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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-20558
NETWORKS ASSOCIATES, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0316593
(State of incorporation) (IRS Employer Identification Number)
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
---------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities 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___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the issuer as of March 31,1999 was approximately $4,236,866,941. The number of
shares outstanding of the issuer's common stock as of March 31, 1998 was
138,062,661.
Documents incorporated by reference: Items 10, 11, 12, and 13 of Part III
are incorporated by reference from the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held June 24, 1999.
THIS REPORT CONTAINS 89 PAGES. THE EXHIBIT INDEX IS ON PAGE 82.
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PART I
ITEM 1. BUSINESS
GENERAL
Some of the statements contained in this Annual Report on Form 10-K are
forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors which may cause our or our industry's actual
results to differ materially from those implied by the forward-looking
statements. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential," or "continue" or the negative
of these terms or other comparable terminology. Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Moreover, neither we nor any other person assumes responsibility
for the accuracy and completeness of such statements. We are under no duty to
update any of the forward-looking statements. Important factors that may cause
actual results to differ from expectations include those discussed in "-- Risk
Factors" and elsewhere in this document.
Networks Associates, Inc. was formed in December 1997 as a result of the
merger of McAfee Associates, Inc. and Network General Corporation. Following the
merger, McAfee, changed its legal name to Networks Associates, Inc. During 1998,
we acquired the following companies:
<TABLE>
<CAPTION>
COMPANY NAME REFERRED TO AS: DESCRIPTION OF BUSINESS COUNTRY
- ------------ --------------- ----------------------- -------
<S> <C> <C> <C>
Dr Solomon's Group PLC Dr Solomon's Provider of anti-virus U.K.
software
Trusted Information Systems, Inc. TIS Provider of comprehensive U.S.A
security systems for
computer networks
Magic Solutions International, Inc. Magic Privately held provider of U.S.A
internal help desk and asset
management solutions
CyberMedia, Inc. CyberMedia Provider of desktop utility U.S.A
solutions
Secure Networks Systems, Inc. Secure Privately held provider of Canada
internal security systems for
computer networks
Anyware Seguridad Informatica S.A. Anyware Distributor Spain
CSB Consulenza Software di Base
S.r.l. CSB Distributor Italy
Nordic Lantools OY and AB Nordic Distributor Scandanavia
QA Information Security Holding AB QA Distributor Scandanavia
Syscon (Proprietary) Limited Syscon Distributor South Africa
</TABLE>
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 the 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
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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
suite called "Net Tools".
We organize our products for sale to corporate customers into four
product suites:
NET TOOLS
<TABLE>
<CAPTION>
NET TOOLS SECURE NET TOOLS MANAGER
----------------------------------------- ----------------------------------------------
MCAFEE TOTAL VIRUS PGP TOTAL NETWORK SNIFFER TOTAL NETWORK MAGIC TOTAL SERVICE
DEFENSE SECURITY VISIBILITY DESK
------------------ ---------------- --------------------- -------------------
<S> <C> <C> <C>
- - VirusScan Security - PGP Enterprise - Sniffer Distributed - Magic HelpDesk
Suite Security Suite Analysis Suite Suite
- - NetShield Security - Gauntlet Active - Sniffer Pro 98 - Self ServiceDesk
Suite Firewall Suite Portable Analysis Suite
Suite
- - GroupShield - CyberCop - Network Informant - Zero Admin Client
Security Suite Intrusion Detection Suite Suite
Suite
- Zero Admin Client
2001 Suite
</TABLE>
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.
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. Our VirusScan
and Nuts & Bolts products also leverage the suite sales model by being sold in
Deluxe
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and Platinum level suites. The Deluxe and Platinum level suites offer the
consumer name brand products bundled together. We generally utilize a perpetual
or unlimited license for products sold in the retail channel.
NET TOOLS SECURE
The Net Tools Secure product suite is comprised of McAfee Total Virus
Defense and PGP Total Active Network Security. The current U.S. list price for a
1,000 node Net Tools Secure license is $108 per node for a two-year license. A
number of the products incorporated in the Net Tools Secure product suite may be
purchased as stand-alone products or as part of smaller product suites.
MCAFEE TOTAL VIRUS DEFENSE
McAfee Total Virus Defense or TVD is designed to provide a single
integrated line of defense against computer viruses by providing security at the
desktop, network server, groupware server and Internet gateway levels of an
enterprise. With more than 400 new viruses discovered each month, many of them
increasingly destructive, it is critical that corporations protect themselves
from all possible entry points into the network. McAfee TVD includes a package
of products that cover each point in the corporate network: VirusScan for
desktops, NetShield for network servers, GroupShield for groupware servers, and
WebShield for Internet gateway protection. Management tools for central control
and deployment of these products are also included in the TVD package through a
set of tools called Management Edition. The current U.S. list price for a 1,000
node McAfee Total Virus Defense license is $40 per node for a two-year license.
The following products are part of the McAfee Total Virus Defense package:
- - VIRUSSCAN: DESKTOP VIRUS SECURITY
Whether from floppy disks or connection to the Internet, individual PCs
are still a key source of viruses. VirusScan provides PCs with protection
against computer viruses, including macro viruses, malicious Java and
ActiveX attacks, and email intrusions. VirusScan is available for all
major desktop operating systems, including Window 3.x, 95, 98, and NT as
well as Macintosh and DOS. VirusScan is available in a retail version for
home users at a suggested list price of $49. The corporate edition of
VirusScan is included as part of TVD.
- - NETSHIELD: NETWORK SERVER VIRUS SECURITY
Central computers that perform administrative tasks and oversee many
groups of individual PCs in an enterprise are known as servers, and are
another source of virus proliferation in organizations. Servers keep
information flowing by storing and forwarding files to not only other
users, but often to customers and e-commerce partners as well. If a
network server is infected by a virus, it can be spread rapidly
throughout the organization causing multiple infections in a short amount
of time. NetShield, available for Windows NT, Novell NetWare, and several
versions of Unix, offers comprehensive server-based virus protection that
helps prevent the spread of viruses at critical servers in the corporate
network. NetShield is included as part of TVD.
- - GROUPSHIELD: GROUPWARE VIRUS SECURITY
Since many of today's companies rely on email, shared electronic files,
and shared workgroups, viruses are also spread through "groupware"
programs such as Microsoft Exchange and Lotus Notes. GroupShield stops
virus proliferation at the electronic mail level of an enterprise,
scanning files sent through Exchange and Notes servers and catching
viruses before they can be passed on to other users. GroupShield is
included as part of TVD. It is also sold separately at a price of $35 per
node for a two-year license.
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- - WEBSHIELD: INTERNET GATEWAY PROTECTION
As a corporation connects to the Internet, it opens its network of
individual and server computers to the outside world and to potential new
viruses. WebShield serves as a final layer of corporate virus security by
scanning email, firewall and web traffic for viruses and other hostile
code before it enters the corporation. WebShield is included as part of
TVD.
TVD MANAGEMENT EDITION
Because new viruses are discovered at a rate of over 400 per month, it is
critical that network administrators keep their anti-virus software updated with
the latest virus signature files. TVD Management Edition gives administrators an
easy way to install, configure and upgrade anti-virus software across enterprise
networks scaling to any size. TVD Management Edition protects a network from
virus attacks by enabling centralized upgrading of the network's anti-virus
software. When attacks do occur, Management Edition detects the occurrence and
offers alerting via a variety of channels including pager, e-mail, SNMP message,
and DMI alert. It reduces the time a network administrator has to spend
installing and managing anti-virus software, particularly on large networks,
ensuring uninterrupted network security. Management Edition is included as part
of the TVD package.
ENTERPRISE SECURE CAST
To get new virus updates rapidly to network administrators for
distribution within their companies, TVD also includes a web-based "push"
technology called Enterprise Secure Cast. Enterprise Secure Cast uses advanced
web technology to provide registered companies with lists of new viruses that
help the enterprise continually maintain their virus protection at the highest
possible level. Enterprise Secure Cast is also included as part of the TVD
package.
PGP TOTAL NETWORK SECURITY
PGP Total Network Security or TNS completes the Net Tools Secure line by
adding best-in-class firewall, intrusion protection, encryption and virtual
private network security products. The Total Network Security product line
features Gauntlet for firewall, CyberCop for intrusion protection, PGP for
encryption and PGP VPN for virtual private networking .We have also integrated
these individual security products so that they can "actively" communicate with
one another in an effort to respond to security threats automatically. This
integration, known as "Active Security" is achieved by integrating each of the
individual TNS products with Event Orchestrator, the "Active Ingredient". The
PGP Total Network Security suite is currently priced at $80 per node for a
two-year license.
- - GAUNTLET FIREWALL is the flagship product of our security product line.
It was originally developed by Trusted Information Systems a company we
acquired in April 1998, on contract from the Defense Advanced Research
Project Agency in an effort to find a more secure way of building
firewalls. In addition to its security features, Gauntlet offers an
enterprise management console, enabling one-to-many configuration control
over numerous firewalls throughout the enterprise, and allows for direct
interface with anti-virus scanning technology. Gauntlet Firewall also has
strong encryption capabilities for VPN technology which are deployable
without sacrificing network throughput. Gauntlet is used by customers
around the world as an Intranet, Extranet, and an internal network
firewall. Gauntlet Firewall is currently available at a price of $17,000
per server for a two-year license.
- - CYBERCOP INTRUSION PROTECTION SUITE provides a comprehensive suite of
software tools designed to protect all aspects of enterprise systems and
network devices from external and internal attacks. The multi-tiered
approach of penetration testing through CyberCop Scanner, real-time
surveillance of systems through CyberCop Monitor and decoy servers
through CyberCop Sting combine to ensure survivability of mission
critical devices against increasingly sophisticated and hostile threats.
The current U.S. list price for a 1,000 node CyberCop Intrusion
Protection Suite site license is $31 per node for a two-year license.
- - CYBERCOP SCANNER is an integrated network scanning tool designed to
locate system and network device vulnerabilities exposing previously
undiscovered security threats via an easy-to-use graphical
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interface. Integrated into our "Active Security" architecture, CyberCop
Scanner provides event orchestration and security management. With the
ability to scan network devices for multiple policy, mis-configuration
and system vulnerabilities that diminish security within a network,
CyberCop Scanner provides a means of quantifying and qualifying the
enterprise security risk. Engine, scan tests and vulnerability databases
are kept current utilizing VirusScan's "AutoUpdate" technology to
automatically download monthly product updates on a scheduled basis.
CyberCop Scanner includes a number of unique testing tools to audit the
security of your firewalls, intrusion detection systems and routers. In
addition, CyberCop Scanner also includes functionality to produce
multi-layer reporting options and network diagrams via a 3D Graphical
Interface via an easy to use report generator. CyberCop Scanner is used
extensively by value added resellers or VARs, and independent security
consultants providing services to enhance security on enterprise
networks. CyberCop Scanner is currently available on the Windows NT and
Linux platform. The current U.S. list price for a 1,000 node CyberCop
Scanner Site License is $13 per node for a two-year license.
- - CYBERCOP MONITOR, scheduled for a mid-1999 release, provides host based,
real-time intrusion detection. CyberCop Monitor supports a multi-tiered
detection architecture that monitors not only host log file activities
and system events, but also host-based packet analysis providing event
correlation and trend analysis. CyberCop Monitor provides a central
monitor to facilitate one to many configuration, remote installation and
reporting options. Integrated into our "Active Security" architecture,
CyberCop Monitor provides event orchestration and increased security
integration. The "AutoUpdate" feature, already used by millions of
VirusScan customers, enables CyberCop Monitor to automatically download
monthly updates on a scheduled basis keeping the engine, scan tests and
signature databases current.
- - CYBERCOP STING, also scheduled for a mid-1999 release, completes the
CyberCop line by offering a new approach to intrusion detection. CyberCop
Sting provides an additional information gathering device to help combat
snooping on internal networks. Configured as an inviting host, CyberCop
Sting utilizes replication technology to simulate "virtual machines" in a
simulated environment, allowing any unauthorized activity to be logged
while at the same time not placing systems or data at risk.
- - PGP ENTERPRISE SECURITY encrypts, authenticates and provides the complete
infrastructure and applications necessary for data protection for a wide
range of desktop computers. PGP, which is used by millions of consumers
and corporations around the world, is based on the principle of strong
encryption without compromise. PGP Enterprise Security suite combines the
worldwide de-facto standard for file, disk and email encryption with
precise management tools both at the desktop and server level. Included
in this suite are several tightly integrated components: PGP Desktop
Security, PGP Certificate Server, PGP Policy Management Agent, PGP VPN
client and the PGPsdk. The PGP Enterprise Security suite is currently
sold at a price of $44 per node for a two-year license.
- - PGP DESKTOP encrypts and authenticates e-mail, files and disks
automatically, ensuring that only the authorized recipient can read their
contents. It integrates seamlessly with all commonly used e-mail
applications, allowing users with different email systems to communicate
securely. Complete enterprise management features are built-in, allowing
administrators to easily pre-configure and deploy PGP to users throughout
the corporation.
- - PGP CERTIFICATE SERVER acts as a central dispatch for PGP digital
certificates. Digital certificates allow users to "authenticate"
communications so that the recipient can be certain of the sender's true
identity. When users run PGP Desktop, their computers automatically
access the PGP Certificate Server and retrieve the appropriate
certificates needed.
- - PGP POLICY MANAGEMENT AGENT works in conjunction with PGP Desktop to
ensure that incoming and outgoing email adheres to the appropriate
corporate email security policies.
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- - PGP VPN CLIENT adds a robust, standards-based virtual private networking
(VPN) client to the PGP suite. By encrypting and authenticating remote
communications, PGP VPN client users can securely connect remotely over
inexpensive local Internet connections with complete security.
- - PGP VPN SUITE provides a standards-based infrastructure for end-to-end
"virtual private network" security. The PGP VPN suite offers low cost
virtual private network security to cover multiple business needs
including server-to-server for supply chain and remote office extranets,
server-to-client for secure remote access for mobile users and
client-to-client for secure network communications. The PGP VPN suite
includes Gauntlet Firewall, Gauntlet VPN server, PGP VPN client and Net
Tools PKI, a standards-based public key infrastructure that ships with
several our security suites to enable secure integration The PGP VPN
suite also works with other public key infrastructure, or PKI, vendors
such as VeriSign and Entrust, allowing customers to communicate securely,
regardless of the preferred PKI.
NAI LABS SECURITY RESEARCH
NAI Labs is the division of Networks Associates that performs advanced
research in the network security technology area. Over 100 dedicated researchers
company-wide are engaged in fulltime research. Research efforts are grouped into
two different categories: rapid response research, and advanced research.
RAPID RESPONSE RESEARCH teams are responsible for researching new viruses
and security threats and providing updates to customers rapidly. We have the
ability to quickly respond to new security risks around the clock across all
continents. These research teams currently fall into two categories:
- - AVERT, the Anti-virus Emergency Response Team, formerly known as McAfee
Labs; and
- - COVERT, the Computer Vulnerability Emergency Response Team, staffed
primarily with researchers from the Secure Networks, which we acquired in
1998.
ADVANCED RESEARCH is pursued by the Advanced Security Research Division
or ASRD, formerly part of TIS, and focuses on long-term scientific,
mathematical, cryptographic, and technological issues which reside outside the
standard product development pathway. The advanced security research division
pursues its formalized research using funds awarded by the U.S. Defense Advanced
Research Project Agency, National Security Agency, and other government
agencies. Research topics include theoretical cryptographic models,
survivability studies, advanced OS development, next generation Internet or NGI
initiatives. Integrated within the advanced research model is mandatory planning
for technology transfer into the commercial marketplace. To date, we have
incorporated this advanced research into a number of our products.
NET TOOLS MANAGER
Net Tools Manager, or NTM, is a network management and service desk
solution designed to make networks more efficient and network users more
productive. The Net Tools Manager product suite is comprised of Sniffer Total
Network Visibility and Magic Total Service Desk. A number of the products
incorporated in the Net Tools Manager product suite may be purchased as
stand-alone products or as part of smaller product suites. The current U.S. list
price for a 1,000 node Net Tools Manager license is $144 per node for a two-year
license.
SNIFFER TOTAL NETWORK VISIBILITY
Sniffer Total Network Visibility, or Sniffer TNV, offers comprehensive
network fault and performance solutions designed to provide optimum network
performance. Sniffer TNV is comprised of three product
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suites: Sniffer Portable Analysis, Sniffer Distributed Analysis and Network
Informant Suite. The U.S. list price for a 1,000 node Sniffer TNV license is
$92 per node for a two year license.
- - SNIFFER PRO 98 PORTABLE ANALYSIS SUITE, or Sniffer PAS, consists of
portable tools designed to automatically pinpoint and analyze network
problems and to recommend solutions. To address the growing complexity of
multi-vendor, multi-protocol, multi-topology network environments,
Sniffer PAS is designed and tested to run on a variety of computer
platforms. The product is intended to be used as a portable tool, either
on a portable or notebook size computer platform. The Sniffer PAS
addresses a variety of network needs ranging from departments coverage to
high-speed, mission-critical or backbone networks. Products sold under
the Sniffer PAS range from products which capture data, monitor network
traffic and collect key network statistics for small networks, to
products which optimize network performance and increase network
reliability by uncovering and analyzing network problems and recommending
solutions to such problems, automatically and in real-time for mid-level
and high-speed networks. The U.S. list price for the Sniffer Portable
Analysis Suite is $16,995 per copy for a two-year license.
- - SNIFFER DISTRIBUTED ANALYSIS SUITE, or Sniffer DAS, is designed to allow
customers to monitor and diagnose problems on complex, multi-segment
networks from centralized locations. Distributed Sniffer System/RMON, or
DSS/RMON, is available in Basic and Pro configurations. DSS/RMON Basic
incorporates an industry standard RMON2 agent with the protocol capture
and decode capabilities of a portable Sniffer. DSS/RMON Pro adds expert
analysis capabilities and automatic problem diagnosis to recommends
solutions which are displayed on a central console. The Sniffer DAS
addresses a variety of network needs ranging from high speed backbones,
WAN links and switched networks. The U.S. list price for a 1,000 node
Sniffer DAS license is $50 per node for a two-year license.
- - NETWORK INFORMANT SUITE, or Network Informant, is a web browser-based
network management suite that is designed to automate and manage the
process of resolving network problems proactively by identifying,
analyzing, tracking and resolving network problems and assessing trends.
The Network Informant Suite is comprised of products designed to
automatically collect data on instrumented network components and to
provide real-time and historic health and availability summaries; to
monitor and analyze the long-term performance of routers, switches, hubs,
and frame relay devices; and to provide immediate access to service desk
trouble tickets from any browser. The U.S. list price for a 1,000 node
Network Informant Suite license is $22 per node for a two-year
license.
MAGIC TOTAL SERVICE DESK
Magic Total Service Desk, or Magic TSD, provides proactive network
management and help desk technology in one integrated service desk solution.
Magic TSD comprises two suites: Magic HelpDesk Suite and Zero Administration
Suite. The current U.S. list price for a 1,000 node Magic TSD license is $68 per
node for a two year license.
- - MAGIC HELPDESK SUITE is designed to provide complete call management,
problem resolution, crisis management, change management and reporting
for mid-range and departmental help desks. The Magic HelpDesk Suite
automates the process of entering caller information and automatically
displays information about a caller allowing faster service and
minimizing duplication of efforts. In addition, the Magic HelpDesk Suite
is designed to provide automated crisis management, by posting notices of
known problems on a centralized "white board." Related calls can be
linked, automatically generating or resolving, and subsequently closing,
all linked trouble tickets. Finally, the Magic HelpDesk Suite is designed
to automate change management throughout the enterprise, allowing work
orders for a selected task to be automatically sent to all appropriate
parties. Detailed reports generated by the Magic HelpDesk Suite help
measure the impact of each problem and the use of enterprise resources to
solve each problem. The current U.S. list price for a 10-users Magic
HelpDesk Suite is $2,915 for a two-year license.
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- - SELF SERVICEDESK SUITE provides information services organizations with
self service oriented applications designed to make all supported PCs
help desk ready. The Self ServiceDesk Suite integrates PC diagnostic
software with remote control and web-based access, allowing cost savings
for help desk and network administrators. The Self ServiceDesk Suite
allows employees to solve their own PC application problems over the web
using SupportWeb 98, a searchable information database that gives
employees instant answers to thousands of common hardware and software
application questions. The Self ServiceDesk Suite also includes PCMedic
and Remote Desktop 32. PCMedic is designed to automatically diagnose and
correct PC system problems, as well as prevents errors and crashes which
damage data. Remote Desktop 32 provides remote management capabilities
for network administrators. The current U.S. list price for a 1,000 node
Self Service Desk Suite site license is $47 per node for a two-year
license.
- - ZERO ADMINISTRATION CLIENT SUITE, or ZAC Suite is designed to provide
enterprise wide control of network software with integrated software
distribution, software and hardware inventory, desktop
management/menuing, license metering and remote control features. The ZAC
Suite is designed to automatically distribute, install and track new
software and updates throughout an enterprise and to perform an
enterprise-wide hardware, software and system file inventory without
having to visit each station. The ZAC Suite also includes
management/menuing capabilities which enable central configuration of
application access and desktop layout. In addition, the ZAC Suite
provides software metering capabilities, allowing the efficient
management of license sharing, and transfers and reducing the number of
licenses that need to be purchased based on actual usage. Furthermore,
the ZAC Suite is designed to allow compliance with license limitations by
restricting concurrent usage of a software product to only the total of
number of licenses purchased. Finally, the ZAC Suite is designed to allow
remote access to critical information on multiple platforms. The Zero
Administrator Client Suite console controls DOS, Windows, Windows 95 and
Windows NT-based PC assets connected to NT and NetWare file servers, and
its open database structure is designed to ensure accessibility. The
current U.S. list price for a 1,000 node ZAC Suite site license is $47
per node for a two-year license.
- - ZERO ADMINISTRATION CLIENT 2001 SUITE combines the inventory and remote
control capabilities of the ZAC Suite with a Year 2000 compliance checker
for applications and data on PCs. ZAC2001 detects packaged applications
across the network and compares the data against a year 2000 compliance
catalog and produces management reports to assess the Y2K readiness of
desktop applications. ZAC2001 scans potential Y2K problems in two-digit
and pivot dates in popular spreadsheet and ODBC data source files. The
current U.S. list price for a 1,000 node ZAC2001 site license is $27 per
node for a two-year license.
PROFESSIONAL SERVICES
As our products and computer networks become more complex, customers
increasingly require greater professional assistance in the design,
installation, configuration and implementation of their networks and acquired
products. To meet these evolving customer needs, we have established
Professional Services. Professional Services is focused on three services
segments: Consulting Services, Education Services and PrimeSupport.
Consulting Services supports product integrations, customization and
deployment with an array of standardized and custom offerings. Consulting
Services also offers other services ranging from proactive and emergency
troubleshooting to network design, planning and simulation.
Education Services represents the combined training organizations of
Sniffer University, TIS, McAfee University, and Magic University. Together,
these training organizations offer customers an extensive curriculum of computer
network technology courses, including protocol analysis and troubleshooting,
security, help desk and network management tools. Education Services provides
public classes and
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customized on-site training at customer locations. To date we have trained over
35,000 individuals in Fortune 500 and other companies.
The PrimeSupport program provides online and telephone-based technical
support is necessary to ensure that our products are installed and working
properly. PrimeSupport offers a choice of the online KnowledgeCenter, or the
telephone-based Connect, Connect 24X7 and Enterprise options to meet customers'
varying business needs. PrimeSupport is available to all customers on a
worldwide basis from a nearby global support center.
PRODUCT LICENSING MODEL
We typically license our products, together with the related maintenance,
to corporate and government customers for a period of two years. Upon expiration
of the two-year period, customers are contacted by us to renew their license. We
believe that the two-year license and related maintenance offers several
benefits to our customers. For one initial fee, the customer receives the
software and all upgrades, updates and technical support for two years. In
addition, the customer only has to make a decision on its investment in the
software every two years. Since we are able to distribute our products and
upgrades at a lower cost than companies using traditional distribution methods,
we also have the ability to offer upgrades and updates and address user feature
requirements on a more regular basis. In addition, by offering a two-year
license, as opposed to a traditional perpetual license, we are able to meet a
lower initial cost threshold for customers with annual budgetary constraints.
Our two-year licensing model creates the opportunity for recurring
revenue for us through the renewal of existing licenses. Since we typically
license our products on a per user basis, at the time of renewal we have the
potential to increase the number of computers licensed at existing sites and to
expand our licenses to new sites in an organization. The renewal process also
provides an opportunity to cross-sell new products and product suites to
existing customers. However, we may be unable to sustain current renewal rates
in the future.
We also provide single user licenses for our products under traditional
perpetual licenses with product updates, upgrades and support available to
customers under separate maintenance contracts.
ELECTRONIC SOFTWARE DISTRIBUTION
We were the first company to successfully utilize electronic software
distribution to reach corporate and government customers. Through the World Wide
Web and various online services such as America Online, Compuserve and the
Microsoft Network, we are able to electronically communicate and interact with
our customers from pre-sales evaluation through product delivery and post-sales
support. We believe that the electronic channel is an important source of
information and support for IT professionals. By making fully-functioning,
unencrypted versions of many of our products widely available for evaluation, we
seek to encourage product sampling among these sophisticated users. Potential
customers desiring to evaluate our products for a 30-day period can anonymously
download our products from our World Wide Web site. This contrasts favorably to
traditional software evaluation programs, where potential customers often are
required to identify themselves, typically resulting in their inclusion in a
sales database, go through a qualification process and then wait for the
evaluation copy to be shipped.
We use electronic software distribution as a principal means of
delivering licensed software, as well as upgrades and updates to our customers.
Electronic software distribution offers a number of advantages to us over
traditional software distribution methods including the ability to distribute
our products and upgrades more rapidly and at a lower cost than traditional
distribution methods. Since all of the software and documentation can be
distributed electronically, the cost of internal distribution by the customer is
also lower than with traditional software and printed documentation.
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We also seek to increase awareness of our products, to provide customer
and technical support and to encourage dialogue regarding our products by
maintaining a World Wide Web site and forums on CompuServe, America Online and
The Microsoft Network. We also provide support through the World Wide Web. By
providing support electronically, we believe that we are often able to identify
and solve customer problems more rapidly.
MCAFEE.COM
McAfee.com is an Internet destination dedicated to updating, upgrading,
and managing PCs over the web. Described below are services under development
which are being developed to enable McAfee.com to provide powerful online
applications over the Internet, including delivering recommendations,
comparative shopping, and powerful Internet based utilities for both the novice
and expert PC users.
- MCAFEE PC OILCHANGE ONLINE is an Internet service which is being
developed to automatically recommends updates and upgrades based
on a user's installed hardware and software. Updates, such as a
software fix or a printer driver, can be quickly found and freely
downloaded from the web. Recommended upgrades can also be found
and purchased online. Accessories related to a user's PC
configuration, such as books, training videos, or peripherals are
also available for purchase online.
- MCAFEE CLINIC is a web-based PC management service which is being
developed to defend, diagnose, and repair PCs over the web. This
service is based on the underlying technology found in the McAfee
desktop products: VirusScan, First Aid, Nuts & Bolts, ToolBox
2000, UnInstaller, and Guard Dog. As an Internet-based service,
this set of version-less, PC applications never needs to be
upgraded by the user.
- MCAFEE STORE offers a convenient one-stop-shop experience on the
Internet. Customers can purchase McAfee software and services or
other related PC products, as well as other helpful PC
information.
In December 1998, we created McAfee.com Corporation as our subsidiary. In
1999, we intend to transfer the McAfee.com domain name to this subsidiary and to
enter into the agreements and arrangements necessary to allow McAfee.com
Corporation to operate the McAfee.com web site independently, with its own
workforce and research and development staff.
SALES AND MARKETING
To augment and capitalize upon the awareness of our products resulting
from our electronic distribution model, our sales and marketing efforts are
directed primarily at large corporate and government customers as well as to
resellers, distributors and system integrators worldwide through the following
channels:
NORTH AMERICAN DIRECT SALES
Our North American direct sales force is organized into three tiers. The
first tier focuses on the sale of all our products 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 telesales forces who actively market our individual product
suites for transactions of less than 1,000 nodes. Our corporate telesales
representatives also respond to prospective customers who contact us as a result
of a particular marketing program or after electronically evaluating one of our
products. Another significant focus of our corporate telesales force is to
contact existing customers to cross-sell additional products and product suites.
To augment our sales organization, our executives are involved with sales to
many major accounts. We have
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not historically had a large enterprise or national accounts sales force and
only recently developed a direct sales group focused on these larger accounts.
We devote a portion of our corporate telesales force to the renewal of
our existing licenses. Prior to expiration of a license, a corporate telesales
representative contacts the customer and encourages renewal of the expiring
license while determining if increasing the number of computers licensed is
appropriate and, additionally, marketing new products and product suites to this
existing customer.
INTERNATIONAL SALES
We have sales and support operations in Europe, Asia, South America and
Australia. In 1998, international revenues accounted for approximately 36% of
our net revenues. We expect that international revenues will continue to account
for a significant percentage of net revenues. Historically, we have relied
primarily upon independent agents and distributors to market our products
internationally. In recent periods we have focused our efforts on expanding
internationally including through distribution acquisitions. In 1998, we
acquired distributors in Scandinavia, South Africa and Spain. We expect to
continue using independent agents primarily in smaller markets where a direct
sales presence is not currently warranted. While our agents and distributors
include some large systems integrators, most are small companies that market our
software along with products of other companies that they represent. We
typically enter into agreements with our agents which obligate our agents to
provide technical support and the most current versions of our products to our
customers and to provide us with information about our licensees. These
agreements permit either us or the agent to terminate the agreement upon proper
prior written notice. International agents invoice their own orders and collect
payment, remitting the license fee, net of commissions, to us in United States
dollars.
RESELLERS AND DISTRIBUTORS
To complement its direct sales, we market many of our products through
corporate resellers and distributors, and indirectly through retailers. While
historical sales through these distribution channels have generated a relatively
small portion of our net revenue, over the past two years our presence in these
channels has expanded significantly. We currently utilize corporate resellers,
including STREAM, Software Spectrum, Softmart and ASAP, which focus primarily on
selling site licenses for our software to corporate customers.
Independent software distributors who market our products include Ingram
Micro, Merisel America and Tech Data. These distributors stock our products in
inventory for redistribution primarily to large retailers, value added
resellers, or VARs, and mail order companies. Through our authorized
distributors, we sell our retail packaged products to several of the large
computer and software retailers in the United States, including Staples,
CompUSA, Computer City, Software Etc. and Best Buy. Several members of our
channel sales force work closely with our major reseller and distributor
accounts on the management of orders and inventory level, as well as on
promotion and selling activities.
Our distributors generally are permitted stock balancing and stock
rotation rights but are typically required to place offsetting orders of equal
value. We often rely on resellers and distributors, including retail outlets, to
market and support our products. Our agreements with our distributors are not
exclusive and may be terminated by either party without cause. These
distributors may not continue to represent our products.
ORIGINAL EQUIPMENT MANUFACTURERS
Original Equipment Manufacturers, or OEMs, license our products (mainly
anti-virus products) and bundle them with personal computer hardware or
software. OEMs typically sublicense a single version of our products to end
users who must contact us in order to license updates. We typically receive a
per copy royalty from our OEMs.
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OTHER MARKETING ACTIVITIES
Our principal means of marketing our products is through the World Wide
Web. Not only do our NAI.com and McAfee.com Websites contain various marketing
materials and information about our products, but Website customers may download
and purchase products and potential customers may download our products for a
30-day free trial. We also promote our products through advertising activities
in trade publications and direct mail campaigns. We also attend trade shows,
sponsor conferences and publish a quarterly newsletter which is mailed to
existing and prospective customers. In addition, we also maintain forums on
CompuServe, America Online and The Microsoft Network which provide electronic
forums for subscribers of these services to discuss issues related to computer
viruses and make inquiries regarding our products.
CUSTOMERS
We primarily market our products directly to large corporate and
government customers as well as to resellers and distributors.
A significant majority of the Company's products are sold through two
tiers of distribution. In the US, substantially all of the Company's sales are
through four major distributors. In Europe, substantially all sales are through
five major distributors. At December 31,1998, one customer had an accounts
receivable balance representing 11% of our total accounts receivable balance. No
other distributor had an accounts receivable balance that exceeded 10% at
December 31, 1998. The Company relies upon a broad base of second tier
distribution partners, specifically large retailers, resellers and VARS to
maintain and grow its business. For the year ended December 31,1998, the largest
retailer accounted for 1% of total revenue and in aggregate the five largest
retailers accounted for approximately 4% of total revenue. The largest reseller
accounted for 2% of total revenue.
PRODUCT DEVELOPMENT AND ACQUISITION
We believe that our ability to maintain our competitiveness will depend
in large part upon our ability to enhance existing products, develop and acquire
new products and develop and integrate acquired products. The market for
computer software includes low barriers to entry and rapid technological change,
and is highly competitive with respect to timely product introductions. Product
enhancements or new products may not be developed or acquired on a timely basis
or at all. As part of our growth strategy, we have made and expect to continue
to make investment sin complementary businesses, products and technologies. In
addition, we recently began making strategic minority investments in
complementary Internet related companies.
In addition to developing new products, our internal development staff is
also focused on developing updates to existing products and modifying and
enhancing any acquired products. 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 98, 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 operation 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
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computer users would have a material adverse effect on our business, results of
operations and financial condition.
We expended $135.5 million$103.1 million and $63.8 million in the years
ended December 31, 1998, 1997 and 1996, respectively, on research and
development.
MANUFACTURING AND SUPPLIERS
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.
Our Sniffer products are designed to work with a variety of network
topologies and computer platforms available from multiple manufacturers. We rely
on a limited number of suppliers for certain critical components of our
products. Some of the Sniffer products are designed around a specific computer
platform available only from certain manufacturers. In the case of Sniffer
products, customers purchase the required platform either from us or from
suppliers. As a result of product transitions by our computer platform vendors,
we have found it necessary to purchase and inventory computer platforms for
resale to customers. Any significant shortage of computer platforms or other
critical components for Sniffer products could lead to cancellations or delays
of purchases of these products, which could materially and adversely affect our
results of operations. If purchases of computer platforms or other components
exceed demand, we could incur expenses for disposing of excess inventory, which
would also adversely affect our results of operations.
We have developed software only versions of some of our Sniffer products.
Purchasers of these Sniffer software products are required to already own or
purchase directly from the manufacturer or other vendors the necessary hardware
products, such as computer platforms and components. Customers may require that
we continue to provide the necessary hardware products.
COMPETITION
The markets for our products are intensely competitive 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;
- our 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 market with their
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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 price reductions but also in a decline in sales volume,
could cause our business to suffer. In addition, competitive pressures may make
it difficult for us to maintain or exceed our growth rate.
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 or Unicenter. However, both of these
companies products have been characterized as framework systems requiring a
multi-year product rollout and having products plug into their frameworks as a
secondary focus. In contrast to this, our Net Tools product suite follows a
philosophy of providing "best-of-breed" products with integration where it makes
sense. By focusing on products first, customers can begin deriving benefit
immediately. Several of our individual Net Tools products already support
interaction with framework products including Tivoli's TME framework and
Computer Associates Unicenter framework.
We cannot assure you that we will continue to compete effectively against
existing and potential competitors, many of whom have substantially greater
financial, technical, marketing and support resources and name recognition than
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.
NET TOOLS SECURE COMPETITION
Our principal competitor in the anti-virus market worldwide the Peter
Norton Group of Symantec in the network security market. Trend Micro remains the
strongest competitor in the Asian anti-virus market. Other competitors include
Computer Associates/Cheyenne Software, IBM and Trend Micro, Inc., as well as
numerous smaller companies and shareware authors that may in the future develop
into stronger competitors or be consolidated into larger competitors.
In the firewall market, Checkpoint owns the top market share position
(1998 Information Security Market Survey - Computers Security Institute/Zona
Research) and is currently Gauntlet's most frequently-encountered competitor.
Axent, with our recently acquired Raptor firewall, is a strong competitor in the
growing market for Windows NT-based firewalls. Larger companies such as Cisco
Systems and Microsoft each have firewall products as well and are beginning to
make inroads in this space. Our CyberCop intrusion protection products compete
primarily with ISS, the earliest entry into this small, but rapidly growing
market segment. Axent and Cisco also have competitive intrusion protection
products. The encryption and VPN markets are still extremely fragmented with
numerous small and large vendors. Public key infrastructure, or PKI, vendors
such as Entrust Technologies offer some products with similar functionality to
PGP, while the VPN space is crowded with hardware and software vendors,
including telecommunications companies as well as traditional networking
suppliers.
NET TOOLS MANAGER COMPETITION
Our principal competitor in the network management market is Hewlett
Packard Company, or HP. Some of our competitors have been in the network
management market longer than the we have, and competitors, such as Cisco,
Computer Associates and HP are larger and have greater name recognition than we
do.
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Our other competitors include Remedy, Royalblue Group PLC, Bendata,
Peregrine Systems and Tivoli Systems in the help desk market and HP, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies , Shomiti Systems, Inc. and Wandel & Goltermann, Inc. in the
software-based network fault and performance management market. We also 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
RETAIL MARKET COMPETITION
As a result of our acquisitions of CyberMedia and Dr. Solomon's, we have
increased our retail presence and established our commitment to the retail
marketplace with the development of the McAfee Software Division. We expect
competition to increase in the near-term due to consolidation of the retail
personal productivity/utility market with the acquisition of Quarterdeck by
Symantec. With price erosion in the traditional superstore and mail order
channels by our key retail competitor in 1998, we have been forced to lower our
retail prices. We are also expanding into the mass merchant and club channel.
However, while the industry's personal productivity/utility software sales
through these channels have increased, the profit margins and average selling
prices in the retail channel are considerably lower than in traditional software
channels.
PROPRIETARY TECHNOLOGY
Our success depends significantly upon proprietary software technology.
We rely on a combination of contractual rights, trademarks, trade secrets and
copyrights to establish and protect proprietary rights in our software. However,
these protections may be inadequate or competitors may independently develop
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 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.
EMPLOYEES
As of December 31, 1998, we employed approximately 2,700 individuals
worldwide. Competition for qualified management and technical personnel is
intense in the software industry. Our continued success will depend in part upon
our ability to attract and retain qualified personnel. None of our employees is
represented by a labor union and we believe that our employee relations are
good.
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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;
- 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;
- our investment experience related to our strategic minority equity
investments; 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 revenue is typically higher in the
fourth quarter, as many customers complete annual budgetary cycles, and lower
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.
IT WILL BE DIFFICULT TO SUSTAIN OR EXCEED OUR HISTORIC GROWTH RATE
We have experienced significant growth in net income (before acquisition
and related costs) and net revenue. However, our rate of growth has slowed in
recent periods due to increased price competition, a maturing anti-virus market
and an increasingly higher base from which to grow. Our growth rate and net
revenue depend significantly on renewals of existing orders. Recently, we began
a strategy of up-selling existing licenses to higher level product suites. If
our renewal or up-sale rates slow or decline, our net revenues and operating
results would be adversely affected. In addition, 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
compliance issues. If the purchasing patterns of our current
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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 revenue, net income and related growth.
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 1998 our stock price ranged from a per share high of $66.25 to a
low of $26.63. At the close of market on April 12, 1999, our stock price was
$16.75 per share. 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 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. In April 1999,
a number of putative class actions were brought against us, our officers and
directors. See "Item 3, Legal Proceedings." 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.
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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;
- Vycor Corporation in February 1996;
- Saber Software in August 1995; and
- Pro Tools in January 1994.
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. In the three
months ended March 31, 1999, these minority investments totaled $26.5 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 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.
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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 the
incurrence of 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 sales force;
- successful development of a national accounts sales force; and
- the development and expansion of an effective professional
services organization.
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
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corresponding hardware component (currently the hardware component
has a lower gross margin than the total product gross margin).
WE FACE RISKS RELATED TO OUR STRATEGY OF ACQUIRING INDEPENDENT AGENTS AND
DISTRIBUTORS
We have been acquiring existing independent agents and distributors of our
products in certain strategic markets. We may be required to provide the
technical support to customers 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.
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
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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.
WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenue 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 revenue 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.
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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 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
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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 tow separate sales groups focused on the sale of the two product supersuites
(Net Tools Secure and Net Tools Manage) to the departmental level. The third
tier consists of four separate outbound corporate telesales forces who actively
market our individual product suites to customers with less than 1,000 end
users. Historically, we have not a large enterprise or national accounts 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
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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,
CHS, our largest European distributor, has experienced a significant downturn in
its business. As a result, we have experienced a delay in collections from them
and may experience difficulties in collecting amounts owed to us. 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.
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
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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, 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.
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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 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 "Item 3, Legal Proceedings."
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
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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 1998, 1997 and 1996, net revenue from international licenses
represented approximately 36%, 36%, and 32%, respectively, of our net revenue.
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 revenue. We also expect
that a significant portion of this international revenue will be denominated in
local currencies. To reduce the 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 activit
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 will 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.
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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
Certain of our network security products, technology and associated
assistance are subject to export restrictions imposed by the U.S. Department of
State and the U.S. Department of Commerce. These restrictions permit the export
of encryption products so long as certain requirements are met, but prohibit the
export of these products to countries deemed hostile by the U.S. Government.
U.S. export regulations regarding the export of encryption technology require
either a transactional export license or the granting of Department of Commerce
Commodity jurisdiction. As result of this regulatory regime, foreign competitors
facing less stringent controls may be able to compete more effectively than we
can in the global market. While we have obtained approval from the Department of
Commerce to export to certain end users, the U.S. Government may not approve
pending or future export license requests. Further, the list of products and
countries for which export approval is required, and the regulatory policies
with respect thereto, may be revised from time to time. Failure to obtain the
required licenses or the costs of compliance could have a material adverse
effect on our international revenues.
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. The
security afforded by public key cryptography technology is based on our belief
that the factoring of large prime numbers is difficult. Should an easy factoring
method be developed, 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, factoring problems can theoretically be solved by
computer systems significantly faster and more powerful than those presently
available. If these improved techniques for attacking cryptographic systems are
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
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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 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 early April 1998, Messrs.
Leslie Denend, David Carver and John Stringer resigned from their positions as
executive officers, although Mr. Denend remains a director. 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.
WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING
We expect that in the near term, a meaningful portion of our revenues
will result from existing 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. However, we may be unable to
procure additional government contracts.
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 and there have
been no terminations of any government contracts 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.
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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.
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 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.
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<PAGE> 32
OUR DELAWARE LAW AND OUR ADOPTION OF A RIGHTS PLAN 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 1/1000th 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.
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, 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.
ITEM 2. PROPERTIES
Our headquarters currently occupy approximately 200,000 square feet in
facilities located in Santa Clara, California under leases expiring in 2013. We
believe that our existing facilities are adequate for the present and that
additional space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
Set forth below are certain litigation matters in which we are a party.
We believe that we have meritorious defenses to these suits and will vigorously
defend ourselves. However, an unfavorable resolution of one or more of these
lawsuits could have a material adverse effect on our business, results of
operations or financial condition.
On April 7, 1999, a putative securities class action, captioned Kinsley
v. Network Associates, Inc., et al., Civil Action No. C-99-1729-SI, was filed
against Network Associates and several of our 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. Several similar actions
have been filed by other plaintiffs, including Wetzel v. Network Associates, et
al., Case No. 99-01731 JL (N.D. Cal), Klein v. Network Associates, et al., Case
No. C-99-1789-WHO (N.D. Cal), Hallowell v. Network Associates, et al., Case No.
C-99-1778-MEJ (N.D. Cal.), and Estate of Lillian Herschkowitz v. Network
Associates, et al., Case No. C-99-1738-SI (N.D. Cal.).
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
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<PAGE> 33
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" and
"GroupShield" products infringe a Trend patent which issued on April 22, 1997.
Trend's complaint seeks injunctive relief and unspecified money damages. On June
6, 1997, 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
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<PAGE> 34
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.
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. Almost all discovery has been completed. The Court
will hear the parties' motions for summary judgment on May 5, 1999. A trial date
has been set for June, 1999.
On September 10, 1998, Network Associates acquired control of CyberMedia,
Inc. ("CyberMedia"). Set forth below are matters upon which Wilson Sonsini
Goodrich & Rosati, Professional Corporation, represents CyberMedia and certain
of its former officers and directors.
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 the
company 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. 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 Mach 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. The second consolidated amended complaint did not specify
damages. Defendants' response to the second consolidated amended complaint must
be filed by April 7, 1999.
CyberMedia and certain of its former officers and directors were named as
defendants in three securities class action lawsuits filed in the Superior Court
of Los Angeles County. Such complaints have been ordered consolidated, although
a consolidated amended complaint has not yet been filed. The
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consolidated complaints include: Brown v. CyberMedia, Inc., et al., No. B
C187898, filed on March 19, 1998, Smith v. CyberMedia, Inc., et al. No. B
C188527, filed on March 31, 1998, and Stockwell v. CyberMedia, Inc., et al., No.
B C189020, filed on April 8, 1998. The complaints allege that defendants
violated California state securities laws and common law by artificially
inflating the price of CyberMedia stock to the detriment of a purported class of
investors who purchased or otherwise acquired CyberMedia stock between March 31,
1997 and March 13, 1998. The complaints do not specify damages. The consolidated
state securities litigation has been stayed pending resolution of the federal
securities litigation pursuant to a stipulation and order entered by the Court
on January 5, 1999.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders' during the fourth
quarter of the year ended December 31, 1998.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
Since our initial public offering on October 6, 1992, our common stock has
traded on the NASDAQ National Market. Since the combination with Network General
Corporation on December 1, 1997, our common stock has traded under the symbol
NETA. Prior thereto, our common stock traded under the symbol MCAF. The
following tables set forth, for the period indicated, the high and low closing
sales prices for our common stock for the last eight quarters, all as reported
by NASDAQ. The prices appearing in the tables below reflect over the counter
market quotations which reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
<S> <C> <C>
YEAR ENDED DECEMBER 31, 1998
First Quarter $ 48.00 $ 31.33
Second Quarter 47.88 38.81
Third Quarter 55.75 32.06
Fourth Quarter 66.25 26.63
YEAR ENDED DECEMBER 31, 1997
First Quarter $ 43.00 $ 25.67
Second Quarter 45.67 28.17
Third Quarter 51.83 33.00
Fourth Quarter 44.25 29.71
</TABLE>
Per share amounts have been restated to give effect retroactively to a
three-for-two stock split which was effected by a stock dividend on May 29,1998.
DIVIDEND POLICY
We have not paid any cash dividends since our reorganization into a
corporate form in October 1992. We intend to retain future earnings for use in
our business and do not anticipate paying cash dividends in the foreseeable
future.
HOLDERS OF COMMON STOCK
As of March 31, 1999, there were 1,391 record owners of our common stock.
ITEM 6. SELECTED FINANCIAL DATA
We have restated our financial results to incorporate the following
companies acquired through pooling of interests: Anyware, CSB, Dr Solomon's,
Nordic, QA, Secure, Syscon, (all acquired in 1998); Helix, Jade, Network
General, SHBV (all acquired in 1997), and FSA (acquired in 1996). In addition,
results for the nine months ended September 30, 1998 and each of the years ended
December 31, 1997, 1996 and 1995, have been restated from those previously
reported to reflect a change in the purchase price allocation and related
amortization of intangibles for acquisitions accounted for by the purchase
method of accounting.
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Dr Solomon's had a fiscal year ended May 31. Financial statements for the
periods through December 31, 1997, reflect the combination of our operating
results for the years ended December 31, 1997, 1996, 1995 and 1994 and the
operating results of Dr Solomon's for the years ended November 31. Restated
financial statements for the year ended December 31, 1998 reflect our operating
results for the year ended December 31, 1998 and the operating results of
Dr Solomon's for the thirteen months ended December 31, 1998.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenue .................. $990,045 $735,692 $514,997 $328,541 $216,294
Income from operations ....... 119,966 61,947 57,568 73,941 38,115
Income before income taxes ... 138,167 82,813 65,419 82,989 44,413
Net income ................... 36,438 $ 10,639 $ 10,711 $ 53,752 $ 28,212
Net income per share, diluted $ 0.26 $ 0.08 $ 0.09 $ 0.45 $ 0.26
Shares used in per share
calculation - diluted ...... 138,609 132,729 125,502 119,243 109,819
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital .............. $537,056 $247,811 $307,478 $179,049 $133,287
Total assets ................. 1,536,721 805,350 613,867 366,280 289,582
Deferred revenue and taxes ... 205,598 129,557 91,020 68,838 57,482
Total equity ................. 722,838 492,501 425,671 251,810 204,719
</TABLE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The following table sets forth for the periods indicated the percentage of
net revenue represented by certain items in our Statements of Operations.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net revenue:
Product ......................................... 84% 86% 85%
Services and support ............................ 16 14 15
---- ---- ----
Total revenue ...................................... 100 100 100
Cost of revenue:
Product ......................................... 14 15 15
Services and support ............................ 4 4 4
---- ---- ----
Total cost of revenue .............................. 18 19 19
Operating costs and expenses:
Research and development ......................... 14 14 12
Marketing and sales .............................. 30 30 29
General and administrative ....................... 8 11 17
Amortization of intangibles ...................... 4 2 5
Compensation - Cinco acquisition ................. -- 2 --
Acquisition and other related costs .............. 14 13 7
---- ---- ----
Total operating costs and expenses ....... 70 72 70
---- ---- ----
Income from operations ................. 12 8 11
Interest and other income .......................... 4 3 2
Interest and other expense ......................... (2) -- --
---- ---- ----
Income before provision for income taxes 14 11 13
Provision for income taxes ......................... 10 10 11
---- ---- ----
Net income ...... ...................... 4% 1% 2%
==== ==== ====
</TABLE>
Net Revenue. Net revenue increased 35% to $990.0 million in 1998 from
$735.7 million in 1997, and 43% from $515.0 million in 1996. The increases in
net revenue are due to the increases in product revenue and services and support
revenues described below.
Product revenue increased 31% to $831.4 million from $634.3 million in
1997, and 46% from $435.5 million in 1996. The increase in the growth rate in
product revenues was primarily due to increases in the licensing of anti-virus
software products, renewing expiring anti-virus licenses, continued acceptance
of the our Sniffer products and continued acceptance of our support services.
The increase is also attributable to a lesser extent to the licensing of
products, other than anti-virus and Sniffer products, to new and existing
customers as well as expansion into indirect product distribution channels and
international markets.
Services and support revenues include revenues from software support,
maintenance contracts, education and consulting services, as well as those
revenues from customer support and maintenance contracts which are deferred and
recognized over the related service period. Service revenues increased 56% to
$158.7 million in 1998 from $101.4 million in 1997, and 28% from $79.5 million
in 1996. The increase in services and support revenues resulted from growth in
all categories of service revenues,
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principally due to the growth of our installed customer base and the resulting
renewal of maintenance contracts.
We have experienced significant growth in net income (before acquisition
and related costs) and net revenue. However, our rate of growth has slowed in
recent periods due to increased price competition, a maturing anti-virus market
and an increasingly higher base from which to grow. Our growth rate and net
revenue depend significantly on renewals of existing orders. Recently, we began
a strategy of up-selling existing licenses to higher level product suites. If
our renewal or up-sale rates slow or decline, our net revenues and operating
results would be adversely affected. As we have continued to evolve as an
enterprise-wide software provider, we have seen a lengthening in our sales
cycle. In addition, 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 compliance issues. 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 revenue,
net income and related growth.
International revenue accounted for approximately 36%, 36%, and 32% of net
revenue for 1998, 1997 and 1996, respectively. The increase in international net
revenue as a percentage of net revenue from 1996 to 1997 was due primarily to
increased acceptance of our products in international markets and the continued
investment in international operations. We expect that international revenues
will increase in absolute terms. To minimize the impact of foreign currency
fluctuations, we use non-leveraged 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
activity during the third quarter, tariffs and other trade barriers,
uncertainties relative to regional economic circumstance (such as the current
economic turbulence in Asia and Latin America), political instability in
emerging markets and difficulties 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.
Cost of Net Revenue. Cost of Net Revenue increased 25% to $177.0 million in
1998 from $142.1 million in 1997, and 46% from $97.6 million in 1996. The
increases in net revenue are due to the increases in cost of product revenue and
cost of services and support revenue described below.
Our 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 product revenues increased 23% to $137.4
million in 1998 from $111.6 million in 1997. From 1996 to 1997 cost of product
revenues increased 44% from $77.2 million. The increase in cost of product
revenues from 1997 to 1998 was primarily due to a corresponding increase in
product revenues. The increase in cost of product revenues from 1996 to 1997 was
due to an increase in product revenues as well as the increase in sales of third
party computer platforms and other hardware components as part of certain
Sniffer products, which have a lower gross margin than our own products. As a
percentage of net product revenue, cost of product revenue was 17% in 1998, 18%
in 1997 and 18% in 1996.
Cost of services and support revenue consists principally of salaries and
benefits related to employees providing customer support and consulting
services. In 1998, cost of services and support revenue increased 30% to $39.7
million from $30.5 million in 1997. From 1996 to 1997, cost of services and
support revenues increased 50% from $20.4 million. These increases are due to
increases in net revenue. Costs increased at a higher rate than revenue due to
the shift in the mix of support and professional services revenue versus revenue
from warranty and maintenance contracts previously deferred. Cost of services
and support revenue as a percentage of net services and support revenue was 25%
in 1998, 30% in 1997 and 26% in 1996.
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To the extent that the percentage of our net revenue which is generated
through traditional distribution channels increases, our cost of net revenue
will increase and, accordingly, gross margins will decrease. In addition, to the
extent that we increase our reliance on retail distribution, we may encounter
problems related to product returns and limited shelf space availability.
Research and Development. Research and development expenses consist
primarily of salary and benefits for our development and technical support
staff. Research and development expenses increased 31% to $135.5 million in 1998
from $103.1 million in 1997. From 1996 to 1997, research and development
expenses increased 62% from $63.8 million. These increases were primarily a
result of the expansion of our product development and technical support staff
and, to a lesser extent, the increased use of independent contractors. As a
percentage of net revenue, research and development expenses was 14% in 1998 and
1997. Research and development spending increased as a percentage of net revenue
in 1997 from 12% in 1996. We anticipate that research and development expenses
will continue to increase in absolute dollars, but may fluctuate as a percentage
of net revenue.
We believe that our ability to maintain our competitiveness will depend in
large part upon our ability to enhance existing products, develop and acquire
new products and develop and integrate acquired products. The market for
computer software is characterized by low barriers to entry and rapid
technological change, and is highly competitive with respect to timely product
introductions. The timing and amount of research and development expenses may
vary significantly based upon the number of new products and significant
upgrades under development and products acquired during a given period.
Marketing and Sales. Marketing and sales expenses consist primarily of
salary, commissions and benefits for marketing, sales and customer support
personnel and costs associated with advertising and promotions. Marketing and
sales expenses increased 33% to $294.8 million in 1998 from $222.2 million in
1997. From 1996 to 1997, marketing and sales expenses increased 50% from $148.2
million in 1996. These increases were primarily the result of an increase in
marketing and sales personnel and, to a lesser extent, increased advertising and
promotional activities required to support increased sales volumes and expanding
product lines. As a percentage of net revenue, marketing and sales expense was
30% in 1998, 1997 and 29% in 1996. Although in absolute dollars, marketing and
sales spending increased from 1996 to 1997, as a percentage of net revenue these
expenses decreased due to a higher rate of growth in net revenue. We are
continuing to expand the breadth and depth of our product suites. This expansion
is expected to contribute to a further increase in marketing and sales expenses
in absolute dollars, which expenses may fluctuate as a percentage of net
revenue.
General and Administrative. General and administrative expenses consist
principally of salary and benefit costs for administrative personnel and general
operating costs. General and administrative costs increased 1% to $83.9 million
in 1998 from $83.1 million in 1997. From 1996 to 1997, general and
administrative expenses decreased 6% from $88.7 million. The relatively small
increase from 1997 to 1998 and the decrease from 1996 to 1997 is primarily due
to the consolidation of staffing both domestically and internationally,
including elimination of staff following our various acquisitions. As a
percentage of net revenue, general and administrative expenses was 8% in 1998,
11% in 1997 and 17% in 1996. We intend to continue to make investments in our
finance and administrative infrastructure, and, as a result, expect general and
administrative expenses will increase in absolute dollars, but may fluctuate as
a percentage of net revenue.
Amortization of Intangibles. We expensed $43.2 million, $12.9 million and
$24.9 million of amortization related to intangibles in the years ended December
31, 1998, 1997 and 1996, respectively. Intangibles consist of purchased goodwill
and certain technology acquired through acquisitions. The increase from 1997 to
1998 is due to the acquisitions of PGP, Magic, and CyberMedia, as well as the
acquisitions of the Virex and NetOctopus products by Dr Solomon's. The decrease
from 1996 to 1997 is due to the end of the life of goodwill and technology from
acquisitions prior to 1996.
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<PAGE> 41
Compensation Related to Cinco Acquisition. The $18 million of compensation
expense that occurred in 1997 resulted from an amendment of the purchase
agreement between Network General and Cinco. The purchase agreement originally
provided for $18 million in contingent payments based primarily on the timely
satisfaction of certain technical and product development and revenue goals.
As a result of the McAfee/Network General merger in December 1997,
significant changes in product directions were undertaken and it was believed
that these changes and the related uncertainties would adversely impact the
ability of the Cinco founders/selling stockholders to achieve the specified
goals. Therefore, in order to retain the founders in the our employ, the
purchase agreement was amended to remove the specified goals. As of December 31,
1998, four of the five founders have continued with us. However, the
consideration is payable whether the founders remain with us or not.
Acquisition and Other Related Costs.
Year Ended December 31, 1998
In connection with the acquisitions 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. The following is a summary of these charges together
with charges for certain restructuring activities taken by us during the year
ended December 31, 1998 ($000's):
<TABLE>
<CAPTION>
Direct Lease Costs
Transaction Severance and Asset In-Process
Costs & Benefits Write downs R&D Other Total
----------- ---------- ------------ ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
TIS ....................... $ 15,023 $ 3,818 $ 4,414 $ -- $ (924) $ 22,331
Dr. Solomon's ............. 19,898 11,425 18,312 -- 0 49,635
Secure .................... 500 500 1,200 -- 100 2,300
Magic ..................... -- -- -- 27,014 -- 27,014
CyberMedia ................ -- -- -- 22,830 -- 22,830
Restructuring Costs-Q2 .... -- 11,318 8,644 -- 610 20,572
Restructuring Costs-Q3 .... -- 3,285 370 -- -- 3,655
Reversal of excess reserves
(6,750) (2,276) (3,909) -- 214 (12,721)
--------- --------- --------- --------- --------- ---------
Total Charges ............. $ 28,671 $ 28,070 $ 29,031 $ 49,844 $ -- $ 135,616
========= ========= ========= ========= ========= =========
</TABLE>
Direct transaction costs included $18.0 million in investment banking fees,
$9.2 million in legal and accounting fees, and $1.5 million in filing fees,
travel and other costs. Lease costs and asset write downs include the costs of
closing approximately 33 facilities throughout the world ($12.2 million), the
disposal of excess and obsolete assets (generally computer equipment which did
not comply with our standards ($12.0 million)), and the write-off of goodwill
and intangibles associated with discontinued Dr Solomon's products ($4.8
million). The Dr Solomon's write-off related to two minor products which we
discontinued and which had no sales subsequent to the Dr Solomon's acquisition.
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<PAGE> 42
The following table summarizes the activity in the acquisition and other
costs reserves established in the second and third quarters of 1998 ($000's):
<TABLE>
<CAPTION>
Direct Asset
Transaction Severance Lease Write
Costs & Benefits Costs downs Other Total
----------- ---------- ------------ ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Charged in Year Ended
December 31, 1998 ......... $ 35,421 $ 30,346 $ 12,249 $ 20,691 $ (214) $ 98,493
Paid Out or Charged
against the related assets (18,771) (19,732) (6,741) (15,377) 2,144 (58,477)
Reversal of excess reserves (6,750) (2,276) -- (3,909) 214 (12,721)
-------- -------- -------- -------- -------- --------
Balance, December 31, 1998 $ 9,900 $ 8,338 $ 5,508 $ 1,405 $ 2,144 $ 27,295
======== ======== ======== ======== ======== ========
</TABLE>
The severance and benefits charges related to company-wide reductions in
force following our major acquisitions in the second and third quarters of 1998
of approximately 784 employees of which 107 were in research and development
functions, 302 were in sales and marketing functions and the remainder were in
administrative and other support functions. Substantially all terminated
employees left our employment in the period the related accounting charge was
recorded. We retained a limited number of employees from each acquisition for
short transition periods. The cost of these employees was charged to operating
expenses during the transition period
The lease costs represent an estimate of lease expense during the period
prior to re-leasing the property together with losses on subleases, if any. The
leased facilities were substantially vacated in the period in which the related
accounting charges were recorded. The costs related to any facilities which we
used during this period were charged to operations. However, these charges were
not material. Asset write downs, exclusive of the intangible assets of Dr.
Solomon's described above, comprised $5.6 million in losses on company owned
buildings (which were written down to estimated values) and $10.3 million in
net losses of computer and other miscellaneous assets. In general, this
equipment was discarded or sold for nominal value. Due to the immediate
consolidation of facilities, depreciation allocable to these facilities and the
related assets, during the transition period, was not material. Of all the
facilities acquired in our 1998 acquisitions identified for closure, as of
December 31, 1998, 9 facilities worldwide have yet to be disposed of or
subleased (8 leased; 1 owned). These facilities are insignificant to our
operations and, other than a portion of a leased facility which we have decided
to retain, each is intended for disposal or sublease in 1999.
The following table summarizes the activity in the reserves for severance
and benefits and facilities write downs established in the year ended December
31, 1997 ($000's):
<TABLE>
<CAPTION>
Direct Asset
Transaction Severance Lease Write
Costs & Benefits Costs downs Other Total
----------- ---------- ------------ ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 8,050 $ 10,697 $ 3,842 $ 1,865 $ 2,893 $ 27,347
Paid Out or Charged against
the related assets ....... (8,086) (7,158) (4,264) (4,381) (2,519) $ (26,408)
Adjustment to liability ... -- (3,000) -- 3,000 -- --
--------- --------- --------- --------- --------- ---------
Balance, December 31, 1998 $ (36) $ 539 $ (422) $ 484 $ 374 $ 939
========= ========= ========= ========= ========= =========
</TABLE>
We believe that the balances remaining at December 31, 1998 are adequate to
cover any additional benefits or losses yet to be paid or realized. Any reserves
not used will be recorded as a credit to Acquisition and related costs in future
periods.
The in-process research and development costs comprise approximately $22.8
million and $27.0 million in connection with the acquisitions of CyberMedia in
the three months ended September 30, 1998 and Magic Solutions in the three
months ended June 30, 1998, respectively. The following is a summary
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<PAGE> 43
of the projects acquired and the assumptions used in determining the value of
the in-process research and development costs.
CyberMedia:
The ongoing projects at CyberMedia at the time of the purchase included
upgrade versions of four products (First Aid 6.0 and 7.0, UnInstaller 6.0, Guard
Dog 3.0, and Oil Change 3.0) as well as work on technologies to be used in two
of the our projects (a replacement product for PC Medic and McAfee Office).
These upgrades will include new interfaces with the Internet, enhanced use of
Active-X controls and Java and enhanced user interfaces. At the date we acquired
CyberMedia, we estimated that, on average, 42% of the development effort had
been completed and that the remaining 58% of the development effort would take
approximately 12 months to complete and would cost $2.7 million. The efforts
required to complete the development of these projects principally relate to
additional design efforts to integrate the technologies into our suite of
products, finalization of coding, and completion of prototyping, verification,
and testing activities required to establish that products associated with the
technologies can be successfully introduced. The value of the in-process
technologies was determined by estimating the projected net cash flows related
to products, including costs to complete the development of the technologies or
products, and the future net revenues that may be earned from the products,
excluding the value attributed to integration with our products or that may have
been achieved due to efficiencies resulting from the combined sales force or the
use of our more effective distribution channel. In conformity with the SEC's
revised guidelines for accounting for in-process technologies, these cash flows
were discounted back to their net present value using a discount rate of 28%
(which represents a premium of approximately 5% over our average weighted cost
of capital) and excluding the value attributable to the use of the in-process
technologies in future products. If we do not deploy commercially accepted
products based on the acquired in-process technologies, our operating results
could be adversely affected in future periods. Additionally, the failure of any
particular project would impair the value of other intangibles, particularly
goodwill, acquired from CyberMedia.
Magic Solutions:
The ongoing projects at Magic Solutions at the time of the purchase
comprised an upgrade version of Support Magic 4.0, Magic Solutions current
product. This upgrade, known as Merlin Enterprise, represents new technologies
with significant enhanced functionality, including increased scalability, a
32-bit browser-based technology, an enhanced user interface and integrated
management features. At the date we acquired Magic Solutions, we estimated that,
on average, 80% of the development effort had been completed and that the
remaining 20% of the development effort would take approximately 12 months to
complete and would cost $1.8 million. The efforts required to complete the
development of these projects principally relate to additional design efforts to
integrate the technologies into our suite of products, finalization of coding,
and completion of prototyping, verification, and testing activities required to
establish that products associated with the technologies can be successfully
introduced. The value of the in-process technologies was determined by
estimating the projected net cash flows related to products, including costs to
complete the development of the technologies or products, and the future net
revenues that may be earned from the products, excluding the value attributed to
integration with our products or that may have been achieved due to efficiencies
resulting from the combined sales force or the use of the our more effective
distribution channel. In conformity with the SEC's revised guidelines for
accounting for in-process technologies, these cash flows were discounted back to
their net present value using a discount rate of 28% (which represents a premium
of approximately 5% over our average weighted cost of capital) and excluding the
value attributable to the use of the in-process technologies in future products.
If we do not deploy commercially accepted products based on the acquired
in-process technologies, operating results could be adversely affected in future
periods. Additionally, the failure of any particular project would impair the
value of other intangibles, particularly goodwill, acquired from Magic
Solutions.
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<PAGE> 44
Year Ended December 31, 1997
The Acquisition and other related costs for 1997 comprise (i) the
write-off of acquired in-process research and development projects of companies
acquired in purchase accounting transactions; (ii) direct transaction costs of
companies acquired in pooling of interests transactions; (iii) accrual for
severance and benefits for terminations; and (iv) lease costs and asset
write-downs in connection with the Network General merger. The following is a
summary of these charges (in thousands):
<TABLE>
<CAPTION>
Direct
Transaction Severance & Lease Costs and Asset In-Process
Costs Benefits Writedowns R&D Other Total
----------- ----------- --------------------- ----------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Network General ............. $15,347 $11,083 $18,916 $ -- $ 603 $45,949
Helix ....................... -- -- -- -- 1,874 1,874
(acquired by NAI)
Paradigm .................... -- -- -- -- 2,330 2,330
(acquired by NAI)
PGP ......................... -- -- -- 3,937 -- 3,937
(acquired by NAI)
Sybari ...................... -- -- -- -- 1,100 1,100
(acquired by NAI)
Datawatch ................... -- -- -- 9,336 -- 9,336
(acquired by Dr Solomon's)
Haystack .................... 3,535 -- -- -- -- 3,535
(acquired by TIS)
Cinco ....................... -- -- -- 5,234 -- 5,234
(acquired by Network General)
3DV ......................... -- -- -- 19,504 -- 19,504
(acquired by Network General)
------- ------- ------- ------- ------- -------
Total Charges ............... $18,882 $11,083 $18,916 $38,011 $ 5,907 $92,799
======= ======= ======= ======= ======= =======
</TABLE>
Direct transaction costs included $14.0 million in investment banking
fees, $3.7 million in legal and accounting fees, $709,000 in filing fees and
$438,000 in other related charges.
The following table summarizes the activity in the reserves for
acquisition and other related costs ($000's):
<TABLE>
<CAPTION>
Direct
Transaction Severance & Lease Asset Write
Costs Benefits Costs Downs Other Total
----------- ----------- -------- ------------ -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ -- $ -- $ -- $ -- $ 2,708 $ 2,708
Charged in the three months
ended December 31, 1997 18,882 11,083 3,842 15,074 5,907 54,788
Paid Out or Charged against
the related assets (10,832) (386) -- (13,209) (5,722) (30,149)
-------- -------- -------- -------- -------- --------
Balance, December 31, 1997 $ 8,050 $ 10,697 $ 3,842 $ 1,865 $ 2,893 $ 27,347
======== ======== ======== ======== ======== ========
</TABLE>
The severance and benefits charges relate to company-wide reductions in
force following our acquisition of Network General, PGP and Helix in the fourth
quarter of approximately 186 employees across all employee groups. The
termination plan, which took place in January 1998, was finalized and approved
by management prior to December 31, 1997. The employees to be terminated and the
benefit arrangements were communicated to employees on December 31, 1997. A
limited number of employees were retained for a short period to help with the
transition. Costs associated with these transition employees were charged to
operations during the transition period.
Lease costs and asset writedowns include $3.8 million related to the costs
of closing approximately 35 facilities throughout the world and the disposal of
excess and obsolete assets (generally computer equipment which did not comply
with our standards) of $15.1 million.
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<PAGE> 45
The lease costs of $3.8 million represent an estimate of lease expense
during the period prior to re-leasing the property together with losses on
subleases, if any. The costs, excluding amortization of leasehold improvements
related to any facilities which were used by us during a short transition
period, were charged to operations. However, these charges were not material.
Due to the immediate consolidation of facilities, depreciation allocable to
these facilities during the transition period was also not material. Asset write
downs of $15.1 million comprised the write-off of leasehold improvements ($9.6
million) and the sale or abandonment of old and obsolete equipment ($5.5
million) which was discarded or sold for nominal value. To the extent that such
equipment was used during the transition, period, depreciation (which was not
material) was charged to operations. Facilities identified for closure were
available for sale or sublease as of December 31, 1997.
The Helix charge related to direct transaction costs ($838,000), severance
costs ($495,000) and other related charges ($541,000) incurred in connection
with the Helix acquisition which was accounted for under the pooling method of
accounting.
The Paradigm charge related to the write-off of the purchase price paid in
our acquisition of an Australian distributor, Paradigm Agency Ltd., who had the
right to use the McAfee brand name in Australia. This acquisition was part of
our initiative to establish a direct presence in major foreign markets and to
recapture its brand names in these countries.
The Sybari Technology charge related to a buy-out in December 1997 of a
license agreement we entered into earlier in 1997. The buy-out was motivated in
an effort to resolve potential disputes with Sybari, and the technology was
considered obsolete at the time of the buy-out and had no alternative use in our
products.
The in-process research and development costs in 1997 comprise
approximately $5.2 million, $3.9 million, $19.5 million and $9.3 million in
connection with the acquisitions of Cinco Networks, Inc., PGP, 3DV, and
Datawatch, respectively. The following is a summary of the projects acquired in
the PGP and Cinco acquisitions and the assumptions used in determining the value
of the in-process research and development costs. The 3DV projects in process at
the date of the Network General merger, together with all other 3DV
technologies, were discontinued at that date.
PGP:
The ongoing projects at PGP at the time of the purchase included upgrade
versions of PGP Product Suite components, including PGP for Personal Privacy,
PGP for Business Security and PGP Certificate Server. These upgrades will
include features such as improved key recovery certificate management and key
splitting and enhanced user interfaces. At the date we acquired PGP, we
estimated that, on average, 20% of the development effort had been completed and
that the remaining 80% of the development effort would take approximately six
months to complete and would cost $3.6 million. The efforts required to complete
the development of these projects principally relate to additional design
efforts to integrate the technologies into our suite of products, finalization
of coding, and completion of prototyping, verification, and testing activities
required to establish that products associated with the technologies can be
successfully introduced. The value of the in-process technologies was determined
by estimating the projected net cash flows related to products, including costs
to complete the development of the technologies or products, and the future net
revenues that may be earned from the products, excluding the value attributed to
integration with our products or that may have been achieved due to efficiencies
resulting from the combined sales force or the use of our more effective
distribution channel. In conformity with the SEC's revised guidelines for
purchased in-process technologies, these cash flows were discounted back to
their net present value using a discount rate of 27% (which represents a premium
of approximately 5% over PGP's average weighted cost of capital) and excluding
the value attributable to the use of the in-process technologies in future
products. If we do not deploy commercially accepted products based on the
acquired in-process technologies, operating results could be adversely affected
in future periods. Additionally, the failure of any particular project would
impair the value of other intangibles,
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<PAGE> 46
particularly goodwill, acquired from PGP. As of December 31, 1998, the projects
related to this acquisition were substantially complete.
Cinco:
The ongoing projects at Cinco at the time of the purchase comprised upgrade
versions of NetXRay, WebXRay and Distributed NetXRay, Cinco's current products.
At the date we acquired Cinco, we estimated that, on average, 80% of the
development effort had been completed and that the remaining 20% of the
development effort would take approximately 4 months to complete and would cost
$240,000. The efforts required to complete the development of these projects
principally relate to the completion of prototyping, verification, and testing
activities required to establish that products associated with the technologies
can be successfully introduced. The value of the in-process technologies was
determined by estimating the projected net cash flows related to products,
including costs to complete the development of the technologies or products, and
the future net revenues that may be earned from the products, excluding the
value attributed to integration with our products or that may have been achieved
due to efficiencies resulting from the combined sales force or the use of our
more effective distribution channel. In conformity with the SEC's revised
guidelines for purchased in-process technologies, these cash flows were
discounted back to their net present value using a discount rate of 37.5% and
excluding the value attributable to the use of the in-process technologies in
future products. If we do not deploy commercially accepted products based on the
acquired in-process technologies, operating results could be adversely affected
in future periods. Additionally, the failure of any particular project would
impair the value of other intangibles, particularly goodwill, acquired from
Cinco Networks. As of December 31, 1998, the projects related to this
acquisition were substantially complete.
Other Acquisitions:
Acquisition and other related costs in 1996 principally comprise the
write-off of acquired in-process research and development in connection with the
acquisition of 3DV. This charge ($19.5 million) is also included in the 1997
Acquisition and other related costs due to the first quarter of 1997 being
included in our results in 1997 and 1996 (see Note 4 in Notes to Consolidated
Financial Statements). Subsequent to the Network General merger in December
1997, all 3DV projects were terminated. The remaining $3.4 million of
Acquisition and other related costs are comprised of $2.1 million recorded in
connection with the acquisition of Interactive Distributed Systems Software GmbH
and $1.3 million of transaction costs in connection with the acquisition of FSA.
Interest and Other Income. Interest and miscellaneous income increased to
$33.4 million in 1998 from $21.0 million in 1997 and $7.9 million in 1996.
Interest and other income increased from 1997 to 1998 as primarily as a result
of the investment of the funds from our Zero Coupon Convertible Subordinated
Debentures (the "Debentures") issued in February 1998. Interest and other income
increased from 1996 to 1997 and from 1996 to 1997 due to the investment of cash
generated from operating activities.
Interest and Other Expense. Interest and other expense increased to $15.2
million in 1998 from $87,000 in 1997 and $13,000 in 1996. Interest and other
expense increased in 1998 primarily as a result of the issuance of the
Debentures.
Provision for Income Taxes. Our effective tax rate for 1998, 1997 and 1996
was 74%, 87% and 84% respectively. Our effective tax rate for 1998, 1997 and
1996 was 32%, 37% and 44% respectively, excluding the effect of one-time
non-deductible in-process research and development, merger and other acquisition
costs and amortization of intangibles.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, we had $418.9 million in cash and cash equivalents
and $315.0 million in marketable securities, for a combined total of $733.9
million.
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<PAGE> 47
Net cash provided by operating activities was $52.5 million, $92.0 million
and $37.9 million in 1998, 1997 and 1996, respectively. Net cash provided by
operating activities in 1998 consisted primarily of net income before acquired
in-process research and development, depreciation and amortization and interest
on the Debentures as well as an increase in deferred revenue which were offset
primarily by increases in accounts receivable and prepaids and other assets and
a decrease in accounts payable and accrued liabilities. Net cash provided by
operating activities in 1997 consisted primarily of net income before acquired
in-process research and development and depreciation and amortization, plus
increases in accounts payable and accrued liabilities and deferred revenue which
were offset primarily by an increase in accounts receivable and deferred taxes.
In 1996, net cash provided by operating activities consisted primarily of net
income before acquired in-process research and development and depreciation and
amortization, as well as an increase in accounts payable and accrued liabilities
which were offset primarily by increases in accounts receivable, prepaids and
other assets and deferred taxes.
We expect our accounts receivable balance as a percentage of sales to
increase due to our increased emphasis on international sales typically having
longer payment terms; a higher percentage of indirect sales through indirect
channels and a shift in our product mix to more server/enterprise based
products. 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 receivables balance increases, we will be subject to greater general
credit risks with respect thereto.
Net cash used in investing activities was $318.8 million, $145.2 million
and $104.0 million in 1998, 1997 and 1996, respectively, primarily reflecting
investments in acquisitions and mergers, purchases of marketable securities and
additions to fixed assets and intangible assets.
Net cash provided by financing activities was $533.3 million in 1998
consisting primarily of the proceeds from the issuance of the Debentures as well
as proceeds and tax benefits associated with the exercise of non-qualified stock
options. Net cash provided by financing activities was $45.2 million in 1997 and
consisting primarily of the proceeds and tax benefits associated with the
exercise of non-qualified stock options partially offset by the repurchase of
common stock. Net cash provided by financing activities was $159.2 million in
1996, consisting primarily of proceeds from the issuance of common stock by TIS
and Dr. Solomon's and proceeds and tax benefits associated with the exercise of
non-qualified stock options partially offset by the repurchase of common stock.
We believe that its 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, partially offset
by the repurchase of common stock. Net cash provided by financing activities was
$159.2 million in 1996, consisting primarily of proceeds from the issuance of
common stock by TIS and Dr. Solomon's and proceeds and tax benefits associated
with the exercise of non-qualified stock options.
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 for all areas and target
completion of corrective actions by the end of the third quarter of 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.
<PAGE> 48
Core IT Systems. We have implemented the R3 system from SAP A.G. The SAP
system is designed to automate more fully our business processes and is
certified by SAP A.G. as Year 2000 compliant. This implementation was completed
in late 1997 and early 1998 and included most of the major functional areas of
our business.
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;
electronic data interchange systems; and human resources 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 system compliance projects
are expected to be completed by the end of the third 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 are actively engaged in working with each facilities and
safety systems vendor to identify and resolve any Year 2000 compliance issues.
We will assign the highest resolution priority to repair or replacement of
items that affect our product development, distribution and support operations.
Supplier and Business Partner Compliance. Our suppliers and business
partners include the sources of the equipment and supplies used by us in the
conduct of our business, as well as our landlords, financial institutions, and
other service providers. Assessment of our suppliers is underway and will
include determination of the level of risk of business interruption associated
with a failure of a vendor or supplier to properly address the Year 2000 Issue
and assignment of priority to resolution activities. We are requesting written
assurance of Year 2000 compliance from our vendors and suppliers whose Year
2000 compliance is important to our business. We are working to develop
alternative suppliers in the cases where our vendors will not provide written
assurances.
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 $4,500,000 of compliance related expenditures.
These expenditures relate primarily to the replacement of certain internal
systems hardware and software, the most significant being new 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 will be developed in connection with the assessment and resolution of the
risks identified. We have established certain preliminary information
technology contingency plans, and we are continuing
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<PAGE> 49
to develop contingency plans for each specific area of risk associated with the
Year 2000 Issue. We expect to finalize our contingency plans by the end of the
third quarter of 1999.
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 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 revenue, 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.
<PAGE> 50
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 conversion to 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 flexiblity to transact business with
vendors and customers in either euro or traditional national currency units. For
those countries where bank accounts were not automatically translated into dual
currency bank accounts a separate we maintain separate euro accounts.
FINANCIAL RISK MANAGEMENT
The following discussion about our risk management activities includes
"forward-looking statements" that involve risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements.
As a global concern, we face exposure to adverse movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could have a material adverse impact on our financial
results. Historically, our primary exposures related to nondollar-denominated
sales and operating expenses in Japan, Canada, Australia, Europe, Latin America,
and Asia. We have recently expanded our business activities in Europe. As a
result, we expect to see an increase in exposures related to
nondollar-denominated sales in several European currencies. At the present time,
we hedge only those currency exposures associated with certain assets and
liabilities denominated in nonfunctional currencies and does not generally hedge
anticipated foreign currency cash flows. Our hedging activity is intended to
offset the impact of currency fluctuations on certain nonfunctional currency
assets and liabilities. The success of this activity depends upon estimates of
transaction activity denominated in various currencies, primarily the Japanese
yen, Canadian dollar, Australian dollar, and certain European currencies. To the
extent that these estimates are over- or understated during periods of currency
volatility, we could experience unanticipated currency gains or losses.
We maintain investment portfolio holdings of various issuers, types and
maturities. These securities are generally classified as available-for-sale, and
consequently are recorded o the balance sheet at fair market value with
unrealized gains and losses reported as a separate component of shareholders'
equity. These securities are not leveraged and are held for purposes other than
trading.
The following tables present the hypothetical changes in fair values in the
securities held us at December 31, 1998 that are sensitive to the changes in
interest rates. The modeling technique used measures the change in fair market
values arising from hypothetical parallel shifts in the yield curve of plus or
minus 50 basis points (BPS), 100 BPS and 150 BPS over six and twelve-month time
horizons. Beginning fair market values represent the market principal plus
accrued interest and dividends at December 31, 1998. Ending fair market values
are the market principal plus accrued interest, dividends and reinvestment
income at six and twelve month time horizons.
50
<PAGE> 51
The following table estimates the fair value of the portfolio at a
six-month time horizon (in millions):
<TABLE>
<CAPTION>
ISSUER VALUATION OF SECURITIES VALUATION OF SECURITIES
- ------ GIVEN AN INTEREST RATE GIVEN AN INTEREST RATE
DECREASE OF X BASIS POINTS NO CHANGE INCREASE OF X BASIS POINTS
---------------------------------- IN INTEREST -----------------------------------
150BPS 100 BPS 50 BPS RATE 50 BPS 100 BPS 150 BPS
------ ------ ------ ----------- ------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Government
notes and bonds $149.9 $149.4 $149.0 $148.5 $147.8 $147.1 $146.3
Municipal notes
and bonds 55.3 55.0 54.8 54.6 54.3 54.1 53.9
Corporate notes,
bonds and preferreds 265.7 265.2 264.7 263.5 263.7 263.2 262.6
------ ------ ------ ------ ------ ------ ------
Total $470.9 $469.6 $468.5 $466.6 $465.8 $464.4 $462.8
====== ====== ====== ====== ====== ====== ======
</TABLE>
The following table estimates the fair value of the portfolio at a
twelve-month time horizon (in millions):
<TABLE>
<CAPTION>
ISSUER VALUATION OF SECURITIES VALUATION OF SECURITIES
- ------ GIVEN AN INTEREST RATE GIVEN AN INTEREST RATE
DECREASE OF X BASIS POINTS NO CHANGE INCREASE OF X BASIS POINTS
---------------------------------- IN INTEREST -----------------------------------
150BPS 100 BPS 50 BPS RATE 50 BPS 100 BPS 150 BPS
------ ------ ------ ----------- ------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Government
notes and bonds $151.7 $151.4 $151.0 $150.7 $150.1 $149.5 $149.0
Municipal notes
and bonds 55.0 54.9 54.7 54.6 54.5 53.5 53.4
Corporate notes,
bonds and preferreds 267.4 267.3 267.1 266.9 266.8 266.6 266.5
------ ------ ------ ------ ------ ------ ------
Total $474.1 $473.6 $472.8 $472.2 $471.4 $469.6 $468.9
====== ====== ====== ====== ====== ====== ======
</TABLE>
CONVERTIBLE DEBT
On February 13, 1998, we completed a private placement of Zero
Coupon Convertible Subordinated Debentures due in 2018 (the "Debentures"). The
Debentures, with an aggregate face amount at maturity of $885.5 million,
generated net proceeds to us of approximately $337.6 million (after deducting
the fee paid to the initial purchaser of the Debentures but no other expenses of
the placement). The initial price to the public for the Debentures was $391.06
per $1,000 of face amount at maturity, which equates to a yield to maturity over
the term of the bonds of 4.75% (on a semi-annual bond equivalent basis). The
Debentures are convertible into common stock at the rate of 8.538 shares per
$1,000 of face amount at maturity, which equates to an initial conversion price
of $45.80 per share. The Debentures are subordinated in right of payment to all
existing and future Senior Indebtedness (as defined) and effectively
subordinated in right of payment to all indebtedness and other liabilities of
our subsidiaries. The Debentures may be redeemed for cash at our option
beginning on February 13, 2003. At the option of the holder, we will purchase
the Debentures as of February 13, 2003, February 13, 2008 and February 13, 2013
at purchase prices (to be paid in cash or Common Stock or any combination
thereof, our election and subject to certain conditions) equal to the initial
issue price plus accrued original issue discount to such dates. The Debentures
may also be redeemed at the option of the holder if there is a Fundamental
Change (as defined) at a price equal to the issue price plus accrued original
issue discount to the date of redemption, subject to adjustment.
51
<PAGE> 52
QUARTERLY OPERATING RESULTS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1998 1998 1998 1998 1997 1997 1997 1997
--------- --------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
AND OTHER DATA:
Net revenues $ 272,191 $ 242,444 $ 249,317 $ 226,093 $ 198,127 $ 188,407 $ 178,400 $ 170,758
Gross Margin 232,838 197,888 199,444 182,827 153,437 154,395 146,907 138,854
Income (loss) from operations 80,970 8,167 (18,499) 49,328 (54,726) 44,523 45,416 26,734
Income (loss) before
provision for income taxes 85,225 12,266 (14,348) 55,024 (50,005) 51,004 51,131 30,683
Net income (loss) $ 56,685 $ (14,444) (38,547) $ 32,744 $ (60,324) $ 28,782 $ 30,956 $ 11,225
Diluted earnings (loss)
per share $ 0.40 $ (0.11) $ (0.29) $ 0.24 $ (0.47) $ 0.22 $ 0.23 $ 0.08
Shares used in per
share calculation - diluted 149,002 133,531 131,503 140,412 127,645 132,436 132,195 132,657
</TABLE>
In view of our acquisitions in various quarters of 1998 and 1997, the
growth in revenues and operating income experienced by us in 1998 and 1997 are
not necessarily indicative of future results. In addition, we believe that
period-to-period comparisons of our financial results should not be relied upon
as an indication of future performance.
Our revenues and results of operations have been subject to significant
fluctuations, particularly on a quarterly basis, and our revenues and results of
operations could fluctuate significantly quarter to quarter and year to year.
Causes of such fluctuations may include the volume and timing of new orders and
renewals, the sales cycle for our products, the introduction of new products,
distributor inventory levels and return rates, inventory levels, product
upgrades or updates by us or our competitors, changes in product mix, changes in
product prices and pricing models, seasonality, trends in the computer industry,
general economic conditions (such as the recent economic turbulence in Asia),
extraordinary events such as acquisitions or litigation and the occurrence of
unexpected events.
Significant quarterly fluctuations in revenues will cause significant
fluctuations in our cash flows and the cash and cash equivalents, accounts
receivable and deferred revenue accounts on our balance sheet. In addition, the
operating results of many software companies reflect seasonal trends, and our
business, financial condition and results of operations may be affected by such
trends in the future. These trends may include higher net revenue in the fourth
quarter as many customers complete annual budgetary cycles, and lower net
revenue in the summer months when many businesses experience lower sales,
particularly in the European market.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Quantitative and qualitative disclosure about market risk is set forth at
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" under Item 6.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Financial Statements and supplementary data of required by this item
are set forth at the pages indicated at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with our annual meeting of
stockholders to be held on June 24, 1999.
ITEM 11. EXECUTIVE COMPENSATION
The information required hereunder is incorporated by reference from our Proxy
Statement to be filed in connection with our annual meeting of stockholders to
be held on June 24, 1999.
52
<PAGE> 53
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with our annual meeting of
stockholders to be held on June 24, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with our annual meeting of
stockholders to be held on June 24, 1999.
53
<PAGE> 54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C>
Report of Independent Accountants
Consolidated Balance Sheets:
December 31, 1998 and 1997
Consolidated Statements of Operations:
Years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Stockholder's
Equity:
Years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows:
Years ended December 31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
Report of Independent Accountants
Schedule II - Schedule of Valuation and Qualifying Accounts
Other Schedules are omitted because the
conditions required for filing do not exist
or the required information is included in
the financial statements or notes thereto.
</TABLE>
(a)(3) Exhibits: See Index to Exhibits on Page [ ]. The
Exhibits listed on the accompanying Index of Exhibits
are filed or incorporated by reference as part of this
report.
(b) Reports on Form 8-K:
(i) On October 22, 1998, we filed a Form 8-K
reporting the adoption of a Preferred Shares
Rights Agreement and the distribution of the
related Rights.
(ii) On November 23, 1998 we filed a Form 8-K in
connection with the acquisition of CyberMedia.
54
<PAGE> 55
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders
Networks Associates, Inc.
Santa Clara, California
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, stockholders' equity, and of cash
flows present fairly, in all material respects, the financial position of
Networks Associates, Inc. and its subsidiaries at December 31, 1998 and December
31, 1997, and the results of their operations and cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
March 31, 1999,
except for the matters discussed
in Note 17 as to which the date is
April 7, 1999.
55
<PAGE> 56
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ..................................................... $ 418,899 $ 157,031
Short term marketable securities .............................................. 98,515 151,580
Accounts receivable, net of allowance for doubtful accounts
of $11,682 in 1998 and $5,107 in 1997 ................................... 260,784 156,197
Prepaid expenses and income taxes ............................................... 59,554 42,882
Deferred taxes .................................................................. 65,866 30,089
----------- -----------
Total current assets .................................................. 903,618 537,779
Long term marketable securities ................................................. 216,457 109,184
Fixed assets, net ............................................................... 54,489 48,328
Deferred taxes .................................................................. 38,205 16,173
Intangible and other assets ..................................................... 323,952 93,886
----------- -----------
Total assets .......................................................... $ 1,536,721 $ 805,350
=========== ===========
LIABILITIES
Current liabilities:
Accounts payable .............................................................. $ 20,881 $ 26,444
Accrued liabilities ........................................................... 210,070 154,185
Deferred revenue .............................................................. 132,409 109,029
Notes payable ................................................................. 3,202 310
----------- -----------
Total current liabilities ............................................. 366,562 289,968
Deferred taxes .................................................................. 13,000 2,135
Deferred revenue, less current portion .......................................... 60,189 18,393
Long term debt and other liabilities ............................................ 374,132 2,353
----------- -----------
Total liabilities ..................................................... 813,883 312,849
=========== ===========
Commitments and contingencies (Notes 7 and 5)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value:
Authorized: 5,000,000 shares;
Issued and outstanding: one share
Common stock, $.01 par value:
Authorized: 300,000,000 shares;
Issued and outstanding: 137,123,562 shares in 1998 and
128,059,000 shares in 1997 .................................................... 1,371 1,281
Additional paid-in capital ...................................................... 527,862 331,409
Cumulative other comprehensive income - unrealized gain (loss) on investments and
foreign currency translation .................................................. (1,534) 1,778
Other ........................................................................... -- (668)
Retained earnings ............................................................... 195,139 158,701
----------- -----------
Total stockholders' equity ............................................ 722,838 492,501
----------- -----------
Total liabilities and stockholders' equity ............................ $ 1,536,721 $ 805,350
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
56
<PAGE> 57
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net revenue:
Product ....................................... $ 831,363 634,269 $ 435,466
Services and support .......................... 158,682 101,423 79,531
--------- --------- ---------
Total revenue .................................... 990,045 735,692 514,997
--------- --------- ---------
Cost of revenue:
Product ....................................... 137,374 111,552 77,207
Services and support .......................... 39,674 30,547 20,351
--------- --------- ---------
Total cost of revenue ............................ 177,048 142,099 97,558
--------- --------- ---------
Operating costs and expenses:
Research and development ....................... 135,475 103,051 63,795
Marketing and sales ............................ 294,812 222,194 148,151
General and administrative ..................... 83,946 83,083 88,662
Amortization of intangibles .................... 43,182 12,866 24,904
Compensation - Cinco Acquisition ............... -- 17,653 --
Acquisition and other related costs ............ 135,616 92,799 34,359
--------- --------- ---------
Total operating costs and expenses ........ 693,031 531,646 359,871
--------- --------- ---------
Income from operations ................. 119,966 61,947 57,568
Interest and other income ........................ 33,447 20,953 7,864
Interest and other expense ....................... (15,246) (87) (13)
--------- --------- ---------
Income before provision for income taxes 138,167 82,813 65,419
Provision for income taxes ....................... 101,729 72,174 54,708
--------- --------- ---------
Net income ............................. $ 36,438 $ 10,639 $ 10,711
========= ========= =========
Other comprehensive income (loss):
Unrealized gain on investments ................. $ 1,793 $ 56 $ --
Foreign currency translation gain (loss) ....... (5,101) (791) 469
--------- --------- ---------
Comprehensive income ............................. $ 33,130 $ 9,904 $ 11,180
========= ========= =========
Net income per share - basic ..................... $ 0.27 $ 0.08 $ 0.09
========= ========= =========
Shares used in per share calculation - basic ..... 133,075 126,662 115,626
========= ========= =========
Net income per share - diluted ................... $ 0.26 $ 0.08 $ 0.09
========= ========= =========
Shares used in per share calculation - diluted ... 138,609 132,729 125,502
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
57
<PAGE> 58
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
OTHER
COMMON STOCK ADDITIONAL COMPREHEN-
------------------- PAID-IN DEFERRED SIVE RETAINED TREASURY
SHARES AMOUNT CAPITAL COMP INCOME EARNINGS STOCK TOTAL
-------- ------- ---------- --------- ------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1995 ......... 116,995 1,170 157,688 -- 1,648 130,931 (39,625) 251,812
Issuance of common stock .......... 5,540 55 126,029 -- -- -- -- 126,084
Issuance of common stock upon
exercise of stock options ....... 5,024 50 44,653 -- -- -- -- 44,703
Issuance of common stock from
Employee Stock Purchase Plan .... 236 2 3,697 -- -- -- -- 3,699
Fractional shares returned upon
stock split ..................... (236) (2) 2 -- -- -- -- --
Tax benefit from exercise of
nonqualified stock options ...... -- -- 40,981 --
Foreign currency translation ...... -- -- -- -- -- -- -- 40,981
Repurchase of common stock ........ -- -- -- -- 469 -- -- 469
Retirement of treasury stock ...... (2,931) (29) (92,545) -- -- -- (52,949) (52,949)
Deferred stock compensation ....... -- -- 1,105 (1,105) -- -- 92,574 --
Amortization of deferred stock -- -- -- --
compensation .................... -- -- -- 161 -- -- -- 161
Net income ........................ -- -- -- -- -- 10,711 -- 10,711
-------- --------- --------- --------- ------ --------- --------- ---------
Balances, December 31, 1996 ......... 124,628 1,246 281,610 (944) 2,117 141,642 -- 425,671
Elimination of net loss for
Network General for the quarter
ended March 31,1997 ............ 1,689 17 83,702 --
Issuance of common stock upon
exercise of stock options ....... 4,999 50 35,126 -- 396 6,420 (79,196) 11,339
Issuance of common stock from
Employee Stock Purchase Plan .... 549 6 6,925 -- -- -- -- 35,176
Tax benefit from exercise of
nonqualified stock options ...... -- -- 39,941 -- -- -- -- 6,931
Foreign currency translation ...... -- -- -- -- -- -- -- 39,941
Unrealized gain on investments .... -- -- -- -- (791) -- -- (791)
Repurchase of common stock ........ (3,806) (38) (115,895) 56 -- -- 56
Amortization of deferred stock -- -- 79,196 (36,737)
compensation ................... -- -- -- 276 -- -- -- 276
Net income ........................ -- -- -- -- -- 10,639 -- 10,639
-------- --------- --------- --------- ------- --------- --------- - --------
Balances, December 31, 1997 ......... 128,059 1,281 $ 331,409 (668) 1,778 158,701 -- 92,501
Issuance of common stock upon
exercise of stock options ....... 8,560 86 144,646 -- -- -- -- 44,732
Issuance of common stock from
Employee Stock Purchase Plan .... 445 4 6,363 --
Tax benefit from exercise of -- -- -- 6,367
nonqualified stock options ...... -- -- 43,500 --
Foreign currency translation ...... -- -- -- -- -- -- -- 43,500
Unrealized gain on investments .... -- -- -- -- (5,105) -- -- (5,105)
Amortization of deferred stock 1,793 -- -- 1,793
compensation ................... -- -- -- 668 -- -- -- 668
Exercise of warrants .............. 59 -- 1,944 -- -- -- -- 1,944
Net income ........................ -- -- -- -- -- 36,438 -- 36,438
-------- --------- --------- --------- --------- --------- --------- ---------
Balances, December 31, 1998 ......... 137,123 $ 1,371 $ 527,862 $ -- $ (1,534) $ 195,139 $ -- 722,838
========= ========= ========= ========= ========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
58
<PAGE> 59
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .................................................. $ 36,438 $ 10,639 $ 10,711
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Acquired in-process research and development ............. 49,843 38,011 19,504
Depreciation and amortization ............................ 75,335 37,720 39,933
Write down of owned facility ............................. 1,177 -- --
Deferred taxes ........................................... (47,266) (22,220) (22,288)
Interest on convertible notes ............................ 14,525 -- --
Unrealized gain /loss on investments ..................... 1,793 56 --
Changes in assets and liabilities:
Accounts receivable .................................... (97,776) (51,510) (34,795)
Prepaids and other assets .............................. (28,627) (26,212) (31,959)
Accounts payable and accrued liabilities ............... (2,300) 66,380 35,339
Deferred revenue ....................................... 49,324 39,180 21,418
----------- ----------- -----------
Net cash provided by operating activities ........... 52,466 92,044 37,863
----------- ----------- -----------
Cash flows from investing activities:
Elimination of Network General cash flow for the quarter
ended March 31, 1997 ........................................ -- 11,339 --
Purchases of available-for-sale investments ................. (3,284,620) (785,060) (239,857)
Sales of available-for-sale investments ..................... 3,230,412 780,987 162,332
Purchases of held-to-maturity investments ................... -- (81,668) (112,062)
Sales of held-to-maturity investments ....................... -- 45,307 112,977
Additions to fixed assets ................................... (34,940) (31,154) (27,373)
Acquisition of CyberMedia ................................... (119,958) -- --
Acquisition of Magic ........................................ (109,717) -- --
Acquisition of Cinco, Networks, Inc. ........................ -- (25,079) --
Acquisition of Compusul ..................................... -- (3,350) --
Acquisition of 3DV Technology, Inc. ......................... -- (20,000) --
Acquisition of Paradigm ..................................... -- (1,833) --
Acquisition of Datawatch .................................... -- (9,336) --
Acquisition of PGP .......................................... -- (24,974) --
Purchased intangibles ....................................... -- (374) --
----------- ----------- -----------
Net cash used in investing activities ............... (318,823) (145,195) (103,983)
----------- ----------- -----------
Cash flows from financing activities:
Issuance of convertible debentures, net of issuance costs ... 337,624 -- --
Repayment of notes payable .................................. (837) (125) (3,298)
Proceeds from issuance of common stock,
net of offering costs ..................................... -- -- 126,084
Issuance of stock under stock option and stock purchase plans 151,099 42,110 48,402
Tax benefit from exercise of nonqualified stock options ..... 43,500 39,941 40,981
Cost of secondary security offering ......................... -- --
Repurchase of common stock .................................. -- (36,738) (52,949)
Exercise of warrants ........................................ 1,944 -- --
----------- ----------- -----------
Net cash provided by financing activities ........... 533,330 45,188 159,220
----------- ----------- -----------
Effect of exchange rate fluctuations on cash and cash
equivalents ............................................... (5,105) (791) 469
----------- ----------- -----------
Net increase in cash and cash equivalents ..................... 261,868 (8,754) 93,569
Cash and cash equivalents at beginning of year ................ 157,031 165,785 72,216
----------- ----------- -----------
Cash and cash equivalents at end of year ...................... $ 418,899 $ 157,031 $ 165,785
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes .................. $ 68,446 $ 14,316 $ 12,610
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
59
<PAGE> 60
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Networks Associates, Inc. (the "Company"), formally McAfee Associates,
Inc., develops, markets, distributes and supports network security and network
management software products. The Company's markets are worldwide and include
corporate, governmental, and institutional users as well as resellers and
distributors throughout the world. Software products and updates are delivered
primarily through electronic distribution under two-year subscription licenses
and as boxed product sold through the retail channel. International sales and
support are provided by subsidiaries in principal European markets and
independent agents and distributors elsewhere internationally. The Company
changed its name to Networks Associates, Inc. in connection with the merger with
Network General, in December 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Presentation:
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period.
Specifically, significant estimates are required in the valuation of intangible
assets acquired in purchase combinations including amounts accounted for as
in-process research and development, costs accrued for restructuring merged
businesses, allowances for doubtful accounts and sales returns, and valuation
allowances for deferred tax assets. Actual results could differ from those
estimates.
Certain Risks and Concentrations:
The Company's product revenues are concentrated in the computer software
industry that is highly competitive and rapidly changing. Significant
technological changes in the industry or customer requirements, or the emergence
of competitive products with new capabilities or technologies could adversely
affect operating results. Also, a majority of the Company's revenues are derived
from sales to distributors and resellers. Significant changes in operations,
buying behavior or financial stability of our channel partners could adversely
affect operating results. In addition, a significant portion of the Company's
revenue and net income is derived from international sales and distributors.
Fluctuations of the U.S. dollar against foreign currencies, changes in local
regulatory or economic conditions, piracy or significant dislocations in local
distribution channels could adversely affect operating results.
The Company maintains the majority of cash balances and all of its
short-term investments with six financial institutions. The Company invests with
high credit quality financial institutions and, by policy, limits the amount of
credit exposure to any one financial institution. The Company has significant
accounts receivable from several major distributors and from customers across a
broad demographic base. Management of the Company performs ongoing credit
evaluations of its customers and maintains allowances for doubtful accounts.
60
<PAGE> 61
Certain of the Company's products contain critical components supplied by a
single or a limited number of third parties. The Company has been required to
purchase and inventory certain of the computer platforms around which it designs
its products so as to ensure an available supply of the product for its
customers. Any significant shortage of these platforms or other components or
the failure of the third party supplier to maintain or enhance these products
could materially adversely affect the Company's results of operations.
Foreign Currency Translation:
The Company considers the local currency to be the functional currency for
its international subsidiaries. Assets and liabilities denominated in foreign
currencies are translated using the exchange rate on the balance sheet date.
Translation adjustments resulting from this process are charged or credited to
equity. Revenues and expenses are translated at average exchange rates
prevailing during the year. Foreign currency transaction gains and losses, which
to date have not been material, are included in the determination of net income.
Revenue Recognition:
Revenue from product licenses is generally recognized when a customer
purchase order has been received, a license agreement has been delivered, the
software or system has been shipped (or software has been electronically
delivered), remaining obligations are insignificant, and collection of the
resulting account receivable is probable. Maintenance revenue for providing
product updates and customer support is deferred and recognized ratably over the
service period. For sales that have the maintenance fee included with the
licensing fee, maintenance revenue is derived based upon the amount charged for
such services when they are sold separately. Revenue from hardware products is
recognized upon shipment subject to a reserve for returns. Revenues on rental
units under operating leases and service agreements are recognized ratably over
the term of the rental or service period.
Revenue generated from products sold through traditional channels where the
right of return exists is reduced by reserves for estimated sales returns. Such
reserves are based on estimates developed by management. As unsold products in
these distribution channels are exposed to rapid changes in consumer preferences
or technological obsolescence due to new operating environments, product updates
or competing products, it is reasonably possible that these estimates will
change in the near term.
Government Contracts
The Company enters into research and development contracts with government
agencies under various pricing arrangements. Revenue from "cost-plus-fixed-fee"
contracts is recognized on the basis of reimbursable contract costs incurred
during the period, plus a percentage of the fixed fee. Revenue from "time and
material" contracts is recognized on the basis of hours utilized, plus other
reimbursable contract costs incurred during the period. Revenue from
"firm-fixed-price" contracts is recognized on the percentage of completion
method. Under this method, individual contract revenues are recorded based on
the percentage relationship that contract costs incurred bear to management's
estimate of work completed. Losses, if any, are accrued when their occurrence
becomes known and the amount of the loss is reasonably determined.
Under government contracts, the Company is subject to audit by the Defense
Contract Audit Agency (DCAA) which could result in the renegotiation of amounts
previously billed. The DCAA has performed audits of the Company's costs through
1996. Management believes that the results of such audits will not have a
material adverse impact on the Company's financial position or results of
operations.
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<PAGE> 62
Research and Development:
Research and development expenditures are charged to operations as
incurred. Under the Company's development process, technological feasibility is
established on completing a working model. Subsequent costs for the Company have
not been significant and all software development costs have therefore been
expensed.
Advertising Costs
Advertising production costs are expensed as incurred. is run. Media (TV
and print) placement costs are expensed in the period the advertising appears.
Total advertising and promotional expenses were $30.4 million, $22.6 million and
$12.1 million for the years ended December 31, 1998, 1997, 1996, respectively.
Cash and Cash Equivalents:
Cash equivalents are comprised of highly liquid debt instruments with
original maturities of 90 days or less.
Marketable Securities:
All marketable securities are classified as either available-for-sale or
held-to-maturity. Available-for-sale securities are carried at fair value, and
held-to-maturity securities are stated at cost, adjusted for amortization or
premiums and accretion of discounts to maturity, in accordance with Statement of
Financial Accounting Standards No. 115 ("SFAS 115). Short-term marketable
securities are those with maturities greater than 90 days but less than one
year. Long term marketable securities have original maturities greater than one
year. Unrealized gains and losses on marketable securities classified as
available-for-sale, when material, are reported net of related taxes as a
separate component of stockholders' equity. Realized gains and losses on sales
of all such investments are reported in earnings and computed using the specific
identification cost method. No debt or equity securities were classified as
held-to-maturity at December 31, 1998.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out) or market
and include material and related manufacturing overhead.
Long Lived Assets
Fixed Assets:
Fixed assets are stated at cost. Depreciation and amortization of fixed
assets is provided using the straight-line method over the estimated useful
lives of the assets (2 to 5 years).
Intangible Assets:
Intangible assets include the estimated fair market values of purchased
technology when the related products or products under development are
considered technologically feasible and goodwill arising from acquisitions and
other intangibles. Intangibles are amortized over their estimated useful lives
(typically three years to seven years).
In accordance with FASB Statement 121, Accounting for the Impairment of
Long Lived Assets and for Long Lived Assets to be Disposed Of, the Company
assesses impairment losses on long lived assets, principally goodwill and
purchased technology when events or changes in circumstances indicate that the
carrying amount may not be recoverable. Impairment is considered to have
occurred when the undiscounted future net cash flows the assets are expected to
generate are less than the carrying value of
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<PAGE> 63
the related asset. If such assets are considered to be impaired, the impairment
to be recognized is measured as the amount by which the carrying amount of the
asset exceeds the present value of the future net cash flows.
Fair Value of Financial Instruments:
Carrying amounts of the Company's financial instruments including cash and
cash equivalents, investments, accounts receivable, accounts payable and accrued
liabilities approximate fair value due to their short maturities.
The fair value of the Company's convertible debentures is based on the
current market value. The carrying amount and estimated fair value of
convertible debentures at December 31, 1998 were $360.8 million and $546.8
million, respectively.
Net Income Per Share:
Net income (loss) per share has been computed in accordance with SFAS 128.
Basic net income (loss) per share is computed using the weighted average common
shares outstanding during the period. Diluted net income per share is computed
using the weighted average common shares and common equivalent shares
outstanding during the period.
Stock Dividend:
On June 1, 1998 the Company distributed a 3:2 stock split effected through
a stock dividend, paid to holders of record on May 12, 1998, as one share of
Common Stock for every two shares of Common Stock outstanding. All share and per
share data contained herein has been restated to reflect the increased number of
shares outstanding as a result of such stock split.
3. BUSINESS COMBINATIONS AND ACQUISITIONS:
CyberMedia, Inc.
On September 9, 1998, the Company obtained control of CyberMedia, Inc.
("CyberMedia"), a provider of desktop utility software solutions, when
CyberMedia's stockholders tendered approximately 97% of the outstanding shares
to the Company for $9.50 per share in cash. On September 10, 1998, a subsidiary
of the Company merged into CyberMedia in a transaction in which CyberMedia
shares not tendered were converted into the right to receive the same per share
cash price paid in the tender offer. Total cash paid to stockholders was $130.4
million. The transaction was accounted for as a purchase transaction. The total
purchase price including transaction costs and assumed net liabilities was
approximately $174.3 million. As the Company had assessed and formulated its
plans to terminate certain CyberMedia employees and close certain CyberMedia
facilities as of the acquisition date, the total purchase price includes related
liabilities of $13.3 million. Of the total purchase price, $22.8 million was
allocated to in-process research and development. In addition, $12.2 million was
allocated to existing technology and other intangibles and $139.3 million to
goodwill, to be amortized over 3 and 7 years, respectively. To determine the
value of the in-process research and development, the Company considered, among
other factors, the stage of development of each project at the time of
acquisition, the time and cost needed to complete each project, expected income
from the projects, and the projected incremental cash flows from the projects
when completed and any associated risks. Associated risks include the inherent
difficulties and uncertainties in completing a project and thereby achieving
technological feasibility and risks related to the impact of potential changes
in future target markets. This analysis resulted in $22.8 million being assigned
to in-process research and development projects which had not yet reached
technological feasibility and did not have alternative future use.
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Dr Solomon's Group PLC
On August 13, 1998, the Company acquired Dr Solomon's Group PLC ("Dr
Solomon's"), (the "Acquisition"), a European-based publicly-held provider of
anti-virus software products for approximately 15.3 million shares of the
Company's Common Stock (including 1.7 million shares held in trust pending the
exercise of certain outstanding and fully vested Dr Solomon's options). In the
Acquisition, each outstanding ordinary share of Dr Solomon's was exchanged for
0.27625 shares of Common Stock of the Company. The Company assumed all
outstanding options to acquire Dr Solomon's ordinary shares.
The Acquisition was accounted for as a pooling of interests and therefore
all prior period financial statements have been restated to include the results
of Dr Solomon's for all periods presented. Financial statements for the years
ended December 31, 1997, 1996 and 1995, reflect the combination of the
statements of operations of the Company for the years ended December 31, 1997,
1996 and 1995 and the aggregation of the unaudited quarterly statements of
operations of Dr Solomon's for the years ended November 31, 1997, 1996 and 1995.
The results of operations for the year ended December 31, 1998 reflect the
results of operations of the Company for the year ended December 31, 1998 and
the results of operations of Dr Solomon's for the thirteen months ended December
31, 1998.
Separate and combined results of operations for the periods prior to the
merger are as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Year Ended December 31, Six Months Ended June 30,
---------------------------------------- -------------------------
1997 1996 1995 1998 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Networks Associates ............ $ 656,322 $ 470,722 $ 305,206 $ 419,512 $ 313,991
Dr Solomon's ................... 79,370 44,275 23,335 55,898 35,167
--------- --------- --------- --------- ---------
Combined ....................... $ 735,692 $ 514,997 $ 328,541 $ 475,410 $ 349,158
========= ========= ========= ========= =========
Net income (loss)
Networks Associates ............. $ 10,635 $ 67,447 $ 52,890 $ (6,305) $ 38,503
Dr Solomon's .................... 4 (56,736) 862 502 3,678
--------- --------- --------- --------- ---------
Combined ........................ $ 10,639 $ 10,711 $ 53,752 $ (5,803) $ 42,181
========= ========= ========= ========= =========
Net income (loss) per share - diluted
Networks Associates ............. $ 0.09 $ 0.58 $ 0.48 $ (0.05) $ 0.33
========= ========= ========= ========= =========
Dr Solomon's .................... $ 0.00 $ (6.34) $ 0.10 $ 0.03 $ 0.24
========= ========= ========= ========= =========
Combined ........................ $ 0.08 $ 0.09 $ 0.45 $ (0.04) $ 0.32
========= ========= ========= ========= =========
</TABLE>
Trusted Information Systems
On April 28, 1998, the Company acquired Trusted Information Systems
("TIS"), a publicly-held provider of comprehensive security systems for computer
networks in an acquisition. The acquisition was accounted for as a pooling of
interests and therefore all prior period financial statements have been restated
to include the results of TIS for all periods presented. In the acquisition, a
wholly owned subsidiary of the Company merged with and into TIS; TIS became a
wholly owned subsidiary of the Company; and all outstanding common stock of TIS
was converted into approximately 6.8 million shares of Common Stock of the
Company, at an exchange ratio of 0.4845. The Company also assumed all
outstanding options and other rights to acquire TIS capital stock.
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<PAGE> 65
Magic Solutions International, Inc.
On April 1, 1998, the Company acquired all of the outstanding capital stock
and options of Magic Solutions International, Inc. ("Magic Solutions"), a
privately held provider of internal help desk and asset management solutions,
for approximately $109.8 million in cash. The acquisition was accounted for
using the purchase method of accounting and the total purchase price was $140.3
million, including transaction costs and assumed net liabilities. As the Company
had assessed and formulated its plans to terminate certain Magic Solutions
employees and close the Magic Solutions facilities as of the acquisition date,
the total purchase price includes related liabilities of $8.7 million.
Approximately $27.0 million of the total purchase price was expensed as
purchased in-process research and development. The remaining excess of the
purchase price over the net assets acquired was $113.3 million of which, $20.3
million has been recorded as purchased technology and trademarks and $92.9
million as goodwill which are being amortized on a straight-line basis over 5
and 7 years, respectively. To determine the value of the in-process research and
development, the Company considered, among other factors, the stage of
development of each project at the time of acquisition, the time and cost needed
to complete each project, expected income from the projects, and the projected
incremental cash flows from the projects when completed and any associated
risks. Associated risks include the inherent difficulties and uncertainties in
completing a project and thereby achieving technological feasibility and risks
related to the impact of potential changes in future target markets. This
analysis resulted in $27.0 million being assigned to in-process research and
development projects which had not yet reached technological feasibility and did
not have alternative future use.
The following summary, prepared on a pro forma basis, combines the results
of operations as if CyberMedia and Magic Solutions had been acquired as of the
beginning of the periods presented, after including the impact of certain
adjustments, such as amortization of intangibles, the write-off of in-process
technology and the related income tax effects (dollars in thousands, except per
share amounts):
<TABLE>
<CAPTION>
Years Ended
December 31,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
Revenue ...................... $ 1,003,636 $ 851,004
Net loss ..................... (42,556) (59,337)
Net loss per share ........... (0.32) (0.47)
</TABLE>
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition had been in effect for the entire periods
presented. In addition, they are not intended to be a projection of future
results and do not reflect any synergies that might be achieved from combined
operations.
Other Acquisitions
On May 15, 1998, the Company acquired Secure Networks, Inc. ("Secure"). The
aggregate consideration payable in the acquisition was 567,000 shares of the
Company's Common Stock. The acquisition was accounted for as a pooling of
interests and therefore all prior period financial statements have been restated
to include the results of Secure for all periods presented. Secure is a
developer and licensor of network security auditing software based in Canada.
On August 31, 1998, the Company acquired QA Information Security Holding AB
("QA"). The consideration payable in the acquisition was 305,557 shares of the
Company's Common Stock in a transaction accounted for as a pooling of interests.
QA, based in Sweden, is a distributor of network security products. On July 30,
1998, the Company acquired Anyware Seguridad Informatica S.A.
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<PAGE> 66
("Anyware"). The aggregate consideration payable in the acquisition was 228,204
shares of the Company's Common Stock in a transaction accounted for as a pooling
of interests. Anyware, based in Madrid, Spain, is a developer and distributor of
anti-virus software products. The Company's financial statements have been
restated for these poolings, the effect of which was not material.
The following table is a summary of acquisitions by the Company in the
three years ended December 31, 1998:
<TABLE>
<CAPTION>
Common Stock issued Purchase price of purchase
in pooling of interests transactions
----------------------- --------------------------
<S> <C> <C>
1998
Syscon 1,230 shares
Nordic 30,508 shares
Magic Solutions 140.3 million
TIS 6,755,540 shares
Secure 567,000 shares
CSB 9,815 shares
QA 305,557 shares
Anyware 228,204 shares
Dr Solomon's 15,813,142 shares
CyberMedia 174.3 million
1997
Jade K.K. 504,107 shares
Schuijers Holdings B.V. 95,582 shares
3DV Technology, Inc. $20.0 million
Compusul Consultores de Informatica, $2.6 million plus $1.0 million
Ltda. contingently payable
Cinco Networks, Inc. $26.0 million
Paradigm Agency Pty Ltd. $2.0 million
Helix Software Company 825,000 shares
Pretty Good Privacy, Inc. $35 million plus warrants to
purchase 375,000 shares of
Common Stock at $40 per share
1996
Vycor Corporation $9.0 million
Assets acquired from Interactive
Distributed Systems Software Gmbh $2.1 million
FSA Corporation 801,000 shares
</TABLE>
4. MARKETABLE SECURITIES:
At December 31, 1998 and 1997, marketable securities are summarized as
follows (in thousands):
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<PAGE> 67
<TABLE>
<CAPTION>
Available-For-Sale-Securities
-------------------------------------
(In thousands)
1998: Amortized Aggregate Unrealized
Cost Fair Value Gains
--------- -------- --------
<S> <C> <C> <C>
U.S. Government debt securities $148,363 $148,221 $ (142)
Municipal debt securities 53,463 53,677 214
Corporate debt securities 275,270 275,980 710
--------- -------- --------
$477,096 $477,878 $ 782
======== ======== ========
</TABLE>
Unrealized gains at December 31, 1998, include $1.0 million related to
unrealized gains on our investments in equity securities.
At December 31, 1998, all marketable debt securities have scheduled
maturities of less than three years. Marketable debt securities totaling $162.9
million have maturities of less than 3 months and are classified as cash
equivalents.
<TABLE>
<CAPTION>
Available-For-Sale-Securities
-------------------------------------
(In thousands)
1997: Amortized Aggregate Unrealized
Cost Fair Value Gains
--------- -------- --------
<S> <C> <C> <C>
U.S. Government debt securities $ 33,174 $ 33,181 $ 7
Municipal debt securities 245,671 246,049 378
Corporate debt securities 35,655 36,273 618
-------- -------- --------
$314,500 $315,503 $ 1,003
======== ======== ========
</TABLE>
At December 31, 1997, marketable debt securities totaling $54.7 million
have maturities of less than 3 months and are classified as cash equivalents.
5. DERIVATIVES
During fiscal year 1997, the Company began using forward foreign exchange
contracts to hedge certain assets denominated in foreign currencies. For these
instruments, risk reduction is assessed on a transaction basis and the
instruments are designated as a hedge and are highly inversely correlated to the
hedged item as required by generally accepted accounting principles. Gains and
losses on these hedges are included in the carrying amount of the assets and are
ultimately recognized in income. If a hedging instrument ceases to qualify for
hedge accounting, it is accounted for on a mark to market basis and any
subsequent gains and losses are recognized currently in income. The Company does
not use any derivatives for trading or speculative purposes.
FORWARD EXCHANGE CONTRACTS
The Company conducts business globally. As a result, it is exposed to
movements in foreign currency exchange rates. The Company enters into forward
exchange contracts to hedge exposures associated with nonfunctional currency
assets and liabilities denominated in Canadian, Australian and several European
currencies.
The Company does not generally hedge anticipated foreign currency cash
flows nor does the Company enter into forward contracts for trading purposes.
Gains and losses on the contracts are reported in other income and generally
offset gains or losses from the revaluation of nonfunctional currency assets and
liabilities. The forward contracts range from one to three months in original
maturity. The forward contracts outstanding and their unrealized gains and
(losses) are presented below (in thousands):
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<PAGE> 68
<TABLE>
<CAPTION>
Notional Value Notional Value Unrealized
Purchased Sold Gain/(loss)
-------------- -------------- --------
<S> <C> <C> <C>
Australian Dollar $ -- $ 3,600 $ 5
Canadian Dollar -- 24,067 23
Dutch Guilder 123,000 -- (2)
Other European Currencies 20,741 -- 185
-------- -------- --------
$143,741 $ 27,667 $ 211
======== ======== ========
</TABLE>
6. BALANCE SHEET DETAIL (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
--------- ---------
<S> <C> <C>
Fixed assets:
Furniture and fixtures ....................... $ 16,520 $ 26,752
Computers, demonstration and rental equipment 97,665 82,865
Leasehold improvements ....................... 13,464 16,453
--------- ---------
127,649 126,070
Less accumulated depreciation and amortization (73,160) (77,742)
--------- ---------
$ 54,489 $ 48,328
========= =========
Intangibles assets (see Note 2):
Purchased technology ......................... $ 68,905 $ 12,431
Other ........................................ 1,261 2,401
Goodwill ..................................... 327,760 98,062
--------- ---------
397,926 112,894
Less accumulated amortization ................ (86,350) (22,854)
--------- ---------
311,576 90,040
Other assets ................................... 12,376 3,846
--------- ---------
$ 323,952 $ 93,886
========= =========
Accrued liabilities:
Accrued compensation ......................... $ 26,954 $ 22,559
Accrued acquisition and merger costs ......... 28,234 27,347
Accrued compensation - Cinco acquisition ..... 10,837 17,653
Accrued legal and accounting ................. 12,482 2,502
Accrued inventory ............................ 10,068 4,636
Accrued taxes ................................ 64,744 31,593
Other accrued expenses ....................... 56,751 47,895
--------- ---------
$ 210,070 $ 154,185
========= =========
</TABLE>
7. COMMITMENTS:
LEASES
The Company leases its operating facilities under non-cancelable operating
leases through December 2001. In addition, the Company has leased certain
equipment under various leases, which expire no later than 1998.
At December 31, 1998, future minimum payments under non-cancelable
operating leases are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1999 .............. 21,858
2000 .............. 20,190
2001 .............. 16,617
2002 .............. 14,642
2003 and thereafter 92,259
--------
$165,566
========
</TABLE>
Rent expense for the years ended December 31, 1998, 1997 and 1996 amounted
to $10.8 million, $12.4 million and $8.7 million, respectively.
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8 NETWORK GENERAL SHARE REPURCHASE PROGRAM
In July 1993, the Board of Directors of Network General authorized Network
General to repurchase up to 1,666,800 shares of its common stock on the open
market to satisfy commitments under its stock option and stock purchase plans.
In fiscal year 1996, up to an additional 1,666,800 shares of the Network General
common stock were authorized for repurchase for the same purpose. As of December
1, 1997, the Network General had repurchased and retired 1,954,323 shares at an
aggregate cost of $92,574,000. This program was terminated at the time of the
merger.
9. CONVERTIBLE DEBENTURES
On February 13, 1998, the Company completed a private placement of zero
coupon convertible subordinated debentures due in 2018 (the "Debentures"). The
debentures, with an aggregate face amount at maturity of $885.5 million,
generated net proceeds to the Company of approximately $337.6 million. The
initial price to the public for the debentures was $391.06 per $1,000 of face
amount at maturity, which equates to a yield to maturity over the term of the
bonds of 4.75% (on a semi-annual bond equivalent basis). The debentures are
convertible into Common Stock at the rate of 8.538 shares per $1,000 of face
amount at maturity, which equates to an initial conversion price of $45.80 per
share. The Debentures are subordinated in right of payment to all existing and
future Senior Indebtedness (as defined) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the Company's subsidiaries.
The Debentures may be redeemed for cash at the option of the Company beginning
on February 13, 2003. At the option of the holder, the Company will purchase the
Debentures on February 13, 2003, February 13, 2008 and February 13, 2013 at
purchase prices (to be paid in cash or Common Stock or any combination thereof,
at the election of the Company and subject to certain conditions) equal to the
initial issue price plus accrued original issue discount to such dates. The
Debentures may also be redeemed at the option of the holder if there is a
Fundamental Change (as defined) at a price equal to the issue price plus accrued
original issue discount to the date of redemption, subject to adjustment.
10. EMPLOYEE BENEFIT PLANS
401(k) and Profit Sharing Plan
Under the Company's 401(k) and Profit Sharing Plans, the Board of
Directors, at its discretion, can match employee contributions in an amount not
to exceed 20% of total compensation. Annual amounts provided by the Company
under the plan to date have not been material.
Employee Stock Purchase Plan:
Under the 1994 Employee Qualified Stock Purchase Plan, the Company can
grant stock purchase rights to all eligible employees during one year offering
periods with exercise dates approximately every six months (beginning each
August and February). The Company has reserved 2,073,522 shares of common stock
for issuance under the plan. Shares are purchased through employees' payroll
deductions at exercise prices equal to 85% of the lesser of the fair market
value of the Company's common stock at either the first day of an offering
period or the last day of such offering period. No participant may purchase more
than $25,000 worth of common stock in any one calendar year.
11. STOCKHOLDERS' EQUITY:
Preferred Stock:
The Company has authorized 5,000,000 shares of preferred stock, par value
$.01 per share. The Company's Board of Directors has authority to provide for
the issuance of the shares of preferred stock in series, to establish from time
to time the number of shares to be included in each such series and to fix the
designation, powers, preferences and rights of the shares of each such series
and the qualifications, limitations or restrictions thereof, without any further
vote or action by the shareholders.
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<PAGE> 70
In connection with the acquisition of FSA, the Company issued one share of
Series A preferred stock. The share of Series A preferred stock has no
preferential rights other than the right to cast a number of votes equal to the
number of common shares issuable in exchange for certain exchangeable non-voting
shares of FSA. At December 31, 1998, 487,593 shares of the Company's common
stock were reserved for conversion.
Stock Option Plans:
In June 1997, the Board of Directors approved the 1997 Stock Incentive Plan
(the "1997 Plan") to replace the 1995 Stock Incentive Plan. Under the 1997 Plan,
the Company has reserved 11,775,000 shares for issuance to employees, officers,
directors, third-party contractors and consultants. The plan provides for an
option price no less than 100% of the fair market value of the Company's common
stock on the date of grant for incentive stock options granted to employees and
officers (including directors who are also employees) or 85% of the fair market
value on the date of grant for all others. The options may be exercisable
immediately, or over time, generally vest 25% one year after commencing
employment or from date of grant and vest thereafter in monthly increments over
three years. All options under the option plan expire ten years after grant.
Under the amended Stock Option Plan for Outside Directors, the Company has
reserved 137,809 shares for issuance to certain members of its Board who are not
employees of the Company or any affiliated corporation. The plan provides for an
option price at fair market value of the Company's common stock on the date of
grant. The initial grant to each outside director generally vests ratably over a
three-year period. Subsequent option grants will vest after three years from the
date of grant. All options under the option plan expire ten years after grant.
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<PAGE> 71
Aggregate activity under stock option plans is as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
--------------------------------------------------------------------------
SHARES
AVAILABLE NUMBER OF PRICE PER AGGREGATE WEIGHTED
FOR GRANT SHARES SHARE PRICE AVG. EX. PRICE
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1995 .. 7,841,062 17,541,147 $0.00-$34.60 $ 150,539,101 $ 8.59
Additional shares authorized . 2,724,120
Shares granted ............... (9,217,603) 9,217,603 $0.75-$74.23 138,399,898 $15.01
Shares exercised ............. -- (5,025,188) $0.00-$32.00 (44,652,863) $ 8.89
Shares canceled .............. 2,309,252 (2,309,252) $1.14-$35.90 (11,707,057) $ 5.07
-------------- -------------- --------------
Balances, December 31, 1996 .. 3,656,831 19,424,310 $0.48-$74.23 232,579,079 $11.98
Additional shares authorized . 8,775,000
Eliminate NGC duplicate period 83,016 223,466 $0.53-$43.79 1,106,862 $ 4.95
Shares granted ............... (9,669,921) 9,669,921 $0.23-$79.21 282,196,266 $29.18
Shares exercised ............. -- (4,998,801) $0.53-$40.20 (35,126,226) $ 7.03
Shares canceled .............. 4,247,884 (4,247,884) $0.65-$44.42 (79,717,708) $18.77
-------------- -------------- --------------
Balances, December 31, 1997 .. 7,092,810 20,071,012 $0.23-$44.42 401,038,273 $19.98
Additional shares authorized . 3,000,000 --
Shares granted ............... (11,397,414) 11,397,414 $21.41-$121.8 419,774,937 $36.83
Shares exercised ............. -- (8,560,824) $0.06-$44.42 (144,646,193) $16.90
Shares canceled .............. 3,587,906 (3,587,906) $0.65-$48.38 (92,013,391) $25.65
-------------- -------------- --------------
Balances, December 31, 1998 .. 2,283,302 19,319,696 $0.06-$121.8 $ 584,153,626 $30.24
============== ============== ==============
</TABLE>
At December 31, 1998, a total of 3,717,314 options to purchase common stock
were exercisable at an average exercise price of $21.59.
The following information regarding the stock option program and employee
stock purchase programs is provided in compliance with SFAS 123, "Accounting for
Stock Based Compensation". The company has elected to continue accounting for
such plans in accordance with APB No. 25.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------- ----------------------------------
Number Weighted Average Weighted Average Number Weighted Average
Range of Outstanding Remaining Exercisable Exercisable Exercise
Exercise Prices at 12/31/98 Contractual Life (yrs) Price at 12/31/98 Price
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.06 $ 12.68 2,045,490 6.0 $ 6.55 1,250,255 $ 6.31
$12.89 - $ 26.21 1,736,711 6.3 $ 20.68 781,462 $ 20.78
$26.67 - $ 26.68 2,348,655 7.6 $ 26.67 606,306 $ 26.67
$26.80 - $ 31.21 1,629,888 7.3 $ 29.06 517,064 $ 29.32
$31.33 - $ 31.34 5,319,546 8.0 $ 31.33 76,611 $ 31.33
$31.40 - $ 34.68 1,663,432 8.5 $ 32.98 215,204 $ 33.33
$35.38 - $ 43.76 1,893,633 8.7 $ 40.16 175,424 $ 37.80
$43.79 - $ 45.26 1,568,123 9.3 $ 44.14 34,410 $ 44.21
$45.44 - $ 51.51 1,055,090 9.4 $ 48.31 3,787 $ 50.83
$74.23 - $121.81 59,128 4.9 $119.45 56,791 $121.11
$ 0.06 - $121.81 19,319,696 7.8 $ 30.24 3,717,314 $ 21.59
</TABLE>
71
<PAGE> 72
At December 31, 1997 and December 31, 1996, approximately million, 5.5
million and 2.8 million outstanding options, respectively, were exercisable. The
weighted average exercise prices for exercisable options were $14.17 and $9.98
at December 31, 1997 and December 31, 1996, respectively.
The fair market value of options granted has been calculated using the
Black-Scholes option pricing model using the multiple option approach. A typical
option grant vests over a four year period. Parameters for the option analysis
are listed below.
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Risk free interest rate 5.85% 5.39% 5.04%
Expected life (yrs) 4 4 4
Volatility 0.66 0.66 0.63
Dividend yield 0 0 0
</TABLE>
The weighted average expected life of the option grants was estimated based
on examination of previously exercised options over the life of the program.
Volatility was estimated on a monthly basis since the company became public in
October of 1992. The average volatility for 36 month period from January 1996
through December 1998 was 63%. The Company has not paid a dividend, and has no
plans to do so.
The weighted average fair value of options granted in 1998,1997 and 1996
was $19.08, $18.29 and $12.53, respectively.
The company has also estimated the fair value of purchase rights issued
under the Employee Stock Purchase Program. Rights under this plan were also
evaluated using the Black-Scholes option pricing model. The company's plan is
described in Note 10 . Purchase periods occur twice yearly and each effectively
contains a 6 and 12 month option.
<TABLE>
<CAPTION>
Feb. 1996 Aug. 1996 Feb. 1997 Aug. 1997 Feb. 1998 Aug. 1998
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Risk Free Interest Rate 4.84% 5.73% 5.40% 5.44% 5.36% 5.28%
Expected Life 6,12 mos 6,12 mos 6,12 mos 6,12 mos 6,12 mos 6,12 mos
Volatility 0.66 0.66 0.66 0.66 0.63 0.63
Dividend Yield -- -- -- -- -- --
</TABLE>
The weighted average fair value of options granted pursuant to the Employee
Stock Purchase Program in 1998, 1997 and 1996 was $14.81, $10.77 and $7.01,
respectively.
The following pro forma income information has been prepared following the
provisions of SFAS 123.
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net loss - pro forma (thousands) $ (35,002) $ (46,671) $ (31,653)
Net loss per share - diluted - pro forma $ (0.26) $ (0.37) $ (0.27)
</TABLE>
The impact on pro forma earnings per share and net income in the table
above may not be indicative of the effect in future years as options vest over
several years and the company continues to grant stock options to new employees.
This policy may or may not continue.
72
<PAGE> 73
Warrants:
Pursuant to the acquisition of PGP, the Company issued warrants to
purchase 375,000 shares of common stock at a price of $40 per share, which
expire, subject to certain extensions, on June 5, 1999. As of December 31, 1998
warrants for 315,816 shares were outstanding. The warrants issued pursuant to
the acquisition of PGP were valued using the Black Scholes model, using the
following parameters: Stock price $50.44 (prior to a 3:2 stock split in May
1998); Exercise Price $60.00 (prior to the 3:2 stock split); Term 1 year;
Volatility 66%; Annual dividend 0%; Discount rate 5.5%. The resulting valuation
of the 375,000 warrants was $2,722,500, the total amount of which was included
in the purchase price allocation. In addition, warrants for the purchase of
6,340 shares of Common Stock issued in connection with the Company's 1995
acquisition of Assurdata were exercised during the year ended December 31, 1998.
Preferred Shares Rights Agreement
On October 19, 1998, pursuant to a Preferred Shares Rights Agreement
between the Company and BankBoston, N.A. as Rights Agent, the Board of Directors
of the Company announced that it had declared a dividend distribution of one
preferred share purchase right (a "Right") on each outstanding share of the
Company's Common Stock. Each Right will entitle stockholders to buy one-one
thousandth of a share of the Company's Series B Participating Preferred Stock at
an exercise price of $200.00. The Rights will become exercisable following the
tenth day after a person or group announces the acquisition of 15% or more of
the Company's Common Stock or announces commencement of a tender or exchange
offer, the consummation of which would result in ownership by the person or
group of 15% or more of the Common Stock of the Company. The Company will be
entitled to redeem the Rights at $0.01 per Right at any time on or before the
tenth day following acquisition by a person or group of 15% or more of the
Company's Common Stock. The dividend distribution was made on November 3, 1998,
payable to the stockholders of record on November 3, 1998. The Rights will
expire on October 20, 2008.
12. PROVISION FOR INCOME TAXES:
Income taxes have been provided using the liability method in accordance
with FASB No. 109 Accounting For Income Taxes.
Pre-tax book income from continuing operations for the years ended December
31, was earned in the following jurisdictions (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Domestic $ 123,535 $ 55,222 $ 119,324
Foreign 14,632 27,591 (53,905)
--------- --------- ---------
$ 138,167 $ 82,813 $ 65,419
========= ========= =========
</TABLE>
Significant components of the provision (benefit) for income taxes
attributable to continuing operations are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Federal:
Current payable ........ $ 113,575 $ 63,826 $ 42,930
Deferred ............... (41,311) (18,515) (3,856)
--------- --------- ---------
Total federal ............ 72,264 45,311 39,074
State:
Current payable ........ 21,224 11,950 9,878
Deferred ............... (5,633) (3,203) 55
--------- --------- ---------
Total state .............. 15,591 8,747 9,933
--------- --------- ---------
Foreign .................. 13,874 18,116 5,701
--------- --------- ---------
Provision for income taxes $ 101,729 $ 72,174 $ 54,708
========= ========= =========
</TABLE>
73
<PAGE> 74
Significant components of net deferred tax assets at December 31 are as
follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Deferred revenue .................... $ 10,390 $ 1,387 $ 1,865
State taxes ......................... 2,082 1,740 1,631
Accrued liabilities and reserves .... 53,394 28,349 8,690
Depreciation and amortization ....... 30,533 11,917 10,223
Subsidiaries operating loss carryover 30,130 10,597 968
--------- --------- ---------
126,529 53,990 23,377
Valuation allowance ................. (22,458) (7,728) (968)
--------- --------- ---------
$ 104,071 $ 46,262 $ 22,409
========= ========= =========
Current portion ..................... $ 65,866 $ 30,089 $ 10,321
Non-current portion ................. 38,205 16,173 12,088
--------- --------- ---------
$ 104,071 $ 46,262 $ 22,409
========= ========= =========
</TABLE>
Deferred tax liabilities consist of differences between the assigned values
and tax bases of certain intangible assets acquired in purchase business
combinations and amounted to $13.0 million at December 31, 1998 and $2.1 million
at December 31, 1997.
The valuation allowance as of December 31, 1998 relates to the tax benefit
of operating losses acquired in connection with the acquisition of Cybermedia
and Dr Solomon's. The operating losses are subject to certain annual limitations
as a result of the acquisition and may expire before the Company may utilize
them. The Company believes sufficient uncertainty exists regarding the
realizability of these losses on a separate entity basis, and accordingly, a
valuation allowance has been established. Approximately $2,800,000 of the
valuation allowance is attributable to stock options, the benefit of which will
be credited to shareholder's equity when realized.
Realization of the remaining net deferred tax assets of $104,071,000 as of
December 31, 1998 is dependent on generating sufficient taxable income to offset
future deduction of the related items. Although realization is not assured,
management believes it is more likely than not that all of the net deferred tax
assets will be realized. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income are reduced.
The Company paid income taxes of $68,446,000 in 1998, $14,316,000 in 1997,
and $12,610,000 in 1996. Income taxes paid are less than current expense
principally due to tax benefits from stock options recorded directly to
stockholder's equity. The tax benefit is the difference between the market value
of the stock option at the time of exercise and the option price tax effected.
U.S. income taxes were not provided for on a cumulative total of
approximately $13,807,000 of undistributed earnings for certain non-U.S.
subsidiaries. The Company intends to reinvest these earnings indefinitely in
operations outside the United States. As of December 31, 1998, the unrecognized
deferred tax liability for these earnings is approximately $4,832,000.
The Company's effective tax rate on income before income taxes differs from
the U.S. Federal statutory regular tax rate as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
U.S. Federal statutory income tax rate ....... 35.0% 35.0% 35.0%
State taxes, net of federal income tax benefit 4.4 4.7 5.9
Non deductible acquisition and other costs ... 29.6 48.9 31.5
Tax exempt interest income ................... (1.1) (3.4) (2.3)
Foreign earnings subject to lower tax rates .. (6.3) (7.1) (4.1)
Goodwill and other permanent differences ..... 16.3 10.6 19.0
Tax Credits .................................. (4.3) (1.5) (1.4)
---- ---- ----
73.6% 87.2% 83.6%
==== ==== ====
</TABLE>
74
<PAGE> 75
13. NET INCOME PER SHARE
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted net income
per share is provided as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
NUMERATOR - BASIC
Net income $ 36,438 $ 10,639 $ 10,711
NUMERATOR - DILUTED
Net income $ 36,438 $ 10,639 $ 10,711
Interest on convertible debentures (1) -- -- --
-------- -------- --------
$ 36,438 $ 10,639 $ 10,711
======== ======== ========
DENOMINATOR - BASIC
Basic weighted average common shares outstanding 133,075 126,662 115,626
======== ======== ========
DENOMINATOR - DILUTED
Basic weighted average common shares outstanding 133,075 126,662 115,626
Effective of dilutive securities:
Common stock options 5,534 6,067 9,876
-------- -------- --------
Diluted weighted average shares 138,609 132,729 125,502
======== ======== ========
Net income per share - Basic $ 0.27 $ 0.08 $ 0.09
======== ======== ========
Net income per share - Diluted $ 0.26 $ 0.08 $ 0.09
======== ======== ========
</TABLE>
(1) Convertible debt interest and related as-if converted shares are excluded
from the 1998 calculation as they are anti-dilutive.
14. BUSINESS SEGMENT AND MAJOR CUSTOMER INFORMATION
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. SFAS No.131 supersedes SFAS No.14, Financial Reporting for
Segments of a Business Enterprise. SFAS No. 131 changes current practice under
SFAS No. 14 by establishing a new framework on which to base segment reporting
and introduces requirements for interim reporting of segment information.
The Company has determined that it has a single reportable segment
consisting of the development, sale and support of computer security and
management software. Management uses one measurement of profitability and does
not disaggregate its business for internal reporting. The Company has a
world-wide sales and support network. Products 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.
75
<PAGE> 76
The table below presents information about the revenues and long-lived
assets by geographic area as of and for the years ended December 31:
<TABLE>
<CAPTION>
(in thousands) Revenue
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
United States $629,450 $479,224 $344,844
Netherlands 217,177 64,449 24,500
Other Foreign 143,418 192,019 145,653
-------- -------- --------
Total $990,045 $735,692 $514,997
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
Long-Lived Assets
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
United States $39,429 $30,434 $ 29,996
United Kingdom 6,713 11,420 6,610
Other Foreign 8,347 6,474 4,323
------- ------- --------
Total $54,489 $48,328 $ 40,930
======= ======= ========
</TABLE>
Revenue amounts shown above are classified by location in which the related
sales were recorded. Long-lived assets located outside the U.S. consist
principally of facilities and equipment in the U.K. and the Netherlands.
A significant majority of the Company's products are sold through two
tiers of distribution. In the US, substantially all of the Company's sales are
through four major distributors. In Europe, substantially all sales are through
five major distributors. At December 31,1998, one customer had an accounts
receivable balance representing 11% of our total accounts receivable balance.
No other distributor had an accounts receivable balance that exceeded 10% at
December 31, 1998. The Company relies upon a broad base of second tier
distribution partners, specifically large retailers, resellers and VARS to
maintain and grow its business. For the year ended December 31,1998, the
largest retailer accounted for 1% of total revenue and in aggregate the five
largest retailers accounted for approximately 4% of total revenue. The largest
reseller accounted for 2% of total revenue.
15. LITIGATION
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.
76
<PAGE> 77
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 the Company 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" and
"GroupShield" products infringe a Trend patent which issued on April 22, 1997.
Trend's complaint seeks injunctive relief and unspecified money damages. On June
6, 1997, 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.
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. Almost all discovery has been completed. The Court
will hear the parties' motions for summary judgment on May 5, 1999. A trial date
has been set for June, 1999.
On September 10, 1998, Network Associates acquired control of CyberMedia,
Inc. ("CyberMedia"). Set forth below are matters upon which Wilson Sonsini
Goodrich & Rosati, Professional Corporation, represents CyberMedia and certain
of its former officers and directors.
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 the
Company in the Network Associates/CyberMedia merger. On December 16, 1998,
plaintiffs filed a stipulation of voluntary dismissal.
77
<PAGE> 78
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. 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 Mach 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. The second consolidated amended complaint did not specify
damages. Defendants' response to the second consolidated amended complaint must
be filed by April 7, 1999.
CyberMedia and certain of its former officers and directors were named as
defendants in three securities class action lawsuits filed in the Superior Court
of Los Angeles County. Such complaints have been ordered consolidated, although
a consolidated amended complaint has not yet been filed. The consolidated
complaints include: Brown v. CyberMedia, Inc., et al., No. B C187898, filed on
March 19, 1998, Smith v. CyberMedia, Inc., et al. No. B C188527, filed on March
31, 1998, and Stockwell v. CyberMedia, Inc., et al., No. B C189020, filed on
April 8, 1998. The complaints allege that defendants violated California state
securities laws and common law by artificially inflating the price of CyberMedia
stock to the detriment of a purported class of investors who purchased or
otherwise acquired CyberMedia stock between March 31, 1997 and March 13, 1998.
The complaints do not specify damages. The consolidated state securities
litigation has been stayed pending resolution of the federal securities
litigation pursuant to a stipulation and order entered by the Court on January
5, 1999.
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
78
<PAGE> 79
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.
16. RECENT ACCOUNTING PRONOUNCEMENTS
In October 1997, the AICPA issued Statement of Position No. 97-2 ("SOP
97-2") "Software Revenue Recognition," which the Company has adopted for
transactions entered into during the year beginning January 1, 1998. SOP 97-2
provides guidance for recognizing revenue on software transactions and
supersedes previous guidance provided by SOP 91-1, "Software Revenue
Recognition." Under SOP 97-2, revenue from product licenses is recognized when a
signed agreement or other persuasive evidence of an arrangement exists, the
software or system has been shipped (or software has been electronically
delivered), the license fee is fixed and determinable, and collection of the
resulting receivable is probable. For contracts with multiple
elements/obligations, (e.g. software products, upgrades/enhancements,
maintenance and services), revenue is allocated to each element of the
arrangement based on the Company's evidence of fair value as determined by the
amount charged when the element is sold separately. Maintenance revenue for
providing product updates and customer support is deferred and recognized
ratably over the service period. Revenue on rental units under operating leases
and service agreements is recognized over the term of the rental agreement or
the period during which services are expected to be performed. Revenue generated
from products sold through traditional channels where the right of return exists
is reduced by reserves for estimated sales returns.
In March 1998, the AICPA issued Statement of Position No. 98-4 ("SOP
98-4"), "Deferral of the Effective Date of a Provision of SOP 97-2, Software
Revenue Recognition." SOP 98-4 defers, for one year, the application of certain
passages in SOP 97-2, which limit what is considered vendor-specific objective
evidence ("VSOE") necessary to recognize revenue for software licenses in
multiple-element arrangements when undelivered elements exist. The adoption of
SOP 97-2, as amended by SOP 98-4, in the first quarter of 1998 did not have a
material effect on the Company's revenue recognition practices. The Company has
evaluated the amendments expected to be issued under SOP 98-9 and does not
expect their adoption will have a material effect on its revenue recognition
practices.
In December 1998, the AICPA issued Statement of Position No. 98-9 ("SOP
98-9") "Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions" which clarifies guidance regarding VSOE and multiple
element arrangements. SOP 98-9 amends SOP 98-4 to extend the deferral of
guidance in SOP 97-2 as it relates to these matters through fiscal years
beginning after March 15, 1999.
79
<PAGE> 80
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 requires the Company to recognize
all derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through net income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of the
derivative are either offset against the change in fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. SFAS 133 is effective for years beginning after June 15,
1999, but companies can early adopt as of the beginning of any fiscal quarter
that begins after June 1998. The Company is evaluating the requirements of SFAS
133, but does not expect this pronouncement to materially impact the Company's
results of operations.
17. SUBSEQUENT EVENTS:
Related Party Transactions
In December 1998, the Company agreed to acquire 3,948,199 shares of Series
A Preferred Stock of DirectWeb, Inc. for $2.5 million. DirectWeb, Inc. is a
subscription-based online service offering a complete turn-key Windows-98 based
PC, unlimited Internet access and technical support for a fixed user only fee.
The shares were acquired in January 1999. In late February 1999, the Company
acquired 4,615,385 shares of DirectWeb Series B Preferred Stock for $6.0
million. 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 March 31, 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.
Litigation
On April 7, 1999, a putative securities class action, captioned
Kinsley v. Network Associates, Inc., et al., Civil Action No. C-99-1729-SI, was
filed against the Company 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 money damages on behalf of a purported class of purchasers
of the Company's stock between January 20, 1998 and April 6, 1999. Several
similar actions have been filed by other plaintiffs, including Wetzel v. Network
Associates, Case No. 99-D1731 JL (Northern District of California).
80
<PAGE> 81
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Santa
Clara, State of California, on the 15th day of April, 1999.
NETWORKS ASSOCIATES, INC.
/s/ William L. Larson
- -----------------------------------------
William L. Larson
Chief Executive Officer and
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on April 15, 1999 by the following persons on
behalf of the Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
----------------------------------------- ---------------------------------------------------------
<S> <C>
/s/ William L. Larson Chief Executive Officer and
----------------------------------------- Chairman of the Board (Principal Executive Officer)
(William L. Larson)
/s/ Prabhat K. Goyal Vice President of Administration, Chief Financial Officer,
----------------------------------------- Treasurer and Secretary (Principal Financial Officer and
(Prabhat K. Goyal) Principal Accounting Officer)
/s/ Leslie G. Denend Director
-----------------------------------------
(Leslie G. Denend)
/s/ Virginia Gemmell Director
-----------------------------------------
(Virginia Gemmell)
/s/ Edwin L. Harper Director
-----------------------------------------
(Edwin L. Harper)
</TABLE>
81
<PAGE> 82
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<S> <C> <C>
2.1 Agreement and Plan of Reorganization, dated October 13, 1997,
among McAfee Associates, Inc., Mystery Acquisition Corp. and
Network General Corporation, as amended by the First Amendment
dated as of October 22, 1997.(1) ................................
2.2 Combination Agreement dated August 16, 1996 among the Registrant,
FSA Combination Corp., FSA Corporation and Daniel Freedman.(2) ..
2.3 Stock Exchange Agreement dated January 13, 1996 among the
Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and the
shareholders of Jade.(3) ........................................
2.4 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, Helix Software Company an DNA Acquisition
Corp.(4) ........................................................
2.5 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, PGP and PG Acquisition Corp.(5)..........
2.6 Agreement and Plan of Reorganization dated February 22, 1998,
between the Registrant, TIS and Thor Acquisition Corp.(6) .......
2.7 Agreement and Plan of Reorganization by and among the Registrant,
Magic Solutions International, Inc., Merlin Acquisition Corp. and
Igal Lichtman, Amendment Agreement by and among the Registrant,
Magic Solutions International, Inc., Merlin Acquisition Corp.,
and Igal Lichtman dated March 24, 1998. Second Amendment
Agreement by and among the Registrant, Magic Solutions
International, Inc., Merlin Acquisition Corp., and Igal Lichtman
dated April 1, 1998.(7) .........................................
2.8 Stock Purchase Agreement, dated as of February 26, 1998, by and
between FSA Combination Corp., and Brenda Joyce Cook.(8).........
2.9 Share Purchase Agreement, dated as of March 30, 1998, among FSA
Combination Corp., and Irina Karlsson and Jarmo Rouvinen.(8).....
2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA
Combination Corp., and Secure Networks, Inc.(8)..................
2.11 Transaction Agreement, dated June 9, 1998, by and between the
Registrant and Dr Solomon's Group Plc.(21).......................
2.12 Agreement and Plan of Merger, dated July 28, 1998, by and between
the Registrant and CyberMedia, Inc.(22) .........................
3.1 Second Restated Certificate of Incorporation of Networks
Associates, Inc., as amended on December 1, 1997.(6).............
3.2 Restated Bylaws of Networks Associates, Inc.(6) .................
3.3 Certificate of Designation of Series A Preferred Stock of
Networks Associates, Inc.(9).....................................
3.4 Certificate of Designation of Series B Participating Preferred
Stock of the Registrant.(23) ....................................
4.2 Registration Rights Agreement dated August 30, 1996 between the
Registrant and Daniel Freedman.(1)...............................
4.5 Registration Rights Agreement dated December 9, 1997 between the
Registrant and certain shareholders of PGP.(4)...................
4.6 Registration Rights Agreement, dated as of February 13, 1998, by
and between the Registrant and Morgan Stanley & Co.
Incorporated.(10)................................................
4.7 Indenture dated as of February 13, 1998 between the Registrant
and State Street Bank and Trust Company of California, N.A., as
Trustee.(10).....................................................
4.10 Registration Rights Agreement dated May 8, 1998, by and between
the Registrant and the stockholders of Secure Networks, Inc.(8)..
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) ............................
</TABLE>
82
<PAGE> 83
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<S> <C> <C>
4.12 Registration Rights Agreement, dated July 30, 1998, by and
between the Registrant and certain stockholders of Anyware
Seguridad Informatica S.A.(11)...................................
4.13 Registration Rights Agreement, dated August 31, 1998, by and
between the Registrant and certain stockholders of QA Information
Security Holding AB(24)..........................................
10.1 Standard Business Lease (Net) for Network General's principal
facility dated June 19, 1991, between Network General and Menlo
Oaks Partners, L.P.(12)..........................................
10.2 First Amendment to Lease dated June 10, 1992, between Network
General and Menlo Parks Partners, L.P.(12).......................
10.3 Standard Business Lease (Net) for Network General's principal
facility dated March 11, 1992, between Network General and Menlo
Oaks Partners L.P.(13)...........................................
10.4 First Amendment to Lease dated June 18, 1992, between Network
General and Menlo Oaks Partners, L.P.(12)........................
10.5 Lease dated March 31, 1992, between Network General and Equitable
Life Assurance Society of the United States.(12).................
10.6 Second Amendment to Lease dated February 1, 1995, between Network
General and Menlo Oaks Partners, L.P.(13)........................
10.7 Third amendment to Lease dated February 1, 1995 between Network
General and Menlo Oaks Partners L.P.(13).........................
10.8 Fourth Amendment to Lease dated May 31, 1995, between Network
General and Menlo Oaks Partners, L.P.(14)........................
10.9 Fifth Amendment to Lease dated June 13, 1995, between Network
General and Menlo Oaks Partners, L.P.(14)........................
10.10 Lease dated July 3, 1996 between Network General and Campbell
Avenue Associates.(15)...........................................
10.11 Sixth Amendment to Lease dated November 29, 1996, between Network
General and Menlo Oaks Partners, L.P.(15)........................
10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa
Clara, California, dated as of February 20, 1997, by and between
McAfee Associates, Inc. and National Semiconductor
Corporation.(16).................................................
10.13 Lease Agreement dated November 17, 1997 for facility at 3965
Freedom Circle, Santa Clara, California by and between Informix
Corporation and McAfee Associates, Inc.(4).......................
10.14 Consent to Assignment Agreement dated December 19, 1997 by and
among Birk S. McCandless, LLC, Guaranty Federal Bank, F.S.B.,
Informix Corporation and Networks Associates, Inc.(4)............
10.15 Subordination, Nondisturbance and Attornment Agreement dated
December 18, 1997, between Guaranty Federal Bank, F.S.B.,
Networks Associates, Inc. and Birk S. McCandless, LLC.(4)........
10.16 Lease dated November 22, 1996 by and between Birk S. McCandless,
LLC and Informix Corporation for facility at 3965 Freedom Circle,
Santa Clara, California.(4)......................................
10.17 Quota Purchase Agreement, dated as of April 14, 1997 by and among
McAfee Associates, Inc. and McAfee Do Brasil Ltda.,
Compusul-Consultoria E Comercio De Informatica Ltda., and the
stockholders of Compusul-Consultoria E Comercio De Informatica
Ltda.(17) .......................................................
10.18* 1997 Stock Incentive Plan.(17)...................................
10.19* Stock Option Plan for Outside Directors(18) .....................
10.20* Change in control agreement between the Company and Dennis Cline
dated April 14, 1995.(17)........................................
10.21* Change in control agreement between the Company and Peter Watkins
May 1, 1995.(17).................................................
</TABLE>
83
<PAGE> 84
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<S> <C> <C>
10.22* Change in control agreement between the Company and William S.
Larson dated April 14, 1995.(17).................................
10.23* Change in control agreement between the Company and Prabhat K.
Goyal dated April 18, 1996.(19)..................................
10.27* Change in control agreement between the Company and Zachary
Nelson, dated May 12, 1998.(20)..................................
21.1 Subsidiaries of Networks Associates, Inc.........................
23.2 Consent of PricewaterhouseCoopers LLP............................
27.1 Financial Data Sheet.............................................
</TABLE>
- ----------
(1) Incorporated by reference from the Registrant's Registration Statement
on Form S-4 filed with the Commission on October 31, 1997.
(2) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the Commission on September 24, 1996.
(3) Incorporated by reference from the Registrants Current Report on Form
8-K filed with the Commission on March 14, 1997.
(4) Incorporated by reference from the Registrant's Registration Statement
on Form S-3, filed with the Commission on February 12, 1998.
(5) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on December 11, 1997.
(6) Incorporated by reference from the Registrant's Registration Statement
on Form S-4 filed with the Commission on March 25, 1998.
(7) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on April 2, 1998.
(8) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 filed with the Commission on May 26, 1998.
(9) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1996, filed with the Commission on
November 4, 1997.
(10) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 filed with the Commission on May 6, 1998.
(11) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 filed with the Commission on August 5, 1998.
(12) Incorporated by reference from the Network General Corporation's Report
on Form 10-K for the year ended March 31, 1992. Network General's
filings with the Commission were made under File Number 0-17431.
(13) Incorporated by reference from the Network General Corporation's Report
on Form 10-Q for the quarter ended December 31, 1994. Network General's
filings with the Commission were made under File Number 0-17431.
(14) Incorporated by reference from the Network General Corporation's Report
on Form 10-Q for the quarter ended June 30, 1995. Network General's
filings with the Commission were made under File Number 0-17431.
(15) Incorporated by reference from the Network General Corporation's Report
on Form 10-Q for the quarter ended June 30, 1996. Network General's
filings with the Commission were made under File Number 0-17431.
(16) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended June 30, 1997, filed with the Commission on August 14,
1997.
(17) Incorporated by reference from the Registrant's Registration Statement
on Form S-4 filed with the Commission on July 31, 1995.
(18) Incorporated by reference from the Registrant's Report on Form S-8 filed
with the Commission on December 2, 1997.
84
<PAGE> 85
(19) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended June 30, 1996, filed with the Commission on August 13,
1996.
(20) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended March 31, 1998, filed with the Commission on May 15,
1998.
(21) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on June 16, 1998.
(22) Incorporated by reference from CyberMedia Inc.'s Schedule 13D filed by
the Registrant with the Commission on August 7, 1998. CyberMedia Inc.'s
filings with the Commission were made under File Number 0-21289.
(23) Incorporated by reference from the Registrant's Report on Form 8-A filed
with the Commission on October 22, 1998.
(24) Incorporated by reference from the registrant's report on form 10-Q for
the quarter ended September 30, 1998, filed with the Commission on
November 13, 1998.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
85
<PAGE> 86
SCHEDULE II
NETWORKS ASSOCIATES, INC.
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS AT DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT OF ADDITIONS CHARGED BALANCE AT END
PERIOD TO EXPENSE DEDUCTIONS OF PERIOD
------------- ----------------- ---------- --------------
<S> <C> <C> <C> <C>
Year Ended December 31, 1998
Allowance for Doubtful Accounts 5,107 11,283 (4,708) 11,682
Allowance for Sales Returns 21,294 170,714 (106,377) 85,631
Year Ended December 31, 1997(1)
Allowance for Doubtful Accounts 4,205 3,575 (2,673) 5,107
Allowance for Sales Returns 2,523 47,032 (28,261) 21,294
Year Ended December 31, 1996(2)
Allowance for Doubtful Accounts 3,429 2,785 (2,137) 4,077
Allowance for Sales Returns 1,614 25,251 (24,342) 2,523
</TABLE>
(1) Includes Network General balance sheet data as at December 31, 1997
(2) Includes Network General balance sheet data as at March 31, 1997
86
<PAGE> 1
EXHIBIT 21.1
NETWORKS ASSOCIATES, INC.
Consolidated Subsidiaries at December 31, 1998
<TABLE>
<S> <C>
1. McAfee (UK) Limited 36. McAfee.Com Corporation
2. Network Associates, GmbH 37. Magic Solutions, Ltd.
3. Network Associates, S.A. 38. Magic Solutions Gmbh.
4. Network Associates, S.r.l. 39. Trusted Information Systems, Ltd.
5. Network Associates, A.G. 40. Trusted Information Systems, Gmbh
6. Network Associates International, B.V. 41. NA NetTools Holding Company, Inc.
7. Network Associates Software Development GmbH 42. NetTools Company Ltd.
8. Network Associates Software Trading LLC, Hungary 43. NetTools Associates (Pty) Ltd.
9. Network Associates NA, Sweden 44. NA Network Associates OY
10. Network Associates, S.L. Spain 45. Dr Solomon Ltd.
11. Network Associates International, Ltd. 46. Solomon Software Ltd.
12. Network Associates Canada Ltd. 47. Solomon Australia Pty Ltd.
13. Network Associates Combination Company, Inc. 48. Solomon GmbH
14. Network Associates Technology, Inc. 49. Solomon AG
15. Network Associates Holding Company, Inc. 50. Dr Solomon's Software, Inc.
16. Network Associates K.K. 51. QA Information Security Holding AB
17. Network Associates Australia Pty. Ltd. 52. QA Information Security AB
18. Network Associates (Hong Kong) Ltd. 53. QA Information Security OY
19. Network Associates Software (Singapore) Pte Ltd. 54. CSB Consulenza Software di Base S.r.l.
20. Network Associates (NS) ULC
21. FSA Canada Ltd.
22. Network General Europe Holding B.V.
23. Network General Barbados, Inc.
24. Paradigm Pty Ltd.
25. McAfee Do Brazil Ltda
26. McAfee Software de Mexico S.A. de C.V.
27. Network General Canada, Ltd
28. Network General Japan K.K.
29. Network Associates N.V.
30. Network General France SARL
31. Network General Italy SARL
32. Shuijers Holdings B.V.
33. McAfee Nederland
34. GoTech Europe B.V.
35. Network General Gmbh
</TABLE>
88
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statements of
Network Associates, Inc. on Form S-8 (File Nos. 33-80272, 33-80272, 33-80260,
33-80258, 33-96586 and 333-11155) of our report dated March 31, 1999 appearing
on page 55 of this Form 10-K.
We also consent to the incorporation by reference of our report on the Financial
Statement Schedule, which appears on page 86 of this Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
March 31, 1999, except for the matters
discussed in Note 17 as to which
the date is April 7, 1999.
89
<PAGE> 1
EXHIBIT 23.2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Networks Associates, Inc.:
Our audits of the consolidated financial statements referred to in our report
dated March 31, 1999 appearing on page 55 of this Annual Report on Form 10-K
also included an audit of the financial statement schedules listed in Item
14(a)(2) of this Form 10-K. In our opinion, these financial statement schedules
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
San Jose, California
March 31, 1999
87
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<PERIOD-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<CASH> 418,899 157,031 165,785
<SECURITIES> 314,972 260,764 220,330
<RECEIVABLES> 272,466 161,304 107,226
<ALLOWANCES> (11,682) (5,107) (4,077)
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 903,618 537,779 481,343
<PP&E> 127,649 126,070 85,170
<DEPRECIATION> (73,160) (77,742) (44,240)
<TOTAL-ASSETS> 1,536,721 805,350 613,867
<CURRENT-LIABILITIES> 366,562 289,968 173,865
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 1,371 1,281 1,246
<OTHER-SE> 721,467 491,220 424,425
<TOTAL-LIABILITY-AND-EQUITY> 722,838 805,350 613,867
<SALES> 990,045 735,692 514,997
<TOTAL-REVENUES> 990,045 735,692 514,997
<CGS> 177,048 142,099 97,558
<TOTAL-COSTS> 693,031 531,646 97,558
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> (15,246) 0 0
<INCOME-PRETAX> 138,167 82,813 65,419
<INCOME-TAX> 101,729 72,174 54,708
<INCOME-CONTINUING> 36,438 10,639 10,711
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 36,438 10,639 10,711
<EPS-PRIMARY> 0.27<F1> 0.08<F1> 0.09<F1>
<EPS-DILUTED> 0.26 0.08 0.09
<FN>
<F1>FOR PURPOSES OF THIS FDS, PRIMARY MEANS BASIC
</FN>
</TABLE>
