<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-20558
----------------
NETWORKS ASSOCIATES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0316593
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
----------------
Indicate by check mark whether registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
YES [X] NO [ ]
116,575,046 shares of the registrant's common stock, $0.01 par value, were
outstanding as of July 31, 1998.
THIS DOCUMENT CONTAINS 48 PAGES.
THE EXHIBIT INDEX IS ON PAGE 46.
================================================================================
<PAGE> 2
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, JUNE 30, 1998
----------------
CONTENTS
<TABLE>
<CAPTION>
ITEM NUMBER PAGE
- ----------- ----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets:
June 30, 1998 and December 31, 1997....................... 3
Condensed Consolidated Statements of Operations:
Three and six months ended June 30, 1998 and 1997......... 4
Condensed Consolidated Statements of Cash Flows:
Six months ended June 30, 1998 and 1997................... 5
Notes to Condensed Consolidated Financial Statements......... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................... 22
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................... 42
ITEM 2. CHANGES IN SECURITIES........................................... 42
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 43
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................ 43
SIGNATURES............................................................... 45
EXHIBIT INDEX............................................................ 46
</TABLE>
2
<PAGE> 3
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
(AS RESTATED NOTE 2.)
JUNE 30, DECEMBER 31,
1998 1997
---------- ----------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................. $ 101,634 $ 125,532
Marketable securities ................................. 451,794 151,181
Accounts receivable, net of allowances for
doubtful accounts of $6,086 and $3,662 at
June 30, 1998 and December 31, 1997 .................. 175,712 127,150
Prepaid expenses, taxes and other ..................... 50,257 64,121
---------- ----------
Total current assets .......................... 779,397 467,984
Marketable securities ................................... 122,438 109,184
Fixed assets, net ....................................... 49,238 36,900
Deferred taxes .......................................... 70,276 16,173
Intangibles and other assets ............................ 186,305 67,131
---------- ----------
Total assets .................................. $1,207,654 $ 697,372
========== ==========
LIABILITIES
Current liabilities:
Accounts payable ...................................... $ 34,084 $ 19,726
Accrued liabilities ................................... 107,476 132,437
Deferred taxes ........................................ 31,023 --
Deferred revenue ...................................... 82,132 72,914
Long term debt, current portion ....................... 3,769 310
---------- ----------
Total current liabilities ..................... 258,484 225,387
Deferred taxes, less current portion .................. 16,634 2,135
Deferred revenue, less current portion ................ 30,183 11,069
Long term debt and other liabilities .................. 356,460 2,352
---------- ----------
Total liabilities ............................. 661,761 240,943
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value;
authorized: 5,000,000 shares
Common stock, $.01 par value;
authorized: 300,000,000 shares; issued and outstanding:
115,807,784 shares at June 30, 1998 and 111,294,113
shares at December 31, 1997 ........................... 1,158 1,122
Additional paid-in capital ............................. 333,607 241,194
Retained earnings ....................................... 211,128 214,113
---------- ----------
Total stockholders' equity .................... 545,893 456,429
---------- ----------
Total liabilities and stockholders' equity .... $1,207,654 $ 697,372
========== ==========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
<PAGE> 4
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(AS RESTATED NOTE 2.)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenue ........................................... $ 212,454 $ 155,183 $ 408,909 $ 306,066
Operating costs and expenses:
Cost of net revenue ................................. 38,939 26,009 75,763 53,468
Research and development ............................ 27,614 23,545 55,125 43,828
Marketing and sales ................................. 59,250 48,800 131,818 93,067
General and administrative .......................... 17,437 14,943 28,702 28,998
Amortization of intangibles ......................... 9,077 1,463 13,235 2,817
Acquisition and other related costs ................. 72,217 -- 72,217 19,504
--------- --------- --------- ---------
Total operating costs and expenses .............. 224,534 114,760 376,860 241,682
--------- --------- --------- ---------
Income (loss) from operations ................... (12,080) 40,423 32,049 64,384
Interest and other income and expense, net ............ 3,275 5,066 8,382 8,416
--------- --------- --------- ---------
Income (loss) before provision for income taxes (8,805) 45,489 40,431 72,800
Provision for income taxes ............................ 23,677 18,178 44,711 35,951
--------- --------- --------- ---------
Net income (loss) ........................... $ (32,482) $ 27,311 $ (4,280) $ 36,849
========= ========= ========= =========
Net income (loss) per share -- basic ................. $ (0.28) $ 0.25 $ (0.04) $ 0.33
--------- --------- --------- ---------
Shares used in per share calculation -- basic ......... 115,690 110,562 115,381 113,147
========= ========= ========= =========
Net income (loss) per share -- diluted ................ $ (0.28) $ 0.23 $ (0.04) $ 0.32
========= ========= ========= =========
Shares used in per share calculation -- diluted ....... 115,690 116,382 115,381 116,463
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
<PAGE> 5
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS RESTATED (NOTE 2.)
SIX MONTHS ENDED
JUNE 30,
---------------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ........................................... $ (4,279) $ 36,849
Adjustments to reconcile net income to net
cash provided from operating activities:
Acquired in-process research and
development ........................................... 27,013 19,504
Depreciation and amortization .......................... 22,482 12,902
Interest on convertible notes .......................... 6,609 --
Unrealized loss on investments ......................... -- (693)
Deferred taxes ......................................... (12,504) (2,348)
Changes in assets and liabilities:
Accounts receivable .................................. (40,849) (27,883)
Prepaid expenses, taxes and other .................... (6,141) 2,319
Accounts payable and accrued liabilities ............. (14,890) 10,674
Deferred revenue ..................................... 12,466 12,847
Other ................................................ -- (197)
--------- ---------
Net cash (used in)/provided by operating activities (10,093) 63,974
--------- ---------
Cash flows from investing activities:
Purchase of investment securities, net .................... (313,867) (16,687)
Additions to fixed assets ................................. (21,182) (21,623)
Acquisition of Magic Solutions, Inc. ...................... (109,717) --
Acquisition of Compusul ................................... -- (2,709)
Acquisition of 3DV Technology, Inc. ....................... -- (20,000)
--------- ---------
Net cash used in investing activities.............. (444,766) (61,019)
--------- ---------
Cash flows from financing activities:
Effect of exchange rate fluctuations ...................... (2,691) (534)
Issuance of common stock .................................. 2,249 11
Repayments of notes payable ............................... -- (90)
Sale of convertible debentures ............................ 337,624 50
Stock option exercises .................................... 72,449 25,444
Tax benefit from exercise of nonqualified stock options.... 20,998 24,898
Exercise of warrant ....................................... 332 --
Repurchase of common stock ................................ -- (28,102)
--------- ---------
Net cash provided by financing activities ......... 430,961 21,677
--------- ---------
Net (decrease)/increase in cash and cash equivalents ........ (23,898) 24,632
Cash and cash equivalents at beginning of period ...... 125,532 123,955
--------- ---------
Cash and cash equivalents at end of period .................. $ 101,634 $ 148,587
========= =========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
<PAGE> 6
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
During the six months ended June 30, 1998, the Company completed the
acquisitions of Trusted Information Systems ("TIS"), Syscon (Proprietary)
Limited ("Syscon"), Nordic Lantools OY and Nordic Lantools AB (together
"Nordic"), Secure Networks, Inc. ("Secure") and CSB Consulenza Software di Base
S.r.l. ("CSB"). All of these acquisitions were accounted for under the pooling
of interests method of accounting. Financial data of the Company has been
restated to reflect these acquisitions for all periods presented.
The unaudited consolidated financial statements have been prepared by the
Company without audit in accordance with instructions to Form 10-Q and Article
10 of Regulation S-X. The consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. In the opinion of management,
all adjustments, consisting only of normal recurring adjustments considered
necessary for a fair presentation, have been included. The results of operations
for the three and six month periods ended June 30, 1998 are not necessarily
indicative of the results to be expected for the full year or for any future
periods.
2. RESTATEMENT
After discussions with the Staff of the Securities and Exchange Commission
(the "SEC"), the Company has restated the accompanying consolidated financial
statements as of June 30, 1998 and for the three and six month periods ended
June 30, 1998. The financial statements have been restated to reflect a change
in the purchase price allocation and related amortization of intangibles for
acquisitions accounted for by the purchase method of accounting in 1997 (Cinco
Networks, Pretty Good Privacy) and 1998 (Magic Solutions, Inc), as well as two
smaller acquisitions in 1995 and 1996 (AIM Technology and Vycor Corporation,
respectively). The Company has also revised the original accounting for several
previously reported small acquisitions accounted for under the poolings of
interests method of accounting and for certain other adjustments to the
Acquisition and other related costs charge taken in the fourth quarter of 1997.
The following schedules summarize these restatements.
6
<PAGE> 7
NETWORKS ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, 1998
-------------
AS PREVIOUSLY
REPORTED OTHER AS RESTATED
---------- ---------- ----------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents ........................ $ 101,634 $ -- $ 101,634
Short term marketable securities ................. 451,794 -- 451,794
Accounts receivable, net of allowance for
doubtful accounts of $6,086 ...................... 175,010 702 175,712
Prepaid expenses, taxes and other current assets . 52,228 (1,971) 50,257
---------- ---------- ----------
Total current assets ..................... 780,666 (1,269) 779,397
Long term marketable securities .................... 122,438 -- 122,438
Fixed assets, net .................................. 49,238 -- 49,238
Deferred taxes ..................................... 70,276 -- 70,276
Intangible and other assets ........................ 61,323 124,982 186,305
---------- ---------- ----------
Total assets ............................. $1,083,941 $ 123,713 $1,207,654
========== ========== ==========
LIABILITIES
Current liabilities:
Accounts payable ................................. $ 34,084 $ -- $ 34,084
Accrued liabilities .............................. 101,402 6,074 107,476
Deferred taxes ................................... 31,023 -- 31,023
Deferred revenue ................................. 82,132 -- 82,132
Long term debt, current portion .................. 3,769 -- 3,769
---------- ---------- ----------
Total current liabilities ................ 252,410 6,074 258,484
Deferred taxes, less current portion ............. 16,634 -- 16,634
Deferred revenue, less current portion ........... 30,183 -- 30,183
Long term debt and other liabilities ............. 356,460 -- 356,460
---------- ---------- ----------
Total liabilities ........................ 655,687 6,074 661,761
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: 134,378,883 shares ....... 1,158 -- 1,158
Additional paid-in capital ......................... 333,607 -- 333,607
Retained earnings .................................. 93,489 117,639 211,128
---------- ---------- ----------
Total stockholders' equity ............... 428,254 117,639 545,893
---------- ---------- ----------
Total liabilities and stockholders' equity $1,083,941 $ 123,713 $1,207,654
========== ========== ==========
</TABLE>
7
<PAGE> 8
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION> QUARTER ENDED JUNE 30, 1998
---------------------------
AS PREVIOUSLY
REPORTED OTHER AS RESTATED
--------- --------- -----------
<S> <C> <C> <C>
Net revenue ....................................... $ 212,454 $ -- $ 212,454
Operating costs and expenses:
Cost of net revenue ............................. 38,939 -- 38,939
Research and development ........................ 27,614 -- 27,614
Marketing and sales ............................. 58,685 565 59,250
General and administrative ...................... 12,437 5,000 17,437
Amortization of intangibles ..................... 2,756 6,321 9,077
Acquisition and other related costs ............. 150,910 (78,693) 72,217
--------- --------- ---------
Total operating costs and expenses ......... 291,341 (66,807) 224,534
--------- --------- ---------
Income from operations .................. (78,887) 66,807 (12,080)
Interest and other income, net .................... 3,275 -- 3,275
--------- --------- ---------
Income before provision for income taxes (75,612) 66,807 (8,805)
Provision for income taxes ........................ 25,569 (1,892) 23,677
--------- --------- ---------
Net income (loss) ....................... $(101,181) $ 68,699 $ (32,482)
========= ========= =========
Net income (loss) per share - basic ............... $ (0.87) $ (0.28)
========= =========
Shares used in per share calculation - basic ...... 115,690 115,690
========= =========
Net income (loss) per share - diluted ............ $ (0.87) $ (0.28)
========= =========
Shares used in per share calculation - diluted 115,690 115,690
========= =========
</TABLE>
8
<PAGE> 9
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1998
------------------------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenue ........................................ $ 408,785 $ 124 $ -- $ 408,909
Operating costs and expenses:
Cost of revenue .................................. 75,763 -- -- 75,763
Research and development ......................... 55,125 -- -- 55,125
Marketing and sales .............................. 124,500 -- 7,318 131,818
General and administrative ....................... 23,609 93 5,000 28,702
Amortization of intangibles ...................... 3,548 -- 9,687 13,235
Acquisition and other related costs .............. 150,910 -- (78,693) 72,217
--------- --------- --------- ---------
Total operating costs and expenses .......... 433,455 93 (56,688) 376,860
--------- --------- --------- ---------
Income from operations ................... (24,670) 31 56,688 32,049
Interest and other income, net ..................... 8,382 -- -- 8,382
--------- --------- --------- ---------
Income before provision for income taxes . (16,288) 31 56,688 40,431
Provision for income taxes ......................... 49,034 -- (4,323) 44,711
--------- --------- --------- ---------
Net income (loss) ........................ $ (65,322) $ 31 61,011 $ (4,280)
========= ========= ========= =========
Net income (loss) per share - basic ................ $ (0.57) $ (0.04)
========= =========
Shares used in per share calculation - basic ....... 115,098 283 115,381
========= ========= =========
Net income (loss) per share - diluted ............. $ (0.57) $ (0.04)
========= =========
Shares used in per share calculation - diluted 115,098 283 115,381
========= ========= =========
</TABLE>
9
<PAGE> 10
NETWORKS ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
------------- ------------ ------- -----------
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents ........................... $124,784 $ 748 $ -- $125,532
Short term marketable securities .................... 151,042 139 -- 151,181
Accounts receivable, net of allowance for
doubtful accounts of $3,662 ........................... 136,650 800 (10,300) 127,150
Prepaid expenses, taxes and other current assets 62,738 58 1,325 64,121
-------- -------- -------- --------
Total current assets ........................ 475,214 1,745 (8,975) 467,984
Long term marketable securities ....................... 109,184 -- -- 109,184
Fixed assets, net ..................................... 36,731 169 -- 36,900
Deferred taxes ........................................ 16,173 -- -- 16,173
Intangible and other assets ........................... 18,397 20 48,714 67,131
-------- -------- -------- --------
Total assets ................................ $655,699 $ 1,934 $ 39,739 $697,372
======== ======== ======== ========
LIABILITIES
Current liabilities:
Accounts payable .................................... $ 19,007 $ 719 $ -- $ 19,726
Accrued liabilities ................................. 147,598 239 (15,400) 132,437
Deferred revenue .................................... 72,911 3 -- 72,914
Long term debt, current portion ..................... 153 157 -- 310
-------- -------- -------- --------
Total current liabilities ................... 239,669 1,118 (15,400) 225,387
Deferred taxes, less current portion ................ 2,117 18 -- 2,135
Deferred revenue, less current portion .............. 11,069 -- -- 11,069
Long term debt and other liabilities ................ 2,352 -- -- 2,352
-------- -------- -------- --------
Total liabilities ........................... 255,207 1,136 (15,400) 240,943
-------- -------- -------- --------
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: 128,435,232 shares at
December 31, 1997 ..................................... 1,116 6 -- 1,122
Additional paid-in capital ............................ 241,171 23 -- 241,194
Retained earnings ..................................... 158,205 769 55,139 214,113
-------- -------- -------- --------
Total stockholders' equity .................. 400,492 798 55,139 456,429
-------- -------- -------- --------
Total liabilities and stockholders' equity .. $655,699 $ 1,934 $ 39,739 $697,372
======== ======== ======== ========
</TABLE>
10
<PAGE> 11
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED JUNE 30, 1997
---------------------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
------------- ------------ ------- -----------
<S> <C> <C> <C> <C>
Net revenue ...................................... $152,780 $ 2,403 $- $155,183
Operating costs and expenses:
Cost of revenue ................................ 25,595 414 -- 26,009
Research and development ....................... 23,257 288 -- 23,545
Marketing and sales ............................ 48,102 698 -- 48,800
General and administrative ..................... 14,520 423 -- 14,943
Amortization of intangibles .................... 213 -- 1,250 1,463
Acquisition and other related costs ............ -- -- -- --
-------- -------- ------- --------
Total operating costs and expenses ........ 111,687 1,823 1,250 114,760
-------- -------- ------- --------
Income from operations ................. 41,093 580 (1,250) 40,423
Interest and other income, net ................... 5,060 6 -- 5,066
-------- -------- ------- --------
Income before provision for income taxes 46,153 586 (1,250) 45,489
Provision for income taxes ....................... 17,380 798 -- 18,178
-------- -------- ------- --------
Net income ............................. $ 28,773 $ (212) $(1,250) $ 27,311
======== ======== ======= ========
Net income per share - basic ..................... $ 0.26 $ 0.25
======== ========
Shares used in per share calculation - basic ..... 109,335 1,227 110,562
======== ======== ========
Net income per share - diluted ................... $ 0.25 $ 0.23
======== ========
Shares used in per share calculation - diluted ... 115,155 1,227 116,382
======== ======== ========
</TABLE>
11
<PAGE> 12
NETWORKS ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1997
------------------------------
RESTATEMENT
AS PREVIOUSLY FOR POOLING
REPORTED TRANSACTIONS OTHER AS RESTATED
------------- ------------ ------- -----------
<S> <C> <C> <C> <C>
Net revenue ...................................... $301,260 $ 4,806 $-- $306,066
Operating costs and expenses:
Cost of revenue ................................ 52,640 828 -- 53,468
Research and development ....................... 43,253 575 -- 43,828
Marketing and sales ............................ 91,671 1,396 -- 93,067
General and administrative ..................... 28,151 847 -- 28,998
Amortization of intangibles .................... 317 -- 2,500 2,817
Acquisition and other related costs ............ 19,504 -- -- 19,504
-------- -------- ------- --------
Total operating costs and expenses ........ 235,536 3,646 2,500 241,682
-------- -------- ------- --------
Income from operations ................. 65,724 1,160 (2,500) 64,384
Interest and other income, net ................... 8,403 13 -- 8,416
-------- -------- ------- --------
Income before provision for income taxes 74,127 1,173 (2,500) 72,800
Provision for income taxes ....................... 34,355 1,596 -- 35,951
-------- -------- ------- --------
Net income ............................. $ 39,772 $ (423) $(2,500) $ 36,849
======== ======== ======= ========
Net income per share - basic ..................... $ 0.36 $ 0.33
======== ========
Shares used in per share calculation - basic ..... 111,920 1,227 113,147
======== ======== ========
Net income per share - diluted ................... $ 0.35 $ 0.32
======== ========
Shares used in per share calculation - diluted ... 115,236 1,227 116,463
======== ======== ========
</TABLE>
DESCRIPTION OF ADJUSTMENTS
RESTATEMENT FOR POOLING TRANSACTIONS - NOT PREVIOUSLY RECORDED
The above adjustments reflect the acquisitions of Syscon, Nordic, Secure, CSB
(each acquired in 1998) and Helix Software Company (acquired in December 1997),
for all periods presented. The Company originally included the financial
statements of the acquired entities only in the quarter in which they were
acquired, with an adjustment to retained earnings for prior periods. At the
request of the SEC, the Company has restated all periods to reflect the
historical financial statements of all these acquisitions.
RESTATEMENT FOR ACQUISITION AND OTHER RELATED COSTS:
In-process research and development charges:
During 1997 and 1998, the Company completed a number of acquisitions in
transactions accounted for by the purchase method. Purchase price allocations
performed at the time of these acquisitions resulted in substantial allocations
to in-process research and development for projects underway by the acquired
companies which had not reached technological feasibility and which had no
alternative future use. These allocations were performed following methods
generally in use by technology companies based on appraisals at the time. Recent
guidance published by the SEC has resulted in a general re-evaluation of the
methodology used in such appraisals. Following a review of its Form 10-Q for the
nine months ended September 30, 1998 and its Form 10-K for the year ended
December 31, 1997 by the SEC and subsequent discussions with the SEC, the
Company has re-evaluated its allocations for purchase transactions in 1997 and
1998. The restatements included above reflect the adjustments to the in-process
research and development write-offs resulting from such re-evaluations as
follows:
12
<PAGE> 13
<TABLE>
<CAPTION>
As Additional
Originally As Amount
Reported Restated Capitalized
$'000 $'000 $'000
----- ----- -----
<S> <C> <C> <C>
Magic Solutions (acquired by
Network Associates in 1998) ...... $97,001 $27,014 $69,987
Cinco (acquired by Network
General in 1997) ................. 23,688 5,234 18,454
Pretty Good Privacy
(acquired by Network ............. 30,878 3,937 26,941
Associates in 1997)
Vycor (acquired by McAfee in 1996) 7,800 -- 7,800
AIM (acquired by Network
General in 1995) ................. 7,200 -- 7,200
</TABLE>
Restatements relating to other acquisition charges:
The Company has also made a number of other reclassifications relating
to acquisitions made in 1998 as follows:
<TABLE>
<CAPTION>
THREE
SIX MONTHS MONTHS
ENDED JUNE ENDED JUNE
DESCRIPTION OF RECLASSIFICATION 30, 1998 30, 1998
$'000 $'000
-------- --------
<S> <C> <C>
Reclassification of severance and benefits for terminated
employees of companies acquired in transactions accounted for
by the purchase method of accounting to goodwill, previously $ (2,410) $ (2,410)
charged to earnings in the period of acquisition
Reclassification of facility cost write downs and reserves relating to
facilities and assets of companies acquired in transactions accounted for by
the purchase method of accounting to goodwill, previously charged to earnings in the
period of acquisition (6,296) (6,296)
Restatement of acquired in-process research and development
This adjustment increased intangible and other assets by the same amount (69,987) (69,987)
-------- --------
Total adjustments to Acquisition and other related costs $(78,693) $(78,693)
======== ========
Reclassification of the write-off of uncollectable receivables
associated with the acquisition of Network General to general
and administrative expenses $ 5,000 $ 5,000
======== ========
Reclassification of TV advertising costs incurred in 1998
related to the Network General merger and related name change,
previously charged to acquisition and other related costs in
1997, to marketing expense in 1998 4,825 --
Reclassification of TV advertising costs incurred in 1998 related to the
Network General merger and related name change, previously charged to
acquisition and other related costs in
the six months ended June 30, 1998, to marketing expense in 1998 2,493 565
-------- --------
Total adjustments to Marketing and sales expense $ 7,318 $ 565
======== ========
Additional amortization resulting form restatement of acquired
in-process research and development. This adjustment reduced
intangible and other assets $ 9,687 $ 6,321
======== ========
</TABLE>
The net increase to Intangible and other assets of $125.0 million is
comprised of the above reclassifications of severance and benefits and
facilities and asset write downs of $8.7 million, adjustments to in-process
research and development for 1998
13
<PAGE> 14
acquisitions of $70.0 million plus adjustments to prior year acquisitions of
$60.4 million, an increase in goodwill of Magic of $4.1 million and
reclassification to trademarks of $3.2 million, from accrued acquisition costs.
As a result of the re-evaluations of the purchase transactions above,
amortization of goodwill and other intangibles resulting from these acquisitions
for the three and six months ended June 30, 1998 was increased from amounts
previously reported by $6.3 million and $9.7 million respectively, and future
amortization will be increased for the next 7 years as follows:
<TABLE>
<CAPTION>
Year Ended
December 31, Amount $'000
------------ ------------
<S> <C>
Q3 1998 $ 6,481
Q4 1998 5,881
1999 21,576
2000 20,926
2001 20,926
2002 20,479
2003 13,936
2004 11,822
2005 2,955
</TABLE>
3. RECENT ACCOUNTING PRONOUNCEMENTS
In October 1997, the AICPA issued Statement of Position No. 97-2 ("SOP 97-2")
"Software Revenue Recognition," which the Company has adopted for transactions
entered into during the year beginning January 1, 1998. SOP 97-2 provides
guidance for recognizing revenue on software transactions and supersedes
previous guidance provided by SOP 91-1, "Software Revenue Recognition." Under
SOP 97-2, revenue from product licenses is recognized when a signed agreement or
other persuasive evidence of an arrangement exists, the software or system has
been shipped (or software has been electronically delivered), the license fee is
fixed and determinable, and collection of the resulting receivable is probable.
For contracts with multiple elements/obligations, (e.g. software products,
upgrades/enhancements, maintenance and services), revenue is allocated to each
element of the arrangement based on the Company's evidence of fair value as
determined by the amount charged when the element is sold separately.
Maintenance revenue for providing product updates and customer support is
deferred and recognized ratably over the service period. Revenue on rental units
under operating leases and service agreements is recognized over the term of the
rental agreement or the period during which services are expected to be
performed. Revenue generated from products sold through traditional channels
where the right of return exists is reduced by reserves for estimated sales
returns.
In March 1998, the AICPA issued Statement of Position No. 98-4 ("SOP 98-4"),
"Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue
Recognition." SOP 98-4 defers, for one year, the application of certain passages
in SOP 97-2, which limit what is considered vendor-specific objective evidence
("VSOE") necessary to recognize revenue for software licenses in
multiple-element arrangements when undelivered elements exist. Additional
guidance is expected prior to adoption of any resulting final amendments related
to the deferred provisions of SOP 97-2. Because of the uncertainties related to
the outcome of these proceedings, the impact, if any, on future financial
results of the Company is not currently determinable. Adoption of the remaining
provisions of SOP 97-2, as amended, did not have a material impact on revenue
recognition during the first or second quarters of 1998.
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income," effective January 1, 1998.
This statement requires the disclosure of comprehensive income and its
components in a full set of general-purpose financial statements. Comprehensive
income is defined as net income plus revenues, expenses, gains and losses that,
under generally accepted accounting principles, are excluded from net income.
The components of comprehensive income, which are excluded from net income, are
not significant individually or in aggregate, and therefore, no separate
statement of comprehensive income has been presented.
14
<PAGE> 15
In July 1997, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an
Enterprise and Related Information", which requires companies to report certain
information about operating segments, including certain information about their
products, services, the geographic areas in which they operate and their major
customers. This statement supersedes FASB Statements Nos. 14, 18, 24 and 30.
SFAS 131 is effective for financial statements for fiscal years beginning after
December 15, 1997. The Company is evaluating the requirements of SFAS 131 and
the effects, if any, on the Company's current reporting and disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments
and Hedging Activities". SFAS 133 requires the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not hedges
must be adjusted to fair value through net income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of the
derivative are either offset against the change in fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. SFAS 133 is effective for years beginning after June 15,
1999, but companies can early adopt as of the beginning of any fiscal quarter
that begins after June 1998. The Company is evaluating the requirements of SFAS
133, but does not expect this pronouncement to materially impact the Company's
results of operations.
4. NET INCOME (LOSS) PER SHARE
In accordance with the disclosure requirements of SFAS 128, a reconciliation
of the numerator and denominator of basic and diluted net income (loss) per
share calculations is provided as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Numerator -- basic
Net income (loss) $(32,482) $ 27,312 $ (4,280) $ 36,849
======== ======== ========= ========
Numerator -- diluted
Net income (loss) $(32,482) $ 27,312 $ (4,280) $ 36,849
======== ======== ========= ========
Interest on convertible debentures, net of tax -- -- -- --
-------- -------- --------- --------
Net income (loss) available to common stockholders $(32,482) $ 27,312 $ (4,280) $ 36,849
======== ======== ========= ========
Denominator -- basic
Basic weighted average common shares outstanding 115,690 110,562 115,381 113,147
======== ======== ========= ========
Denominator -- diluted
Basic weighted average common shares outstanding 115,690 110,562 115,381 113,147
Effect of dilutive securities:
Common stock options -- 5,820 -- 3,316
-------- -------- --------- --------
Diluted weighted average shares 115,690 116,382 115,381 116,463
======== ======== ========= ========
Net income (loss) per share -- basic $ (0.28) $ 0.25 $ (0.04) $ 0.33
======== ======== ========= ========
Net income (loss) per share -- diluted $ (0.28) $ 0.23 $ (0.04) $ 0.32
======== ======== ========= ========
</TABLE>
5. ACQUISITIONS
Secure Networks, Inc.
On May 15, 1998, the Company acquired Secure Networks, Inc. ("Secure"). The
aggregate consideration payable in the acquisition was 567,000 shares of the
Company's Common Stock in a transaction accounted for as a pooling of interests.
Secure is a developer and licensor of network security auditing software based
in Canada.
Trusted Information Systems
On April 28, 1998, the Company acquired Trusted Information Systems ("TIS"),
a publicly-held provider of comprehensive security systems for computer networks
in an acquisition accounted for as a pooling of interests. 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
15
<PAGE> 16
common stock of TIS was converted into approximately 6.8 million shares of
Common Stock of the Company, at an exchange ratio of 0.4845. The Company also
assumed all outstanding options and other rights to acquire TIS capital stock.
Magic Solutions International, Inc.
On April 1, 1998, the Company acquired all of the outstanding capital stock
and options of Magic Solutions International, Inc. ("Magic Solutions"), a
privately held provider of internal help desk and asset management solutions,
for approximately $109.8 million in cash. The acquisition was accounted for
using the purchase method of accounting and the total purchase price was $138.0
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 $111.0 million of which, $20.3
million has been recorded as purchased technology and trademarks and $90.7
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 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>
Six Months Ended
June 30
---------------------
1998 1997
-------- --------
(unaudited)
<S> <C> <C>
Revenue $415,083 $325,605
Net income (loss) (6,650) 13,898
Net income (loss) per share $(0.06) $0.12
</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.
In connection with the acquisitions accounted for as a pooling of interests,
the Company incurred direct transaction costs and other restructuring and
related charges in the amount of $45.2 million in the three months ended June
30, 1998. In connection with the acquisitions accounted for as purchase
transactions, the Company incurred a charge of $27.0 million in the three months
ended June 30, 1998, consisting principally of the write off of in-process
research and development acquired. The following is a summary of these charges
for the three months ended June 30, 1998 together with charges for certain
restructuring activities taken by the Company ($ 000's):
<TABLE>
<CAPTION>
Direct Severance Lease Costs
Transaction & 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
Secure 500 500 1,200 -- 100 2,300
Magic -- -- -- 27,014 27,014
Restructuring Costs-Q2 -- 11,318 8,644 -- 610 20,572
-------- -------- -------- -------- -------- --------
Total Charges $ 15,523 $ 15,636 $ 14,258 $ 27,014 $ (214) $ 72,217
-------- -------- -------- -------- -------- --------
</TABLE>
16
<PAGE> 17
Direct transaction costs included $10.5 million in investment banking fees,
$4.3 million in legal and accounting fees, and $709,000 in filing fees, travel
and other costs. Lease costs and asset writedowns include the costs of closing
approximately 18 facilities throughout the world ($6.5 million) and the disposal
of excess and obsolete assets (generally computer equipment which did not comply
with the Company's standards ($7.8 million)).
The following table summarizes the activity in the reserves for severance and
benefits, lease costs and asset write downs established in the second quarter 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 Three Months
ended June 30, 1998 $ 15,523 $ 15,636 $ 6,485 $ 7,773 $ (214) $ 45,203
Paid Out or Charged against
the related assets (5,254) (9,053) (596) (1,310) -- (16,213)
-------- -------- -------- -------- -------- --------
Balance, June 30, 1998 $ 10,269 $ 6,583 $ 5,889 $ 6,463 $ (214) $ 28,990
======== ======== ======== ======== ======== ========
</TABLE>
The severance and benefits charges for the three months ended June 30, 1998
related to company-wide reductions in force following the Company's acquisition
of TIS in the second quarter, of approximately 122 employees across all employee
groups. Substantially all terminated employees left the Company in the period
the related accounting charge was recorded. A limited number of employees from
each acquisition were retained for short transition periods. The cost of these
employees was charged to operating expenses during the transition period.
The lease costs represent an estimate of lease expenses during the period
prior to re-leasing the property together with losses on sub-leases, if any. The
leased facilities were substantially vacated in the period in which the related
accounting charges were recorded. The costs related to any facilities which were
used by the Company during this period were charged to operations, however, such
charges were not material. Asset write downs comprised $2.5 million in losses on
Company owned buildings (which were written down to estimated values determined
by appraisals) and $5.3 million in net losses of computer and other
miscellaneous assets. In general, this equipment was discarded or sold for
nominal value. Due to the immediate consolidation of facilities, depreciation
allocable to these facilities and the related assets, during the transition
period, was not material. Of the facilities acquired in its 1998 acquisitions
identified for closure, the Company has 9 facilities worldwide which have not
been subleased (8 leased, one owned). These facilities are insignificant to the
Company's operations and each is intended for disposal or sublease in 1999.
The following table summarizes the activity in the reserves for severance and
benefits, lease costs and asset and write downs established in the year ended
December 31, 1997 ($000's):
<TABLE>
<CAPTION>
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 (8,116) (5,738) (2,725) (3,722) (2,439) (22,740)
Adjustment to liability -- (3,000) -- 3,000 -- --
-------- -------- -------- -------- -------- --------
Balance, June 30, 1998 $ (66) $ 1,959 $ 1,117 $ 1,143 $ 454 $ 4,607
======== -------- -------- -------- ======== ========
</TABLE>
The Company believes that the reserve balances remaining at June 30,
1998 are adequate to cover any additional benefits or losses yet to be paid or
realized. Any reserves not used will be recorded as a credit to Acquisition and
other related costs in future periods.
17
<PAGE> 18
6. CONVERTIBLE DEBENTURES
On February 13, 1998, the Company completed a private placement of zero
coupon convertible subordinated Debentures due in 2018 (the "Debentures"). The
Debentures, with an aggregate face amount at maturity of $885.5 million,
generated net proceeds to the Company of approximately $337.6 million. The
initial price to the public for the Debentures was $391.06 per $1,000 of face
amount at maturity, which equates to a yield to maturity over the term of the
bonds of 4.75% (on a semi-annual bond equivalent basis). The debentures are
convertible into Common Stock at the rate of 8.538 shares per $1,000 of face
amount at maturity, which equates to an initial conversion price of $45.80 per
share. The Debentures are subordinated in right of payment to all existing and
future Senior Indebtedness (as defined) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the Company's subsidiaries.
The Debentures may be redeemed for cash at the option of the Company beginning
on February 13, 2003. At the option of the holder, the Company will purchase the
Debentures on February 13, 2003, February 13, 2008 and February 13, 2013 at
purchase prices (to be paid in cash or Common Stock or any combination thereof,
at the election of the Company and subject to certain conditions) equal to the
initial issue price plus accrued original issue discount to such dates. The
Debentures may also be redeemed at the option of the holder if there is a
Fundamental Change (as defined) at a price equal to the issue price plus accrued
original issue discount to the date of redemption, subject to adjustment.
7. STOCK DIVIDEND
On April 30, 1998 the Company declared a 3:2 stock split effected through a
stock dividend, payable to all holders of record of Common Stock on May 12,
1998, as one share of Common Stock for every two shares of Common Stock
outstanding. The stock dividend was distributed on June 1, 1998. All per share
data contained herein (including information as to the convertibility of the
Debentures into Common Stock) has been restated to reflect the increased number
of shares outstanding as a result of such stock split.
8. LITIGATION
The Company has changed its legal name to "Networks Associates, Inc." and has
begun conducting business as "Network Associates." Two companies, (Network
Associates, Inc. in Kansas ("NAI-Kansas"); and Network Associates, Inc. in
Oregon ("NAI-Oregon")) and Ronald L. Meyers ("Meyers"), a California resident
doing business as The Network Associates, have made unresolved claims (including
various trademark claims) or demands with respect to the Company's use of the
name Network Associates. On March 26, 1998, the Company commenced a declaratory
judgement action in the United States District Court, Northern District of
California against all three of the above-cited claimants. The Company seeks a
declaration that its use of the NETWORK ASSOCIATES title does not violate the
federal, state or common law rights of any of the defendants. Defendants
NAI-Oregon and NAI-Kansas have since been granted extensions of time in which to
respond to the Complaint; defendant Meyers has not yet been served. NAI-Kansas
has moved to dismiss the claims against it for lack of personal jurisdiction.
On April 24, 1997, the Company was served by Symantec with a suit filed in
the United States District Court, Northern District of California, San Jose
Division, alleging copyright infringement and unfair competition by the Company.
Symantec alleges that the Company's computer software program called "PC Medic"
copied portions of Symantec's computer software program entitled "CrashGuard."
Symantec's complaint sought injunctive relief and unspecified money damages. On
July 20, 1997, Symantec sought leave to amend its complaint to include
additional allegations of copyright infringement and trade secret
misappropriation pertaining to the Company's "VirusScan" product. Symantec
sought injunctive relief and unspecified money damages. On October 6, 1997, the
Court issued an order granting Symantec's motion to amend its complaint and
enjoining the Company from shipping any product containing either an
approximately 30-line routine found in Crash Guard or an approximately 100-line
routine found in a Symantec DLL. The Court's order expressly stated that "the
court is not enjoining the sale or distribution of [McAfee's] current product."
On December 19, 1997, the Court denied Symantec's motion to enjoin sale or
distribution of the Company's current PC Medic product. On 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 the
Company employees of proprietary Symantec customer information. On April 10,
1998, the Company moved to dismiss the RICO claims. Symantec also filed a motion
for a preliminary injunction relating to these new allegations which was
scheduled for hearing on June 5, 1998.
Trial is currently set for September 1998.
18
<PAGE> 19
On June 9, 1998, the Court dismissed Symantec's unfair competition claim
regarding allegations concerning source code with prejudice and dismissed
Symantec's racketeering claim without prejudice. On June 15, 1998, the Court
entered a stipulated preliminary injunction prohibiting the Company from making
use of any Symantec customer list data.
On May 13, 1997, Trend Micro, Inc. ("Trend") filed suit in United States
District Court for the Northern District of California against both the Company
and Symantec. Trend alleges that the Company's "WebShield" and "GroupShield"
products infringe a Trend patent which issued on April 22, 1997. Trend's
complaint seeks injunctive relief and unspecified money damages. On June 6,
1997, the Company filed its answer denying any infringement. The Company also
filed counterclaims against Trend alleging unfair competition, false
advertising, trade libel, and interference with prospective economic advantage.
On September 19, 1997, Symantec filed a motion to sever Trend's action against
the Company from its action against Symantec. The Company did not oppose
Symantec's motion to sever, other than to recommend a joint hearing on patent
claim interpretation. On December 19, 1997, the Court granted Symantec's motion
to sever and adopted the Company's recommendation regarding a joint hearing on
patent claim interpretation. As a result of the Court's decision, Trend's
actions against the Company and Symantec will proceed separately. The Court has
set the date for the joint patent claim interpretation hearing for September
1998. Thirty days after the joint patent claim interpretation hearing, the Court
has indicated it will set further dates for discovery and trial.
On May 6, 1997, RSA Data Security, Inc. ("RSA") filed a lawsuit against
PGP, a wholly owned subsidiary of the Company since December 9, 1997, in San
Mateo County Superior Court. RSA seeks a declaration from the court that certain
paragraphs of a license agreement between PGP and Public Key Partners (the
"License Agreement") have been terminated and certain other paragraphs have
survived RSA's purported termination of the License Agreement. RSA, which
purports to act on behalf of Public Key Partners, also seeks an accounting of
PGP's sales of products subject to the License Agreement. PGP denies that RSA
has the authority to act on behalf of Public Key Partners, and denies that the
License Agreement has been breached or terminated in whole or in part. On May
22, 1997, PGP filed a motion to compel arbitration of the action pursuant to an
Arbitration clause in the License Agreement. PGP's motion was granted on October
9, 1997. The Court stayed the state court proceedings and ordered the action to
arbitration.
On October 14, 1997, RSA filed a patent infringement lawsuit against PGP in
the United States District Court for the Northern District of California. RSA
alleges PGP has infringed one of the patents which was licensed to PGP under the
License Agreement. On November 4, 1997, PGP moved to stay the federal action,
or, in the alternative, compel it to arbitration. On December 23, 1997, RSA
filed a motion to amend its complaint to include the Company as defendant. On
March 2, 1998, the court granted PGP's motion to stay the federal patent action.
On April 15, 1998, RSA filed a patent infringement lawsuit against the
Company in the United States District Court for the Northern District of
California, alleging that the Company has infringed the same patent as in the
earlier lawsuit against PGP. Counsel for RSA has orally indicated that RSA will
stipulate to stay this lawsuit on the same basis as the prior lawsuit against
PGP. On May 13, 1998, RSA filed a copyright infringement suit in the United
States District Court for the Northern District of California seeking an
injunction against Network Associates and its Trusted Information Systems
subsidiary from using certain RSA software.
All four of the above RSA cases were settled on May 29, 1998, and were
dismissed in June, 1998.
On September 15, 1997, the Company was named as a defendant in a patent
infringement action filed by Hilgraeve Corporation ("Hilgraeve") in the United
States District Court for the Eastern District of Michigan. Hilgraeve alleges
that the Company's VirusScan product infringes a Hilgraeve patent which was
issued on June 7, 1994. Hilgraeve's action seeks injunctive relief and
unspecified money damages. The case is in discovery. Discovery is presently
scheduled to be completed by December 15, 1998. There is a status conference
scheduled for September 22, 1998. A trial date has been set for June, 1999.
Although the Company intends to defend itself vigorously against the claims
asserted against it in the foregoing actions or matters, there can be no
assurance that such pending litigation will not have a material adverse effect
on the Company's business, financial condition or operating results. The
litigation process is subject to inherent uncertainties and no assurance can be
given that the Company will prevail in any such matters, or will be able to
obtain licenses, on commercially reasonable terms, or at all, under any patents
or other intellectual property rights that may be held valid or infringed by the
Company or its products. Uncertainties inherent in the litigation process
involve, among other things, the complexity of the technologies involved,
potentially adverse changes in the law and discovery of facts unfavorable to the
Company.
9. SUBSEQUENT EVENTS
19
<PAGE> 20
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 will be accounted for under the pooling of interests method
of accounting. Historical financial data in future reports will be restated to
include Dr Solomon's data. The following unaudited pro forma summary presents
the combined results of operations as if the Acquisition had been completed on
January 1, 1995.
<TABLE>
<CAPTION>
(unaudited pro forma)
(in thousands, except per share data)
Year Ended December 31, Three Months Ended
March 31,
1997 1996 1995 1998 1997
<S> <C> <C> <C> <C> <C>
Net revenue $719,842 $511,107 $331,104 220,704 $166,796
Net income (loss) 9,557 9,466 52,511 31,745 10,398
======== ======== ======== ======== ========
Net income (loss) per
share - diluted $ 0.07 $ 0.08 $ 0.44 $ 0.24 $ 0.08
======== ======== ======== ======== ========
</TABLE>
The pro forma summary financial data for the years ended December 31, 1997,
1996 and 1995, reflects 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 pro forma summary financial
data for the three month periods ended March 31, 1998 and 1997 reflects the
combination of the statements of operations of the Company for the three months
ended March 31, 1998 and 1997 and the statements of operations of Dr Solomon's
for the three months ended February 28, 1998 and 1997.
Estimated direct transaction costs of approximately $18 million associated
with the Acquisition, consisting of transaction fees for investment bankers,
attorneys, accountants, financial printing and other related charges will be
charged to operations in the three months ended September 30, 1998. It is
expected that the Company and Dr Solomon's will incur additional significant
charges to operations, which are not currently reasonably estimable, to reflect
the costs associated with integrating the two companies. This charge has not
been reflected in the pro forma financial data. There can be no assurance that
the combined company will not incur additional charges to reflect costs
associated with the Acquisition or that management will be successful in its
efforts to integrate the two companies.
On July 30, 1998, the Company acquired Anyware Seguridad Informatica, S.A.
("Anyware"). The aggregate consideration payable in the acquisition was 228,204
shares of the Company's Common Stock in a transaction accounted for as a pooling
of interests. Anyware is a developer and distributor of anti-virus software
products based in Madrid, Spain. On June 29, 1998, the Company acquired CSB
Consulenza Software di Base S.r.l. ("CSB"). The aggregate consideration payable
in the acquisition was 9,815 shares of the Company's Common Stock in a
transaction accounted for as a pooling of interests. CSB is a reseller of
software applications and services based in Milan, Italy.
On July 28, 1998, the Company announced that it had entered into a definitive
merger agreement to acquire CyberMedia, Inc. ("CyberMedia"), a provider of
desktop utility software solutions. Under the terms of the agreement, a
subsidiary of the Company will commence a tender offer for all outstanding
shares of CyberMedia Common Stock at a net price of $9.50 per share in cash for
an aggregate purchase price of approximately $130 million. Following completion
of the tender offer, the Company's subsidiary will be merged into CyberMedia in
a transaction in which any CyberMedia shares not tendered will be converted into
the right to receive the same per share cash price paid in the tender offer.
Completion of the tender offer is subject to customary conditions, including the
tender of a majority of the CyberMedia shares, receipt of necessary governmental
approvals and the expiration of applicable waiting periods under the
Hart-Scott-Rodino Act. The transaction will be accounted for as a purchase
transaction.
20
<PAGE> 21
NETWORKS ASSOCIATES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed
consolidated financial statements and related notes included elsewhere in this
report. The results shown herein are not necessarily indicative of the results
to be expected for the full year or any future periods.
This Report on Form 10-Q/A contains forward-looking statements, including
but not limited to those specifically identified as such, that involve risks and
uncertainties. The statements contained in this Report on Form 10-Q/A that are
not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act, including
without limitation statements regarding the Company's expectations, beliefs,
intentions or strategies regarding the future. All forward-looking statements
included in this Report on Form 10-Q/A are based on information available to the
Company on the date hereof, and the Company assumes no obligation to update any
such forward-looking statements. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including, but not limited to, those set forth in
"Risk Factors" and elsewhere in this Report on Form 10-Q/A.
OVERVIEW
The Company is a leading developer and provider of network security and
management software products. The Company has historically derived a significant
majority of its revenues from the licensing of its flagship McAfee anti-virus
products and Sniffer network fault and performance management products. The
Company is currently focusing its efforts on broadening its revenue base by
providing network security and management solutions to enterprise customers,
targeting in particular the Windows NT/Intel platform. In furtherance of this
strategy, the Company recently organized its products into four product suites
- -- McAfee Total Virus Defense and PGP Total Network Security (together
comprising "Net Tools Secure") and Sniffer Total Network Visibility and McAfee
Total Service Desk (together comprising "Net Tools Manager"). These four product
suites together form an integrated solution called "Net Tools".
The following table depicts the Company's product suites:
NET TOOLS
<TABLE>
<CAPTION>
NET TOOLS SECURE NET TOOLS MANAGER
------------------------------------------------ -----------------------------------------------------------
MCAFEE TOTAL TOTAL NETWORK SNIFFER TOTAL NETWORK MCAFEE TOTAL SERVICE
VIRUS DEFENSE (TVD) SECURITY (TNS) VISIBILITY (TNV) DESK (TSD)
------------------- -------------- --------------------- --------------------
<S> <C> <C> <C>
- - VirusScan Security Suite - PGP Encryption Suite - Sniffer Portable Analysis Suite - McAfee Help Desk Suite
- - Net Shield Security Suite - Gauntlet Active Firewall Suite - Sniffer Distributed Analysis Suite - Zero Administration Client
Suite
- - Internet Security Suite - CyberCop Intrusion Protection - Sniffer Service Desk Suite - Self Service Desk Suite
Suite
</TABLE>
Net Tools Secure is designed to protect the enterprise from viruses, hackers,
thefts, lost data and threats to data security at all points of entry. McAfee
Total Virus Defense is a multi-tiered approach to virus protection covering the
client, server and Internet gateway; and PGP Total Network Security combines
security products with desktop encryption software and key management tools. Net
Tools Manager is a network management and service desk solution designed to make
computer networks more efficient and users more productive. Sniffer Total
Network Visibility is a comprehensive set of products and services for network
fault and performance management (also known as analysis and monitoring); and
McAfee Total Service Desk is designed to integrate robust help desk applications
with asset management software. The Company also provides product support,
education and consulting services.
Many of the Company's network security and management products, including its
industry-leading network security products for anti-virus protection and Sniffer
software-based fault and performance solutions for managing computer networks,
are also available as stand-alone products or as part of smaller product suites.
The Company is also a leader in electronic software distribution, which is the
principal means by which it markets its products and one of the principal ways
it distributes its software products to its customers.
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<PAGE> 22
The Company generally utilizes a two-year subscription model for licensing its
non-Sniffer products to corporate clients and is in the process of developing a
two-year subscription model for licensing its Sniffer products as well.
The Company's results of operations can fluctuate significantly on a
quarterly basis. Causes of such fluctuations may include the volume and timing
of new orders and renewals, the introduction of new products, distributor
inventory levels and return rates, Company inventory levels, product upgrades or
updates released by the Company or its competitors, changes in product prices,
the impact of competitive pricing or products, timely availability and
acceptance of new products, changes in product mix, changes in the market for
anti-virus or network management software, inclusion of network security or
management software functionality in system software, failure to manage growth
and/or potential acquisitions, seasonality, trends in the computer industry,
general economic conditions, extraordinary events such as acquisitions or
litigation and the occurrence of unexpected events. Historically, renewals have
accounted for a significant portion of the Company's net revenue, however, there
can be no assurance that the Company will be able to sustain current renewal
rates in the future. In addition, revenue generated through distribution
channels tends to be non-linear and this may cause the Company's revenue to
fluctuate in the future. The Company's results for any given period should not
be relied upon as indicative of future performance. See "Risk Factors --
Variability of Quarterly Operating Results."
The Company's future earnings and stock price may be subject to volatility in
any period. Any shortfall in various operating results, including licensing
activity, product sales, net revenue, operating income, net income or net income
per share from historical levels or expectations of securities analysts may have
significant adverse effects on the trading price of the Company's stock.
Furthermore, other factors such as acquisitions or unforeseen events in the
technology or software industry or in the Company's day to day activities can
have a material adverse effect on the Company's stock performance. See "Risk
Factors -- Volatility of Stock Price" and "Risk Factors -- Risks Associated with
Failure to Manage Growth; Potential Future Acquisitions."
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of
net revenue represented by certain items in the Company's statements of
operations for the three months and six months ended June 30, 1998 and 1997:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net revenue 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Cost of net revenue 18.3 16.8 18.5 17.5
Research and development . 13.0 15.2 13.5 14.2
Marketing and sales 27.9 31.5 32.2 30.4
General and administrative 8.2 9.6 7.0 9.5
Amortization of intangibles 4.3 0.9 3.2 0.9
Acquisition and other unusual costs 34.0 -- 17.7 6.4
----- ----- ----- -----
Total operating costs and expenses 105.7 74.0 92.1 78.9
----- ----- ----- -----
Income (loss) from operations (5.7) 26.0 7.9 21.0
Other income 1.5 3.3 2.0 2.7
----- ----- ----- -----
Income (loss) before income taxes (4.2) 29.3 9.9 23.8
Provision for income taxes . 11.1 11.7 10.9 11.7
----- ----- ----- -----
Net income (loss) (15.3)% 17.6% (1.0)% 12.0%
===== ===== ===== =====
</TABLE>
Net Revenue. Net revenue includes product revenues, revenues from software
support, maintenance contracts, education and consulting services as well as
revenues from those warranty, customer support and maintenance contracts which
are deferred and recognized over the related service period. Net revenue
increased 37% to $212.5 million in the three months ended June 30, 1998 from
$155.2 million in the three months ended June 30, 1997. For the six month period
ended June 30, 1998, net revenue increased 34% to $408.9 million from $306.1
million in the same period in 1997. The increase in net revenues is due to
increases in the licensing of anti-virus and network security software products
to new customers, renewing expiring anti-virus and network security licenses,
continued acceptance of the Company's Network Visibility and Service Desk
product suites as well as the growth of the installed customer base and the
resulting renewal of maintenance contracts.
Although the Company has had significant growth in net revenue and net income
(before acquisition and other related charges), the Company's historic growth
rate will be difficult to sustain or exceed. The Company has experienced
increased price competition for its products and the Company expects competition
to increase in the near-term, which may result in reduced average selling prices
23
<PAGE> 23
for the Company's products.* Due to these and factors such as a maturing
anti-virus market and an increasingly higher base from which to grow, the
historic revenue growth rate will be difficult to sustain or increase.* To the
extent these trends continue, the Company's results of operations could be
materially adversely affected. Renewals have historically accounted for a
significant portion of the Company's net revenue; however, there can be no
assurance that the Company will be able to sustain historic renewal rates for
its products in the future.* Risks related to the Company's change in business
strategies, including its newly introduced suite pricing model and its
development of a two- year subscription licensing model for the Company's
Sniffer products and a software only version of the Company's Sniffer products,
could also cause fluctuations in the Company's operating results and could make
comparisons with historic operating results and balances difficult.* To more
effectively service its customer's evolving needs, the Company also intends to
significantly expand and develop its worldwide professional service
organization. The Company expects that it will have lower profit margins on its
service revenues relative to licensing revenues.* See "Risk Factors --
Variability of Quarterly Operating Results," "-- Risks Related to Certain
Business Strategies" and "-- Need to Expand and Develop An Effective
Professional Services Organization; Risks * Related to Third-Party Professional
Services".
International revenue accounted for approximately 31% and 26% of net revenue
for the three months ended June 30, 1998 and 1997, respectively. For the six
month periods ended June 30, 1998 and 1997, the percentage of net revenue from
international licenses was approximately 31% and 27%, respectively. The increase
in international net revenue as a percentage of net revenue was due primarily to
increased acceptance of the Company's products in international markets and the
continued investment in international operations. The Company expects that
international revenue will continue to account for a significant percentage of
net revenue, particularly in light of the recent Dr. Solomon's acquisition. The
Company also expects that a significant portion of such international revenue
will be denominated in local currencies. To reduce the impact of foreign
currency fluctuations, the Company engages in financial risk management
activities. However, there can be no assurance that the Company's future results
of operations will not be adversely affected by such fluctuations or by costs
associated with currency risk management strategies. Other risks inherent in
international revenue generally include the impact of longer payment cycles,
greater difficulty in accounts receivable collection, unexpected changes in
regulatory requirements, seasonality due to the slowdown in European business
activity during the third quarter, tariffs and other trade barriers,
uncertainties relative to regional economic circumstances (such as the current
economic turbulence in Asia), political instability in emerging markets and
difficulties in staffing and managing foreign operations. There can be no
assurance that these factors will not have a material adverse affect on the
Company's future international license revenue. Further, in countries with a
high incidence of software piracy, the Company may experience a higher rate of
piracy of its products.* There are a number of additional risks related to the
export of the Company's PGP and TIS security products.
Cost of Revenue. Cost of revenue is comprised of cost of product revenue and
cost of services and support revenue. Cost of product revenue consists primarily
of the cost of media, manuals and packaging for products distributed through
traditional channels, royalties and, with respect to certain Sniffer products,
computer platforms and other hardware components. Cost of services and support
revenue consists principally of salaries and benefits related to employees
providing customer support and consulting and education services. Cost of
revenue increased 50% to $38.9 million in the three months ended June 30, 1998
from $26.0 million in the three months ended June 30, 1997. For the six months
ended June 30, 1998, cost of revenue increased 42% to $75.8 million from $53.5
million for the six months ended June 30, 1997. These increases are due to an
increase in net revenue (particularly product revenues) as well as the continued
investment in the professional services organization. To the extent that the
product mix fluctuates from quarter to quarter, the cost of revenue will
increase or decrease accordingly.
The Company continued to expand its professional services organization which
is expected to cause the cost of services and support revenue to increase in
absolute dollars and may cause such expenses as a percentage of net revenue to
increase. To the extent that the percentage of the Company's net revenue which
is generated through traditional distribution channels increases, the Company's
cost of net revenue will increase and, accordingly, gross margins will
decrease.* In addition, to the extent that the Company increases its reliance on
retail distribution (including through the pending CyberMedia acquisition), it
may encounter problems related to product returns and limited shelf space
availability.*
- --------
* This statement is a forward looking statement reflecting current expectations.
There can be no assurance that the Company's actual performance will meet the
Company's current expectations. See the Risk Factors on page 30 for a
discussion of certain factors that could affect future performance.
24
<PAGE> 24
Research and Development. Research and development expenses consist primarily
of salary and benefits for the Company's development and technical support
staff. Research and development expenses increased 17% to $27.6 million in the
three months ended June 30, 1998 from $23.5 million in the three months ended
June 30, 1997. For the six months ended June 30, 1998 research and development
expenses increased 26% to $55.1 million from $43.8 million in the six months
ended June 30, 1997. These increases were primarily a result of the expansion of
the Company's product development and technical support staff. As a percentage
of net revenue, research and development expenses decreased to 13.0% in the
three months ended June 30, 1998 from 15.2% in the three months ended June 30,
1997 and decreased to 13.5% in the six months ended June 30, 1998 from 14.3% in
the six months ended June 30, 1997. The Company anticipates that research and
development expenses will continue to increase in absolute dollars, but may
fluctuate as a percentage of net revenue.*
The Company believes that its ability to maintain its competitiveness will
depend in large part upon its ability to enhance existing products, 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 21% to $59.3 million in the three months ended June 30,
1998 from $48.8 million in the three months ended June 30, 1997. For the six
months ended June 30, 1998 marketing and sales expenses increased 42% to $131.8
million from $93.1 million in the six months ended June 30, 1997. This increase
was primarily the result of an increase in marketing and sales personnel and, to
a lesser extent, increased advertising and promotional activities required to
support increased sales volumes and expanding product lines. As a percentage of
net revenue, marketing and sales expense was 27.9% and 31.4% in the three month
periods ended June 30, 1998 and 1997 and 32.2% and 30.4% in the six month
periods ended June 30, 1998 and 1997. The Company is seeking to expand the
breadth and depth of its product suites. Such expansion, together with the
Company's efforts to build brand identity under its new corporate name are
expected to contribute to a further increase in marketing and sales expenses in
absolute dollars, which, may cause expenses to fluctuate as a percentage of net
revenue.
General and Administrative. General and administrative expenses consist
principally of salary and benefit costs for administrative personnel and general
operating costs. General and administrative costs decreased 17% to $17.4 million
in the three months ended June 30, 1998 from $14.9 million in the three months
ended June 30, 1997. For the six months ended June 30, 1998 general and
administrative costs decreased 1% to $28.7 million from $29.0 million in the six
months ended June 30, 1998. The decrease is a result of the consolidated
staffing both domestically and internationally. As a percentage of net revenue,
general and administrative expenses were 8.2% and 9.6% in the three months
periods ended June 30, 1998 and 1997 and 7.0% and 9.5% in the six month periods
ended June 30, 1998 and 1997. The Company intends to continue to make
investments in its finance and administrative infrastructure, and, as a result,
expects general and administrative expenses will increase in absolute dollars,
but may fluctuate as a percentage of net revenue.*
Amortization of Intangibles. The Company expensed $9.1 million and $1.5
million of amortization related to intangibles in the three months ended June
30, 1998 and 1997, respectively and $13.2 million and $2.8 million in the six
months ended June 30, 1998 and 1997, respectively. Intangibles consist of
purchased goodwill and certain technology acquired through acquisitions. The
increases are due to the acquisitions of PGP and Magic Solutions.
Acquisition and Other Related Costs
In connection with the acquisitions accounted for as a pooling of interests,
the Company incurred direct transaction costs and other restructuring and
related charges in the amount of $45.2 million in the three months ended June
30, 1998. In connection with the acquisitions accounted for as purchase
transactions, the Company incurred a charge of $27.0 million in the three months
ended June 30, 1998, consisting principally of the write off of in-process
research and development acquired. The following is a summary of these charges
for the three months ended June 30, 1998 together with charges for certain
restructuring activities taken by the Company ($ 000's):
25
<PAGE> 25
<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
Secure 500 500 1,200 -- 100 2,300
Magic -- -- -- 27,014 27,014
Restructuring Costs-Q2 -- 11,318 8,644 -- 610 20,572
-------- -------- -------- -------- -------- --------
Total Charges $ 15,523 $ 15,636 $ 14,258 $ 27,014 $ (214) $ 72,217
-------- -------- -------- -------- -------- --------
</TABLE>
Direct transaction costs included $10.5 million in investment banking fees,
$4.3 million in legal and accounting fees, and $709,000 in filing fees, travel
and other costs. Lease costs and asset writedowns include the costs of closing
approximately 18 facilities throughout the world ($6.5 million) and the disposal
of excess and obsolete assets (generally computer equipment which did not comply
with the Company's standards ($7.8 million)).
The following table summarizes the activity in the reserves for severance and
benefits, lease costs and asset write downs established in the second quarter 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 Three Months
ended June 30, 1998 $ 15,523 $ 15,636 $ 6,485 $ 7,773 $ (214) $ 45,203
Paid out or charged against
the related assets (5,254) (9,053) (596) (1,310) -- (16,213)
-------- -------- -------- -------- -------- --------
Balance, June 30, 1998 $ 10,269 $ 6,583 $ 5,889 $ 6,463 $ (214) $ 28,990
======== ======== ======== ======== ======== ========
</TABLE>
The severance and benefits charges for the three months ended June 30, 1998
related to company-wide reductions in force following the Company's acquisition
of TIS in the second quarter, of approximately 122 employees across all employee
groups. Substantially all terminated employees left the Company in the period
the related accounting charge was recorded. A limited number of employees from
each acquisition were retained for short transition periods. The cost of these
employees was charged to operating expenses during the transition period.
The lease costs represent an estimate of lease expenses during the period
prior to re-leasing the property together with losses on sub-leases, if any. The
leased facilities were substantially vacated in the period in which the related
accounting charges were recorded. The costs related to any facilities which were
used by the Company during this period were charged to operations, however, such
charges were not material. Other asset write downs comprised $2.5 million in
losses on Company owned buildings (which were written down to estimated values
determined by appraisals) and $5.3 million in net losses of computer and other
miscellaneous assets. In general, this equipment was discarded or sold for
nominal value. Due to the immediate consolidation of facilities, depreciation
allocable to these facilities and the related assets, during the transition
period, was not material. Of the facilities acquired in its 1998 acquisitions
identified for closure, the Company has 9 facilities worldwide which have not
been disposed of or subleased (8 leased, one owned). These facilities are
insignificant to the Company's operations and, other than a portion of a leased
facility which the Company has decided to retain, each is intended for disposal
or sublease in 1999.
The following table summarizes the activity in the reserves for severance and
benefits, lease costs and asset and write downs established in the year ended
December 31, 1997 ($000's):
26
<PAGE> 26
<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 (8,116) (5,738) (2,725) (3,722) (2,439) (22,740)
Adjustment to liability -- (3,000) -- 3,000 -- --
-------- -------- -------- -------- -------- --------
Balance, June 30, 1998 $ (66) $ 1,959 $ 1,117 $ 1,143 $ 454 $ 4,607
======== -------- -------- -------- ======== ========
</TABLE>
The Company believes that the reserve balances remaining at June 30,
1998 are adequate to cover any additional benefits or losses yet to be paid or
realized. Any reserves not used will be recorded as a credit to Acquisition and
other related costs in future periods.
The in-process research and development costs were approximately $27.0
million in connection with the acquisition of Magic Solutions in the three
months ended June 30, 1998. The following is a summary of the projects acquired
and the assumptions used in determining the value of the in-process research and
development costs.
Magic Solutions:
The ongoing projects at Magic Solutions at the time of the purchase comprised
an upgrade version of Support Magic 4.0, Magic Solutions current product. This
upgrade, known as Merlin Enterprise, represents new technologies with
significant enhanced functionality, including increased scalability, a 32-bit
browser-based technology, an enhanced user interface and integrated management
features. At the date the Company acquired Magic Solutions, the Company
estimated that, on average, 80% of the development effort had been completed and
that the remaining 20% of the development effort would take approximately 12
months to complete and would cost $1.8 million. The efforts required to complete
the development of these projects principally relate to additional design
efforts to integrate the technologies into the Company's suite of products,
finalization of coding, and completion of prototyping, verification, and testing
activities required to establish that products associated with the technologies
can be successfully introduced. The value of the in-process technologies was
determined by estimating the projected net cash flows related to products,
including costs to complete the development of the technologies or products, and
the future net revenues that may be earned from the products, excluding the
value attributed to integration with the Company's products or that may have
been achieved due to efficiencies resulting from the combined sales force or the
use of the Company's more effective distribution channel. In conformity with the
SEC's revised guidelines, these cash flows were discounted back to their net
present value using a discount rate of 28% (which represents a premium of
approximately 5% over the Company's average weighted cost of capital) and
excluding the value attributable to the use of the in-process technologies in
future products. If the Company does not deploy commercially accepted products
based on the acquired in-process technologies, operating results could be
adversely affected in future periods. Additionally, the failure of any
particular project would impair the value of other intangibles, particularly
goodwill, acquired from Magic Solutions.
Other Acquisitions:
In addition to the above transactions, the Company acquired Cinco Networks,
Inc. and Pretty Good Privacy, Inc. in 1997 which, in conformity with the SEC's
revised guidelines, resulted in in-process research charges of $5.2 million and
$3.9 million respectively. As of June 30, 1998, the projects related to the
acquisitions of Cinco and PGP were substantially complete.
Finally, in conformity with the SEC's revised guidelines, Acquisition and
other related costs for the nine months ended September 30, 1997 consisted of
$19.5 million and $5.2 million of acquired in-process technology in connection
with the acquisitions of 3DV and Cinco, respectively. Subsequent to the Network
General merger in December 1997, all 3DV projects were terminated.
Interest and Other Income and Expense, Net. Interest and other income and
expense decreased to $3.3 million in the three months ended June 30, 1998 from
$5.1 million in the three months ended June 30, 1997. Interest and other income
and expense was $8.4 million in the six months ended June 30, 1998 and 1997. The
decrease from quarter to quarter was primarily due to the increase of interest
expense to $4.1 million in the three months ended June 30, 1998 from zero in the
three months ended June 30, 1997, partially offset by increased interest income
from the increased funds invested. Interest expense relates to the Company's
Zero Coupon Convertible Subordinated Debentures (the "Debentures"), issued in
February 1998.
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<PAGE> 27
Provision for Income Taxes. The Company's effective tax rate was 34% and 38%
for the three months ended June 30, 1998 and 1997, respectively, and 41% and 39%
for the six months ended June 30, 1998 and 1997, respectively. The Company's
effective tax rate was 37% and 40% for the three months ended June 30, 1998 and
1997, respectively, and 36% and 37% for the six months ended June 30, 1998 and
1997, respectively, excluding the effect of one-time non-deductible in-process
research and development, merger and acquisition costs and amortization of
intangibles.
Liquidity and Capital Resources
At June 30, 1998, the Company had $101.6 million in cash and cash equivalents
and $574.2 million in marketable securities, for a combined total of $675.9
million.
Net cash used in operating activities was $10.1 million in the six months
ended June 30, 1998 and net cash provided by operating activities was $64.0
million in the six months ended June 30, 1997. Net cash used in operating
activities in the six months ended June 30, 1998, consisted primarily of net
income before acquisition costs and depreciation and amortization plus an
increase in deferred revenue which were offset primarily by an increase in
accounts receivable, prepaid and other assets and a decrease in accounts payable
and accrued liabilities. In the six months ended June 30, 1997, net cash
provided by operating activities consisted primarily of net income before
acquisition costs, plus increases in deferred revenue, accounts payable and
accrued liabilities and prepaid and other assets, offset primarily by increases
in accounts receivable and deferred taxes.
The Company expects that its accounts receivable balances as a percentage of
sales will increase in the foreseeable future due to various factors, including
its recent and pending acquisitions of companies with longer payment cycles
(particularly its acquisitions of Dr. Solomon's and CyberMedia) and its
increased emphasis on international sales, typically having longer payment
terms.* In addition, the longer payment cycles associated with licensing
enterprise-wide network security and management product suites and with
licensing products through indirect channels, such as systems integrators and
VARs, are also expected to contribute to an increase in the Company's
receivables balances.* Lastly, development of a two-year subscription license
model for the Company's Sniffer products, which as compared to product sales
typically results in lower current revenue and a corresponding increase in
deferred revenue, is expected to result in an increase in accounts receivable
balances as a percentage of sales.* To address the increased level of the
Company's accounts receivables and to improve cash flow, the Company
continuously evaluates available options, including actions to encourage earlier
payment of receivables and receivable sales.* To the extent the Company's
receivable balances increase, the Company will be subject to increased general
credit risks with respect thereto.* There can be no assurance that the Company
will be successful in mitigating the impact which such increased receivable
levels may have on its financial conditions and operating results.
Net cash used in investing activities was $444.8 million in the six months
ended June 30, 1998 consisting primarily of the purchase of marketable
securities, additions to fixed assets and the acquisition of Magic Solutions.
Net cash used in investing activities was $61.0 million in the six months ended
June 30, 1997, primarily reflecting the acquisitions of Compusul and 3DV
Technology, purchases of marketable securities and additions to fixed assets and
intangible assets.
Net cash provided by financing activities was $431.0 million in the six
months ended June 30, 1998, consisting primarily of net proceeds from the
issuance of the Debentures, and the proceeds and tax benefits associated with
the exercise of non-qualified stock options. Net cash provided by financing
activities was $21.7 million in the six months ended June 30, 1997, consisting
primarily of the proceeds and tax benefits associated with the exercise of
non-qualified stock options partially offset by the repurchase of common stock
under the Network General stock repurchase program.
The Company believes that its available cash and anticipated cash flow from
operations will be sufficient to fund the Company's working capital and capital
expenditure requirements for at least the next twelve months.
Financial Risk Management
As a result of the continued expansion of the Company's business in Europe,
the Company expects to see an increase over time in exposures related to
nonfunctional currency denominated sales in several European currencies.
Currently, the Company hedges only those currency exposures associated with
certain assets and liabilities denominated in nonfunctional currencies and does
not generally hedge anticipated foreign currency cash flows. The hedging
activity undertaken by the Company is intended to offset the impact of
28
<PAGE> 28
currency fluctuations on certain non-functional currency assets and liabilities.
The success of this activity depends upon forecasts of transaction activity
denominated in various currencies, primarily the Canadian dollar, Australian
dollar and certain European currencies. To the extent that these forecasts are
over or understated during periods of currency volatility, the Company could
experience unanticipated currency gains or losses.
Year 2000
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with such "Year 2000"
requirements. Although the Company believes that its current products and
systems are Year 2000 compliant, the Company utilizes third-party equipment and
software that may not be Year 2000 compliant and the Company may acquire
third-party equipment and software products that may not be Year 2000 compliant.
Failure of such third-party equipment or software to operate properly with
regard to the Year 2000 and thereafter could require the Company to incur
unanticipated expenses to remedy any problems, which could have a material
adverse effect on the Company's business, operating results and financial
condition. The business, operating results and financial condition of the
Company's customers could be adversely affected to the extent that they utilize
third-party software products which are not Year 2000 compliant. Furthermore,
the purchasing patterns of customers or potential customers may be affected by
Year 2000 issues as companies expend significant resources to correct their
current systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase products and services such as those offered
by the Company, which could have a material adverse effect on the Company's
business, operating results and financial condition.
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RISK FACTORS
The following risk factors should be considered in conjunction with the
information in this Report on Form 10-Q/A.
Variability of Quarterly Operating Results. The Company's results of
operations have been subject to significant fluctuations, particularly on a
quarterly basis, and the Company's future results of operations could fluctuate
significantly from quarter to quarter and from year to year. Causes of such
fluctuations may include the volume and timing of new orders and renewals,
distributor inventory levels and return rates, Company inventory levels, the
introduction of new products, product upgrades or updates by the Company or its
competitors, changes in product mix, changes in product prices and pricing
models, seasonality, trends in the computer industry, general economic
conditions (such as the recent economic turbulence in Asia), extraordinary
events such as acquisitions or litigation and the occurrence of unexpected
events. The operating results of many software companies reflect seasonal
trends, and the Company's business, financial condition and results of
operations may be affected by such trends in the future. Such trends may include
higher net revenue in the fourth quarter as many customers complete annual
budgetary cycles, and lower net revenue in the summer months when many
businesses experience lower sales, particularly in the European market.
Although the Company has experienced significant growth in net revenue and
net income (before acquisition and other related costs) in absolute terms, the
Company has experienced increased price competition for its products and the
Company expects competition to increase in the near-term, which may result in
reduced average selling prices for the Company's products. Due to these and
other factors (such as a maturing anti-virus market and an increasingly higher
base from which to grow), the Company's historic revenue growth rate will be
difficult to sustain or increase. To the extent these trends continue, the
Company's results of operations could be materially adversely affected. Renewals
have historically accounted for a significant portion of the Company's net
revenue; however, there can be no assurance that the Company will be able to
sustain historic renewal rates for its products in the future. Risks related to
the Company's recent change in business strategies could also cause fluctuations
in operating results and could make comparisons with historic operating results
and balances difficult or not meaningful. See "-- Risks Related to Certain
Business Strategies."
The timing and amount of the Company's revenues are subject to a number of
factors that make estimating operating results prior to the end of a quarter
uncertain. The Company does not expect to maintain a significant level of
backlog and, as a result, product revenues in any quarter will be dependent on
contracts entered into or orders booked and shipped in that quarter. During the
three months ended June 30, 1998 and the year ended December 31, 1997, the
Company generally experienced a trend toward higher order receipts toward the
end of the last month of a quarter, resulting in a higher percentage of revenue
shipments during the corresponding period in the prior year, which makes
predicting revenues more difficult. The timing of closing larger orders
increases the risks of quarter-to-quarter fluctuation. To the extent that the
Company is successful in licensing larger product suites under the Net Tools
umbrella (particularly to large enterprise and national accounts), the size of
its orders and the length of its sales cycle are likely to increase. If orders
forecasted for a specific customer for a particular quarter are not realized or
revenues are not otherwise recognized in that quarter, the Company's operating
results for that quarter could be materially adversely affected. See
"Potentially Longer Sales and Implementation Cycles for Certain Products."
The trading price of the Company's Common Stock has historically been subject
to wide fluctuations, with factors such as earnings announcements, acquisition
announcements and litigation developments contributing to this volatility.
Failure to achieve periodic revenue, earnings and other operating and financial
results as forecasted or anticipated by brokerage firms, industry analysts or
investors could result in an immediate and adverse effect on the market price of
the Company's Common Stock. The Company may not discover, or be able to confirm,
revenue or earnings shortfalls until the end of a quarter, which could result in
an immediate and adverse effect on the price of the Company's Common Stock.
Risk of Inclusion of Network Management and Security Functionality in
Hardware and Other Software. In the future, vendors of hardware and of operating
system software or other software (such as firewall or electronic mail software)
may continue to enhance their products or bundle separate products to include
functionality that currently is provided primarily by network security and
management software. Such enhancements may be achieved through the addition of
functionality to operating system software or other software or the bundling of
network security and management software with operating system software or other
products. For example, Cisco Systems, Inc. ("Cisco") recently incorporated a
firewall in certain of its hardware products and Microsoft introduced limited
anti-virus functionality into its MS-DOS versions in 1993. The widespread
inclusion of the functionality of the Company's products as standard features of
computer hardware or of operating system software or other software could render
the Company's
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products obsolete and unmarketable, particularly if the quality of such
functionality were comparable to that of the Company's products. Furthermore,
even if the network security and/or management functionality provided as
standard features by hardware providers or operating systems or other software
is more limited than that of the Company's products, there can be no assurance
that a significant number of customers would not elect to accept such
functionality in lieu of purchasing additional software. If the Company were
unable to develop new network security and management products to further
enhance operating systems or other software and to replace successfully any
obsolete products, the Company's business, financial condition and results of
operations would be materially adversely affected.
Risks Associated with Pending and Recent Acquisitions. In addition to risks
described under "-- Risks Associated with Acquisitions Generally," the Company
faces significant risks associated with its recent combination with Network
General and other pending and recent acquisitions (including the acquisitions of
Dr Solomon's, CyberMedia, TIS, Magic Solutions, Pretty Good Privacy, Inc.
("PGP") and Helix Software Company ("Helix")). There can be no assurance that
the Company will realize the desired benefits of these transactions. In order to
successfully integrate these companies, the Company must, among other things,
continue to attract and retain key management and other personnel; integrate,
both from an engineering and a sales and marketing perspective, the acquired
products (including Dr Solomon's anti-virus products, TIS' firewall products,
Magic Solutions' helpdesk products, Network General's Sniffer and CyberCop
products, PGP's encryption products and Helix's utilities products) into its
suite of product offerings; integrate and develop a cohesive focused direct and
indirect sales force for its product offerings; consolidate duplicate
facilities; implement standardized accounting and reporting systems and develop
name recognition for its new name. The diversion of the attention of management
from the day-to-day operations of the Company, or difficulties encountered in
the integration process, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "-- Need to Develop
Enterprise and National Accounts Sales Force and Security Products Sales Force;
Risks Related to Direct Sales Force" and "-- Use of Indirect Sales Channels;
Need to Develop Indirect Sales Channel for Sniffer and PGP Security Products."
During 1997, the Company incurred significant non-recurring charges
associated with the Network General combination and the acquisitions of PGP and
Helix. During the second quarter of 1998, the Company to incurred additional
significant non-recurring charges associated with the acquisitions of TIS and
Magic Solutions. In the third quarter of 1998, the Company expects to incur
additional significant non-recurring charges associated with the acquisitions of
Dr Solomon's and CyberMedia. There can be no assurance that the Company will not
incur additional material charges in subsequent quarters to reflect additional
costs associated with these transactions and with respect to its name change and
the marketing of its products under the "Network Associates" name.
Risks Related to Certain Business Strategies. The Company has historically
derived a significant majority of its revenues from the licensing of its
flagship anti-virus products and Sniffer products. See "-- Dependence on Revenue
from Flagship Anti-Virus and Sniffer Products." The Company is currently
focusing its efforts on broadening its revenue base by providing network
security and management solutions to enterprise customers, targeting in
particular the Windows NT/Intel platform. In furtherance of this strategy, the
Company recently organized its products into four product suites -- McAfee Total
Virus Defense, PGP Total Network Security, and Sniffer Total Network Visibility
and McAfee Total Virus Defense. These four product suites together form an
integrated solution called "Net Tools" which utilizes a new pricing model. There
can be no assurance that potential customers (including the installed customer
base of acquired companies) will respond favorably to the modified pricing
structure and the lack of a favorable response could materially adversely affect
the Company's operating results. Although the Company will continue to offer
perpetual licenses with annual support and maintenance contracts for its Sniffer
products, it is currently developing a subscription licensing model for those
products. In addition, in an effort to increase total Sniffer unit sales, the
Company intends to develop software only versions of certain of its Sniffer
products. There can be no assurance that the Company can produce a software only
Sniffer product on a timely basis or at all, that customers will not continue to
require that the Company provide the associated hardware platform and
components, that total unit licenses of Sniffer products will increase over
previous levels or that customers will react favorably to the subscription
pricing model for Sniffer products. To the extent that customers do license
Sniffer products on a two-year subscription basis or license significant amounts
of software only Sniffer products, the Company's operating results and financial
condition would likely be affected. In the case of subscription licenses, the
Company would, among other things, expect an increase in deferred revenues
related to the service portion of the two-year Sniffer license that would be
capitalized on the Company's balance sheet. In the initial year of the license,
the corresponding revenue would be lower than if the license were perpetual. In
the case of the software only Sniffer product, for any individual license, the
Company would expect lower total revenues and a higher overall gross margin
related to the transaction, as the Company would not be selling the
corresponding hardware component. Currently, the hardware component has a lower
gross margin than the total product gross margin. Furthermore, the increase in
subscription revenue as a percentage of revenue will have a negative impact on
the Company's receivable balance as a percentage of sales, due to more revenue
being deferred with no impact on the related receivables.
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The Company has been acquiring (and is continuing to investigate the
acquisition of) existing independent agents and distributors of its products in
certain strategic markets or has been converting these independent agents into
resellers who must purchase Company products from Company approved distributors.
These actions may require, among other things, that the Company provide the
technical support to customers that was previously provided by such agents and
distributors. There can be no assurance that the Company can provide such
support as effectively or on a timely basis or at all, that the Company will
operate any acquired distributor or agent as successfully as the previous
operators, that the acquisition of any distributor or agent or the conversion of
any agent into a reseller will result in the desired increased foreign revenues
or that the Company will be able to identify and retain suitable distributors in
any market in which it converts an independent agent. See "-- Risks Associated
with Acquisitions Generally" and "-- Risks Related to International Revenue and
Activities."
As part of the Net Tools concept, the Company is in the process of designing
a centralized console from which the various component suites can be operated,
administered and maintained utilizing a common look and feel. The Company faces
significant engineering challenges related to these efforts. In addition, the
Company faces significant engineering and other challenges related to the
integration of its various products (such as its recently acquired Dr Solomon's
anti-virus products, PGP encryption products, Network General CyberCop product
and TIS firewall products) into marketable product suites and the development of
a software only Sniffer product. Success of the Company's Net Tools suite
strategy will also depend, in part, upon successful development and coordination
of the Company's sales force; on successful development of a national accounts
sales force and an effective indirect sales channel for the Company's Sniffer
and PGP/TIS security products; and on the development and expansion of an
effective professional services organization. See "-- Risks Associated with
Recent Transactions," "-- Risks Associated with Acquisitions Generally," "--
Need to Develop Enterprise and National Accounts Sales Force and Security
Products Sales Force; Risks Related to Direct Sales Force," "-- Use of Indirect
Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and PGP
Security Products" and "-- Need to Expand and Develop An Effective Professional
Services Organization."
The foregoing factors, individually or in the aggregate, could materially
adversely affect the Company's operating results and could make comparison of
historic operating results and balances difficult or not meaningful.
Risks Associated with Acquisitions Generally. The software industry has
experienced and is expected to continue to experience a significant amount of
consolidation. In addition, it is expected that the Company will grow internally
and through strategic acquisitions in order, among other things, to expand the
breadth and depth of its product suites and to build its professional services
organization. The Company continually evaluates potential acquisitions of
complementary businesses, products and technologies. In addition to the
acquisitions of Dr Solomon's in August 1998, Anyware in July 1998 and TIS and
Magic Solutions in April 1998, the Company has consummated a series of
significant acquisitions since 1994, including the combination with Network
General in December 1997, the acquisitions of PGP and Helix in December 1997,
Cinco Networks, Inc. in August 1997, 3DV Technology, Inc. in March 1997, FSA
Corporation of Canada in August 1996, Vycor Corporation in February 1996, Saber
Software Corporation, Inc. in August 1995 and ProTools, Inc. in January 1994. In
addition, since 1995 the Company has acquired a number of its international
distributors, including distributors in Australia, Brazil, Finland, Japan, South
Africa and The Netherlands and is currently investigating acquisitions of
additional foreign distributors. Past acquisitions have consisted of, and future
acquisitions will likely include, acquisitions of businesses, interests in
businesses and assets of businesses. Any acquisition, depending on its size,
could result in the use of a significant portion of the Company's available cash
or, if such acquisition is made utilizing the Company's securities, could result
in significant dilution to the Company's stockholders, and could result in the
incurrence of significant acquisition related charges to earnings. Acquisitions
by the Company may result in the incurrence or the assumption of liabilities,
including liabilities that are unknown or not fully known at the time of
acquisition, which could have a material adverse effect on the Company.
Furthermore, there can be no assurance that any products acquired in connection
with any such acquisition will gain acceptance in the Company's markets or that
the Company will obtain the anticipated or desired benefits of such
transactions.
Achieving the anticipated benefits of an acquisition will depend, in part,
upon whether the integration of the acquired business, products or technology is
accomplished in an efficient and effective manner, and there can be no assurance
that this will occur. Moreover, successful acquisitions in the high technology
industry may be more difficult to accomplish than in other industries. Combining
a merged or acquired company requires, among other things, integration of
product offerings and coordination of sales and marketing and research and
development efforts. There can be no assurance that such an integration can be
accomplished smoothly or successfully. The difficulties of such integration may
be increased by the necessity of coordinating geographically separated
organizations, the complexity of the technologies being integrated, and the
necessity of integrating personnel with disparate business backgrounds and
combining two different corporate cultures. The integration of operations
following an acquisition requires
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the dedication of management resources that may distract attention from the
day-to-day business, and may disrupt key research and development, marketing or
sales efforts. The inability of management to successfully integrate any
acquisition could have a material adverse effect on the business, operating
results and financial condition of the Company. In addition, as commonly occurs,
during the pre-acquisition and integration phases of technology company
acquisitions, aggressive competitors may undertake initiatives to attract
customers and to recruit key employees through various incentives.
Rapid Technological Change; Risks Associated with Product Development. The
network security and management market is highly fragmented and is characterized
by ongoing technological developments, evolving industry standards and rapid
changes in customer requirements. The Company's success depends upon its ability
to offer a broad range of network security and management software products, to
continue to enhance existing products, to develop and introduce in a timely
manner new products that take advantage of technological advances, and to
respond promptly to new customer requirements. While the Company believes that
it offers one of the broadest product lines in the network management and
security market, this market is continuing to evolve and customer requirements
are continuing to change. As the market evolves and competitive pressures
increase, the Company believes that it will need to further expand its product
offerings. There can be no assurance that the Company will be successful in
developing and marketing, on a timely basis, enhancements to its existing
products or new products, or that such enhancements or new products will
adequately address the changing needs of the marketplace.
In addition, from time to time, the Company or its competitors may announce
new products with new or additional capabilities or technologies. Such
announcements of new products could have the potential to replace, or shorten
the life cycles of, the Company's existing products and to cause customers to
defer or cancel purchases of the Company's existing products.
The Company has in the past experienced delays in software development, and
there can be no assurance that the Company will not experience delays in
connection with its current or future product development activities. Complex
software products such as those offered by the Company may contain undetected
errors or version compatibility issues, particularly when first introduced or
when new versions are released, resulting in loss of or delay in market
acceptance. For example, the Company experienced compatibility issues in
connection with its recent NetShield upgrade, and the Company's anti-virus
software products have in the past falsely detected viruses that did not
actually exist. See "-- Risk of False Detection of Viruses." Delays and
difficulties associated with new product introductions, performance or
enhancements could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company's development efforts are impacted by the adoption or evolution
of industry standards related to its products and the environments in which they
operate. For example, no uniform industry standard has developed in the market
for encryption security products. As industry standards are adopted or evolve,
the Company may be required to modify existing products or develop and support
new versions of existing products. In addition, to the extent that no industry
standard develops, the Company's products and those of its competitors may be
incompatible if they use competing standards, which could prevent or
significantly delay overall development of the market for a particular product
or products. The failure of the Company's products to comply, or delays in
compliance, with existing or evolving industry standards could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's long-term success will depend on its ability on a timely and
cost effective basis to develop upgrades and updates to its existing product
offerings, to modify and enhance acquired products, and to introduce new
products which meet the needs of current and potential customers. Future
upgrades and updates may, among other things, include additional functionality,
respond to user problems or address issues of compatibility with changing
operating systems and environments. The Company believes that the ability to
provide these upgrades and updates to users frequently and at a low cost is a
key to success. For example, the proliferation of new and changing viruses makes
it imperative to update anti-virus products frequently in order for the products
to avoid obsolescence. Failure to release such upgrades and updates on a timely
basis could have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that the Company
will be successful in these efforts. In addition, future changes in Windows 95,
Windows NT, NetWare or other popular operating systems may result in
compatibility problems with the Company's products. Further, delays in the
introduction of future versions of operating systems or lack of market
acceptance of future versions of operating systems would result in a delay or a
reduction in the demand for the Company's future products and product versions
which are designed to operate with such future versions of operating systems.
The Company's failure to introduce in a timely manner new products that are
compatible with operating systems and environments preferred by desktop computer
users would have a material adverse effect on the Company's business, financial
condition and results of operations.
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Dependence on Revenue from Flagship Anti-Virus and Sniffer Products. In
recent years, the Company has derived a substantial majority of its net revenue
from its flagship McAfee anti-virus software products and Sniffer network fault
and performance management products. These products are expected to continue to
account for a significant portion of the Company's net revenue for the
foreseeable future. Because of this concentration of revenue, a decline in
demand for, or in the prices of, these anti-virus and network management
products as a result of competition, technological change, a change in the
Company's pricing model for such products, the inclusion of anti-virus or
network management and analysis functionality in system hardware or operating
system software or other software or otherwise, or a maturation in the
respective markets for these products could have a material adverse effect on
the Company's business, financial condition and results of operations.
Dependence on Emergence of Network Management and Network Security Markets.
The markets for the Company's network management and network security products
are evolving, and their growth depends upon broader market acceptance of network
management and network security software, including help desk software. Although
the number of LAN-attached personal computers ("PCs") has increased
dramatically, the network management and network security markets continue to be
emerging markets and there can be no assurance that such markets will continue
to develop or that further market development will be rapid enough to benefit
the Company significantly. In addition, there are a number of potential
approaches to network management and network security, including the
incorporation of management and security tools into network operating systems.
Therefore, even if network management and network security tools gain broader
market acceptance, there can be no assurance that the Company's products will be
chosen by organizations which acquire network management and network security
tools. Furthermore, to the extent that either the network management or network
security market does continue to develop, the Company expects that competition
will increase. See "-- Competition" and "-- Risk of Inclusion of Network
Security and Management Functionality in Hardware and Other Software."
Competition. The markets for the Company's products are intensely competitive
and the Company expects competition to increase in the near-term. The Company
believes that the principal competitive factors affecting the markets for its
products include performance, functionality, quality, customer support, breadth
of product line, frequency of upgrades and updates, integration of products,
manageability of products, brand name recognition, company reputation and price.
Certain of the criteria upon which the performance and quality of the Company's
anti-virus software products compete include the number and types of viruses
detected, the speed at which the products run and ease of use. Certain of the
Company's competitors have been in the network management market longer than the
Company, and other competitors, such as Symantec Corporation ("Symantec"), Intel
Corporation ("Intel"), Seagate Technology, Inc. ("Seagate") and Hewlett-Packard
Company ("HP"), are larger and have greater name recognition than the Company.
The Company will also need to develop name recognition for its new name,
"Network Associates." In addition, certain larger competitors such as Intel,
Microsoft and Novell, Inc. ("Novell") have established relationships with
hardware vendors related to their other product lines. These relationships may
provide them with a competitive advantage in penetrating the OEM market with
their network security and management products. As is the case in many segments
of the software industry, the Company has been encountering, and expects to
further encounter, increasing competition. This increased competition is due in
part to the Company's recent increased size and visibility. Increased
competition could reduce average selling prices and, therefore, profit margins.
Competitive pressures could result not only in sustained price reductions but
also in a decline in sales volume, which events would materially adversely
affect the Company's business, financial condition and results of operations. In
addition, competitive pressures may make it difficult for the Company to
maintain or exceed its growth rate.
Although there is a trend toward consolidation in the network security and
management market, the market is currently highly fragmented with products
offered by many vendors. The Company's principal competitor is the Peter Norton
Group of Symantec in the network security market and Intel's LanDesk in the
network management market. The Company's other competitors include Computer
Associates/Cheyenne Software, IBM, Seagate and Trend Micro, Inc., as well as
numerous smaller companies and shareware authors that may in the future develop
into stronger competitors or be consolidated into larger competitors. In the
encryption portion of the security market, the Company's principal competitors
are Security Dynamics Technologies, Inc., Cylink Corporation, Entrust
Technologies and VeriSign, Inc. The Company's principal competitors in the help
desk market are Remedy Corporation and Software Artistry (recently acquired by
Tivoli Systems/IBM). The Company's principal competitor in the software-based
network fault and performance management market is HP, with other competitors
including Azure Technologies Incorporated, Concord Communications, DeskTalk
Systems, Kaspia Systems, Shomiti Systems, Inc. and Wandel & Goltermann, Inc. The
Company also faces competition in the security market from Cisco, Security
Dynamics Technologies, Inc., Checkpoint Software and other vendors in the
encryption/firewall market. In addition, the Company faces competition from
large and established software companies such as Microsoft, Intel, Novell and HP
which offer network management products as enhancements to their network
operating systems. As the network management market develops, the Company may
face increased competition from these large companies, as well as other
companies seeking to enter the market. The trend toward enterprise-wide network
management and security solutions
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may result in a consolidation of the network management and security market
around a smaller number of vendors who are able to provide the necessary
software and support capabilities. In addition, to the extent that the Company
is successful in developing its Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
the Company will likely compete with large computer systems management companies
such as Tivoli Systems (TME) and Computer Associates (Unicenter). There can be
no assurance that the Company will continue to compete effectively against
existing and potential competitors, many of whom have substantially greater
financial, technical, marketing and support resources and name recognition than
the Company. In addition, there can be no assurance that software vendors who
currently use traditional distribution methods will not in the future decide to
compete more directly with the Company by utilizing electronic software
distribution.
The competitive environment for anti-virus software internationally is
similar to that in North America, although local competitors in specific foreign
markets often present stronger competition and shareware authors control a more
significant portion of the European market. The international market for network
management software has developed more slowly than the North American market,
although larger competitors such as Intel and Symantec have begun to penetrate
European markets. Asian markets have lagged significantly behind North America
and Europe in their adoption of networking technology. There can be no assurance
that the Company will be able to compete successfully in international markets.
Need to Develop Enterprise and National Accounts Sales Force and Security
Products Sales Force; Risks Related to Direct Sales Force. In connection with
its recent acquisitions and as part of its evolving strategy of offering product
suites under the Net Tools umbrella, the Company has recently reorganized its
direct sales force into three tiers. The first tier focuses on the sale of the
full product suite under the Net Tools umbrella to enterprise and national
account customers. The second tier consists of four separate sales groups
focused on the sale of the individual product suites (i.e., McAfee Total Virus
Defense; PGP Total Network Security; Sniffer Total Network Visibility; or McAfee
Total Service Desk) to the departmental level. The third tier consists of four
separate outbound corporate telesales forces who actively market the Company's
individual product suites to customers with less than 1,000 nodes. The Company
historically has not had a large enterprise or national accounts sales force and
only recently developed a direct sales group focused on these larger accounts.
In addition, the Company has not historically had a separate sales force focused
on the sale of its suite of security products (many of which were only recently
acquired and are currently being engineered into a common suite). To succeed in
the direct sales channel for the enterprise and national accounts market and for
the sale of its various product suites, (including its security product suite),
the Company will be required to build a significant direct sales organization
and will be required to attract and retain qualified personnel, which personnel
will require continuous training about, and knowledge of, product attributes for
the Company's suite of products. The need for continuous product training
results, in part, from new developments and enhancements (including those
products acquired in the Company's various acquisitions). There can be no
assurance that the Company will be successful in building the necessary sales
organization or in attracting, retaining or training these individuals.
Historically, the Company has sold its products at the departmental level. To
succeed in the enterprise and national accounts market will require, among other
things, establishing relationships and contacts with senior technology officers
at these accounts. There can be no assurance that the Company or its sales force
will be successful in these efforts.
The Company's sales organization structure may result in multiple customer
contacts by different Company sales representatives (particularly in
circumstances where the customer has multiple facilities and offices), a lack of
coordination between the Company's various sales organizations and a lack of
focus by the individual sales representatives on their designated customers or
products. The occurrence of these events could lead to customer confusion,
disputes in the sales force and lost revenue opportunities which could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, while the development of a direct sales
channel reduces the Company's dependence on resellers and distributors, it may
lead to conflicts for the same customers and further customer confusion,
pressure by current and prospective customers for price reductions on products
and, consequently, in reductions in the Company's gross margin and operating
profit.
Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for
Sniffer and PGP Security Products. The Company markets a significant portion of
its products to end-users through distributors, resellers and VARs. The
Company's distributors sell other products that are complementary to, or compete
with, those of the Company. While the Company encourages its distributors to
focus on its products through market and support programs, there can be no
assurance that these distributors will not give greater priority to products of
other suppliers, including competitors. In addition, to the extent the Company
is successful in building its professional services organization, its ability to
establish and maintain relationships with distributors, resellers and VARs who
market their services along with third party products may be adversely impacted.
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The Company does not have an extensive indirect sales channel for its Network
Sniffer products or its PGP and TIS security products. To succeed in the
indirect sales channel, the Company will be required to build a more extensive
network of distributors, resellers and VARs who will support and market these
products. These indirect channel participants will require significant training
about, and knowledge of, product attributes for these products and the related
product suites. There can be no assurance that the Company can successfully
establish such an indirect channel on a timely basis or at all or that such a
channel, once established, can be maintained.
The Company's agreements with its distributors provide for a right of return.
This right of return may be triggered by a number of events, including returns
to distributors by end users, inaccurate estimates of end user demand by
distributors, increased purchases by distributors in response to sales
incentives or transitions to new products or versions of products. As a result
of this right of return, revenue recognized by the Company upon sales to
distributors is subject to a reserve for returns. Returns could exceed reserves
as a result of distributors holding excessive Company product inventory. There
can be no assurance that current or future reserves established by the Company
will be adequate.
No customer accounted for more than 10% of net revenue during the years ended
December 31, 1997, 1996 and 1995. In the quarter ended June 30, 1998, Ingram
Micro Devices accounted for 16% of net revenue. No other customers accounted for
more than 10% of net revenue during the quarter ended June 30, 1998.
Need to Expand and Develop An Effective Professional Services Organization;
Risks Related to Third-Party Professional Services. As computer networks become
more complex and as the Company's products become more complex and are more
broadly targeted at the enterprise and at mission-critical applications,
customers will increasingly require greater professional assistance in the
design, installation, configuration, implementation and support of their
networks and acquired products. To date, the Company has relied on its limited
professional services capabilities and increasingly on outside professional
service providers (including its distributors, resellers and system
integrators). There can be no assurance that third party service providers can
or will continue to be willing to provide adequate levels (both in terms of time
and quality) of professional services. Moreover, reliance on these third parties
reduces the Company's control over the provision of support services for its
products and places a greater burden on these third parties, which, in turn,
could delay the Company's recognition of product revenue, could harm the
Company's relationships or reputation with such third parties or the end users
of its products and could result in decreased future sales of, or prices for,
its products.
To more effectively service its customer's evolving needs (including the need
for product support), the Company intends to significantly expand and develop
its worldwide professional service organization. There can be no assurance that
the Company will be successful in its efforts to expand and develop an effective
professional services organization. This will require that the Company hire and
train additional service professional who must be continually trained and
educated to ensure that they possess sufficient technical skills and product
knowledge. In particular, the market for qualified professionals is intensely
competitive, making hiring and retention difficult. The Company expects
significant competition in this market from existing providers of professional
services and future entrants. The Company must also properly price its services
to attract customers, while maintaining sufficient margins for its services. The
Company expects that it will have lower profit margins on its service revenues.
The failure to develop an effective professional services organization could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Reliance on Microsoft Technology. Although the Company intends to support
other operating systems, the Company's mission is to be the leading supplier of
network security and management products for Windows NT/Intel based networks.
Sales of the Company's products would be materially and adversely affected by
market developments which are adverse to the Windows operating environments,
including the failure of users and application developers to accept Windows NT.
In addition, the Company's ability to develop products using the Windows
operating environments is substantially dependent on its ability to gain timely
access to, and to develop expertise in, current and future developments by
Microsoft, of which there can be no assurance.
Risks Associated with Failure to Manage Growth. The Company's growth
internally and through its numerous acquisitions has placed, and any further
expansion would continue to place, a significant strain on its limited
personnel, management and other resources. In the future, the Company's ability
to manage any growth, particularly with the anticipated expansion of the
Company's international business, growth in indirect channel business and
increased focus on the enterprise and mission critical applications, will
require it to attract, train, motivate and manage new employees successfully, to
effectively integrate new employees into its operations, provide adequate levels
of product support and to continue to improve its operational, financial,
management and
36
<PAGE> 36
information systems and controls. The failure to effectively manage any further
growth could have a material adverse effect on the Company's business, financial
condition and results of operations.
Proprietary Technology and Rights; Litigation. The Company's success is
heavily dependent upon proprietary software technology. The Company relies on a
combination of contractual rights, trademarks, trade secrets and copyrights to
establish and protect proprietary rights in its software. There can be no
assurance these protections will be adequate or that competitors will not
independently develop technologies or products that are substantially equivalent
or superior to the Company's products.
Network Associates has changed its legal name to "Networks Associates, Inc."
and has begun conducting business as "Network Associates." Two companies,
(Network Associates, Inc. in Kansas ("NAI-Kansas"); and Network Associates, Inc.
in Oregon ("NAI-Oregon")) and Ronald L. Meyers ("Meyers"), a California resident
doing business as The Network Associates, have made unresolved claims (including
various trademark claims) or demands with respect to Network Associates' use of
the name Network Associates. On March 26, 1998, Network Associates commenced a
declaratory judgement action in the United States District Court, Northern
District of California against all three of the above-cited claimants. Network
Associates seeks a declaration that its use of the NETWORK ASSOCIATES title does
not violate the federal, state or common law rights of any of the defendants.
Defendants NAI-Oregon and NAI-Kansas have since been granted extensions of time
in which to respond to the Complaint; defendant Meyers has not yet been served.
NAI Kansas has moved to dismiss the claims against it for lack of personal
jurisdiction.
The Company does not typically obtain signed license agreements from its
corporate, government and institutional customers who license products directly
from it. The Company includes an electronic version of a "shrink-wrap" license
in all of its electronically distributed software and a printed license in the
box for its products distributed through traditional distribution channels in
order to protect its copyrights and trade secrets in those products. Since none
of these licenses are signed by the licensee, many authorities believe that such
licenses may not be enforceable under the laws of many states and foreign
jurisdictions. In addition, the laws of some foreign countries either do not
protect proprietary rights or offer only limited protection for those rights.
There can be no assurance that the steps taken by the Company to protect its
proprietary software technology will be adequate to deter misappropriation of
this technology. For example, the Company is aware that a substantial number of
users of its anti-virus products have not paid any registration or license fees
to the Company. Changing legal interpretations of liability for unauthorized use
of the Company's software, or lessened sensitivity by corporate, government or
institutional users to avoiding copyright infringement, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's principal assets are its intellectual property, and the Company
competes in an increasingly competitive market. There has been substantial
litigation regarding intellectual property rights of technology companies. The
Company has in the past been, and currently is, subject to litigation related to
its intellectual property. There can be no assurance that there will be no
developments arising out of such pending litigation or any other litigation to
which the Company is or may become party which could have a material adverse
effect on the Company's business, financial condition and results of operation.
See Note 8 to the Notes to the Condensed Consolidated Financial Statements.
In addition, as the Company may acquire a portion of software included in its
products from third parties, its exposure to infringement actions may increase
because it must rely upon such third parties as to the origin and ownership of
any software being acquired. Similarly, exposure to infringement claims exists
and will increase to the extent that the Company employs or hires additional
software engineers previously employed by competitors, notwithstanding measures
taken by them to prevent usage by such software engineers of intellectual
property used or developed by them while employed by a competitor. In the
future, litigation may be necessary to enforce and protect trade secrets and
other intellectual property rights owned by the Company. The Company may also be
subject to litigation to defend it against claimed infringement of the rights of
others or to determine the scope and validity of the proprietary rights of
others. Any such litigation could be costly and cause diversion of management's
attention, either of which could have a material adverse effect on the Company's
business, financial condition and results of operations. Adverse determinations
in such litigation could result in the loss of the Company's proprietary rights,
subject the Company to significant liabilities, require the Company to seek
licenses from third parties or prevent the Company from manufacturing or selling
its products, any one of which could have a material adverse effect on the
Company's business, financial condition and results of operations. Furthermore,
there can be no assurance that any necessary licenses will be available on
reasonable terms, or at all.
Risks Related to International Revenue and Activities. In 1997, 1996 and
1995, net revenue from international licenses represented approximately 28%, 24%
and 25%, respectively, of the Company's net revenue. In the quarter ended June
30, 1998, net revenue from international licenses represented approximately 31%
of the Company's net revenue. Historically, the Company has relied primarily
37
<PAGE> 37
upon independent agents and distributors to market its products internationally.
The Company expects that international revenues will continue to account for a
significant percentage of net revenue, with that percentage increasing as a
result of the recent Dr Solomon's acquisition. The Company also expects that a
significant portion of such international revenue will be denominated in local
currencies. To reduce the impact of foreign currency fluctuations, the Company
has engaged in various financial risk management activities. However, there can
be no assurance that the Company's future results of operations will not be
adversely affected by such fluctuations or by costs associated with financial
risk management strategies. Other risks inherent in international revenue
generally include the impact of longer payment cycles, greater difficulty in
accounts receivable collection, unexpected changes in regulatory requirements,
seasonality due to the slowdown in European business activity during the third
quarter, tariffs and other trade barriers, uncertainties relative to regional
economic circumstances (such as the current economic turbulence in Asia),
political instability in emerging markets and difficulties in staffing and
managing foreign operations. There can be no assurance that these factors will
not have a material adverse effect on the Company's future international license
revenue. Further, in countries with a high incidence of software piracy, the
Company may experience a higher rate of piracy of its products. There are a
number of additional risks related to the export of the Company's encryption
products. See "-- Risks Relating to Cryptography Technology."
In addition, a portion of the Company's international revenue is expected to
continue to be generated through independent agents. Since these agents will not
be employees of the Company and will not be required to offer the Company's
products exclusively, there can be no assurance that they will continue to
market the Company's products. Also, the Company is likely to have limited
control over its agents, limited access to the names of the customers to whom
the agents sell its products and limited knowledge of the information provided
by, or representations made by, these agents to its customers.
Risk of Sabotage. Given the Company's high profile in the security software
market, the Company has been a target of computer "hackers" who have, among
other things, created viruses to sabotage its products or otherwise attack the
Company's products. While to date these efforts have been discovered quickly and
their adverse impact has been limited, there can be no assurance that similar
viruses or efforts will not be created or replicated in the future, that they
will not cause damage to users' computer systems and that demand for the
Company's software products will not suffer as a result. In addition, since the
Company does not control diskette duplication by distributors or its independent
agents, there can be no assurance that diskettes containing the Company's
software will not be infected with viruses.
Risk of False Detection of Viruses and of Actual or Perceived Security
Breaches. The Company's anti-virus software products have in the past and may at
times in the future falsely detect viruses that do not actually exist. Such
"false alarms," while typical in the industry, may impair the perceived
reliability of the Company's products and may therefore adversely impact market
acceptance of the Company's products. In addition, the Company has in the past
been subject to litigation claiming damages related to a false alarm, and there
can be no assurance that similar claims will not be made in the future.
Similarly, while a well-publicized actual or perceived breach of network or
computer security could trigger a heightened awareness of computer abuse
(resulting in a potential increase in demand for security products), an actual
or perceived breach of network or computer security at one of the Company's
customers, regardless of whether such breach is attributable to the Company's
products, could adversely affect the market's perception of such products.
Risks Relating to Cryptography Technology. Certain of the Company's PGP and
TIS network security products, technology and associated assistance are subject
to export restrictions administered by the U.S. Department of State and the U.S.
Department of Commerce, which permit the export of encryption products only with
the required level of export license. In addition, these U.S. export laws
prohibit the export of encryption products to a number of countries deemed
hostile by the U.S. government. U.S. export regulations regarding the export of
encryption technology require either a transactional export license or the
granting of Department of Commerce Commodity jurisdiction. As result of this
regulatory regime, foreign competitors facing less stringent controls on their
products may be able to compete more effectively than the Company in the global
market. While the Company has obtained approval from the Department of Commerce
to export to certain end users, there can be no assurance that the U.S.
government will approve pending or future export license requests. Further,
there can be no assurance that the list of products and countries for which
export approval is required, and the regulatory policies with respect thereto,
will not be revised from time to time. Failure to obtain the required licenses
or the costs of compliance could have a material adverse effect on the Company's
international revenues.
Certain of the Company's PGP and TIS network security products are dependent
on the use of public key cryptography technology, which depends in part on the
application of certain mathematical principles known as "factoring." The
security afforded by public key cryptography technology is predicated on the
assumption that the factoring of the composite of large prime numbers is
difficult. Should an easy factoring method be developed, then the security
afforded by encryption products utilizing public key
38
<PAGE> 38
cryptography technology would be reduced or eliminated. Furthermore, any
significant advance in techniques for attacking cryptographic systems could also
render some or all of the Company's existing products and services obsolete or
unmarketable. There can be no assurance that such developments will not occur.
Moreover, even if no breakthroughs in factoring or other methods of attacking
cryptographic systems are made, factoring problems can theoretically be solved
by computer systems significantly faster and more powerful than those presently
available. If such improved techniques for attacking cryptographic systems are
ever developed, it could have a material adverse effect on the Company's
business, operating results and financial condition.
Product Liability. The Company's security and network management software
products are used to protect and manage computer systems and networks that may
be critical to organizations and, as a result, the sale and support of these
products by the Company may entail the risk of product liability and related
claims. The Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims. It is possible, however, that the limitation of liability
provisions contained in these license agreements may not be effective under the
laws of certain jurisdictions, particularly in circumstances involving unsigned
licenses. A product liability claim brought against the Company could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Dependence upon Key Personnel. The success of the Company will depend to a
significant extent upon a number of key technical and management employees.
While employees are required to sign standard agreements concerning
confidentiality and ownership of inventions, Company employees are generally not
otherwise subject to employment agreements or to noncompetition covenants. The
loss of the services of any key employees could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company does not maintain life insurance policies on its key employees. The
ability of the Company to achieve its revenue and operating performance
objectives will depend in large part on its ability to attract and retain
technically qualified and highly skilled sales, consulting, technical, marketing
and management personnel. Competition for such personnel is intense and is
expected to remain so for the foreseeable future. There can be no assurance the
Company will be successful in retaining its existing key personnel and in
attracting and retaining the personnel it requires, and failure of the Company
to retain and grow its key employee population could adversely affect the
Company's business and operating results. In April, 1998, Messers. Leslie
Denend, David Carver and John Stringer resigned from their positions as
executive officers of the Company. Mr. Denend will remain a director of the
Company. Additions of new personnel and departures of existing personnel,
particularly in key positions, can be disruptive and can result in departures of
existing personnel, which could have a material adverse effect upon the
Company's business, operating results and financial condition.
Customer Purchase Decisions; Potentially Longer Sales and Implementation
Cycles for Certain Products Suites. The products offered by the Company may be
considered to be capital purchases by certain customers or prospective
customers. Capital purchases are often considered discretionary and, therefore,
are canceled or delayed if the customer experiences a downturn in its business
or prospects or as a result of economic conditions in general. Any such
cancellation or delay could adversely affect the Company's results of
operations. In addition, as the Company proceeds with its strategy of selling
product suites under the Net Tools umbrella (particularly to larger enterprise
and national accounts), its sales cycle is likely to lengthen. Such sales may
involve a lengthy education process and a significant technical evaluation and
commitment of capital and other resources and may be subject to the risk of
delays associated with customers' internal budget and other procedures for
approving large capital expenditures, deploying new technologies within their
networks and testing and accepting new technologies that affect key operations.
Because of the potentially lengthy sales cycle and the potentially large size of
such orders, if orders forecasted for a specific customer for a particular
quarter are not realized or revenues are not otherwise recognized in that
quarter, the Company's operating results for that quarter could be materially
adversely affected. See "--Variability of Quarterly Operating Results" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Risks of Doing Business with the U.S. Government. As a result of its recent
acquisition of TIS, the Company expects that, in the near term, a meaningful
portion of its revenues will result from existing and future research and
development contracts with agencies of the U.S. government. Network Associates
believes that the awarding to it of future government contracts will in part be
dependent upon the continued favorable reaction of government agencies to the
Company's research, development and consulting capabilities. There can be no
assurance that Network Associates will be able to procure additional government
contracts. Minimum fee awards for government contracts are usually 3% to 7% of
the contract costs, but may be as low as 1% of the contracts costs, and the
contracts are subject to cancellation for the convenience of the governmental
agencies. Although the Company has been awarded contract fees of more than 1% in
the past and there have been no terminations of its government contracts in the
past, there can be no assurance that minimum fee awards or cancellations will
not occur in the future. Reductions or delays in federal funds available for
projects the Company is performing could also have an adverse impact on its
government business. Contracts involving the U.S. government are
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<PAGE> 39
also subject to the risks of disallowance of costs upon audit, changes in
government procurement policies, the necessity to participate in competitive
bidding and, with respect to contracts involving prime contractors or
government-designated subcontractors, the inability of such parties to perform
under their contracts. Any of the foregoing events could have a material adverse
effect on the Company's financial condition or results of operations.
Year 2000 Compliance. Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, many companies'
software and computer systems may need to be upgraded or replaced in order to
comply with such "Year 2000" requirements. Although the Company believes that
its current products and systems are Year 2000 compliant, the Company utilizes
third-party equipment and software that may not be Year 2000 compliant and the
Company may acquire third-party equipment and software products that may not be
Year 2000 compliant. Failure of such third-party equipment or software to
operate properly with regard to the Year 2000 and thereafter could require the
Company to incur unanticipated expenses to remedy any problems, which could have
a material adverse effect on the Company's business, operating results and
financial condition. The business, operating results and financial condition of
the Company's customers could be adversely affected to the extent that they
utilize third-party software products which are not Year 2000 compliant.
Furthermore, the purchasing patterns of customers or potential customers may be
affected by Year 2000 issues as companies expend significant resources to
correct their current systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase products and services such as
those offered by the Company, which could have a material adverse effect on the
Company's business, operating results and financial condition.
Supplier Dependence; Third Party Manufacturing. Certain of the Company's
products contain critical components supplied by a single or a limited number of
third parties. The Company has been required to purchase and inventory certain
of the computer platforms around which it designs its network fault and
performance management products to ensure an available supply of the product for
its customers. Any significant shortage of these platforms or other components
or the failure of the third party supplier to maintain or enhance these products
could lead to cancellations of customer orders or delays in placement of orders
which could materially adversely affect the Company's results of operations. If
the Company's purchase of such components or platforms exceeds demand, the
Company could incur losses or other charges in disposing of excess inventory,
which could also materially adversely affect the Company's results of
operations.
The Company's manufacturing operations consist primarily of final assembly,
testing and quality control of materials, components, subassemblies and systems
for its Sniffer based products. The Company intends to outsource these
manufacturing operations in 1998. There can be no assurance that the Company
will be able to qualify and secure on commercially acceptable terms satisfactory
third party manufacturers on a timely basis or at all. In addition, reliance on
third party manufacturers will involve a number of risks, including the lack of
direct control over the manufacturing process, the absence or unavailability of
adequate capacity and reduced control over delivery schedules, quality control
and costs. In the event that, once initially secured, the Company's third party
manufacturers are unable or unwilling to continue to manufacture the Sniffer
based products in required volumes, on a cost effective basis, in a timely
manner or at all, the Company will have to secure additional manufacturing
capacity. Even if such additional capacity is available at commercially
acceptable terms, the qualification process could be lengthy and could create
delay in product shipments.
Possible Price Volatility of Common Stock. The trading price of the Company's
Common Stock has historically been, and is expected to be, subject to wide
fluctuations. The market price of the Common Stock may be significantly impacted
by quarterly variations in financial performance, shortfalls in revenue or
earnings from levels forecast by securities analysts, changes in estimates by
such analysts, market conditions in the computer software or hardware
industries, product introductions by the Company or its competitors,
announcements of extraordinary events such as acquisitions or litigation or
general economic conditions. Statements or changes in opinions, ratings, or
earnings estimates made by brokerage firms or industry analysts relating to the
market in which the Company does business or relating to the Company
specifically could result in an immediate and adverse effect on the market price
of the Common Stock. In addition, in recent years the stock market has
experienced extreme price and volume fluctuations. These fluctuations have had a
substantial effect on the market prices for many high technology and emerging
growth companies, often unrelated to the operating performance of the specific
companies. There can be no assurances that the market price of the Common Stock
will not decline below the levels prevailing at the time of this offering.
Securities class action lawsuits are often brought against companies following
periods of volatility in the market price of their securities. Any such
litigation against the Company could result in substantial costs and a diversion
of resources and management attention.
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<PAGE> 40
Effect of Certain Provisional Anti-Takeover Effects of Certificate of
Incorporation, Bylaws and Delaware Law. The board of directors of the Company
has the authority to issue up to 5,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, privileges and restrictions, including
voting rights, of those shares without any further vote or action by its
stockholders. The rights of the holders of Company Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of the outstanding voting stock. Further,
certain provisions of Delaware law and the Company's Certificate of
Incorporation and Bylaws, such as a classified board, could delay or make more
difficult a merger, tender offer or proxy contest involving the Company. While
such provisions are intended to enable the Company's Board to maximize
stockholder value, they may have the effect of discouraging takeovers which
could be in the best interest of certain stockholders. There is no assurance
that such provisions will not have an adverse effect on the market value of the
Company's Common Stock.
41
<PAGE> 41
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, JUNE 30, 1998
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
Information with respect to this item is incorporated by reference to Note 8
of the Notes to the Consolidated Financial Statements included herein on page 18
of this Report on Form 10-Q/A.
ITEM 2. CHANGES IN SECURITIES
On June 29, 1998, the Company acquired CSB Consulenza Software di Base S.r.l.
("CSB"). In connection therewith, the Company issued an aggregate of 9,815
shares of Company Common Stock to the shareholders of CSB. The transaction was
exempt from registration requirements of Section 5 of the Securities Act
pursuant to Section 4(2) thereof and Regulation S promulgated thereunder. The
recipients of the securities represented their intentions to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate access to
information regarding the Company. In addition, the offer and sale of such
securities by the Company occurred outside of the United States.
On May 15, 1998, the Company acquired Secure Networks, Inc. ("Secure"). In
connection therewith, the Company issued an aggregate of 567,000 shares of
Company Common Stock to the shareholders of Secure. The transaction was exempt
from registration requirements of Section 5 of the Securities Act pursuant to
Section 4(2) thereof and Regulation S promulgated thereunder. The recipients of
the securities represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate access to
information regarding the Company.
On March 30, 1998, the Company acquired (subject to right of repurchase) a
percentage interest in Nordic Lantools AB ("Nordic AB"). In connection
therewith, the Company issued an aggregate of 3,063 shares of Company Common
Stock to the shareholders of Nordic AB. The transaction was exempt from
registration requirements of Section 5 of the Securities Act pursuant to Section
4(2) thereof and Regulation S promulgated thereunder. The recipients of the
securities represented their intentions to acquire the securities for investment
only and not with a view to or for sale in connection with any distribution
thereof and appropriate legends were affixed to the share certificates issued in
such transaction. All recipients had adequate access to information regarding
the Company. In addition, the offer and sale of such securities by the Company
occurred outside of the United States.
On February 27, 1998, the Company acquired Nordic Lantools OY ("Nordic OY").
In connection therewith, the Company issued an aggregate of 27,445 shares of
Company Common Stock to the shareholders of Nordic OY. The transaction was
exempt from registration requirements of Section 5 of the Securities Act
pursuant to Section 4(2) thereof and Regulation S promulgated thereunder. The
recipients of the securities represented their intentions to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate access to
information regarding the Company. In addition, the offer and sale of such
securities by the Company occurred outside of the United States.
On February 26, 1998, the Company acquired Syscon (Proprietary) Limited
("Syscon"). In connection therewith, the Company issued an aggregate of 1,230
shares of Company Common Stock to the shareholders of Syscon. The transaction
was exempt from registration requirements of Section 5 of the Securities Act
pursuant to Section 4(2) thereof and Regulation S promulgated thereunder. The
recipients of the securities represented their intentions to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates issued in such transaction. All recipients had adequate access to
information regarding the Company. In addition, the offer and sale of such
securities by the Company occurred outside of the United States.
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<PAGE> 42
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
At the Annual Meeting of Stockholders of the Company on May 29, 1998, the
following matters were acted upon by the stockholders of the Company:
1. The election of William L. Larson as the sole Class III director of the
Company to hold office for a three-year term, until a successor is elected and
qualified:
<TABLE>
<S> <C>
Shares in Favor 62,488,800
Shares Withheld 687,514
</TABLE>
2. The approval of an amendment to the Company's 1997 Stock Incentive Plan, to
increase the number of shares of the Company's Common Stock reserved for
issuance thereunder by 3,000,000 shares (after giving effect to the Company's
recent 3-for-2 Common Stock split):
<TABLE>
<S> <C>
Shares in Favor 43,524,911
Shares Against 19,527,645
Shares Abstained 123,758
No Vote 0
</TABLE>
3. The approval of an amendment to the Company's 1994 Employee Stock Purchase
Plan (as amended on January 20, 1997), to increase the number of shares of the
Company's Common Stock reserved for issuance thereunder by 1,500,000 shares
(after giving effect to the Company's recent 3-for-2 Common Stock split):
<TABLE>
<S> <C>
Shares in Favor 61,545,112
Shares Against 1,508,856
Shares Abstained 122,346
No Vote 0
</TABLE>
4. The ratification of the appointment of PriceWaterhouseCoopers L.L.P.
(formerly Coopers & Lybrand L.L.P.) as the independent accountants of the
Company for the fiscal year ending December 31, 1998:
<TABLE>
<S> <C>
Shares in Favor 63,044,360
Shares Against 51,759
Shares Abstained 80,195
No Vote 0
</TABLE>
The number of shares of Common Stock outstanding and entitled to vote at the
Annual Meeting was 71,790,355 and 63,176,314 shares were represented in person
or by proxy. Unless otherwise noted above, share numbers provided in this Item
4. Do not reflect the effect of the Company's recent 3-for-2 Common Stock Split.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) The Company filed the following reports on Form 8-K:
In a report on Form 8-K filed with the Commission on June 16, 1998, the
Company reported the agreement as to the terms of a proposed acquisition
of Dr Solomon's Group PLC, a corporation duly organized and existing
under the laws of England and Wales. The Company filed an amended Report
on Form 8-K on July 1, 1998, which included certain exhibits in
connection with such proposed acquisition.
In a report on Form 8-K filed with the Commission on April 28, 1998, the
Company reported the closing and principal terms of the acquisition of
Trusted Information Systems, Inc., a Delaware Corporation, which
acquisition was consummated on April 28, 1998.
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In a report on Form 8-K filed with the Commission on April 3, 1998, the
Company reported the closing and the principal terms of the acquisition
of Magic Solutions International, Inc., a Delaware Corporation, which
acquisition was consummated on April 1, 1998.
(b) Exhibits. The exhibits listed in the accompanying Exhibit Index are filed
or incorporated by reference as part of this Report.
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<PAGE> 44
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, JUNE 30, 1998
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, and the
results and regulations promulgated thereunder, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly
authorized.
NETWORKS ASSOCIATES, INC.
/s/ PRABHAT K. GOYAL
----------------------------------------
Name: Prabhat K. Goyal
Title: Vice President Administration,
Chief Financial Officer and
Secretary
Date: April 15, 1999
45
<PAGE> 45
NETWORKS ASSOCIATES, INC.
FORM 10-Q/A, JUNE 30, 1998
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<S> <C> <C>
2.1 Agreement and Plan of Reorganization, dated as of October 13, 1997, among McAfee
Associates, Inc., Mystery Acquisition Corp. and Network General Corporation, as amended
by the First Amendment dated as of October 22, 1997.(1)................................
2.2 Combination Agreement dated August 16, 1996 among the Registrant, FSA Combination Corp.,
FSA Corporation and Daniel Freedman. (2)................................................
2.3 Stock Exchange Agreement dated January 13, 1996 among the Registrant, FSA Combination
Corp., Kabushiki Kaisha Jade and the shareholders of Jade. (3)..........................
2.4 Agreement and Plan of Reorganization dated December 1, 1997 between the Registrant,
Helix Software Company an DNA Acquisition Corp.(4)......................................
2.5 Agreement and Plan of Reorganization dated December 1, 1997 between the Registrant, PGP
and PG Acquisition Corp.(5).............................................................
2.6 Agreement and Plan of Reorganization dated February 22, 1998, between the Registrant,
TIS and Thor Acquisition Corp. (6)......................................................
2.7 Agreement and Plan of Reorganization by and among the Company, Magic Solutions
International, Inc., Merlin Acquisition Corp. and Igal Lichtman, Amendment Agreement by
and among the Registrant, Magic Solutions International, Inc., Merlin Acquisition Corp.,
and Igal Lichtman dated March 24, 1998. Second Amendment Agreement by and among the
Registrant, Magic Solutions International, Inc., Merlin Acquisition Corp., and Igal
Lichtman dated April 1, 1998. (7).......................................................
2.8 Stock Purchase Agreement, dated as of February 26, 1998, by and between FSA Combination
Corp., and Brenda Joyce Cook.(8)........................................................
2.9 Share Purchase Agreement, dated as of March 30, 1998, among FSA Combination Corp., and
Irina Karlsson and Jarmo Rouvinen.(8)...................................................
2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA Combination Corp., and
Secure Networks, Inc.(8)................................................................
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)..
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) ............
4.12 Registration Rights Agreement, dated July 30, 1998, by and between the Registrant and
certain stockholders of Anyware Seguridad Informatica S.A.(11) .........................
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)........................
</TABLE>
46
<PAGE> 46
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
- ----------- ------------- --------
<S> <C> <C>
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)...........
10.18* 1997 Stock Incentive Plan.(17)..........................................................
10.19* Stock Option Plan for Outside Directors (18)............................................
10.20* Change in control agreement between the Company and Dennis Cline dated April 14,
1995.(17)...............................................................................
10.21* Change in control agreement between the Company and Peter Watkins May 1, 1995.(17)......
10.22* Change in control agreement between the Company and William S. Larson dated April 14,
1995.(17)...............................................................................
10.23* Change in control agreement between the Company and Prabhat K. Goyal dated April 18,
1996.(19)...............................................................................
10.27* Change in control agreement between the Company and Zachary Nelson, dated May 12,
1998.(20)...............................................................................
27.1 Financial Data Sheet....................................................................
</TABLE>
- ----------
(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.
47
<PAGE> 47
(8) Incorporated by reference from the Registrant's Registration Statement on
Form S-3 filed with the Commission on May 26, 1998.
(9) Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended September 30, 1996, filed with the Commission on November 4,
1997.
(10)Incorporated by reference from the Registrant's Registration Statement on
Form S-3 filed with the Commission on May 6, 1998.
(11)Incorporated by reference from the Registrant's Registration Statement on
Form S-3 filed with the Commission on August 5, 1998.
(12)Incorporated by reference from the Network General Corporation's Report on
Form 10-K for the year ended March 31, 1992. Network General's filings with
the Commission were made under File Number 0-17431.
(13)Incorporated by reference from the Network General Corporation's Report on
Form 10-Q for the quarter ended December 31, 1994. Network General's filings
with the Commission were made under File Number 0-17431.
(14)Incorporated by reference from the Network General Corporation's Report on
Form 10-Q for the quarter ended June 30, 1995. Network General's filings
with the Commission were made under File Number 0-17431.
(15)Incorporated by reference from the Network General Corporation's Report on
Form 10-Q for the quarter ended June 30, 1996. Network General's filings
with the Commission were made under File Number 0-17431.
(16)Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended June 30, 1997, filed with the Commission on August 14, 1997.
(17)Incorporated by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on July 31, 1995.
(18)Incorporated by reference from the Registrant's Report on Form S-8 filed
with the Commission on December 2, 1997.
(19)Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended June 30, 1996, filed with the Commission on August 13, 1996.
(20)Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended March 31, 1998, filed with the Commission on May 15, 1998.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
48
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 101,634
<SECURITIES> 574,232
<RECEIVABLES> 181,798
<ALLOWANCES> 6,086
<INVENTORY> 0
<CURRENT-ASSETS> 779,397
<PP&E> 49,238
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,207,654
<CURRENT-LIABILITIES> 258,484
<BONDS> 0
0
0
<COMMON> 1,158
<OTHER-SE> 544,735
<TOTAL-LIABILITY-AND-EQUITY> 1,207,654
<SALES> 408,929
<TOTAL-REVENUES> 408,929
<CGS> 75,763
<TOTAL-COSTS> 75,763
<OTHER-EXPENSES> 301,097
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 40,431
<INCOME-TAX> 44,711
<INCOME-CONTINUING> (4,280)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,280)
<EPS-PRIMARY> (0.04)<F1>
<EPS-DILUTED> (0.04)
<FN>
<F1>For Purpose of this Exhibit, Primary means Basic.
</FN>
</TABLE>
