<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
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 [ ]
137,766,494 shares of the registrant's common stock, $0.01 par value, were
outstanding as of June 30, 2000.
THIS DOCUMENT CONTAINS 42 PAGES.
THE EXHIBIT INDEX IS ON PAGE 36.
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<PAGE> 2
NETWORKS ASSOCIATES, INC.
FORM 10-Q, JUNE 30, 2000
----------------
CONTENTS
<TABLE>
<CAPTION>
ITEM NUMBER PAGE
<S> <C>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Operations and
Comprehensive Income:
Three and six months ended June 30, 2000 and 1999 ....... 3
Condensed Consolidated Balance Sheets:
June 30, 2000 and December 31, 1999 ..................... 4
Condensed Consolidated Statements of Cash Flows:
Six months ended June 30, 2000 and 1999 ................. 5
Notes to Condensed Consolidated Financial Statements ....... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ......................................... 11
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS .............................................. 34
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............ 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ............................... 34
SIGNATURES ............................................................. 35
EXHIBIT INDEX .......................................................... 36
</TABLE>
2
<PAGE> 3
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- -----------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenue:
Product .................................... $ 177,902 $ (26,494) $ 344,891 $ 154,210
Services and support ....................... 55,770 51,690 103,237 116,178
--------- --------- --------- ---------
Total revenue ....................... 233,672 25,196 448,128 270,388
--------- --------- --------- ---------
Cost of revenue:
Product .................................... 29,265 13,369 53,003 40,419
Services and support ....................... 8,810 10,185 17,315 18,377
--------- --------- --------- ---------
Total cost of revenue ............... 38,075 23,554 70,318 58,796
--------- --------- --------- ---------
Gross profit ................................. 195,597 1,642 377,810 211,592
Operating expenses:
Research and development .................... 42,491 35,781 83,712 70,912
Marketing and sales ......................... 99,033 90,730 195,078 184,411
General and administrative .................. 21,635 54,238 42,119 76,008
Amortization of intangibles and stock
compensation charge ...................... 16,291 22,055 32,287 37,194
Acquisition and related charges ............. -- (8,359) -- (8,359)
--------- --------- --------- ---------
Total operating expenses ............ 179,450 194,445 353,196 360,166
--------- --------- --------- ---------
Income (loss) from operations ....... 16,147 (192,803) 24,614 (148,574)
Interest and other income and expense, net .. 5,967 1,898 10,569 3,472
--------- --------- --------- ---------
Gain on sale of investments, net ............ -- -- 40,373 --
Minority interest in consolidated
subsidiaries ............................. 1,213 -- 2,336 --
Income (loss) before provision for income
taxes .................................... 23,327 (190,905) 77,892 (145,102)
Provision for income taxes .................... 11,928 4,880 37,468 24,441
--------- --------- --------- ---------
Net income (loss) ................... $ 11,399 $(195,785) $ 40,424 $(169,543)
========= ========= ========= =========
Other comprehensive income (loss):
Unrealized gain (loss) on investments, net .... $ (2,180) $ (2,122) $ 3,450 $ (3,309)
Foreign currency translation loss ............. (5,370) (766) (7,335) (7,388)
--------- --------- --------- ---------
Comprehensive income (loss) ................... $ 3,849 $(198,673) $ 36,539 $(180,240)
--------- --------- --------- ---------
Net income (loss) per share -- basic .......... $ 0.08 $ (1.41) $ 0.29 $ (1.22)
========= ========= ========= =========
Shares used in per share calculation -- basic . 138,072 138,478 138,475 138,437
========= ========= ========= =========
Net income (loss) per share -- diluted ........ $ 0.08 $ (1.41) $ 0.28 $ (1.22)
========= ========= ========= =========
Shares used in per share calculation -- diluted 142,238 138,478 143,272 138,437
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
<PAGE> 4
NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
----------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents ......................................... $ 324,163 $ 316,784
Short term marketable securities .................................. 86,726 72,135
Accounts receivable, net of allowances for doubtful
accounts of $8,312 at June 30, 2000 and $16,249 at
December 31, 1999 ................................................. 176,185 174,646
Prepaid expenses, income taxes and other current
assets ......................................................... 51,385 33,038
Deferred taxes .................................................... 74,264 79,186
----------- -----------
Total current assets ...................................... 712,723 675,789
Long term marketable securities ..................................... 390,036 397,447
Fixed assets, net ................................................... 61,719 45,392
Deferred taxes ...................................................... 111,314 93,904
Intangibles and other assets ........................................ 285,751 266,862
----------- -----------
Total assets .............................................. $ 1,561,543 $ 1,479,394
=========== ===========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................. $ 35,715 $ 13,723
Accrued liabilities ............................................... 263,769 253,062
Deferred revenue .................................................. 129,964 123,236
Long term debt, current portion ................................... -- 103
----------- -----------
Total current liabilities ................................. 429,448 390,124
Deferred taxes .................................................... 9,272 10,575
Deferred revenue, less current portion ............................ 40,989 30,005
Long term debt and other liabilities .............................. 388,278 379,267
----------- -----------
Total liabilities ......................................... 867,987 809,971
----------- -----------
Minority Interest ................................................. 12,054 9,317
----------- -----------
Common stock, $.01 par value; authorized:
300,000,000 shares; issued: 140,360,174 shares at
June 30, 2000 and 139,419,528 shares at December 31,
1999; outstanding: 137,766,494 shares at June 30, 2000
and 138,734,527 shares at December 31, 1999 ......................... 1,387 1,387
Treasury stock ...................................................... (36,620) (11,023)
Additional paid-in capital ......................................... 677,234 644,821
Cumulative other comprehensive loss - unrealized gain
(loss) on investments and foreign currency translation .............. (13,842) (9,957)
Retained earnings ................................................... 53,343 34,878
----------- -----------
Total stockholders' equity ................................ 681,502 660,106
----------- -----------
Total liabilities, minority interest, and
stockholders' equity ................................. $ 1,561,543 $ 1,479,394
----------- -----------
</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>
SIX MONTHS ENDED
JUNE 30,
--------------------------------
2000 1999
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ............................................. $ 40,424 $ (169,543)
Adjustments to reconcile net income (loss) to net cash provided
(used) from operating activities:
Depreciation and amortization ............................ 44,031 41,792
Bad debt expense ......................................... 2,702 36,533
Interest on convertible notes ............................ 8,983 8,572
Minority Interest ........................................ (2,336) --
Deferred taxes ........................................... (13,791) (15,503)
Stock compensation charges ............................... 2,925 8,175
Gain on sale of Goto.com investment ...................... (28,551) --
Gain on sale of Network Associates KK investment ......... (11,947) --
Changes in assets and liabilities:
Accounts receivable .................................... (3,974) 24,857
Prepaid expenses, taxes and other ...................... (28,139) 10,007
Accounts payable and accrued liabilities ............... 31,680 (8,576)
Deferred revenue ....................................... 17,712 (46,807)
----------- -----------
Net cash provided by (used in) operating
activities ....................................... 59,719 (110,493)
----------- -----------
Cash flows from investing activities:
Purchase of investments ..................................... (1,176,585) (882,384)
Sale of marketable securities ............................... 1,164,656 752,122
Purchase of other investments ............................... (17,650) --
Additions to fixed assets ................................... (29,466) (14,022)
Proceeds from sale of Goto.com investment ................... 36,750 --
Proceeds from sale of Network Associates KK investment ...... 11,947 --
Other ....................................................... (1,959) --
----------- -----------
Net cash used in investing activities ............... (12,307) (144,284)
----------- -----------
Cash flows from financing activities:
Repayment of notes payable .................................. (103) (170)
Issuance of common stock under stock option and
stock purchase plans ....................................... 14,768 21,212
Repurchase of common stock .................................. (62,859) --
Exercise of warrants ........................................ -- 459
Change in minority interest ................................. 1,606 --
Proceeds from sale of put options ........................... 13,890 --
----------- -----------
Net cash provided by (used in) financing
activities ........................................ (32,698) 21,501
----------- -----------
Effect of exchange rate fluctuations ........................ (7,335) (7,386)
Net increase (decrease) in cash and cash equivalents .......... 7,379 (240,662)
Cash and cash equivalents at beginning of period .............. 316,784 418,899
----------- -----------
Cash and cash equivalents at end of period .................... $ 324,163 $ 178,237
=========== ===========
Non cash investing activities:
Unrealized gain (loss) on investments ...................... 3,450 (3,309)
</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
The unaudited, consolidated, financial statements have been prepared by the
Networks Associates, Inc. (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 majority owned
subsidiaries. All intercompany accounts and transactions have been eliminated.
The Company has three reportable segments consisting of computer security and
management software ("Infrastructure"), consumer PC security and management
software on the Internet ("McAfee.com"), and managed security and availability
application services to business users on the Internet ("myCIO.com").
In the opinion of management, all adjustments, consisting only of
normal recurring adjustments considered necessary for a fair presentation, have
been included. The results of operations for the three and six month periods
ended June 30, 2000 are not necessarily indicative of the results to be expected
for the full year or for any future periods. The accompanying consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements contained in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 30, 2000. The balance sheet
at December 31, 1999 has been derived from the audited financial statements as
of and for the year ended December 31, 1999, but does not include all the
information and footnotes required by generally accepted accounting principles
for complete financial statements.
2. SEGMENT REPORTING
The Company has adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, effective for fiscal years beginning after
December 15, 1997. Through fiscal year 1999, the Company determined that it had
a single reporting segment consisting of the development, sale, and support of
computer security and management software. Since then, the Company established
two of its subsidiaries, McAfee.com and myCIO.com, as separate business
entities. As of June 30, 2000, the Company evaluated its product segments in
accordance with SFAS 131 and concluded that its reportable segments are
Infrastructure, McAfee.com, and myCIO.com.
The Infrastructure segment is organized into two product suites: Net
Tools Secure and Net Tools Manager. These product suites are marketed and sold
through a direct sales force to distributors, retailers, and end users
worldwide.
The McAfee.com segment is a one-stop destination for consumer PC
security and management needs on the Internet. The McAfee.com website provides a
suite of online products and services personalized for the user based on the
user's PC configuration, attached peripherals and resident software.
The myCIO.com segment is an infrastructure ASP targeted at business
users. myCIO.com delivers network security and availability services hosted on
its servers to businesses on the Internet.
Summarized pre-tax financial information concerning the Company's
reportable segments is provided as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Infrastructure:
Net revenue $ 219,755 $ 19,333 $ 422,916 $ 261,056
Segment income (loss) 25,879 (189,028) 66,331 (158,880)
McAfee.com:
Net revenue 11,907 5,863 22,165 9,332
Segment loss (6,752) (6,757) (13,383) (10,663)
</TABLE>
6
<PAGE> 7
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
<TABLE>
<S> <C> <C> <C> <C>
myCIO
Net revenue 2,010 -- 3,047 --
Segment loss (7,728) -- (12,524) --
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---------- ----------
<S> <C> <C>
Infrastructure:
Total Assets $1,448,141 $1,384,107
McAfee.com:
Total Assets 106,860 95,287
myCIO.com:
Total Assets 6,542 --
</TABLE>
3. STOCK OPTION REPRICING AND STOCK REPURCHASE PLAN
On April 22, 1999, the Company offered to substantially all of its
employees, excluding executive officers, the right to cancel certain outstanding
stock options and receive new options with exercise prices at the current fair
market value of the stock. Options to purchase a total of 10.3 million shares
were canceled and the same number of new options were granted at an exercise
price of $11.063, which was based on the closing price of the Company's common
stock on April 22, 1999. The new options vest at the same rate that they would
have vested under previous option plans. As a result, options to purchase
approximately 3.8 million shares at $11.063 were vested and outstanding at June
30, 2000.
In accordance with Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees," the Company incurred an initial
stock based compensation charge in connection with this repricing. This charge
was calculated based on the difference between the exercise price of the new
options and their market value on the date of acceptance by employees.
Approximately $1.4 million and $2.9 million were expensed in the three and six
months ended June 30, 2000, respectively.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25" ("Interpretation"). Among
other issues, this Interpretation clarifies (a) the definition of employee for
purposes of applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. As a result under the Interpretation, stock options repriced after
December 15, 1998 are subject to variable plan accounting treatment. As of
July 1, 2000, this guidance is effective and the Company will have to remeasure
compensation cost for outstanding repriced options each reporting period based
on changes in the market value of the underlying common stock. Depending upon
movements in the market value of the Company's common stock, this accounting
treatment may result in significant additional compensation charges in future
periods.
In May 1999, the Board of Directors authorized the Company to repurchase
up to $100 million of its common stock in the open market. In July 2000, the
Board of Directors authorized the Company to repurchase additional common stock
of up to $50 million in the open market. Through June 30, 2000, the Company
repurchased 3.1 million shares of its common stock bringing total cash outlay to
date to approximately $75.3 million. The timing and size of any future stock
repurchases are subject to market conditions, stock prices, the Company's cash
position and other cash requirements.
On February 16, 200 and May 31, 2000, Network Associates sold "European
style" put options for 2,000,000 shares of the Company's common stock as part of
its stock repurchase plan. European style put options can only be exercised on
the expiry date, which are February 16, 2001 and May 31, 2001. The strike price
for these put options are $30.00 and $24.07, respectively. The Company received
total proceeds of $13,890,000 from the sale.
7
<PAGE> 8
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 requires the Company to recognize
all derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through net income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of the
derivative are either offset against the change in fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. SFAS 133, as amended, is effective beginning in the
first fiscal quarter of 2001.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under certain
circumstances. The Company is currently evaluating the impact of SAB 101 on its
financial statements and related disclosures, but does not expect that such
impact, if any, will be material. The accounting and disclosures prescribed by
SAB 101 will be effective for our fiscal year ended December 31, 2000.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25" ("Interpretation"). The
Interpretation is intended to clarify certain problems that have arisen in
practice since the issuance of APB 25. The Interpretation provides guidance,
some of which is a significant departure from current practice. The
Interpretation generally provides for prospective application for grants or
modifications to existing stock options or awards made after June 30, 2000.
However, for certain transactions the guidance is effective after December 15,
1998 and January 12, 2000.
5. 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,
--------------------------- ---------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Numerator -- basic
Net income (loss) $ 11,399 $(195,785) $ 40,424 $(169,543)
========= ========= ========= =========
Numerator -- diluted
Net income (loss) $ 11,399 $(195,785) $ 40,424 $(169,543)
========= ========= ========= =========
Denominator -- basic
Basic weighted average common shares
outstanding 138,072 138,478 138,475 138,437
========= ========= ========= =========
Denominator -- diluted
Basic weighted average common shares
outstanding 138,072 138,478 138,475 138,437
--------- --------- --------- ---------
Effect of dilutive securities:
Common stock options 3,874 -- 4,684 --
Put options 292 -- 112 --
--------- --------- --------- ---------
Diluted weighted average shares 142,238 138,478 143,271 138,437
========= ========= ========= =========
Net income (loss) per share -- basic $ 0.08 $ (1.41) $ 0.29 $ (1.22)
========= ========= ========= =========
Net income (loss) per share -- diluted $ 0.08 $ (1.41) $ 0.28 $ (1.22)
========= ========= ========= =========
</TABLE>
8
<PAGE> 9
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
(UNAUDITED)
At June 30, 2000 and 1999, 18.5 million and 10.6 million potential
common shares, respectively, were excluded from the determination of diluted net
income per share as the effect of such shares are anti-dilutive.
6. ACQUISITIONS BY SUBSIDIARIES
In June 2000, Network Associates' subsidiary, McAfee.com, acquired
certain technology for $250,000 in cash and 165,000 shares of Class A common
stock. The acquisition was accounted for using the purchase method of accounting
and the total purchase price was approximately $4.3 million, including
transaction costs. McAfee.com analyzed the intangible assets to determine
whether any amount should be recorded as in-process research and development,
however McAfee.com determined that the acquired technologies are largely
dependent on the core technology and that new versions are released frequently
and contain incremental rather than fundamental improvements. Based on this
analysis $4.3 million was recorded as goodwill, and is being amortized on a
straight-line basis over three years. The activities of the acquired company
were insignificant.
On February 15, 2000, Network Associates' subsidiary, McAfee.com,
acquired all of the outstanding capital stock of Signal 9 Solutions Canada,
Inc., a privately held provider of personal firewall software, for approximately
$2.0 million in cash and 385,001 shares of McAfee.com Class A common stock. The
total purchase price was approximately $18.0 million, including transaction
costs. McAfee.com recorded the total purchase price as purchased technology and
goodwill, and will be amortized on a straight-line basis over three years.
7. LITIGATION
From time to time, the Company is involved in various disputes and
litigation matters that arise in the ordinary course of business. These include
disputes and lawsuits related to intellectual property, licensing, contract law,
distribution arrangements, and employee arrangement matters.
Securities Cases
In Re Network Associates, Inc. Securities Litigation. On April 7, 1999,
a putative securities class action, captioned Knisley v. Network Associates,
Inc., et al., Civil Action No. C-99-1729-SBA, was filed against Network
Associates and several of its officers in the United States District Court for
the Northern District of California. The complaint alleges violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and seeks
unspecified damages on behalf of a purported class of purchasers of common stock
between January 20, 1998 and April 6, 1999. Twenty-five similar actions
asserting virtually identical allegations have been filed by other plaintiffs.
The Court has consolidated these cases and has appointed Lead Plaintiff.
Petitions to the Ninth Circuit to appoint a different lead plaintiff have been
denied. An amended complaint was filed by the Lead Plaintiff asserting the same
claims as above. Defendants' motion to dismiss was filed on June 6, 2000. The
hearing on the motion to dismiss is set for August 16, 2000.
In Re Network Associates, Inc. Derivative Litigation. On May 12, 1999, a
purported derivative action, captioned Dow Jones Investment Club v. Network
Associates, Inc. et al., Civil Action No. CV-781854, was filed against nominal
defendant Network Associates and certain of its officers and directors in the
Superior Court of California, County of Santa Clara. The complaint alleges
violations of Sections 25402 and 1507 of the California Corporations Code,
breach of fiduciary duty, insider trading, gross negligence, and unjust
enrichment. The complaint seeks unspecified damages. Two similar derivative
actions have been filed by other plaintiffs in the Superior Court of California,
County of Santa Clara, including Leighton v. Network Associates, Inc. et al.,
Civil Action No. CV-781947, and Katz v. Network Associates, Inc., et al., Civil
Action No. CV-782194. The court ordered these three actions consolidated for
pretrial and trial proceedings and deemed the complaint filed in the Leighton
action the operative complaint. Defendants' demurrer to the operative complaint
was sustained with leave to amend. A first amended complaint was filed by the
plaintiffs. Network Associates and the individual defendants demurred to the
First Amended Complaint. Discovery is ongoing.
GAGE V. NETWORK ASSOCIATES. A similar case, captioned Gage v. Network
Associates, Inc., et al., Civil Action No. B C211552, has been filed in the
Superior Court of California, County of Los Angeles. Plaintiffs allege
violations of Sections 25400 et seq. of the California Corporations Code,
Section 17200 of the California Business and Professions Code, and breach of
fiduciary duty. The parties stipulated to transfer the action to Santa Clara
County Superior Court where it is now pending under Civil Action No. CV-785715.
The complaint was dismissed without prejudice. Gage has filed an amended
complaint asserting claims in his individual capacity, but has not yet renewed
the assertion of any derivative claims. Defendants will file a demurrer to the
amended complaint. Discovery is ongoing.
OTHER LITIGATION
TREND MICRO, INC. V. NETWORK ASSOCIATES. On May 13, 1997, Trend Micro,
Inc. ("Trend") filed suit in United States District Court for the Northern
District of California against both Network Associates and Symantec. Trend
alleges that Network Associates' "WebShield," "GroupShield," and "Gauntlet
Firewall" products infringe a Trend patent which was issued on April 22, 1997.
Trend's complaint seeks injunctive relief and unspecified money damages. On June
6, 1997, Network Associates filed its answer denying any infringement. Network
Associates also filed counterclaims against Trend alleging unfair competition,
false advertising, trade libel, and interference with prospective economic
advantage. On September 19, 1997, Symantec filed a motion to sever Trend's
action against Network Associates from its action against Symantec. Network
Associates did not oppose Symantec's motion to sever, other than to recommend a
joint hearing on patent claim interpretation. On December 19, 1997, the Court
granted
9
<PAGE> 10
NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
(UNAUDITED)
Symantec's motion to sever and adopted Network Associates' recommendation
regarding a joint hearing on patent claim interpretation. As a result of the
Court's decision, Trend's actions against Network Associates and Symantec were
to proceed separately. Symantec has since settled out of the lawsuit.
The Court held a patent claim interpretation hearing on September 1,
1998. The Court issued a ruling on claim interpretation on or about December 29,
1998. In addition, Trend filed a supplemental complaint on October 5, 1998,
adding the Gauntlet product to the products accused of infringing Trend's
patent. At a case management conference held on October 2, 1998, the Court set a
new trial date of November 8, 1999. The trial began on May 1, 2000. The parties
reached a settlement during trial which was formally executed on May 31, 2000.
The lawsuit was dismissed on July 13, 2000.
HILGRAEVE V. NETWORK ASSOCIATES. On September 15, 1997, Network
Associates was named as a defendant in a patent infringement action filed by
Hilgraeve Corporation ("Hilgraeve") in the United States District Court, Eastern
District of Michigan. Hilgraeve alleges that Network Associates' VirusScan
product infringes a Hilgraeve patent which was issued on June 7, 1994.
Hilgraeve's action seeks injunctive relief and unspecified money damages. All
discovery has been completed. The Court heard Network Associates' motions for
summary judgment of non-infringement on May 20, 1999 and granted the motion in a
written opinion dated June 10, 1999. The Court entered judgment in favor of
Network Associates on July 7, 1999. On August 2, 2000 the United States Court of
Appeal for the Federal Circuit vacated in part, affirmed in part, and remanded
the case to the District Court for further proceedings.
10
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
11
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NETWORKS ASSOCIATES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
condensed consolidated financial statements and related notes included elsewhere
in this report. The results shown herein are not necessarily indicative of the
results to be expected for the full year or any future periods.
This Report on Form 10-Q contains forward-looking statements, including
but not limited to those specifically identified as such, that involve risks and
uncertainties. The statements contained in this Report on Form 10-Q that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act, including without
limitation statements regarding our expectations, beliefs, intentions or
strategies regarding the future. All forward-looking statements included in this
Report on Form 10-Q are based on information available to us on the date hereof,
and we assume no obligation to update any such forward-looking statements. Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of a number of factors, including, but
not limited to, those set forth in "Risk Factors" and elsewhere in this Report
on Form 10-Q.
OVERVIEW
We are a leading supplier of security and availability solutions for
e-business. Our products focus on two important areas of e-business: network
security and network management. In the network security and network management
arenas, the majority of our revenue has historically been derived from our
McAfee anti-virus product line and our Sniffer network fault and performance
management product line, respectively. These two flagship product lines form the
customer base and product base from which the balance of our product line has
developed.
In recent years, we have focused our efforts on building a full line of
complementary network security and network management solutions. On the network
security side, we strengthened our anti-virus lineup by adding complementary
products in the firewall, intrusion protection, encryption, and virtual private
networking categories. On the network management side, we built upon our Sniffer
line by adding products in the help desk, asset management, network monitoring,
and network reporting categories. We continuously seek to expand our product
line. We have combined complementary products into "suites," offering customers
the ability to license multiple products at the same time. Our products are
organized into the suites described below.
In January 2000, we reorganized into four product groups based on our
product suites:
- McAfee, which primarily markets the McAfee Active Virus Defense (AVD)
product suite;
- Sniffer Technologies, which primarily markets the Sniffer Total Network
Visibility (TNV) product suite;
- PGP Security, which primarily markets the PGP Total Network Security
(TNS) product suite; and
- Magic Solutions, which primarily markets the Magic Total Support Desk
(TSD) product suite.
The four individual product suites form our single Net Tools mega-suite
and represent our infrastructure segment. The reorganization around our product
groups is designed to allow us to, among other things, react faster to
customers' changing needs and better specialize our sales force so they know our
products and their markets in greater depth. In addition, although
specialization between security (anti-virus and security product suites) and
manageability (availability and service desk product suites) previously existed,
with the reorganization we seek to better differentiate anti-virus from security
and availability from service desk.
For the three and six months ended June 30, 2000, our infrastructure
segment accounted for approximately $219.8 and $422.9 million in net revenue and
a profit of $25.9 and $66.3 million, respectively.
In addition, to our product groups, we also have two subsidiaries that
are applications service providers. McAfee.com, our publicly traded subsidiary,
is a consumer applications service provider, or ASP, and myCIO, our wholly owned
subsidiary, is a business applications service provider.
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NETWORKS ASSOCIATES, INC.
MCAFEE
McAfee sells anti-virus products to corporate customers. The McAfee
Active Virus Defense, or AVD, product suite incorporates the following products
into a multi-tier virus defense system: VirusScan for desktop protection,
NetShield for file server protection, GroupShield for groupware protection and
WebShield for Internet gateway protection. McAfee also provides tools to manage
and enforce corporate virus security policy, updates and reporting with ePolicy
Orchestrator and Anti-Virus Informant. McAfee products are backed by our
anti-virus research organization, McAfee AVERT (Anti-Virus Emergency Response
Team), which protects McAfee customers against virus attacks that have become
increasingly complex and frequent in recent years. The McAfee Active Virus
Defense product suite consists of the VirusScan, the NetShield, the Group
Shield, the E-Policy Orchestrator, the Anti-Virus Informant, the AutoUpdate, and
the Management Edition. In addition to the Active Virus Defense product suite,
McAfee's product lines also include WebShield and WebShield E-ppliance 100.
SNIFFER TECHNOLOGIES
Sniffer Technologies sells network monitoring, analysis, reporting and
capacity planning tools. The Sniffer Suite, is an integrated product that
enables enterprises and service providers to maintain the availability and
performance of their networks and applications. The Sniffer Suite consists of
the Sniffer Portable Analysis Suite, the Sniffer Distributed Analysis Suite, the
Sniffer Network Informant Suite and the Sniffer Pro for Packet over SONET.
Sniffer Technologies also offers education and consulting services.
Sniffer Technologies' products capture data, monitor network traffic and
collect key network statistics for small networks as well as optimizing network
and application performance and increasing network reliability by uncovering and
analyzing network problems and recommending solutions to such problems,
automatically and in real-time for mid-level and high-speed networks. In
addition, Sniffer Technologies' products proactively monitor and diagnose
network and application-level problems on complex, multi-segment networks from
centralized locations as well as troubleshooting high-speed telecommunications
and Internet service provider networks.
PGP SECURITY
PGP Security sells security products to corporate customers. PGP
Security's principal product suite, PGP Total Network Security (TNS) includes
firewall, intrusion protection, encryption and virtual private network (VPN)
security products. The TNS product line features Gauntlet for firewall and VPN,
CyberCop for intrusion protection and PGP for encryption and VPN. The TNS
product suite consists of the Gauntlet Firewall, the Gauntlet Active Firewall
Suite, the CyberCop Scanner, the CyberCop Monitor, the CyberCop Sting, PGP
Desktop, the PGP Policy Management Agent, the PGP VPN Client, the PGP VPN Suite
and the WebShield E-ppliance 300.
MAGIC SOLUTIONS
Magic Solutions sells help desk, network management and other service
tools. Magic Solutions' principal product suite, Magic Total Service Desk, or
Magic TSD, provides proactive network management and help desk technology in one
integrated service desk solution. The Magic TSD product suite consists of the
Magic HelpDesk, the Self ServiceDesk, the Remote Desktop and the Event
Management. In addition to the Magic TSD product suite, Magic Solution also
sells a Zero Administration Client Suite.
myCIO.COM
We launched our new wholly owned subsidiary, myCIO.com in January 2000.
myCIO.com is an infrastructure ASP targeted at business users. myCIO.com
delivers managed security services hosted on its servers to businesses via the
Internet. myCIO's services are designed to be simple and cost-effective as well
as more rapidly deployable than if the customer were to internally install
network security applications. myCIO.com's hosted services are also designed to
remove the burden and cost of managing software, while seeking to ensure
continuous protection against threats to a company's e-business infrastructure.
myCIO's services include Virus Scan ASaP, CyberCop ASaP, Firewall ASaP,
VirusScreen ASaP, and VPN ASaP.
For the three and six months ended June 30, 2000, on a segment basis,
myCIO.com accounted for approximately $2.0 and $3.0 million in net revenue and a
net loss of $7.7 and $12.5 million, respectively.
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NETWORKS ASSOCIATES, INC.
McAFEE.COM
Effective January 1, 1999, we contributed our consumer e-commerce
business to our then wholly owned subsidiary, McAfee.com. In December 1999
McAfee.com completed its initial public offering in which it sold to the public
approximately 7.2 million shares of its Class A common stock, entitled to one
vote per share. As of June 30, 2000, we owned 36,000,000 shares of the
McAfee.com Class B common stock, entitled to three votes per share and
representing approximately 82% of McAfee.com's outstanding common stock and 93%
of its total voting power.
McAfee.com is an online provider of PC security and management products
and services for consumers. Through the McAfee.com web site, consumers can
secure, repair, update and upgrade their PCs online. The McAfee.com web site
provides a suite of online products and services personalized for consumers
based on their PC configurations, software and attached peripherals, such as
scanners, printers and modems. McAfee.com began operations as one of the first
consumer applications service providers hosting PC security and management
software applications. The McAfee.com applications allow consumers to detect and
eliminate viruses on their PCs, repair their PCs from damage caused by viruses,
optimize their hard drives and update their PCs with current software patches
and upgrades. The McAfee.com home page provides access to free product and
service centers, such as the Shopping Center, and subscriber services, such as
the McAfee Clinic. Subscribers to the McAfee Clinic service can access all of
McAfee.com's online centers.
For the three and six months ended June 30, 2000, on a segment basis
McAfee.com accounted for approximately $11.9 and $22.2 million in net revenue
and a net loss of $6.8 and $13.4 million, respectively.
RESULTS OF OPERATIONS
The following table sets forth, for the period's indicated, the
percentage of net revenues represented by certain items in our statements of
operations for the three months and six months ended June 30, 2000 and 1999.
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net revenue:
Product ............................... 76.1% (105.2)% 77.0% 57.0%
Services and support .................. 23.9 205.2 23.0 43.0
----- ----- ----- -----
Total revenue ........................... 100.0 100.0 100.0 100.0
Cost of revenue:
Product ............................... 12.5 53.1 11.8 14.9
Services and support .................. 3.8 40.4 3.9 6.8
----- ----- ----- -----
Total cost of revenue ................... 16.3 93.5 15.7 21.7
Gross profit ............................ 83.7 6.5 84.3 78.3
Operating expenses:
Research and development .............. 18.2 142.0 18.7 26.2
Marketing and
sales .............................. 42.4 360.1 43.5 68.2
General and administrative ............ 9.3 215.3 9.4 28.1
Amortization of intangibles and stock
compensation charge ................ 7.0 87.5 7.3 13.8
Acquisition and other related
costs ............................. -- (33.2) -- (3.1)
----- ----- ----- -----
Total operating
expenses ........................ 76.9 771.7 78.9 133.2
----- ----- ----- -----
Income (loss) from
operations ..................... 6.8 (765.2) 5.4 (54.9)
Interest and other income and expense,
net ................................ 2.6 7.5 2.4 1.3
Gain on sale of investments, net ...... -- -- 9.0 --
Minority interest in consolidated
subsidiaries ....................... 0.5 -- 0.5 --
----- ----- ----- -----
Income (loss) before provision for
income taxes .................. 9.9 (757.7) 17.3 (53.6)
Provision for income
taxes ................................ 5.1 19.4 8.4 9.0
----- ----- ----- -----
Net income (loss) ............. 4.8% (777.1)% 8.9% (62.6)%
===== ===== ===== =====
</TABLE>
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NETWORKS ASSOCIATES, INC.
Net revenue. Net revenue was $233.7 million in the three months ended
June 30, 2000, an increase of 827.4% from $25.2 million in the three months
ended June 30, 1999. For the six months ended June 30, 2000, net revenue
increased 65.7% to $448.1 million from $270.4 million in the same period in
1999. The significant increase in revenue in the three and six months ended June
30, 1999 to June 30, 2000 primarily relates to our decision to limit distributor
orders in an effort to realign channel inventory levels as a result of Year 2000
concerns and increasing sales cycles for our products in the second quarter of
1999. The increase also reflects positive results from our reorganization into
four product groups, with four separate sales groups focused on selling their
respective product suite.
Product revenue increased to $177.9 million from $(26.5) million in the
three months ended June 30, 2000 and 1999, respectively. For the six months
ended June 30, 2000, product revenue increased 123.7 % to $344.9 million from
$154.2 million in the same period in 1999. Services and support revenue include
revenue from software support, maintenance contracts, education and consulting
services, as well as those revenue from customer support and maintenance
contracts, which are deferred and recognized over the related service period.
Service revenue increased 7.9% to $55.8 million from $51.7 million in the three
months ended June 30, 2000 and 1999, respectively. For the six months ended June
30, 2000, service revenue decreased 11.1 % to $103.2 million from $116.2 million
in the same period in 1999. The increase in product and services and support
revenue primarily relates to our decision to limit distributor orders in an
effort to realign channel inventory levels as a result of Year 2000 concerns and
increasing sales cycles for our products in the second quarter of 1999. The
increase also reflects positive results from our reorganization into four
product groups.
Our rate of growth has slowed in recent periods due to increased price
competition, a maturing anti-virus market and an increasingly higher base from
which to grow. Our growth rate and net revenue depend significantly on renewals
of existing orders as well as expanding our customer base. If our renewal rate
or our pace of new customers slows, our net revenues and operating results would
be adversely affected.*
International revenue accounted for approximately 40% and 51% of net
revenues for the three months ended June 30, 2000 and 1999, respectively. For
the six months ended June 30, 2000 and 1999, international revenue was
approximately 40% and 44%, respectively. The decrease in international revenue
was primarily due to lower overall net revenue in the second quarter of 1999,
relating to our decision to limit distributor orders in an effort to realign
channel inventory levels as a result of Year 2000 concerns and increasing sales
cycles for our products. We expect that international revenue will continue to
account for a significant percentage of net revenue.* We also expect that a
significant portion of our international revenue will be denominated in local
currencies.* To reduce the impact of foreign currency fluctuations we engage in
financial risk management activities. However, future results of income may be
adversely affected by currency fluctuations or by costs associated with currency
risk management strategies. Other risks inherent in international revenue
generally include the impact of longer payment cycles, greater difficulty in
accounts receivable collection, unexpected changes in regulatory requirements,
seasonality due to the slowdown in European business activity during the third
quarter, tariffs and other trade barriers, uncertainties relative to regional
economic circumstances, political instability in emerging markets and
difficulties in staffing and managing foreign operations. There can be no
assurance that these factors will not have a material adverse affect on our
future international revenue. In addition, there can be no assurance that the
macroeconomic issues currently being experienced in Asia will not spread to
Europe, the U.S. or Latin America, and/or not have a material adverse impact on
our revenue or revenue growth in the future. Further, in countries with a high
incidence of software piracy, we may experience a higher rate of piracy of our
products.* There are a number of additional risks related to the export outside
of the United States of our encryption and security products.
Cost of Net Revenue. Cost of net revenue increased 61.6% to $38.1
million from $23.6 million in the three months ended June 30, 2000 and 1999,
respectively. For the six months ended June 30, 2000, cost of net revenue
increased 19.6% to $70.3 million from $58.8 million in the same period in 1999.
The increase in cost of net revenue was primarily due to the increase in net
revenue.
Our cost of product revenue consists primarily of the cost of media,
manuals and packaging for products distributed through traditional channels,
royalties and with respect to certain Sniffer products, computer platforms and
other hardware components. Cost of product revenue increased 118.9% to $29.3
million from $13.4 million in the three months ended June 30, 2000 and 1999,
----------
* This statement is forward looking statement reflecting current expectations.
There can be no assurance that our actual performance will meet our current
expectations. See the risk factor on page 18 for discussion of certain factors
that could affect future performance.
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NETWORKS ASSOCIATES, INC.
respectively. For the six months ended June 30, 2000, cost of product revenue
increased 31.1% to $53.0 million from $40.4 million in the same period in 1999.
As a percentage of net revenue, cost of product revenue was 12.5% and 53.1% for
the three months ended June 30, 2000 and 1999, respectively. The increase in
cost of product revenue as a percentage of net revenue was primarily due to a
corresponding increase in product revenue for the three months ended June 30,
2000.
Cost of services and support revenue consists principally of salaries
and benefits related to employees providing customer support and consulting
services. Cost of services and support revenue decreased 13.5% to $8.8 million
from $10.2 million in the three months ended June 30, 2000 and 1999,
respectively. For the six months ended June 30, 2000, cost of net revenue
decreased 5.8% to $17.3 million from $18.4 million in the same period in 1999.
Research and Development. Research and development expense consist
primarily of salary and benefits for our development and technical support
staff. Research and development expenses were $42.5 million in the three months
ended June 30, 2000, an increase of 18.8% from $35.8 million in the three months
ended June 30, 1999. Research and development expense was $83.7 million in the
six months ended June 30, 2000, an increase of 18.1% from $70.9 million in the
six months ended June 30, 1999. As a percentage of net revenue, research and
development expense was 18.2% and 142.0% in the three months ended June 30, 2000
and June 30, 1999, respectively. As a percentage of net revenue, research and
development expense was 18.7% and 26.2% in the six months ended June 30, 2000
and 1999, respectively. The decrease was due to lower net revenue in the three
months ended June 30, 1999. For the six months ended June 30, 2000, there was an
increase in actual spending in staffing and equipment expense to support growth
in our product and service offerings. We anticipate that research and
development expenses will increase slightly in absolute dollars in Q3 2000, but
may fluctuate as a percentage of net revenue.* We believe that our ability to
maintain our competitiveness will depend in large part upon our ability to
enhance existing products and develop new products and develop and integrate
acquired products. The market for computer software is characterized by low
barriers to entry and rapid technological change, and is highly competitive with
respect to timely product introductions. The timing and amount of research and
development expenses may vary significantly based upon the number of new
products and significant upgrades under development during a given period.*
Marketing and Sales. Marketing and sales expenses consist primarily of
salary, commissions and benefits for marketing, sales and customer support
personnel and costs associated with advertising and promotions. Marketing and
sales expenses were $99.0 million in the three months ended June 30, 2000, an
increase of 9.2% from $90.7 million in the three months ended June 30, 1999.
Marketing and sales expenses were $195.1 million in the six months ended June
30, 2000, an increase of 5.8% from $184.4 million in the six months ended June
30, 1999. As a percentage of net revenue, marketing and sales expense was 42.4%
and 360.1% in the three months ended June 30, 2000 and 1999, respectively. As a
percentage of net revenue, marketing and sales expense was 43.5% and 68.2% in
the six months ended June 30, 2000 and 1999, respectively. The decrease was due
to the lower net revenue in the three months ended June 30, 1999, which was
slightly offset by an increase in actual spending in the marketing of our
products and services, hiring and training of our enterprise level sales force,
and advertising and promotions for the McAfee.com business segment. We expect
sales and marketing to increase in Q3 2000, particularly as McAfee.com continues
with its efforts to build brand recognition and its development of strategic
relationships with a variety of Internet companies, and will fluctuate as a
percentage of net revenue. *
General and Administrative. General and administrative expenses consist
principally of salary and benefit costs for administrative personnel and general
operating costs. General and administrative costs were $21.6 million in the
three months ended June 30, 2000, a decrease of 60.1% from $54.2 million in the
three months ended June 30, 1999. General and administrative costs were $42.1
million in the six months ended June 30, 2000, a decrease of 44.6% from $76.0
million in the six months ended June 30, 1999. As a percentage of net revenue,
general and administrative expense was 9.3% and 215.3% in the three months ended
June 30, 2000 and 1999. As a percentage of net revenue, general and
administrative expense was 9.4% and 28.1% in the six months ended June 30, 2000
and 1999, respectively. The decrease was primarily due to a $31.8 million charge
to cover doubtful accounts for the three months ended June 30, 1999. Excluding
this charge, general and administrative expense was $22.4 million in the three
months ended June 30, 1999, which decreased slightly in the three months ended
June 30, 2000. For the six months ended June 30, 1999, excluding this charge,
general and administrative expense was $44.2 million, which decreased slightly
in the six months ended June 30, 2000. We expect general and administrative
expense to increase in Q3 2000, but may fluctuate as a percentage of net
revenue. *
----------
* This statement is forward looking statement reflecting current expectations.
There can be no assurance that our actual performance will meet our current
expectations. See the risk factor on page 18 for discussion of certain factors
that could affect future performance.
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NETWORKS ASSOCIATES, INC.
Amortization of Intangibles and Stock Compensation Charge. We
expensed $16.3 million and $22.1 million of amortization related to intangibles
and stock compensation charge in the three months ended June 30, 2000 and 1999,
respectively. We expensed $32.3 million and $37.2 million of amortization
related to intangibles and stock compensation charge in the six months ended
June 30, 2000 and 1999, respectively. Intangibles consist of purchased goodwill
and certain technology acquired through acquisitions. Stock compensation charges
relate to our repricing of employee common stock options in April 1999. As a
result of recent changes in the manner for accounting for repriced stock option,
in addition to our historical quarterly charge of approximately $1.4 million, as
of July 1, 2000, we may incur an additional variable accounting charge related
to our repriced options. The additional charge will be determined as the amount
the intrinsic value of the variable option exceeds, if any, the intrinsic value
of the option on July 1, 2000, $20.375. As of July 1, 2000, we currently
estimate that for each $1 increase in our per share stock price above $20.375,
we will experience approximately a $4 million charge to earnings, subject to
exercises and cancellations. *
Acquisition and other related cost. In relation to our
acquisitions as of December 31, 1999, we recorded reserves consisting
principally of expenditures related to accrued lease termination costs and
adjustments to remaining accruals. As of December 31, 1999, all expenditures
related to those accruals have been completed and excess reserves were credited
to Acquisition and other related charges.
Interest and Other Income and Expense, net. Interest and other
income and expense, net, increased to $6.0 million in the three months ended
June 30, 2000 from $1.9 million in the three months ended June 30, 1999.
Interest and other income and expense, net, increased to $10.6 million in the
six months ended June 30, 2000 from $3.5 million in the six months ended June
30, 1999. The increase was primarily due to the increase in interest income,
from the sale of investments.
Gain on Sale of Investments. In the six months ended June 30,
2000, the Company recognized a total gain of $40.4 million on the sale of our
venture and strategic investments.
Minority Interest in Consolidated Subsidiaries. In the three and
six months ended June 30, 2000, minority interest from consolidated subsidiaries
was $1.2 million and $2.3 million, respectively.
Provision for Income Taxes. Our provision for income taxes was
$11.9 million and $4.9 million for the three months ended June 30, 2000 and
1999. The provision for income taxes was $37.5 million and $24.4 million for the
six months ended June 30, 2000 and 1999. The provision for income taxes
primarily relates to federal income tax on capital gains from the sale of
investments and to income taxes currently payable in foreign jurisdictions.
Liquidity and Capital Resources
At June 30, 2000, we had $324.2 million in cash and cash
equivalents and $476.8 million in marketable securities, for a combined total of
$800.9 million.
Net cash provided by operating activities was $59.7 million in
the six months ended June 30, 2000, consisted primarily of net income before
depreciation and amortization, interest expense related to the Zero Coupon
Convertible Subordinated Debentures, gain on sale of venture and strategic
investments, and deferred taxes. In addition, net cash provided by operating
activities in the six months ended June 30, 2000 consisted primarily of an
increase in accounts payable, accrued liabilities, and deferred revenue, and
offset by an increase in accounts receivable, prepaid expenses, taxes, and other
assets. Net cash used in operating activities was $110.3 million in the six
months ended June 30, 1999, consisted primarily of net loss before depreciation
and amortization and deferred taxes, plus a decrease in deferred revenue,
accounts payable, and accrued liabilities, which were partially offset by a
decrease in accounts receivable, prepaid expenses, income taxes and other
current assets.
Our accounts receivable balance as a percentage of sales may
increase due to our increased emphasis on server/enterprise based sales; a
higher percentage of indirect sales through our channel partners and expanding
international sales, both of which typically have longer payment terms. With an
increase in business through indirect channels, our receivable collection
experience has become more dependent on the longer payment cycle for VARs,
distributors and system integrators. To address this increase in accounts
receivable and to improve cash flow, we may from time to time take actions to
encourage earlier payment of receivables and sell receivables. To the extent
that our receivable balance increases, we will be subject to greater general
credit risks with respect thereto.
Net cash used in investing activities was $12.3 million in the
six months ended June 30, 2000, primarily reflecting purchases of marketable
securities, proceeds from sale of venture and strategic investments and offset
by additions in fixed assets. On our venture and strategic investments, we
obtained proceeds of $36.8 million and $11.9 million in the sale of Goto.com
shares and
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NETWORKS ASSOCIATES, INC.
the sale of less than 5% of the shares in our Japanese subsidiary, Network
Associates, KK, respectively. Net cash used in investing activities was $144.3
million in the six months ended June 30, 1999 consisting primarily of the
purchase of marketable securities and additions to fixed assets.
Net cash used in financing activities was $32.7 million in the
six months ended June 30, 2000, consisting primarily of the repurchase of our
common stock which was offset by the proceeds associated with the exercise of
non qualified stock options and sale of put options. Net cash provided by
financing activities was $21.5 million in the six months ended June 30 1999,
consisted primarily of the proceeds associated with the exercise of non
qualified stock options.
We believe that our available cash and anticipated cash flow
from operations will be sufficient to fund our working capital and capital
expenditure requirements for at least the next twelve months.*
EURO
On January 1, 1999, the "euro" was introduced. On that day, the
exchange ratios of the currencies of the eleven countries participating in the
first phase of the European Economic and Monetary Union were fixed. The euro
became a currency in its own right and the currencies of the participating
countries, while continuing to exist for a three-year transition period, are now
fixed denominations of the euro. The introduction of the euro will have
significant effects on the foreign exchange markets and bond markets and is
requiring significant changes in the operations and systems within the European
banking industry. Our information system is designed to accommodate
multi-currency environments. As a result we have the flexibility to transact
business with vendors and customers in either euro or traditional national
currency units. Financial Risk Management
Financial Risk Management.
As a result of the continued expansion of our business in
Europe, we expect to see an increase over time in exposures related to
nonfunctional currency denominated sales in several European currencies.*
Currently, we hedge only those currency exposures associated with certain assets
and liabilities denominated in nonfunctional currencies and we do not generally
hedge anticipated foreign currency cash flows. The hedging activity we have
undertaken is intended to offset the impact of currency fluctuations on certain
non-functional currency assets and liabilities. The success of this activity
depends upon forecasts of transaction activity denominated in various
currencies, primarily the US dollar, British pound, Canadian dollar, Australian
dollar, Dutch Guilder and Euro. To the extent that these forecasts are over or
understated during periods of currency volatility, we could experience
unanticipated currency gains or losses.*
----------
* This statement is forward looking statement reflecting current expectations.
There can be no assurance that our actual performance will meet our current
expectations. See the risk factor on page 18 for discussion of certain factors
that could affect future performance.
18
<PAGE> 19
RISK FACTORS
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.
OUR QUARTERLY FINANCIAL RESULTS WILL LIKELY FLUCTUATE
Our quarterly operating results have varied greatly in the past and will likely
vary greatly in the future depending upon a number of factors. Many of these
factors are beyond our control. Our revenues, gross margins and operating
results may fluctuate significantly from quarter to quarter due to, among other
things:
- volume, size and timing of new licenses and renewals of existing
licenses;
- our distributor inventory levels and product return rates;
- our inventory levels;
- introduction of new products, product upgrades or updates by us
or our competitors;
- the mix of products we sell;
- the size and timing of our non-cash stock-based charges,
including changes related to the options we repriced in April
1999;
- changes in product prices by us or our competitors;
- trends in the computer industry;
- our ability to develop, market and sell our products
particularly in light of our recent sales force reorganization;
- costs related to acquisitions of technology or businesses;
- fluctuations in McAfee.com's expenditure levels related to its
efforts to build brand awareness, and establish strategic
relationships with various Internet companies;
- fluctuations in myCIO.com's expenditure levels related to its
efforts to develop new products, adapt existing products to an
application service provider (or ASP) delivery model and build
brand awareness;
- fluctuations in our Japanese subsidiary's, NAI KK's, expenditure
levels related to its efforts to build its brand and corporate
awareness in Japan;
- our investment experience related to our strategic minority
equity investments;
- the percentage of our revenue, particularly that portion
attributable to McAfee.com and myCIO.com, that is deferred,
which may fluctuate based on the change in product mix and
pricing;
- the effectiveness of and the expenditure levels related to the
recent expansion of our European Sniffer organization;
- the effectiveness of our channel strategy and our mix of direct
and indirect revenues;
- pressure on employee wages as competition for skilled employees
increases; and
- costs related to extraordinary events including litigation and
acquisitions.
Our business is impacted by the seasonal trends and global or regional
macroeconomic trends. For example, our net revenue is typically higher in the
fourth quarter, as many customers complete annual budgetary cycles, and lower in
the summer months when many businesses experience lower sales, particularly in
the European market. Our business in Japan, Asia generally and Latin America has
been adversely impacted by the adverse economic conditions there. If these
conditions were to spread to Europe or the U.S., our business, results of
operations and financial condition would be adversely impacted.
WE FACE RISKS RELATED TO THE DIVISION OF OUR BUSINESS INTO PRODUCT GROUPS
On January 1, 2000, we divided our business into four product groups:
McAfee, which markets the McAfee Active Virus Defense (AVD) product suite;
Sniffer Technologies, which markets the Sniffer Total Network Visibility (TNV)
product suite; PGP Security, which markets the PGP Total Network Security (TNS)
product suite; and Magic Solutions, which markets the Magic Total Support Desk
(TSD) product suite. These four individual product suites form our single Net
Tools mega-suite. This reorganization, along with a related product group sales
force reorganization, is intended to allow us to react faster to customers needs
and to focus each product group's sales force on selling their respective
product suite and the individual point products contained in those product
suites. As part of this reorganization, we also reorganized our U.S.
professional services organization around our product groups. Our customers and
potential customers, sales force and professional service organization may not
respond favorably to the change and our business and future financial
performance could suffer. This reorganization may be unsuccessful due to, among
other things:
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- uncertainty and customer dissatisfaction surrounding our shift
in focus from our "Net Tools" mega-suite strategy to our product
group's strategy, including uncertainty as to our continued
level of support for the Net Tools mega-suite and continued
integration of our various product suites;
- customer confusion or irritation related to multiple sales calls
from different members of our reorganized sales force;
- a loss of potential cross selling opportunities and a lack of
lead sharing between the separate product group's sales
representatives who are generally only compensated for sales
made by them of products within their product groups;
- failure by our employees to embrace the changes, resulting in
possible declines in sales force productivity or employee
departures;
- the possibility that our centralized general and administrative
group may be unable to meet on a timely basis or at all each
product group's individualized infrastructure and support
requirements; and
- one or more of our product groups may lack sufficient qualified
professional service personnel to support its products.
WE COULD EXPERIENCE CUSTOMER AND MARKET CONFUSION DUE TO OUR MARKETING AND
ADVERTISING EFFORTS TARGETED AT THE PRODUCT GROUP OR SUBSIDIARY LEVEL, RATHER
THAN AT THE CORPORATE LEVEL, AND DUE TO SIMILARITIES IN THE NAMES USED BY OUR
PRODUCT GROUPS AND SUBSIDIARIES
Networks Associates, Inc. was formed in December 1997, by the
combination of McAfee Associates, Inc. and Network General Corporation. Since
then, we have spent a significant portion of our total marketing efforts and
advertising spending building awareness of the Network Associates name. In the
future, we plan to focus our marketing efforts and advertising spending on
building brand awareness at the product group and subsidiary level, rather than
at the Network Associates corporate level. This could create confusion in the
market place and in the investor community if people are not clear about the
relationship between Network Associates, our product groups and our McAfee.com
and myCIO.com subsidiaries, many of which have potentially confusing names and
products. For example, our online consumer anti-virus products, our retail and
corporate anti-virus products (other than those hosted online) and our corporate
hosted anti-virus products are marketed and sold, respectively, by our publicly
traded McAfee.com subsidiary, our retail division which is called McAfee Retail
and our McAfee product group and our myCIO.com subsidiary.
THE TIMING AND AMOUNT OF OUR REVENUES ARE SUBJECT TO A NUMBER OF FACTORS THAT
MAKE IT DIFFICULT TO ESTIMATE OPERATING RESULTS PRIOR TO THE END OF A QUARTER
We do not expect to maintain a significant level of backlog. As a
result, product revenues in any quarter are dependent on contracts entered into
or orders' booked and shipped in that quarter. We have generally experienced a
trend toward higher order receipt, and therefore a higher percentage of revenue
shipments, toward the end of the last month of a quarter. This trend makes
predicting revenues more difficult. The timing of closing larger orders
increases the risk of quarter-to-quarter fluctuation. If orders forecasted for a
specific customer for a particular quarter are not realized or revenues are not
otherwise recognized in that quarter, our operating results for that quarter
could be materially adversely affected.
OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE
During the six months ended June 30, 2000, our stock price ranged from a
per-share high of $36.69 to a low of $19.75. On July 28, 2000, the per share
closing price for our common stock was $18.19. Announcements, litigation
developments, and our ability to meet the expectations of brokerage firms,
industry analysts or investors with respect to our operating and financial
results may contribute to current and future stock price volatility. We may not
discover, or be able to confirm, revenue or earnings shortfalls until the end of
a quarter, which could result in an immediate drop in our stock price. In
addition, similar events with respect to McAfee.com, our publicly traded
subsidiary, and fluctuations in its stock price may also contribute to the
volatility of our stock price. In the past, following periods of volatility in
the market price of a company's securities, securities class action litigation
has often been instituted against companies with public traded securities. A
number of putative class actions were brought against our officers, directors
and us. See Note 7, Notes to the Condensed Consolidated Financial Statements.
This litigation, and any other litigation if instituted, could result in
substantial costs and a diversion of management's attention and resources.
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COMPETITORS MAY INCLUDE PRODUCTS SIMILAR TO OURS IN THEIR HARDWARE OR SOFTWARE
AND RENDER OUR PRODUCTS OBSOLETE
Vendors of hardware and of operating system software or other software
(such as firewall or e-mail software) may enhance their products or bundle
separate products to include network security and management software similar to
our products. The widespread inclusion of products that perform the same or
similar function as our products within computer hardware or other software
could render our products obsolete and unmarketable. Furthermore, even if these
incorporated products are inferior or more limited than our products, customers
may elect to accept the incorporated products rather than purchase our products.
If we are unable to develop new network security and management products to
further enhance operating systems or other software and to successfully replace
any obsolete products, our business could suffer.
WE EXPECT SIGNIFICANT STOCK BASED COMPENSATION CHARGES RELATED TO REPRICED
OPTIONS
In light of the decline in our stock price at the time and in an effort
to retain our employee base, in April 1999, we offered to reprice options held
by all employees, other than directors and executive officers. If the employee
agreed not to exercise any of the repriced options for a period of twelve
months, the exercise price of their eligible employee options with an exercise
price in excess of $11.0625 was reduced to $11.0625, the closing market price on
the NASDAQ on April 22, 1999. Option holders electing to have their options
repriced were required to acknowledge their acceptance by April 28, 1999. As a
result of the increase in price between the date on which the options were
repriced, April 22, 1999, and the date on which the employees elected to reprice
their option grants, April 28, 1999, we have and will continue to incur a
stock-based compensation charge. The total compensation charge expensed in the
three and six months ended June 30, 2000 was approximately $1.4 million and $2.9
million, respectively, and approximately $5.4 million will be expensed over the
remaining vesting period of the repriced options.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25" ("Interpretation"). The
Interpretation is intended to clarify certain problems that have arisen in
practice since the issuance of APB 25. The Interpretation provides guidance,
some of which is a significant departure from current practice. The
Interpretation generally provides for prospective application for grants or
modifications to existing stock options or awards made after June 30, 2000.
However, for certain transactions the guidance is effective after December 15,
1998 and January 12, 2000.
As of July 1, 2000, we may incur an additional variable accounting
charge related to our repriced options. The additional charge will be determined
as the amount the intrinsic value of the variable option exceeds, if any, the
option on July 1, 2000, $20,375. As of July 1, 2000 we currently estimate that
for each $1 increase in our per share stock price above $20.375, we will
experience approximately a $4 million charge to earnings, subject to exercises
and cancellations.
WE FACE RISK ASSOCIATED WITH EMPLOYEE RETENTION AND NEW EMPLOYEE ASSIMILATION
Many of our employees are located in areas and have skills in fields
where there is high worker mobility and work force turnover. The departure of a
large number of our employees or a meaningful number of key non-executive
employees could have a material adverse impact on many facets of our business,
including our ability to develop new products, upgrade existing products, sell
our products and provide adequate internal infrastructure. In addition to this
general risk, employees whose options were repriced to $11.0625 per share, as
described above, agreed to not exercise any of the repriced options for a period
of twelve months. Beginning on April 22, 2000, the end of this 12-month lock-up
period, we experienced a larger than normal level of employee departures as many
of these employees elected to terminate their employment with us and exercise
and sell some or all of their repriced vested options. In addition, we hired a
significant number of new employees in the first half of 2000. We face
challenges around assimilating these new employees including reduced levels of
productivity as these individuals are trained or otherwise adapt to our
organization.
WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE TRANSACTIONS
The software industry has experienced, and is expected to continue to
experience, a significant amount of consolidation. As part of our growth
strategy, we may buy or make investments in complementary companies, products
and technologies. Since 1995 we have completed a large number of significant
acquisitions involving both public and private companies, including:
- CyberMedia in September 1998;
- Dr Solomon's in August 1998;
- Secure Networks in May 1998;
- Magic Solutions and TIS in April 1998;
- Network General, PGP and Helix Software in December 1997;
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- Cinco Networks in August 1997 (acquired by Network General);
- Vycor Corporation in February 1996; and
- Saber Software in August 1995.
We have also completed a number of smaller acquisitions and acquired a
number of our international distributors. Recently, we began making venture and
strategic minority investments in complementary pre-public companies with
complementary products, services and technologies. During the quarter, we made
minority venture investments totaling $13.0 million. As of June 30, 2000, the
minority venture investments we continue to hold totaled $29.7 million valued at
cost. We are currently investigating acquisitions of other strategic minority
venture investments.
Our acquisitions and strategic investments involve a number of risks and
we may not realize the expected benefits of these transactions. We may lose all
or a portion of our investment, particularly in the case of our strategic
minority investments.
In 1997 and 1998, we incurred significant nonrecurring charges
associated with our previous acquisitions. Our available cash and our securities
may be used to buy or invest in companies or products, which could result in
significant acquisition-related charges to earnings and dilution to our
stockholders. Moreover, if we buy a company, we may have to incur or assume that
company's liabilities, including liabilities that are unknown at the time of
acquisition, which may result in a material adverse effect on us.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE
NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT
In connection with our previous acquisitions accounted for under the
purchase method of accounting, in future periods we will experience significant
charges related to the amortization of purchased technology and goodwill. In
addition, if we later determine that this purchased technology and goodwill is
impaired, we will be required to take a related non-recurring charge to
earnings.
WE FACE RISKS RELATED TO OUR SNIFFER STRATEGY
We recently began investing significant resources to increase the
European Sniffer sales organization in an effort to increase brand awareness in
Europe. There is no guarantee that this investment will produce the desired
results. Certain of the Sniffer products contain critical components supplied by
a limited number of third party suppliers.
OUR HARDWARE BASED PRODUCTS FACE MANUFACTURING, SUPPLY, INVENTORY, LICENSING AND
OBSOLESCENCE RISKS
Some of our Sniffer products and E-ppliance products include in addition
to our software a hardware platform as well as software licensed from other
companies. Third party manufacturers do the manufacturing of these products
under contract for us. Reliance on third party manufacturers involves a number
of risks, including the lack of control over the manufacturing process and the
potential absence or unavailability of adequate capacity. In the event that any
third party manufacturers cannot or will not continue to manufacture our
products in required volumes, on a cost effective basis, in a timely manner or
at all, we will have to secure additional manufacturing capacity. Even if such
additional capacity is available at commercially acceptable terms, the
qualification process could be lengthy and could create delay in product
shipments.
Our hardware-based products contain critical components supplied by a
single or a limited number of third parties. We have been required to purchase
certain computer platforms around which we design our network fault and
performance management products to ensure an available supply of these products
for our customers. Any significant shortage of these platforms or other
components or the failure of the third party supplier to maintain or enhance
these products could lead to cancellations of customer orders or delays in
placement of orders.
Some of our hardware based products incorporate licensed software, such
as operating system software. Our ability to successfully market these products
depends on our ability to obtain reasonably priced licenses from third party
software providers, as well as on our ability to integrate our hardware and
software with the software provided from third parties. If we are unable to
obtain software licenses from third parties or to integrate third party software
with our hardware products, our ability to market hardware based products would
suffer.
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Hardware based products may face greater obsolescence risks than
software products. If our hardware products are not easily upgradable to meet to
future market needs, they may become obsolete. In addition to lost future sales,
we could incur losses or other charges in disposing of obsolete inventory, both
of which could also materially adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR MyCIO.COM STRATEGY
In January 2000, we launched a new wholly owned subsidiary, myCIO.com.
myCIO.com is an infrastructure ASP which delivers to businesses hosted network
security and availability services via the Internet. This web-based model is a
relatively new concept and there is a risk that myCIO.com and its products may
fail to gain market acceptance.
The growth, market acceptance and ultimate profitability of myCIO.com's
online network security and availability services is highly uncertain and
subject to a number of factors, including:
- myCIO.com's ability to successfully adapt existing products or
develop new or enhanced products that operate in fast, secure
and reliable manner over the Internet;
- increased expenditures associated with the creation of a new
business, such as product development, marketing and technical
and administrative support;
- the introduction of new products by myCIO.com or myCIO.com's
third-party competitors or by our other Network Associates
product groups;
- potential unwillingness of businesses to pay for myCIO.com's
subscription based products and services and its ability to
properly price its products and services to generate the
greatest revenue opportunities;
- business reluctance to change their software purchasing behavior
in favor of services hosted on the myCIO.com or third-party
servers; and
- business concerns about whether the Internet is fast, reliable
and secure enough to deliver critical network security and
availability services effectively.
There is a risk that sales of myCIO.com's products may significantly
reduce the sales of the products offered by our product groups. These sales may
result in less overall revenue and profit for us if the prices and profit
margins of myCIO.com's products are less than the prices and profit margins of
comparable products offered by our product groups. In addition, other Network
Associates product groups and McAfee.com may introduce or develop new products
that could overlap with or compete with those offered by myCIO.com.
myCIO.com is likely to incur significant losses for the foreseeable
future. These losses will be funded by us and will impact our consolidated
financial results.
WE FACE RISKS RELATED TO OUR McAFEE.COM STRATEGY
In December 1998, we incorporated McAfee.com as our Internet destination
dedicated to updating, upgrading and managing PCs over the Internet for single
use retail, non-corporate consumers. We have entered into various inter-company
arrangements including technology, licenses, shared facilities, functions,
services and tax sharing agreements with McAfee.com. On December 2, 1999,
McAfee.com completed an initial public offering. At June 30, 2000, we owned 36.0
million shares of McAfee.com's Class B common stock, which is generally entitled
to three votes per share and converts to shares of McAfee.com Class A common
stock if sold by us to a third party. McAfee.com Class A common stock is
entitled to one vote per share. At June 30, 2000, our McAfee.com holdings
represented approximately 82% of McAfee.com's outstanding capital stock and
approximately 93% of its total voting power.
Pursuant to our cross license agreement with McAfee.com, we have
licensed all our technology to McAfee.com for use in the markets specified below
and McAfee.com has licensed its technology to us for our use outside of
McAfee.com's markets. Under our license and other agreements with McAfee.com,
among other things:
- McAfee.com has the exclusive right to use the licensed
technology for providing single-user consumer licenses for our
products and services sold over the Internet or for
Internet-based products and licensing the technology to original
equipment manufacturers for sale to individual consumers;
- we are permitted to continue to sell our consumer products
through non-online channels, such as traditional retail stores,
however McAfee.com's sales of online products and services could
significantly reduce sales of these products;
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- we may not offer a product incorporating third party technology
if those products are competitive with products offered by
McAfee.com;
- McAfee.com is required to pay us a license fee of 20% of net
revenue derived from product sales that include the licensed
technology commencing on January 1, 1999 and declining 1.625%
per quarter until the rate is 7% in the quarter beginning
January 1, 2001;
- the license agreement is perpetual and may only be terminated by
us if McAfee.com fails to cure a material breach of the license
within 30 days after we notify it of the breach, subject to
mandatory dispute resolution prior to the effectiveness of any
proposed termination;
- we are required to indemnify McAfee.com with respect to existing
litigation related to the licensed technology to which we are a
party, including the litigation described in Note 7 of the Notes
to the Condensed Consolidated Financial Statements;
- McAfee.com has agreed to provide, and we are dependent on
McAfee.com to provide continuously and successfully, the
infrastructure and technical support for our web site;
- generally, we are required to cause to be elected at least two
independent directors to the McAfee.com board of directors,
which term would exclude any serving Network Associates officer
or director; and
- if, without the prior approval of our continuing directors
(being our current directors and directors approved or not
objected to by our current directors), someone acquires 15% or
more of our outstanding capital stock or our continuing
directors cease to constitute a majority of our board (1) we are
required to vote our shares of McAfee.com common stock and
otherwise seek to cause to the McAfee.com board of directors to
consist of at least a majority of independent directors and (2)
our shares of McAfee.com Class B common stock will be entitled
to only one vote per share instead of three.
We expect that the McAfee.com business will incur significant losses for
the foreseeable future. These losses will impact our consolidated financial
results. The growth and market acceptance of McAfee.com's online PC security and
management products and services is highly uncertain and subject to a number of
factors, including:
- potential unwillingness of consumers to pay for McAfee.com's
subscription based products and services and its ability to
properly price its products and services to generate the
greatest revenue opportunities;
- consumer reluctance to change their software purchasing behavior
in favor of services hosted on the McAfee.com's servers; and
- consumer concerns about whether the Internet is fast and
reliable enough to deliver critical PC security and management
functions effectively.
McAfee.com's services are designed to protect consumer privacy by
ensuring that all PC scans are done locally at the PC, all information about the
user's PC is transmitted to it anonymously and no scanned data is stored by it.
However, consumers' misconceptions about this process could prevent McAfee.com's
ASP model from achieving market acceptance.
WE FACE RISKS RELATED TO OUR NAI KK STRATEGY
Our operations in Japan are conducted through our Japanese subsidiary,
NAI KK. Pursuant to a distribution agreement with Network Associates and a
license agreement with McAfee.com, NAI KK is generally the exclusive distributor
of our products in Japan and McAfee.com's reseller in Japan. NAI KK also is a
non-exclusive distributor of our products to Japanese customers located outside
of Japan. Currently, we own more than 95% of NAI KK's securities with the
balance being owned by strategic Japanese investors. NAI KK is considering a
potential offering of its securities in Japan. We believe that an increased
Japanese shareholder base, in combination with the previous strategic private
sale of equity, better positions NAI KK to compete in the Japanese market. NAI
KK does not intend to offer its securities in the U.S. and the offering in Japan
may not be completed in the near-term or at all. If the offering is consummated,
we may not obtain the desired benefits and our ability to influence the Japanese
market and the affairs of NAI KK and its management will be reduced, perhaps
significantly.
WE FACE RISKS RELATED TO THE ALLOCATION OF PRODUCTS, CUSTOMERS AND TERRITORIES
AMONG OUR PRODUCT GROUPS AND SUBSIDIARIES
We are continuing to focus our business around our products, our
customers and geographic territories. Our product groups are primarily products
focused selling their specific product suites. McAfee.com and myCIO.com are both
product and customer
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focused primarily selling their products and services over the Internet to
consumers and businesses, respectively. NAI KK is both geographically and
customer focused, selling Network Associates' products on a generally exclusive
basis in Japan and to large Japanese business customers outside of Japan and
acting as McAfee.com's reseller in Japan. Except as provided under our
technology licensing agreements and arrangements, we do not currently have in
place a policy to govern the pursuit or allocation of business opportunities
between our subsidiaries and product groups. These and any future internal
allocation of products, customers and territories could result in, among other
things:
- sales force conflict;
- customer confusion surrounding the entity or party with whom
they are expected to deal;
- disputes over product and research and development priorities;
- disputes over allocation of corporate resources and focus; and
- loss of management focus due to efforts spent to resolve
internal conflicts.
WE MUST ADAPT TO THE RAPIDLY CHANGING BUSINESS ENVIRONMENT BROUGHT ON BY THE
WIDESPREAD USE OF THE INTERNET
We have integrated the use of the Internet in many parts of our
business, including sales, distribution and support of our products. There are
still many uncertainties regarding many facets of the Internet, including
reliability, security, access, tax, government regulation and cost. We also run
the risk of not adapting to the latest changes in the Internet, which could
affect our business operations. If growth of the Internet does not develop at
the rapid pace we expect, our operating results could be adversely affected.
WE FACE RISKS RELATED TO OUR STRATEGY OF ACQUIRING INDEPENDENT AGENTS AND
DISTRIBUTORS
We have acquired existing independent agents and distributors of our
products in certain strategic markets. We may be required to provide customers
the same level of technical support that was previously provided by the acquired
agents and distributors. We may be unable to provide technical support or
operate any acquired distributor or agent as well as previous operators or at
all. The acquisition of any distributor or agent may not result in increased
foreign revenues.
OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISKS
ASSOCIATED WITH PRODUCT DEVELOPMENT
The network security and management market is highly fragmented and
characterized by ongoing technological developments, evolving industry standards
and rapid changes in customer requirements. Our success will depend on our
ability to:
- offer a broad range of network security and management software
products;
- continue to enhance existing products and expand product
offerings;
- develop and introduce in a timely manner new products with
technological advances;
- respond promptly to new customer requirements;
- comply with evolving industry standards without delays in
compliance;
- provide upgrades and updates to users frequently and at low
cost; and
- remain compatible with popular operating systems, such as
Windows 98, Windows 2000, Windows NT and NetWare, and develop
products that are compatible with new or otherwise emerging
operating systems.
We may not be able to successfully develop and market, on a timely
basis, enhancements to our existing products or new products. Our product
enhancements or new products may not adequately address the changing needs of
the marketplace. New products with new technological capabilities could replace
or shorten the life cycle of our products or cause our customers to defer or
cancel purchases of our products.
We may continue to experience delays in software development as we have
at times in the past. Complex software products like ours may contain undetected
errors or version compatibility problems, particularly when first released,
which could delay or cost us our market acceptance. For example, our anti-virus
software products have in the past falsely detected viruses that did not
actually exist. Difficulties and delays associated with new product
introductions, performance or enhancements could have a material adverse effect
on our business, financial condition and results of operation.
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Our product development efforts are impacted by the adoption or
evolution of industry standards. For example, no uniform industry standard has
developed in the market for encryption security products. As industry standards
are adopted or evolve, we may have to modify existing products or develop and
support new versions of existing products. In addition, if no industry standard
develops, our products and our competitors' products could be incompatible,
which could prevent or delay overall development of the market for a particular
product. If our products fail to comply with existing or evolving industry
standards in a timely fashion, our business, results of operation and financial
condition could be materially and adversely affected.
Our long-term success depends on our ability to upgrade and update
existing product offerings, modify and enhance acquired products and introduce
new products, which meet our customers' needs. Future upgrades and updates may
include additional functionality, respond to user problems or address
compatibility problems with changing operating systems and environments. We
believe that our ability to provide these upgrades and updates frequently and at
low costs is key to our success. For example, the proliferation of new and
changing viruses makes it imperative to update anti-virus products frequently to
avoid obsolescence. Failure to release upgrades and updates could have a
material adverse effect on our business, results of operations and financial
condition. We may not be successful in these efforts. In addition, future
changes in Windows 98, Windows 2000, Windows NT, NetWare or other popular
operating systems could cause compatibility problems with our products. Further,
delays in the introduction of future versions of operating systems or lack of
market acceptance of these future versions would delay or reduce demand for our
future products which were designed to operate with these future operating
systems. Our failure to introduce in a timely manner new products that are
compatible with operating systems and environments preferred by desktop computer
users would have a material adverse effect on our business, results of operation
and financial condition.
WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenues from our
flagship McAfee anti-virus software products and Sniffer network fault and
performance management products. These products are expected to continue to
account for a significant portion of our net revenues for the foreseeable
future. Because of this concentration of revenue, a decline in demand for or in
the prices of these products as a result of competition, technological change, a
change in our pricing model, inclusion of anti-virus or network management and
analysis software as a standard part of hardware or operating system software or
other software, or a maturation in the markets for these products, could harm
our business.
IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE
ANTICIPATE, OUR BUSINESS COULD SUFFER
The markets for our network management and network security products are
evolving, and their growth depends upon broader market acceptance of this
software, including help desk software. Although the number of PCs, attached to
large-area networks has increased dramatically, the network management and
network security markets continue to be emerging markets. These markets may not
continue to develop or may not develop rapidly enough to benefit our business
significantly. In addition, there are a number of potential approaches to
network management and network security, including the incorporation of
management and security tools into network operating systems. Therefore, even if
network management and network security tools gain broader market acceptance,
potential purchasers may not select our products. To the extent that either the
network management or network security market does continue to develop, we
expect that competition will increase.
WE ARE SUBJECT TO INTENSE COMPETITION IN THE NETWORK MANAGEMENT AND SECURITY
MARKETS AND WE EXPECT TO FACE INCREASED COMPETITION IN THE FUTURE
The markets for our products are intensely competitive we expect
competition to increase in the near-term. We believe that the principal
competitive factors affecting the markets for our products include:
- performance;
- functionality;
- quality;
- customer support;
- breadth of product line;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
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<PAGE> 27
- brand name recognition;
- reputation; and
- price.
We may be unable to compete effectively against existing and potential
competitors. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources.
These factors may provide our competitors with an advantage in penetrating the
market with their network security and management products. As is the case in
many segments of the software industry, we have been encountering, and we expect
to further encounter, increasing competition. This increased competition could
reduce average selling prices and, therefore, profit margins. Competitive
pressures could result not only in price reductions but also in a decline in
sales volume, could cause our business to suffer. In addition, competitive
pressures may make it difficult for us to maintain or exceed our growth rate.
Performance and quality of our anti-virus software products are measured
by number and type of viruses detected, the speed at which the products run and
ease of use. Our principal competitor in the anti-virus market serviced by our
McAfee Product Groups and McAfee.com is the Peter Norton Group of Symantec.
Trend Micro remains the strongest competitor in the Asian anti-virus market.
Other competitors include numerous smaller companies and shareware authors that
may in the future develop into stronger competitors or be consolidated into
larger competitors.
Our principal competitors in the security market generally varies by
product type. For firewalls, our principal competitors include CheckPoint,
Axent, particularly for Windows NT-based firewalls, and larger companies such as
Cisco Systems and Microsoft. In July 2000, Axent agreed to be acquired by
Symantec. For intrusion detection products, we compete with ISS, Axent and
Cisco. The markets for encryption and virtual private network, or VPN, products
are highly fragmented with numerous small and large vendors. Public key
infrastructure, or PKI, encryption vendors such as Entrust Technologies offer
some products that compete with our PGP products. VPN competitors include
hardware and software vendors, including telecommunications companies and
traditional networking suppliers.
Our principal competitor in the network management market is Agilent.
Other competitors include Cisco, Computer Associates, Compuware, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies, Shomiti Systems and Wavetek Wandel & Goltermann, Inc.
Our principal competitors in the help desk market are Computer
Associates, Heat, Peregrine and Remedy.
We also face competition from large software companies such as
Microsoft, Intel, Novell and HP, which may offer network security and management
products as enhancements to their operating system.
Finally, as the network management market develops, we may face
increased competition from a number of large companies, as well as other
companies seeking to enter the market. The trend toward enterprise-wide network
management and security solutions may result in a consolidation of the network
management and security market around a smaller number of companies who are able
to provide the necessary software and support capabilities. For example, in July
2000, Symantec, primarily an anti-virus and PC utilities company, agreed to
acquire Axent, a network security company. In addition, to the extent that we
continue to develop our Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
we will likely compete with large computer systems management companies such as
Tivoli Systems and Computer Associates.
OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH COULD
ADVERSELY AFFECT OUR BUSINESS
Our products may be considered to be capital purchases by certain
customers or prospective customers. Capital purchases are often discretionary
and, therefore, are canceled or delayed if the customer experiences a downturn
in its business or prospects or as a result of economic conditions in general.
Any cancellation or delay could adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR SALES FORCE STRUCTURE AND ITS RECENT RESTRUCTURING
Our non-governmental sales force is organized by product group, with
four separately focused sales organizations selling our McAfee, Sniffer
Technology, PGP Security and Magic Solutions products and product suites. All
four sales organizations consist
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of field sales representatives who are located regionally and outbound telesales
representatives who actively focus on selling our individual product suites. The
telesales representatives focus on small customers and transactions. McAfee.com
has, and myCIO.com is developing, a separate sales force, focusing on selling
their ASP solution directly to consumers and businesses, respectively. To
succeed in the direct sales channel, we must build a significant direct sales
organization and must attract and retain qualified personnel. These individuals
will require training about, and knowledge of, product attributes of the
products and product suites sold by them. We may not succeed in building the
necessary sales organization or in attracting, retaining or training these
individuals.
In January 2000 we divided our U.S. direct sales force among our four
product groups, in part, to focus our sales force on selling specialized product
suites versus selling each of the various product suites that form our Net Tools
mega-suite. Our customers and potential customers and sales force may not
respond favorably to the restructuring and our revenues, business and future
financial performance could suffer materially. In addition to customer and sales
related risks described above:
- disputes may occur between our product group sales forces;
- sales representatives may lose productivity while being
retrained or while refocusing their sales efforts; and
- sales representatives may terminate their employment with us.
Although our increased direct sales efforts may also reduce our
dependence on resellers and distributors, it may also lead to conflicts for the
same customers, further customer confusion and may result in pressure by current
and prospective customers for price reductions on products.
WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES, WHO MAY NOT VIGOROUSLY MARKET OUR
PRODUCTS, HAVE RIGHTS OF RETURN OR MAY HAVE DIFFICULTY IN TIMELY PAYING FOR
PURCHASED PRODUCTS
We market a significant portion of our products to end-users through
intermediaries, including distributors, resellers and value-added resellers. Our
distributors sell other products that are complementary to, or compete with, our
products. While we encourage our distributors to focus on our products through
market and support programs, these distributors may give greater priority to
products of other suppliers, including competitors. Our agreements with our
distributors generally permit our distributors to return our product to us in
the event of end user returns to the distributor, inaccurate estimates of end
user demand by the distributor, increased purchases by distributors in response
to sales incentives or transitions to new products. We record sales to
distributors as revenue and at the same time establish a reserve for returns.
Actual returns could exceed reserves as a result of distributors holding
excessive amounts of our product in inventory. Our current or future reserves
for returns could be inadequate which would adversely impact our operating
results.
Some of our distributors are experiencing economic difficulties
worldwide, which may adversely impact our collection of accounts receivable. We
regularly review the collectibility and credit worthiness of our distributors to
determine an appropriate allowance for doubtful accounts' reserve. Our
uncollectible accounts could exceed our current or future allowance for doubtful
accounts' reserve, which would adversely impact our operating results.
WE NEED TO EXPAND AND DEVELOP AN EFFECTIVE PROFESSIONAL SERVICES ORGANIZATION;
WE RELY ON THIRD-PARTY PROFESSIONAL SERVICES
As our products and computer networks in general increase in complexity,
customers require greater professional assistance to design, install, configure
and implement our products. To date, we have relied on our limited professional
service capabilities and increasingly on outside professional service providers,
including our distributors, resellers and system integrators. These third party
service providers may provide inadequate levels of professional services.
Moreover, reliance on these third parties both places a greater burden on them
and reduces our ability to control and establish standards for providing these
support services. Our reliance on these third parties could, delay our
recognition of product revenue, harm our relationships or reputation with these
third parties or the end users of our products or result in decreased future
sales of, or prices for, our products.
The failure to develop and maintain an effective professional service
organization could have a material adverse effect on our business. To more
effectively service our customer's evolving needs, we intend to significantly
expand and develop our worldwide professional service organization. We may not
succeed in these efforts. Effectively expanding and developing our professional
service organization will require that we hire and train more service
professionals who must be continually trained and educated to ensure that they
possess sufficient technical skills and product knowledge. The market for
qualified professionals is intensely
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<PAGE> 29
competitive, making hiring and retention difficult. We expect significant
competition in this market from existing providers of professional services and
future entrants. We must also properly price our services to attract customers,
while maintaining sufficient margins for these services. We therefore expect
that we will have lower profit margins on our service revenues. In addition, in
January 2000, we reorganized our U.S. professional services organization, in
part, to enable the professional service organization to become more specialized
on individual products and product suites. As a result, a particular product
group may have insufficient qualified personnel to perform its professional
services needs as there will no longer be a "pool" of professional service
personnel from which to draw. A product group's lack of sufficient professional
services personnel could lead to customer dissatisfaction, missed revenue
opportunities and a loss of future business.
WE RELY ON THE CONTINUED PROMINENCE OF MICROSOFT TECHNOLOGY
Although we intend to support other operating systems, our mission is to
be the leading supplier of network security and management products for Windows
NT/Intel based networks. Sales of our products would be materially and adversely
affected by market developments that are adverse to the Windows operating
environments, including the failure of users and application developers to
accept Windows NT. In addition, our ability to develop products using the
Windows operating environments is dependent on our ability to gain timely access
to, and to develop expertise in, current and future developments by Microsoft.
We may not be able to gain the necessary access from Microsoft.
WE MAY FAIL TO SUPPORT OPERATING SYSTEMS WHICH SUCCESSFULLY COMPETE WITH
MICROSOFT'S TECHNOLOGY, INCLUDING COMPETING VERSIONS OF THE UNIX OPERATING
SYSTEM
We are expanding our product support to include the Unix operating
system and the Linux operating system. Sales of our products could be materially
and adversely impacted by our failure to support those versions of the Unix
operating system or competing operating systems that receive broad market
acceptance. The Unix system encompasses many separate operating systems of which
we only support a few, including for example, Sun Microsystem's Solaris Unix
operating system.
WE MUST EFFECTIVELY MANAGE OUR GROWTH
Our business has grown rapidly, both internally and through
acquisitions. This growth has placed, and any future growth would continue to
place, a significant strain on our limited personnel, management and other
resources. Our ability to manage any future growth, particularly with the
anticipated expansion of our international business and our ASP businesses, and
growth in distribution business, will require us to:
- attract, train, retain, motivate and manage new employees
successfully;
- effectively integrate new employees into our operations; and
- continue to improve our operational, financial, management and
information systems and controls.
If we continue to grow, our management systems currently in place may be
inadequate or we may not be able to effectively manage this growth. We are
currently investing in our Internet infrastructure in anticipation of expected
growth from the Internet, which may fail to materialize.
WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WHICH OFFER ONLY LIMITED
PROTECTION AGAINST POTENTIAL INFRINGERS; WE MAY FACE LITIGATION RELATED TO OUR
PROPRIETARY TECHNOLOGY AND RIGHTS.
Our success depends significantly upon our proprietary software
technology. We rely on a combination of contractual rights, trademarks, trade
secrets, patents and copyrights to establish and protect proprietary rights in
our software. However, these protections may be inadequate or competitors may
independently develop technologies or products that are substantially equivalent
or superior to our products. We do not typically obtain signed license
agreements from our corporate, government and institutional customers who
license products directly from us. Rather, we include an electronic version of a
shrink-wrap license in all of our electronically distributed software and a
printed license in the box for our products distributed through traditional
distributors in order to protect our copyrights and trade secrets in those
products. Since the licensee has not signed any of these licenses, many legal
authorities believe that such licenses may not be enforceable under the laws of
many states and foreign jurisdictions. In addition, the laws of some foreign
countries either do not protect these rights at all or offer only limited
protection for these rights. The steps taken by us to protect our proprietary
software technology may be inadequate to deter misuse or theft of this
technology.
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For example, we are aware that a substantial number of users of our anti-virus
products have not paid any registration or license fees to us. Changing legal
interpretations of liability for unauthorized use of the our software, or
lessened sensitivity by corporate, government or institutional users to avoiding
infringement of intellectual property, could have a material adverse effect on
our business, results of operations and financial condition.
There has been substantial litigation regarding the intellectual
property rights of technology companies. The increased issuance of software
patents in recent years has led to and is likely to continue to lead to
increased patent and intellectual property litigation in the software industry.
In the past we have been, and we currently are, subject to litigation related to
our intellectual property, including a separate patent infringement case
involving Hilgraeve and a separate patent infringement case involving Trend
Micro which was recently settled. See Note 7, Notes to the Condensed
Consolidated Financial Statements. Although we intend to defend ourselves
vigorously against claims asserted against us in the foregoing actions or
matters, developments arising out of this pending litigation or any other
litigation to which we are or may become a party could have a material adverse
effect on our business, results of operation and financial condition. Adverse
determinations in litigation could:
- result in the loss of our proprietary rights;
- subject us to significant liabilities;
- require us to seek licenses from third parties; or
- prevent us from manufacturing or selling our products.
We may also be subject to litigation in connection with our advertising
and marketing programs. The litigation process is subject to inherent
uncertainties and we may not prevail in these matters, or we may be unable to
obtain licenses with respect to any patents or other intellectual property
rights that may be held valid or infringed upon by our products or us.
Uncertainties inherent in the litigation process involve, among other things,
the complexity of the technologies involved, potentially adverse changes in the
law and discovery of facts unfavorable to us.
In addition, as we may acquire a portion of software included in our
products from third parties, our exposure to infringement actions may increase
because we must rely upon such third parties as to the origin and ownership of
any software being acquired. Similarly, exposure to infringement claims will
increase to the extent that we employ or hire additional software engineers
previously employed by competitors, notwithstanding measures taken by these
competitors to protect their intellectual property. In the future, litigation
may be necessary to enforce and protect trade secrets and other intellectual
property rights that we own. We may also be subject to litigation to defend
against claimed infringement of the rights of others or determine the scope and
validity of the proprietary rights of others. This litigation could be costly
and cause diversion of management's attention, either of which could have a
material adverse effect on our business, results of operations and financial
condition.
OUR INTERNATIONAL OPERATIONS SUBJECT US TO FOREIGN CURRENCY FLUCTUATIONS AND
OTHER INHERENT RISKS RELATED TO DOING BUSINESS IN FOREIGN COUNTRIES
For the six months ended June 30, 2000 and 1999, net revenue from
international sales represented approximately 40% and 44%, respectively, of our
net revenue. Historically, we have relied upon independent agents and
distributors to market our products internationally. We expect that
international revenue will continue to account for a significant percentage of
net revenue. We also expect that a significant portion of this international
revenue will be denominated in local currencies. To reduce the impact of foreign
currency fluctuations, we use non-leveraged forward currency contracts. However,
our future results of operations may be adversely affected by currency
fluctuations or by costs associated with currency risk management strategies.
Other risks inherent in international revenue generally include:
- the impact of longer payment cycles;
- greater difficulty in accounts receivable collection;
- unexpected changes in regulatory requirements;
- seasonality due to the slowdown in European business activities
during the third quarter;
- tariffs and other trade barriers;
- export restrictions on our encryption and other security
products;
- uncertainties relative to regional economic circumstances,
including the current economic turbulence in Asia;
- political instability in emerging markets and difficulties in
staffing; and
- managing foreign operations.
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These factors may have a material adverse effect on our future
international license revenue. Further, in countries with a high incidence of
software piracy, we may experience a higher rate of piracy of our products.
In addition, a portion of our international revenue is expected to
continue to be generated through independent agents. Since these agents are not
our employees and are not required to offer our products exclusively, they may
discontinue marketing our products entirely. Also, we may have limited control
over these agents, limited access to the names of the customers to whom these
agents sell its products and limited knowledge of the information provided by,
or representations made by, these agents to its customers.
COMPUTER "HACKERS" MAY DAMAGE OUR PRODUCTS AND SERVICES
Given our high profile in the security software market, we have been a
target of computer hackers who have, among other things, created viruses to
sabotage or otherwise attack our products. While to date these efforts have been
discovered quickly and their adverse impact has been limited, similar viruses or
efforts may be created or replicated in the future. In this event, users'
computer systems could be damaged and demand for our software products may
suffer as a result. In addition, since we do not control diskette duplication by
distributors or our independent agents, diskettes containing our software may be
infected with viruses. Given our increased use of the Internet to deliver
products and services, any successful sabotage or other attack on our websites,
including the McAfee.com and myCIO.com web sites, could disrupt our ability to
provide products and services to customers. A successful sabotage of one of our
or our affiliates' web based businesses could result in reduced demand for our
or our affiliates' web based products and services and have a material adverse
affect on our business and our results of operation. Recently a number of
websites have been subject to denial of service attacks where a web site is
bombarded with information requests eventually causing the website to overload,
which causes a delay or disruption of service.
FALSE DETECTION OF VIRUSES AND ACTUAL OR PERCEIVED SECURITY BREACHES COULD
ADVERSELY AFFECT OUR BUSINESS
Our anti-virus software products have in the past and may at times in
the future falsely detect viruses that do not actually exist. These false
alarms, while typical in the industry, may impair the perceived reliability of
our products and may therefore adversely impact market acceptance of our
products. In addition, we have in the past been subject to litigation claiming
damages related to a false alarm, and similar claims may be made in the future.
In addition, an actual or perceived breach of network or computer security at
one of our customers, regardless of whether the breach is attributable to our
products, could adversely affect the market's perception of our security
products. This could adversely effect our business, results of operations and
financial condition.
OUR CRYPTOGRAPHY TECHNOLOGY IS SUBJECT TO EXPORT RESTRICTIONS AND MAY BECOME
OBSOLETE
All of our products are subject to the U.S. Export Administration
Regulations, governed by the U.S. Department of Commerce. Certain of our network
security products, technology and associated technical assistance, particularly
products and technology incorporating encryption, may be subject to export
restrictions. Recent changes to U.S. laws enable Network Associates to export
more products without restrictions; however certain products still may not be
exported to foreign government customers without prior approval from the U.S.
government. The list of products and end users for which export approval is
required, and the regulatory policies with respect thereto, are subject to
revision by the U.S. Government at any time. The cost of compliance with U.S.
and international export laws and changes in existing laws could affect our
ability to sell certain products in certain markets, and could have a material
adverse effect on our international revenues.
In addition, some of our network security products are dependent on the
use of public key cryptography technology. This technology depends in part upon
the application of certain mathematical principles known as factoring and
discrete logarithms. The security afforded by public key cryptography technology
is based on our belief that the factoring of large prime numbers and solving the
discrete log problem is not computationally practical. Should an easy factoring
method be developed or the discrete log problem is solved, the security afforded
by encryption products using public key cryptography technology would be reduced
or eliminated. Furthermore, any significant advance in techniques for attacking
cryptographic systems could also render some or all of our existing products and
services obsolete or unmarketable. Moreover, the cryptographic algorithms used
in our products can theoretically be solved by computer systems significantly
faster and more powerful than those presently available. If these improved
techniques for attacking cryptographic systems were ever developed, our business
would be adversely affected.
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PRODUCT LIABILITY CLAIMS ASSERTED AGAINST US IN THE FUTURE COULD ADVERSELY
AFFECT OUR BUSINESS
Our network security and management software products are used to
protect and manage computer systems and networks that may be critical to
organizations. As a result, our sale and support of these products involves the
risk of potential product liability and related claims. Our license agreements
with our customers typically contain provisions designed to limit our exposure
to potential product liability claims. It is possible, however, that the
limitation of liability provisions contained in these license agreements may not
be effective under the laws of certain jurisdictions, particularly in
circumstances involving unsigned licenses. A product liability claim brought
against us could have a material adverse effect on our business, results of
operations and financial condition.
OUR MANAGEMENT AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, THESE
INDIVIDUALS MAY NOT REMAIN WITH US IN THE FUTURE
We rely, and will continue to rely, on a number of key technical and
management employees. While employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, our employees are
generally not otherwise subject to employment agreements or to noncompetition
covenants. If any of our key employees leave, our business, results of
operations and financial condition could suffer. Furthermore, we do not maintain
life insurance policies on our key employees.
Our ability to achieve our revenue and operating performance objectives
will depend in large part on our ability to attract and retain technically
qualified and highly skilled sales, consulting, technical, marketing and
management personnel. Competition for these employees is intense and is expected
to remain so for the foreseeable future. We have seen upward pressure on wages
as a result of this intense competition for employees, which could cause an
increase in our operating expenses. We may not be successful in retaining our
existing key personnel and in attracting and retaining the personnel we require,
and our failure to retain and hire key employees could adversely affect our
business and operating results. Additions of new and departures of existing
employees, particularly in key positions, can be disruptive and can result in
departures of existing employees, which could adversely affect our business.
WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING
We are currently engaged in several research and development contracts
with agencies of the U.S. government. We believe that the willingness of these
government agencies to enter into future contracts with us will in part be
dependent upon our continued ability to meet their expectations.
Minimum fee awards for companies entering into government contracts are
generally between 3% and 7% of the costs incurred by them in performing their
duties under the related contract. However, these fee awards may be as low as 1%
of the contract costs. Furthermore, these contracts are subject to cancellation
at the convenience of the governmental agencies. Although we have been awarded
contract fees of more than 1% of the contract costs in the past, minimum fee
awards or cancellations may occur in the future. Reductions or delays in federal
funds available for projects we are performing could also have an adverse impact
on our government business. Contracts involving the U.S. government are also
subject to the risks of disallowance of costs upon audit, changes in government
procurement policies, required competitive bidding and, with respect to
contracts involving prime contractors or government-designated subcontractors,
the inability of those parties to perform under their contracts. Any of the
foregoing events could adversely affect our results of operations or financial
conditions.
YEAR 2000 ISSUES COULD NEGATIVELY AFFECT OUR BUSINESS
To date we have not experienced any material problems attributable to
the year 2000 problem with respect to our software products and internal
systems, however, our current products could potentially contain undetected
errors or defects associated with year 2000 date functions that may result in
material costs or liabilities to us in the future. Moreover, our software
directly and indirectly interacts with a large number of third party hardware
and software systems, each of which may contain or introduce undetected errors
or defects. We are unable to predict to what extent our business may be affected
if our software or the systems that operate in conjunction with our software
experience a material year 2000 related failure. Any year 2000 defect in our
products or the software and hardware systems with which our products operate,
as well as any year 2000 errors caused by older non-current products that were
not upgraded by our customers, could expose us to litigation that could require
us to incur significant costs in defending the litigation or expose us to the
risk of significant damages.
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EARTHQUAKE
Our corporate headquarters is located near a major earthquake fault. The
impact of a major earthquake on our facilities, infrastructure and overall
operations is not known. Safety precautions have been implemented, however there
is no guarantee that an earthquake would not seriously disturb our entire
business process. We are largely uninsured for losses and business disruptions
caused by an earthquake.
DELAWARE LAW, OUR CERTIFICATE OF INCORPORATION AND BYLAWS, OUR ADOPTION OF A
RIGHTS PLAN AND OUR STOCKHOLDERS AGREEMENT WITH MCAFEE.COM MAY INHIBIT POTENTIAL
ACQUISITION BIDS; THIS MAY ADVERSELY AFFECT THE MARKET PRICE FOR OUR COMMON
STOCK AND PREVENT CHANGES IN OUR MANAGEMENT.
Our board of directors has the authority to issue up to 5,000,000 shares
of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote of action by its stockholders. The issuance of preferred stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of the outstanding voting stock.
In October 1998, our board of directors adopted a shareholders rights
plan. Each right under this plan entitles the record holder to buy 1/1000th of a
share of our series B participating preferred stock at an exercise price of
$200.00. The rights will become exercisable following the tenth day after a
person or group announces acquisition of 15% or more of our common stock or
announces commencement of a tender or exchange offer the consummation of which
would result in ownership by the person or group of 15% or more of our common
stock. If the rights become exercisable, the holders of the rights (other than
the person acquiring 15% or more of our common stock) will be entitled to
acquire in exchange for the $200 exercise price shares of our common stock or
shares of any company in which we are merged having a value of $400. We are
entitled to redeem the rights at $0.01 per right at any time on or before the
tenth day following acquisition by a person or group of 15% or more of our
common stock.
In October 1999, we entered into a stockholders agreement with
McAfee.com. Under this agreement we agreed that if (1) without the prior
approval of our continuing directors, as defined below, any person acquires or
agrees to acquire 15% or more of our outstanding common stock or (2) our
continuing directors cease to constitute a majority of Network Associates
serving directors, then for so long but only for so long as that condition
exists:
- our shares of McAfee.com Class B common stock will be entitled
to only one vote per share instead of three votes per share; and
- we will be obligated to vote our McAfee.com shares to cause, and
to take such actions reasonably within our control to cause, and
shall seek to cause the McAfee.com directors appointed by us to
cause, the McAfee.com board of directors to consist of at least
a majority of independent directors.
Network Associates continuing directors consist of our current directors and any
subsequent directors approved or not objected to by a majority of our
then-continuing directors.
Certain provisions of Delaware law and our certificate of incorporation
and bylaws, such as a classified board, could delay or make a merger, tender
offer or proxy contest involving Network Associates more difficult. While these
provisions and our rights plan are intended to enable our board of directors to
maximize stockholder value, and the provisions of the McAfee.com stockholders
agreement are, among other things, intended to preserve McAfee.com's
independence, they may have the effect of discouraging takeovers, which may not
be in the best interest of certain stockholders. Our rights plan and these
provisions could have an adverse effect on the market value of our common stock.
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NETWORKS ASSOCIATES, INC.
FORM 10-Q, JUNE 30, 2000
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
Information with respect to this item is incorporated by reference to
Note 7 of the Notes to the Consolidated Financial Statements included herein on
page 9 of this Report on Form 10-Q.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
At the Annual Meeting of Stockholders of the Company on May 25, 2000,
the following matters were acted on by the shareholders of the Company:
1. The re-election of Leslie G. Denend as Class II director for an
additional three year term:
<TABLE>
<S> <C>
Shares in Favor 108,170,720
Shares Withheld 1,537,713
</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 by 6.0 million
shares:
<TABLE>
<S> <C>
Shares in Favor 72,395,673
Shares Against 37,055,349
Shares Abstained 257,411
</TABLE>
3. The ratification of the appointment of PricewaterhouseCoopers
L.L.P. as the independent accountants of the Company for the
fiscal year ending December 31, 2000:
<TABLE>
<S> <C>
Shares in Favor 109,227,911
Shares Against 359,853
Shares Abstained 120,669
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits. The exhibits listed in the accompanying Exhibit Index are
filed or incorporated by reference as part of this Report.
(b) No reports on Form 8-K were filed during the quarter.
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NETWORKS ASSOCIATES, INC.
FORM 10-Q, JUNE 30, 2000
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, and
the results and regulations promulgated thereunder, the registrant has duly
caused this amended report to be signed on its behalf by the undersigned
thereunto duly authorized.
NETWORKS ASSOCIATES, INC.
/s/ PRABHAT K. GOYAL
---------------------------------
Name: Prabhat K. Goyal
Title: Vice President Administration,
Chief Financial Officer and Secretary
Date: August 14, 2000
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NETWORKS ASSOCIATES, INC.
FORM 10-Q, JUNE 30, 2000
EXHIBIT INDEX
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2.1 Agreement and Plan of Reorganization, dated October 13, 1997, among McAfee
Associates, Inc., Mystery Acquisition Corp. and Network General
Corporation, as amended by the First Amendment dated as of October 22,
1997.(1)......................................................................
2.2 Combination Agreement dated August 16, 1996 among the Registrant, FSA
Combination Corp., FSA Corporation and Daniel Freedman.(2)....................
2.3 Stock Exchange Agreement dated January 13, 1996 among the Registrant, FSA
Combination Corp., Kabushiki Kaisha Jade and the shareholders of Jade.(3).....
2.4 Agreement and Plan of Reorganization dated December 1, 1997 between the
Registrant, Helix Software Company an DNA Acquisition Corp.(4)................
2.5 Agreement and Plan of Reorganization dated December 1, 1997 between the
Registrant, PGP and PG Acquisition Corp.(5)...................................
2.6 Agreement and Plan of Reorganization dated February 22, 1998, between the
Registrant, TIS and Thor Acquisition Corp.(6).................................
2.7 Agreement and Plan of Reorganization by and among the Registrant, Magic
Solutions International, Inc., Merlin Acquisition Corp. and Igal Lichtman,
Amendment Agreement by and among the Registrant, Magic Solutions
International, Inc., Merlin Acquisition Corp., and Igal Lichtman dated
March 24, 1998. Second Amendment Agreement by and among the Registrant,
Magic Solutions International, Inc., Merlin Acquisition Corp., and Igal
Lichtman dated April 1, 1998.(7)..............................................
2.8 Stock Purchase Agreement, dated as of February 26, 1998, by and between
FSA Combination Corp., and Brenda Joyce Cook.(8)..............................
2.9 Share Purchase Agreement, dated as of March 30, 1998, among FSA
Combination Corp., and Irina Karlsson and Jarmo Rouvinen.(8)..................
2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA Combination
Corp., and Secure Networks, Inc.(8)...........................................
2.11 Transaction Agreement, dated June 9, 1998, by and between the Registrant
and Dr. Solomon's Group Plc.(21)..............................................
2.12 Agreement and Plan of Merger, dated July 28, 1998, by and between the
Registrant and CyberMedia, Inc.(22)...........................................
3.1 Second Restated Certificate of Incorporation of Networks Associates, Inc.,
as amended on December 1, 1997.(6)............................................
3.2 Restated Bylaws of Networks Associates, Inc.(6)...............................
3.3 Certificate of Designation of Series A Preferred Stock of Networks
Associates, Inc.(9)...........................................................
3.4 Certificate of Designation of Series B Participating Preferred Stock of
the Registrant.(23)...........................................................
4.2 Registration Rights Agreement dated August 30, 1996 between the Registrant
and Daniel Freedman.(1).......................................................
4.5 Registration Rights Agreement dated December 9, 1997 between the
Registrant and certain shareholders of PGP.(4)................................
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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)......................................................................
4.13 Registration Rights Agreement, dated August 31, 1998, by and between the
Registrant and certain stockholders of QA Information Security Holding
AB(24)........................................................................
10.1 Standard Business Lease (Net) for Network General's principal facility
dated June 19, 1991, between Network General and Menlo Oaks Partners,
L.P.(12)......................................................................
10.2 First Amendment to Lease dated June 10, 1992, between Network General and
Menlo Parks Partners, L.P.(12)................................................
10.3 Standard Business Lease (Net) for Network General's principal facility
dated March 11, 1992, between Network General and Menlo Oaks Partners
L.P.(13)......................................................................
10.4 First Amendment to Lease dated June 18, 1992, between Network General and
Menlo Oaks Partners, L.P.(12).................................................
10.5 Lease dated March 31, 1992, between Network General and Equitable Life
Assurance Society of the United States.(12)...................................
10.6 Second Amendment to Lease dated February 1, 1995, between Network General
and Menlo Oaks Partners, L.P.(13).............................................
10.7 Third amendment to Lease dated February 1, 1995 between Network General
and Menlo Oaks Partners L.P.(13)..............................................
10.8 Fourth Amendment to Lease dated May 31, 1995, between Network General and
Menlo Oaks Partners, L.P.(14).................................................
10.9 Fifth Amendment to Lease dated June 13, 1995, between Network General and
Menlo Oaks Partners, L.P.(14).................................................
10.10 Lease dated July 3, 1996 between Network General and Campbell Avenue
Associates.(15)
10.11 Sixth Amendment to Lease dated November 29, 1996, between Network General
and Menlo Oaks Partners, L.P.(15).............................................
10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa Clara,
California, dated as of February 20, 1997, by and between McAfee
Associates, Inc. and National Semiconductor Corporation.(16)..................
10.13 Lease Agreement dated November 17, 1997 for facility at 3965 Freedom
Circle, Santa Clara, California by and between Informix Corporation and
McAfee Associates, Inc.(4)....................................................
10.14 Consent to Assignment Agreement dated December 19, 1997 by and among Birk
S. McCandless, LLC, Guaranty Federal Bank, F.S.B., Informix Corporation
and Networks Associates, Inc.(4)..............................................
10.15 Subordination, Nondisturbance and Attornment Agreement dated December 18,
1997, between Guaranty Federal Bank, F.S.B., Networks Associates, Inc. and
Birk S. McCandless, LLC.(4)...................................................
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10.16 Lease dated November 22, 1996 by and between Birk S. McCandless, LLC and
Informix Corporation for facility at 3965 Freedom Circle, Santa Clara,
California.(4)................................................................
10.17 Quota Purchase Agreement, dated as of April 14, 1997 by and among McAfee
Associates, Inc. and McAfee Do Brasil Ltda., Compusul-Consultoria E
Comercio De Informatica Ltda., and the stockholders of
Compusul-Consultoria E Comercio De Informatica Ltda.(17)......................
10.18* 1997 Stock Incentive Plan, as Amended.(17)....................................
10.19* Stock Option Plan for Outside Directors (18)..................................
10.20* 2000 Nonstatutory Stock Option Plan (27)......................................
10.21* Change in control agreement between the Company and Peter Watkins dated
May 11, 1999(25)..............................................................
10.22* Change in control agreement between the Company and William L. Larson
dated May 11, 1999(25)........................................................
10.23* Change in control agreement between the Company and Prabhat K. Goyal dated
May 11, 1999(25)..............................................................
10.24* Change in control agreement between the Company and Zachary Nelson, dated
May 11, 1999(25)..............................................................
10.25 Corporate Management Services Agreement between the Registrant and
McAfee.com Corporation, dated as of January 1, 1999(26).......................
10.26 Technology Cross License Agreement between the Registrant and McAfee.com
Corporation dated as of January 1, 1999(26)...................................
10.27 Registration Rights Agreement between the Registrant and McAfee.com
Corporation, dated as of January 1, 1999(26)..................................
10.28 Asset Contribution and Receivables Settlement Agreement between the
Registrant and McAfee.com Corporation, dated as of January 1, 1999(26)........
10.29 Intercompany Revolving Loan Agreement between the Registrant and
McAfee.com Corporation, dated as of January 1, 1999(26).......................
10.30 Tax Sharing Agreement between the Registrant and McAfee.com dated as of
January 1, 1999(26)...........................................................
10.31 Indemnification and Voting Agreement between the Registrant and McAfee.com
Corporation, dated as of January 1, 1999(26)..................................
10.32 Joint Cooperation and Master Services Agreement between the Registrant and
McAfee.com Corporation, dated as of January 1, 1999(26).......................
21.1 Subsidiaries of Network Associates, Inc (27)..................................
23.1 Consent of PricewaterhouseCoopers LLP.........................................
27.1 Financial Data Schedule.......................................................
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(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.
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(4) Incorporated by reference from the Registrant's Registration Statement
on Form S-3, filed with the Commission on February 12, 1998.
(5) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on December 11, 1997.
(6) Incorporated by reference from the Registrant's Registration Statement
on Form S-4 filed with the Commission on March 25, 1998.
(7) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on April 2, 1998.
(8) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 filed with the Commission on May 26, 1998.
(9) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended September 30, 1996, filed with the Commission on
November 4, 1997.
(10) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 filed with the Commission on May 6, 1998.
(11) Incorporated by reference from the Registrant's Registration Statement
on Form S-3 filed with the Commission on August 5, 1998.
(12) Incorporated by reference from the Network General Corporation's Report
on Form 10-K for the year ended March 31, 1992. Network General's
filings with the Commission were made under File Number 0-17431.
(13) Incorporated by reference from the Network General Corporation's Report
on Form 10-Q for the quarter ended December 31, 1994. Network General's
filings with the Commission were made under File Number 0-17431.
(14) Incorporated by reference from the Network General Corporation's Report
on Form 10-Q for the quarter ended June 30, 1995. Network General's
filings with the Commission were made under File Number 0-17431.
(15) Incorporated by reference from the Network General Corporation's Report
on Form 10-Q for the quarter ended June 30, 1996. Network General's
filings with the Commission were made under File Number 0-17431.
(16) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended June 30, 1997, filed with the Commission on August 14,
1997.
(17) Incorporated by reference from the Registrant's Registration Statement
on Form S-8 filed with the Commission on July 21, 2000.
(18) Incorporated by reference from the Registrant's Registration Statement
on Form S-8 filed with the Commission on July 31, 1995.
(19) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended June 30, 1996, filed with the Commission on August 13,
1996.
(20) Incorporated by reference from the Registrant's Report on Form 10-Q for
the quarter ended March 31, 1998, filed with the Commission on May 15,
1998.
(21) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on June 16, 1998.
(22) Incorporated by reference from CyberMedia Inc.'s Schedule 13D filed by
the Registrant with the Commission on August 7, 1998. CyberMedia Inc.'s
filings with the Commission were made under File Number 0-21289.
(23) Incorporated by reference from the Registrant's Report on Form 8-A filed
with the Commission on October 22, 1998.
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(24) Incorporated by reference from the registrant's report on form 10-Q for
the quarter ended September 30, 1998, filed with the Commission on
November 13, 1998.
(25) Incorporated by reference from the Registrant's report on Form 10-Q for
the quarter ended March 31, 1999, filed with the Commission on May 13,
1999.
(26) Incorporated by reference from the Form S-1 filed by McAfee.com
Corporation with the Commission on September 23, 1999, under File Number
333-87609.
(27) Incorporated by reference from the registrant's report on form 10-K for
the year ended December 31, 2000, filed with the Commission on March 30,
2000
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
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