b) No reports on Form 8-K were filed during the quarter:
40
<PAGE> 41
NETWORKS ASSOCIATES, INC.
FORM 10-Q, SEPTEMBER 30, 1999
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: November 15, 1999
41
<PAGE> 42
NETWORKS ASSOCIATES, INC.
FORM 10-Q, SEPTEMBER 30, 1999
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT TITLE NUMBER
- ------- ------------- ------
<C> <S> <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)...........................................
</TABLE>
<PAGE> 43
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT TITLE NUMBER
- ------- ------------- ------
<C> <S> <C>
4.7 Indenture dated as of February 13, 1998 between the
Registrant and State Street Bank and Trust Company of
California, N.A., as Trustee.(10)...........................
4.10 Registration Rights Agreement dated May 8, 1998, by and
between the Registrant and the stockholders of Secure
Networks, Inc.(8)...........................................
4.11 Registration Rights Agreement, dated June 29, 1998, by and
between the Registrant and certain stockholders of CSB
Consulenza Software di Base S.r.l. ("CSB").(11).............
4.12 Registration Rights Agreement, dated July 30, 1998, by and
between the Registrant and certain stockholders of Anyware
Seguridad Informatica S.A.(11)..............................
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)............
</TABLE>
<PAGE> 44
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT TITLE NUMBER
- ------- ------------- ------
<C> <S> <C>
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).................
10.21* Change in control agreement between the Company and Peter
Watkins dated May 11, 1999(25)..............................
10.22* Change in control agreement between the Company and William
S. Larson dated May 11, 1999(25)............................
10.23* Change in control agreement between the Company and Prabhat
K. Goyal dated May 11, 1999(25).............................
10.24* Change in control agreement between the Company and Zachary
Nelson, dated May 11, 1999(25)..............................
10.25 Corporate Management Services Agreement between the
Registrant and McAfee.com Corporation, dated as of January
1, 1999(26).................................................
10.26 Technology Cross License Agreement between the Registrant
and McAfee.com Corporation dated as of January 1,
1999(26)....................................................
10.27 Registration Rights Agreement between the Registrant and
McAfee.com Corporation, dated as of January 1, 1999(26).....
10.28 Asset Contribution and Receivables Settlement Agreement
between the Registrant and McAfee.com Corporation, dated as
of January 1, 1999(26)......................................
10.29 Intercompany Revolving Loan Agreement between the Registrant
and McAfee.com Corporation, dated as of January 1,
1999(26)....................................................
10.30 Tax Sharing Agreement between McAfee.com and Networks
Associates, Inc., dated as of January 1, 1999(26)...........
10.31 Indemnification and Voting Agreement between the Registrant
and McAfee.com Corporation, dated as of January 1,
1999(26)....................................................
10.32 Joint Cooperation and Master Services Agreement between the
Registrant and McAfee.com Corporation, dated as of January
1, 1999(26).................................................
27.1 Financial Data Schedule.....................................
</TABLE>
- ---------------
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
(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 Company'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.
<PAGE> 45
(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.
(25) Incorporated by reference from the Registrant's report on Form 10-Q for the
quarter ended March 31, 1999, filed with the Commission on May 13, 1999.
(26) Incorporated by reference from the Form S-1 filed by McAfee.com Corporation
with the Commission on September 23, 1999, under File Number 333-87609.
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