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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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
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NETWORKS ASSOCIATES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 77-0316593
(STATE OF INCORPORATION) (IRS EMPLOYER
IDENTIFICATION NUMBER)
</TABLE>
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
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Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
138,701,216 shares of the registrant's common stock, $0.01 par value, were
outstanding as of March 31, 2000.
THIS DOCUMENT CONTAINS 42 PAGES.
THE EXHIBIT INDEX IS ON PAGE 39.
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NETWORKS ASSOCIATES, INC.
FORM 10-Q,
MARCH 31, 2000
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CONTENTS
<TABLE>
<CAPTION>
ITEM PAGE
NUMBER ----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Operations and
Comprehensive Income:
Three months ended March 31, 2000 and 1999.................. 3
Condensed Consolidated Balance Sheets:
March 31, 2000 and December 31, 1999........................ 4
Condensed Consolidated Statements of Cash Flows:
Three months ended March 31, 2000 and 1999.................. 5
Notes to Condensed Consolidated Financial Statements........ 6
ITEM MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
2. AND RESULTS OF OPERATIONS................................... 12
PART II: OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS........................................... 36
ITEM
6. EXHIBITS AND REPORTS ON FORM 8-K............................ 36
SIGNATURES.......................................................... 37
EXHIBIT INDEX....................................................... 38
</TABLE>
2
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
2000 1999
-------- --------
<S> <C> <C>
Net revenue:
Product................................................... $166,989 $180,704
Services & support........................................ 47,467 64,488
-------- --------
Total revenue..................................... 214,456 245,192
-------- --------
Cost of revenue:
Product................................................... 23,738 27,051
Services & support........................................ 8,505 8,192
-------- --------
Total cost of revenue............................. 32,243 35,243
-------- --------
Gross profit................................................ 182,213 209,949
Operating expenses:
Research and development.................................. 41,221 35,131
Marketing and sales....................................... 96,045 93,681
General and administrative................................ 20,484 21,770
Amortization of intangibles and stock compensation
charge................................................. 15,996 15,139
-------- --------
Total operating expenses.......................... 173,746 165,721
-------- --------
Income from operations............................ 8,467 44,228
-------- --------
Interest and other income and expense, net................ 4,602 1,574
Gain (loss) on sale of investments, net................... 40,373 --
Minority interest in consolidated subsidiaries............ 1,123 --
-------- --------
Income before provision for income taxes.......... 54,565 45,802
Provision for income taxes.................................. 25,540 19,561
-------- --------
Net income........................................ $ 29,025 $ 26,241
Other comprehensive income (loss):
Unrealized gain (loss) on investments....................... $ 5,630 $ (1,187)
Foreign currency translation loss........................... (1,965) (9,728)
-------- --------
Comprehensive income........................................ $ 32,690 $ 15,326
======== ========
Net income per share -- basic............................... $ 0.21 $ 0.19
======== ========
Shares used in per share calculation -- basic............... 138,877 138,395
======== ========
Net income per share -- diluted............................. $ 0.20 $ 0.18
======== ========
Shares used in per share calculation -- diluted............. 144,372 142,607
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
---------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 369,312 $ 316,784
Marketable securities..................................... 69,359 72,135
Accounts receivable, net of allowances for doubtful
accounts of $11,853 at March 31, 2000 and $16,249 at
December 31, 1999...................................... 161,115 174,646
Prepaid expenses, income taxes and other current assets... 43,097 33,038
Deferred taxes............................................ 80,525 79,186
---------- ----------
Total current assets.............................. 723,408 675,789
Marketable securities....................................... 391,792 397,447
Fixed assets, net........................................... 47,777 45,392
Deferred taxes.............................................. 98,057 93,904
Intangibles and other assets................................ 284,370 266,862
---------- ----------
Total asset....................................... $1,545,404 $1,479,394
========== ==========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 29,150 $ 13,723
Accrued liabilities....................................... 257,685 253,062
Deferred revenue.......................................... 124,953 123,236
Long term debt, current portion........................... -- 103
---------- ----------
Total current liabilities......................... 411,788 390,124
Deferred taxes............................................ 10,304 10,575
Deferred revenue, less current portion.................... 29,780 30,005
Long term debt and other liabilities...................... 383,685 379,267
---------- ----------
Total liabilities................................. 835,557 809,971
---------- ----------
Minority Interest......................................... 12,354 9,317
---------- ----------
Common stock, $.01 par value; authorized: 300,000,000
shares; Issued: 140,301,216 shares at March 31, 2000 and
139,419,528 shares at December 31, 1999 Outstanding:
138,701,216 shares at March 31, 2000 and 138,734,528
shares at December 31, 1999............................... 1,387 1,387
Treasury stock.............................................. (24,392) (11,023)
Additional paid-in capital.................................. 667,210 644,821
Cumulative other comprehensive loss -- unrealized gain
(loss) on investments and foreign currency translation.... (6,292) (9,957)
Retained earnings........................................... 59,580 34,878
---------- ----------
Total stockholders' equity........................ 697,493 660,106
---------- ----------
Total liabilities, minority interest, and
stockholders' equity............................ $1,545,404 $1,479,394
========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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NETWORKS ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 29,025 $ 26,241
Adjustments to reconcile net income to net cash provided
from operating activities:
Depreciation and amortization........................... 22,839 21,265
Bad debt expense........................................ 1,834 357
Interest on convertible notes........................... 4,465 4,261
Minority Interest....................................... (1,123) --
Realized loss on marketable securities.................. 125 --
Deferred taxes.......................................... (5,763) --
Stock compensation charges.............................. 1,566 --
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................................... 11,964 (32,091)
Prepaid expenses, taxes and other..................... (23,972) 9,646
Accounts payable and accrued liabilities.............. 19,763 12,677
Deferred revenue...................................... 1,492 (3,660)
--------- ---------
Net cash provided by operating activities.......... $ 21,717 $ 38,696
--------- ---------
Cash flows from investing activities:
Purchase of marketable securities......................... (150,490) (503,143)
Sale of marketable securities............................. 156,227 405,858
Proceeds from sale of Goto.com investment................. 36,750 --
Proceeds from sale of Network Associates KK investment.... 11,947 --
Additions to fixed assets................................. (10,792) (6,323)
Purchase by subsidiary net of cash acquired............... (1,981) --
--------- ---------
Net cash provided by (used in) investing
activities....................................... $ 41,661 $(103,608)
--------- ---------
Cash flows from financing activities:
Repayment of notes payable................................ (103) (170)
Issuance of common stock under stock option and stock
purchase plans.......................................... 9,440 16,295
Repurchase of common stock................................ (27,442) --
Exercise of warrants...................................... -- 458
Change in minority interest............................... 1,330 --
Proceeds from sale of put options......................... 7,890 --
--------- ---------
Net cash provided by (used in) financing
activities....................................... $ (8,885) $ 16,583
--------- ---------
Effect of exchange rate fluctuations...................... (1,965) (9,728)
Net increase (decrease) in cash and cash equivalents........ 52,528 (58,057)
Cash and cash equivalents at beginning of period............ 316,784 418,899
--------- ---------
Cash and cash equivalents at end of period.................. $ 369,312 $ 360,842
========= =========
Non cash investing activities:
Unrealized gain (loss) on investments..................... $ 5,630 $ (1,187)
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited consolidated financial statements have been prepared by
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 wholly 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 month periods ended March 31,
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. In fiscal year 1998, the Company determined that it had a
single reporting segment consisting of the development, sale, and support of
computer security and management software. Since then, the Company established
two of its subsidiaries, McAfee.com and myCIO.com, as separate business
entities. As of March 31, 2000, the Company evaluated its product segments in
accordance with SFAS 131 and concluded that its reportable segments are 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").
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 in the United
States, Europe, Asia Pacific and Latin America.
The McAfee.com segment is a one-stop destination for consumer PC security
and management needs on the Internet. The McAfee.com website provides a suite of
online products and services personalized for the user based on the user's PC
configuration, attached peripherals and resident software.
The myCIO.com segment is an infrastructure ASP targeted at business users.
MyCIO delivers network security and availability services hosted on its servers
to businesses on the Internet.
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Summarized pre-tax financial information concerning the Company's
reportable segments is provided as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
---------- ----------
<S> <C> <C>
Infrastructure:
Net revenue....................................... $ 203,161 $ 241,724
Segment profit.................................... 40,452 30,147
McAfee.com:
Net revenue....................................... 10,258 3,468
Segment loss...................................... (6,631) (3,906)
myCIO.com:
Net revenue....................................... 1,037 --
Segment loss...................................... (4,796) --
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
2000 1999
---------- ----------
<S> <C> <C>
Infrastructure:
Total Assets.............................. $1,438,651 $1,571,338
McAfee.com:
Total Assets.............................. 105,232 10,571
myCIO.com:
Total Assets.............................. 1,521 --
</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 3.9 million shares at $11.063 were vested at March 31, 2000,
however the new options cannot be exercised for a period of twelve months from
the date the options were repriced, regardless of vesting status.
In accordance with Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees," the Company incurred an initial stock based
compensation charge in connection with this repricing. This charge was
calculated based on the difference between the exercise price of the new options
and their market value on the date of acceptance by employees. Approximately
$1.6 million was expensed in the three months ended March 31, 2000, and
approximately $9.8 million will be expensed over the remaining vesting period
through 2002.
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 noncompensatory 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 will be subject to variable plan accounting treatment. As of
July 1, 2000, this guidance will require the Company to remeasure compensation
cost for outstanding repriced options each reporting period based on
7
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. Through March 31, 2000,
the Company repurchased $1.6 million shares of its common stock for a total cash
outlay of approximately $39.9 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, 2000, Network Associates sold "European style" put options
for 1,000,000 shares of the Company's common stock as part of its stock
repurchase plan. European style put options can only be exercised on the expiry
date, which is February 16, 2001. The strike price for these put options is
$30.00, and the Company received total proceeds of $7,890,000 from the sale.
4. RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted Statement of Position
("SOP") No. 97-2, "Software Revenue Recognition" and SOP No. 98-4, "Deferral of
the Effective Date of a Provision of SOP No. 97-2." Prior to 1998, the Company
recognized revenues in accordance with SOP No. 91-1, "Software Revenue
Recognition." In December 1998, the American Institute of Certified Public
Accountants ("AICPA") issued SOP No. 98-9, "Modification of SOP No. 97-2,
Software Revenue Recognition, with Respect to Certain Transactions." SOP No.
98-9 clarifies certain provisions of SOP No. 97-2 that were previously deferred
by SOP No. 98-4, and effectively defers the required adoption of those
provisions until the Company's fiscal year beginning January 1, 2000. The
adoption of SOP No. 98-9 is not expected to have a material impact on the
Company's results of operations, financial position or cash flows.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 requires the Company to recognize
all derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through net income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of the
derivative are either offset against the change in fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. SFAS 133, as amended, is effective beginning in the
first 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
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.
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. NET INCOME PER SHARE
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted net income
per share calculations is provided as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
2000 1999
-------- --------
<S> <C> <C>
Numerator -- Basic
Net income.................................................. $ 29,025 $ 26,241
======== ========
Numerator -- Diluted
Net income.................................................. $ 29,025 $ 26,241
======== ========
Denominator -- Basic
Basic weighted average common shares outstanding............ 138,877 138,395
======== ========
Denominator -- Diluted
Basic weighted average common shares outstanding............ 138,877 138,395
======== ========
Effect of dilutive securities:
Common stock options...................................... 5,495 4,212
Diluted weighted average shares............................. 144,372 142,607
======== ========
Net income per share -- basic............................... $ 0.21 $ 0.19
======== ========
Net income per share -- diluted............................. $ 0.20 $ 0.18
======== ========
</TABLE>
At March 31, 2000 and 1999, 16.2 million and 23.7 million potential common
shares, respectively, were excluded from the determination of diluted net loss
per share as the effect of such shares is anti-dilutive.
6. SALE OF VENTURE INVESTMENTS
On March 10, 1999, the Company acquired 597,062 preferred shares of
Tesserae Information Systems, Inc. for approximately $10 million. During 1999,
all shares of Tesserae were acquired by Cadabra, Inc. and, subsequently in
January 2000, was acquired by Goto.com. As a result, the Company's Cadabra
shares were converted into 554,093 preferred shares of Goto.com, and the Company
received $1.2 million in cash. In February 2000, the Company sold the majority
of its Goto.com shares for a net realized gain of approximately $28.6 million.
At March 31, 2000, the Company still holds 109,093 Goto.com shares
7. NETWORK ASSOCIATES KK
Network Associates sells its product suites in Japan through our Japanese
subsidiary, Network Associates KK. Network Associates KK negotiated an agreement
with McAfee.com to act as its Japanese distributor. On February 4, 2000, we
realized a gain of $11.9 million on the sale of less than five percent of our
shares in Network Associates KK to strategic business partners in Japan.
8. PURCHASE OF SIGNAL 9
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 3 years.
9. 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, license, contract law,
distribution arrangements, and employee arrangement matters.
9
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Securities Cases
Knisley v. Network Associates. 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 a 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. The defendants' motion to
dismiss must be filed on or before June 7, 2000.
Dow Jones Investment Club v. Networks Associates. 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 will demur 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.
Ong, et al. v. CyberMedia, et al. On September 14, 1998, CyberMedia and
certain of its former officers and directors were named as defendants in a
consolidated amended securities class action complaint filed in the United
States District Court for the Central District of California. The consolidated
amended complaint consolidated the following previously filed cases: Ong v.
CyberMedia, Inc., et al., No. 98-1811 CBM (Ex), filed on March 12, 1998, St.
John v. CyberMedia, Inc., et al., No. 98-2085 MRP (SHx), filed on March 24,
1998, Zier v. CyberMedia, Inc., et al., No. 98-2210 CM (MCx), filed on March 26,
1998, Liu v. CyberMedia, Inc., et al., No. 98-2617, filed on April 8, 1998,
Kerr, et al. v. CyberMedia, Inc., et al., No. 98-3104 RJK (Anx), filed on April
23, 1998, and Barker v. CyberMedia, Inc., et al., No. SA CV98-401 AHS (ANx),
filed on May 6, 1998. Plaintiffs filed a second consolidated amended complaint
on March 8, 1999. It alleges that the defendants violated federal securities
laws by artificially inflating the price of CyberMedia stock to the detriment of
a purported class of investors who purchased or otherwise acquired CyberMedia
stock between March 31, 1997 and March 12, 1998. CyberMedia and certain of its
former officers and directors were also named as defendants in three securities
class action lawsuits filed in the Superior Court of Los Angeles County. Such
complaints have been ordered consolidated, although a consolidated amended
complaint has not yet been filed. The consolidated complaints include: Brown v.
CyberMedia, Inc., et al., No. B C187898, filed on March 19, 1998, Smith v.
CyberMedia, Inc., et al. No. B C188527, filed on March 31, 1998, and Stockwell
v. CyberMedia, Inc., et al., No. B C189020, filed on April 8, 1998. The
complaints allege that defendants violated California state securities laws and
common law by artificially inflating the price of CyberMedia stock to the
detriment of a purported class
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NETWORKS ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
of investors who purchased or otherwise acquired CyberMedia stock between March
31, 1997 and March 13, 1998. Network Associates has reached an agreement with
plaintiffs to settle the state and federal securities class actions. The
settlement provides for a payment of $11.5 million plus interest from
approximately May 6, 1999, $1.5 million (and interest on that amount) of which
is to be paid by Network Associates and the remainder of which is to be paid by
the Company's insurers. The parties memorialized the agreement in a Stipulation
of Settlement lodged with the District Court on November 12, 1999. The Court
preliminarily approved the settlement on December 15, 1999, and held a hearing
on March 27, 2000 on the issue of final approval. Consummation of the settlement
is contingent upon final judicial approval.
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 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 was postponed and is rescheduled for May 2000.
In May 2000, Trend and Network Associates settled their outstanding
litigation releasing their respective claims against the other based on past
alleged infringements. In connection therewith, the parties agreed to
cross-license their anti-virus patents.
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. Hilgraeve has filed an appeal from the judgment to the United
States Court of Appeals for the Federal Circuit. That appeal is pending.
10. SUBSEQUENT EVENTS
In May 2000, Trend and Network Associates settled their outstanding
litigation releasing their respective claims against the other based on past
alleged infringements. In connection therewith, the parties agreed to
cross-reference their anti-virus patents.
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<PAGE> 12
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. 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 Security Defense
(TSD) 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 product suites) previously existed, with
the reorganization we seek to better differentiate anti-virus from security and
availability from service desk.
For the three months ended March 31, 2000, our infrastructure segment
accounted for approximately $203.2 million in net revenue and a profit of $40.5
million.
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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<PAGE> 13
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, the Enterprise SecureCast, 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 and availability services hosted on its servers to
businesses via the Internet. myCIO's products and 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 and availability
applications. myCIO.com's hosted services are also designed to remove the burden
and cost of managing the software, while seeking to ensure continuous protection
against threats to a
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<PAGE> 14
company's e-business infrastructure. myCIO's products and services include Virus
Scan ASaP, CyberCop ASaP, and Firewall ASaP.
For the three months ended March 31, 2000, on a segment basis, myCIO.com
accounted for approximately $1.0 million in net revenue and a net loss of $4.8
million.
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 March 31, 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 months ended March 31, 2000, on a segment basis McAfee.com
accounted for approximately $10.3 million in net revenue and a net loss of $6.6
million.
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<PAGE> 15
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by certain items in our statements of operations for
the three months ended March 31, 2000 and 1999.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
---------------
2000 1999
----- -----
<S> <C> <C>
Net revenue:
Product................................................... 77.9% 73.7%
Services & support........................................ 22.1 26.3
---- ----
Total revenue..................................... 100 100
---- ----
Cost of revenue:
Product................................................... 11.1 11.0
Services & support........................................ 4.0 3.4
---- ----
Total cost of revenue............................. 15.0 14.4
---- ----
Gross profit................................................ 85.0 85.6
Operating expenses:
Research and development.................................. 19.2 14.3
Marketing and sales....................................... 44.8 38.2
General and administrative................................ 9.6 8.9
Amortization of intangibles and stock compensation charge... 7.5 6.2
---- ----
Total operating expenses.......................... 81.1 67.6
---- ----
Income from operations............................... 3.9 18.0
Interest and other income and expense, net................ 2.2 0.7
---- ----
Gain on sale of investments............................... 18.8 --
Minority interest in consolidated subsidiaries............ 0.5 --
---- ----
Income before provision for income taxes............. 25.4 18.7
Provision for income taxes.................................. 11.9 8.0
---- ----
Net income........................................... 13.5% 10.7%
==== ====
</TABLE>
Net Revenue. Net revenue decreased 13% to $214.5 million in the three
months ended March 31, 2000 from $245.2 million in the three months ended March
31, 1999, including a $6.8 million increase in revenue from McAfee.com. The
decrease in net revenue was a result of our decision in the second quarter of
1999 to further 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.
Product revenue decreased 8% to $167.0 million from $180.7 million in the
three months ended March 31, 2000 and 1999, respectively. 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 decreased 26% to $47.5 million from $64.5
million in the three months ended March 31, 2000 and 1999, respectively. The
decrease in product and services and support revenue was due to our decision
since the second quarter of 1999 to continue 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.
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.*
- ---------------
*This statement is a forward looking statement reflecting current
expectations. There can be no assurance that our actual performance will meet
our current expectations. See the risk factor on pae 19 for discussion of
certain factors that could affect future performance.
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<PAGE> 16
International revenue accounted for approximately 39% and 43% of net
revenue for the three months ended March 31, 2000 and 1999, respectively. We
expect that international revenue will continue to account for a significant
percentage of net revenue.* We also expect that a significant portion of such
international revenue will be denominated in local currencies.* To minimize the
impact of foreign currency fluctuations, we use non-leveraged forward currency
contracts. However, our future results of operations may be adversely affected
by currency fluctuations or by costs associated with currency risk management
strategies. Other risks inherent in international revenue generally include the
impact of longer payment cycles, greater difficulty in accounts receivable
collection, unexpected changes in regulatory requirements, seasonality due to
the slowdown in European business activity during the third quarter, tariffs and
other trade barriers, uncertainties relative to regional economic circumstance,
political instability in emerging markets and difficulties staffing and managing
foreign operations. These factors may have a material adverse effect on our
future international license revenue. Further, in countries with a high
incidence of software piracy, we may experience a higher rate of piracy of our
products.
Cost of Net Revenue. Cost of net revenue decreased 9% to $32.2 million from
$35.2 million in the three months ended March 31, 2000 and 1999, respectively.
The decrease in cost of net revenue was primarily due to the decrease 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 decreased 12% to $23.7
million from $27.1 million in the three months ended March 31, 2000 and 1999,
respectively. The decrease in cost of product revenue was primarily due to a
corresponding decrease in product revenue.
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 increased 4% to $8.5 million from
$8.2 million in the three months ended March 31, 2000 and 1999, respectively.
The increase in cost of services and support revenue was primarily due to
increased technical support staff.
Research and Development. Research and development expenses consist
primarily of salary and benefits for our development and technical support
staff. Research and development expenses increased 17% to $41.2 million from
$35.1 million in the three months ended March 31, 2000 and 1999, respectively.
Research and development expenses increased due to the increase in staffing,
quality assurance programs and equipment expense to support growth in our
product and service offerings. We anticipate that research and development
expenses will continue to increase in absolute dollars, but may fluctuate as a
percentage of net revenue.*
We believe that our ability to maintain our competitiveness will depend in
large part upon our ability to enhance existing products, develop and acquire
new products and develop and integrate acquired products. The market for
computer software is characterized by low barriers to entry and rapid
technological change, and is highly competitive with respect to timely product
introductions. The timing and amount of research and development expenses may
vary significantly based upon the number of new products and significant
upgrades under development and products acquired during a given period.
Marketing and Sales. Marketing and sales expenses consist primarily of
salary, commissions and benefits for marketing, sales and customer support
personnel and costs associated with advertising and promotions. Marketing and
sales expenses increased 3% to $96.0 million from $93.7 million in the three
months ended March 31, 2000 and 1999, respectively. The increase was primarily
due to hiring and training of our sales force, advertising as well as a
significant investment in marketing and promotions by McAfee.com to build
strategic relationships with a variety of Internet companies. We anticipate that
marketing and sales expenses will continue to increase in absolute dollars, but
may fluctuate as a percentage of net revenue.*
- ---------------
*This statement is a forward looking statement reflecting current
expectations. There can be no assurance that our actual performance will meet
our current expectations. See the risk factor on page 19 for discussion of
certain factors that could affect future performance.
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<PAGE> 17
General and Administrative. General and administrative expenses consist
principally of salary and benefit costs for administrative personnel and general
operating costs. General and administrative expenses decreased 6% to $20.5
million from $21.8 million in the three months ended March 31, 2000 and 1999,
respectively, due to continued development of our E-commerce business systems
and expansion of our IT infrastructure, which were offset by a decrease in
general operating costs.
Amortization of Intangibles and Stock Compensation Charges. We expensed
$16.0 million and $15.1 million of amortization related to intangibles and stock
compensation charges in the three months ended March 31, 2000 and 1999,
respectively. Intangibles consist of purchased goodwill and certain technology
acquired through acquisitions. Stock compensation charges relate to the
repricing of employee stock options. In the future, we expect to incur
significant stock based compensation charges related to repriced employee stock
options.
Interest and Other Income and Expense, net. Interest and other income and
expense increased to $4.6 million from $1.6 million in the three months ended
March 31, 2000 and 1999, respectively. The increase was primarily due to an
increase in interest income as a result of higher cash balances.
Gain on Sale of Investments. In the three months ended March 31, 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 months ended
March 31, 2000, minority interest from consolidated subsidiaries was $1.1
million.
Provision for Income Taxes. Our provision for income taxes of $25.6 million
for the three months ended March 31, 2000 and $19.6 million for the three months
ended March 31, 1999 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 March 31, 2000, we had $369.3 million in cash and cash equivalents and
$461.2 million in marketable securities, for a combined total of $830.5 million.
Net cash provided by operating activities was $21.7 million and $38.7
million in the three months ended March 31, 2000 and 1999, respectively. Net
cash provided by operating activities in the three months ended March 31, 2000,
consisted primarily of net income before depreciation and amortization, bad debt
expense, stock compensation charge, interest on the Debentures, gain on sale of
venture and strategic investments, and deferred taxes. In addition net cash
provided by operating activities in the three months ended March 31, 2000,
consisted primarily of an decrease in accounts receivable, an increase in
accounts payable, accrued liabilities and deferred revenue which was offset by
an increase in prepaid expenses, taxes and other assets. Net cash provided by
operating activities in the three months ended March 31, 1999, consisted
primarily of net income before depreciation and amortization, plus an increase
in accounts payable and a decrease in prepaid expenses, income taxes and other
current assets, which were partially offset by an increase in accounts
receivable.
Our accounts receivable balance as a percentage of quarterly net revenue
decreased from December 31, 1999. Our accounts receivable balance as a
percentage of sales may in the future increase due to our increased emphasis on
server/enterprise based sales. In addition, indirect sales through VARs,
distributors and system integrators and expanding international sales, which
typically have longer payment terms, may cause our accounts receivable balance
as a percentage of sales to increase in the future. To address this increase in
accounts receivable and to improve cash flow, we may from time to time take
actions to encourage earlier
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<PAGE> 18
payment of receivables and sell receivables. To the extent that our accounts
receivable balance increases, we will be subject to greater general credit risks
with respect thereto.*
Net cash provided by investing activities was $41.7 million in the three
months ended March 31, 2000, primarily reflecting sales of marketable
securities, and proceeds from sales of venture and strategic investments offset
by additions in fixed assets. On our venture and strategic investments, we
obtained proceeds of $36.8 million and $11.9 million on the sale of Goto.com
shares and the sale of less than 5% of the shares in our Japanese subsidiary,
Network Associates, KK, respectively. Net cash used in investing activities was
$103.6 million in the three months ended March 31, 1999 consisting primarily of
the purchase of marketable securities and additions to fixed assets.
Net cash used in financing activities was $8.9 million in the three months
ended March 31, 2000, consisting primarily of the proceeds associated with the
exercise of non qualified stock options and sale of put options, which was
offset by repurchase of our common stock. Net cash provided by financing
activities was $16.6 million in the three months ended March 31, 1999,
consisting 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
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 a 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 19 for discussion of
certain factors that could affect future performance.
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<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;
- 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;
- our investment experience related to our strategic minority equity
investments;
- 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 employee's
increases; and
- costs related to extraordinary events including litigation and
acquisitions.
Our business is impacted by the seasonal trends and global or regional
macroeconomic trends. For example, our net 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 Security Defense
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<PAGE> 20
(TSD) 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
customer's 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 services 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:
- 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 services 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. Over the last two
years, 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.
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OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE
During the first quarter of 2000, our stock price ranged from a per-share
high of $36.69 to a low of $23.31. 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 9, 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.
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 months ended March 31, 2000 was approximately $1.6 million, and
approximately $9.8 million will be expensed over the remaining vesting period of
the repriced options.
On March 31, 1999, the FASB issued an exposure draft of its Proposed
Interpretation, "Accounting for Certain Transactions involving Stock
Compensation -- an interpretation of APB Opinion No. 25" (the "Proposed
Interpretation"). Under the Proposed Interpretation, stock options repriced
after December 15, 1998 will be subject to variable plan accounting treatment.
If adopted, this proposed guidance will require us to remeasure compensation
cost for outstanding repriced options each reporting period based on changes in
the market value of the underlying common stock after the date of adoption. The
FASB currently expects to approve the interpretation in the second quarter of
year 2000. Depending upon movements in the market value of our common stock,
this accounting treatment may result in significant additional compensation
charges in future periods.
EMPLOYEES MAY LEAVE AFTER THE 12-MONTH LOCK UP PERIOD ON THE EXERCISE OF
REPRICED EMPLOYEES OPTIONS
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. After April 22, 2000, the end of this 12-month lock-up period, employees
may elect to terminate their employment with us and exercise and sell some or
all of
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their repriced vested options. 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.
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;
- 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 $4.6 million. Since inception we have made
investments totaling $20.4 million and $16.7 million as of March 31, 2000 and
the minority venture investments we continue to hold totaled $16.7 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.
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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.
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 competitors;
- 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
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profit margins of myCIO.com's products are less than the prices and profit
margins of comparable products offered by our product groups.
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 March 31, 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 March 31, 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;
- 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 9 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.
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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 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 product focused
selling their specific product suites. McAfee.com and myCIO.com are both product
and customer 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. 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.
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OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISKS
ASSOCIATED WITH PRODUCT DEVELOPMENT
The network security and management market is highly fragmented and
characterized by ongoing technological developments, evolving industry standards
and rapid changes in customer requirements. Our success will depend on our
ability to:
- offer a broad range of network security and management software products;
- continue to enhance existing products and expand product offerings;
- develop and introduce in a timely manner new products with technological
advances;
- respond promptly to new customer requirements;
- comply with evolving industry standards without delays in compliance;
- provide upgrades and updates to users frequently and at low cost; and
- remain compatible with popular operating systems such as Windows 98,
Windows 2000, Windows NT and NetWare.
We may not be able to successfully develop and market, on a timely basis,
enhancements to our existing products or new products. Our product enhancements
or new products may not adequately address the changing needs of the
marketplace. New products with new technological capabilities could replace or
shorten the life cycle of our products or cause our customers to defer or cancel
purchases of our products.
We may continue to experience delays in software development as we have at
times in the past. Complex software products like ours may contain undetected
errors or version compatibility problems, particularly when first released,
which could delay or cost us our market acceptance. For example, our anti-virus
software products have in the past falsely detected viruses that did not
actually exist. Difficulties and delays associated with new product
introductions, performance or enhancements could have a material adverse effect
on our business, financial condition and results of operation.
Our product development efforts are impacted by the adoption or evolution
of industry standards. For example, no uniform industry standard has developed
in the market for encryption security products. As industry standards are
adopted or evolve, we may have to modify existing products or develop and
support new versions of existing products. In addition, if no industry standard
develops, our products and our competitors' products could be incompatible,
which could prevent or delay overall development of the market for a particular
product. If our products fail to comply with existing or evolving industry
standards in a timely fashion, our business, results of operation and financial
condition could be materially and adversely affected.
Our long-term success depends on our ability to upgrade and update existing
product offerings, modify and enhance acquired products and introduce new
products, which meet our customers' needs. Future upgrades and updates may
include additional functionality, respond to user problems or address
compatibility problems with changing operating systems and environments. We
believe that our ability to provide these upgrades and updates frequently and at
low costs is key to our success. For example, the proliferation of new and
changing viruses makes it imperative to update anti-virus products frequently to
avoid obsolescence. Failure to release upgrades and updates could have a
material adverse effect on our business, results of operations and financial
condition. We may not be successful in these efforts. In addition, future
changes in Windows 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.
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WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenues from our
flagship McAfee anti-virus software products and Sniffer network fault and
performance management products. These products are expected to continue to
account for a significant portion of our net revenues for the foreseeable
future. Because of this concentration of revenue, a decline in demand for or in
the prices of these products as a result of competition, technological change, a
change in our pricing model, inclusion of anti-virus or network management and
analysis software as a standard part of hardware or operating system software or
other software, or a maturation in the markets for these products, could harm
our business.
IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE
ANTICIPATE, OUR BUSINESS COULD SUFFER
The markets for our network management and network security products are
evolving, and their growth depends upon broader market acceptance of this
software, including help desk software. Although the number of 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;
- 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
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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. 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. 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 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
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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
services capabilities and increasingly on outside professional service
providers, including our distributors, resellers and system integrators. These
third party service providers may provide inadequate levels of professional
services. Moreover, reliance on these third parties both places a greater burden
on them and reduces our ability to control and establish standards for providing
these support services. Our reliance on these third parties could, delay our
recognition of product revenue, harm our relationships or reputation with these
third parties or the end users of our products or result in decreased future
sales of, or prices for, our products.
The failure to develop and maintain an effective professional services
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
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these efforts. Effectively expanding and developing our professional services
organization will require that we hire and train more service professionals who
must be continually trained and educated to ensure that they possess sufficient
technical skills and product knowledge. The market for qualified professionals
is intensely competitive, making hiring and retention difficult. We expect
significant competition in this market from existing providers of professional
services and future entrants. We must also properly price our services to
attract customers, while maintaining sufficient margins for these services. We
therefore expect that we will have lower profit margins on our service revenues.
In addition, in January 2000, we reorganized our U.S. professional services
organization, in part, to enable the professional services 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
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<PAGE> 31
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. 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 separate patent infringement cases involving
Hilgraeve and Trend Micro. See Note 9, 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 litigations 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 three months ended March 31, 2000 and for 1999 net revenue from
international sales represented approximately 39% and 43%, 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
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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.
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.
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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.
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.
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WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING
We are currently engaged in several research and development contracts with
agencies of the U.S. government. We believe that the willingness of these
government agencies to enter into future contracts with us will in part be
dependent upon our continued ability to meet their expectations.
Minimum fee awards for companies entering into government contracts are
generally between 3% and 7% of the costs incurred by them in performing their
duties under the related contract. However, these fee awards may be as low as 1%
of the contract costs. Furthermore, these contracts are subject to cancellation
at the convenience of the governmental agencies. Although we have been awarded
contract fees of more than 1% of the contract costs in the past, minimum fee
awards or cancellations may occur in the future. Reductions or delays in federal
funds available for projects we are performing could also have an adverse impact
on our government business. Contracts involving the U.S. government are also
subject to the risks of disallowance of costs upon audit, changes in government
procurement policies, required competitive bidding and, with respect to
contracts involving prime contractors or government-designated subcontractors,
the inability of those parties to perform under their contracts. Any of the
foregoing events could adversely affect our results of operations or financial
conditions.
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.
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
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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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PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
Information with respect to this item is incorporated by reference to Note
10 of the Notes to the Consolidated Financial Statements included herein on page
9 of this Report on Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits. The exhibits listed in the accompanying Exhibit Index are
filed or incorporated by reference as part of this Report.
(b) No reports on Form 8-K were filed during the quarter.
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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: May 15, 2000
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EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT TITLE NUMBER
- ------- ------------- ------
<C> <S> <C>
2.1 Agreement and Plan of Reorganization, dated October 13,
1997, among McAfee Associates, Inc., Mystery Acquisition
Corp. and Network General Corporation, as amended by the
First Amendment dated as of October 22, 1997.(1)............
2.2 Combination Agreement dated August 16, 1996 among the
Registrant, FSA Combination Corp., FSA Corporation and
Daniel Freedman.(2).........................................
2.3 Stock Exchange Agreement dated January 13, 1996 among the
Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and
the shareholders of Jade.(3)................................
2.4 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, Helix Software Company an DNA
Acquisition Corp.(4)........................................
2.5 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, PGP and PG Acquisition Corp.(5).....
2.6 Agreement and Plan of Reorganization dated February 22,
1998, between the Registrant, TIS and Thor Acquisition
Corp.(6)....................................................
2.7 Agreement and Plan of Reorganization by and among the
Registrant, Magic Solutions International, Inc., Merlin
Acquisition Corp. and Igal Lichtman, Amendment Agreement by
and among the Registrant, Magic Solutions International,
Inc., Merlin Acquisition Corp., and Igal Lichtman dated
March 24, 1998. Second Amendment Agreement by and among the
Registrant, Magic Solutions International, Inc., Merlin
Acquisition Corp., and Igal Lichtman dated April 1,
1998.(7)....................................................
2.8 Stock Purchase Agreement, dated as of February 26, 1998, by
and between FSA Combination Corp., and Brenda Joyce
Cook.(8)....................................................
2.9 Share Purchase Agreement, dated as of March 30, 1998, among
FSA Combination Corp., and Irina Karlsson and Jarmo
Rouvinen.(8)................................................
2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA
Combination Corp., and Secure Networks, Inc.(8).............
2.11 Transaction Agreement, dated June 9, 1998, by and between
the Registrant and Dr. Solomon's Group Plc.(21).............
2.12 Agreement and Plan of Merger, dated July 28, 1998, by and
between the Registrant and CyberMedia, Inc.(22).............
3.1 Second Restated Certificate of Incorporation of Networks
Associates, Inc., as amended on December 1, 1997.(6)........
3.2 Restated Bylaws of Networks Associates, Inc.(6).............
3.3 Certificate of Designation of Series A Preferred Stock of
Networks Associates, Inc.(9)................................
3.4 Certificate of Designation of Series B Participating
Preferred Stock of the Registrant.(23)......................
4.2 Registration Rights Agreement dated August 30, 1996 between
the Registrant and Daniel Freedman.(1)......................
4.5 Registration Rights Agreement dated December 9, 1997 between
the Registrant and certain shareholders of PGP.(4)..........
4.6 Registration Rights Agreement, dated as of February 13,
1998, by and between the Registrant and Morgan Stanley & Co.
Incorporated.(10)...........................................
4.7 Indenture dated as of February 13, 1998 between the
Registrant and State Street Bank and Trust Company of
California, N.A., as Trustee.(10)...........................
4.10 Registration Rights Agreement dated May 8, 1998, by and
between the Registrant and the stockholders of Secure
Networks, Inc.(8)...........................................
</TABLE>
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<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT TITLE NUMBER
- ------- ------------- ------
<C> <S> <C>
4.11 Registration Rights Agreement, dated June 29, 1998, by and
between the Registrant and certain stockholders of CSB
Consulenza Software di Base S.r.l. ("CSB").(11).............
4.12 Registration Rights Agreement, dated July 30, 1998, by and
between the Registrant and certain stockholders of Anyware
Seguridad Informatica S.A.(11)..............................
4.13 Registration Rights Agreement, dated August 31, 1998, by and
between the Registrant and certain stockholders of QA
Information Security Holding AB(24).........................
10.1 Standard Business Lease (Net) for Network General's
principal facility dated June 19, 1991, between Network
General and Menlo Oaks Partners, L.P.(12)...................
10.2 First Amendment to Lease dated June 10, 1992, between
Network General and Menlo Parks Partners, L.P.(12)..........
10.3 Standard Business Lease (Net) for Network General's
principal facility dated March 11, 1992, between Network
General and Menlo Oaks Partners L.P.(13)....................
10.4 First Amendment to Lease dated June 18, 1992, between
Network General and Menlo Oaks Partners, L.P.(12)...........
10.5 Lease dated March 31, 1992, between Network General and
Equitable Life Assurance Society of the United
States.(12).................................................
10.6 Second Amendment to Lease dated February 1, 1995, between
Network General and Menlo Oaks Partners, L.P.(13)...........
10.7 Third amendment to Lease dated February 1, 1995 between
Network General and Menlo Oaks Partners L.P.(13)............
10.8 Fourth Amendment to Lease dated May 31, 1995, between
Network General and Menlo Oaks Partners, L.P.(14)...........
10.9 Fifth Amendment to Lease dated June 13, 1995, between
Network General and Menlo Oaks Partners, L.P.(14)...........
10.10 Lease dated July 3, 1996 between Network General and
Campbell Avenue Associates.(15).............................
10.11 Sixth Amendment to Lease dated November 29, 1996, between
Network General and Menlo Oaks Partners, L.P.(15)...........
10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa
Clara, California, dated as of February 20, 1997, by and
between McAfee Associates, Inc. and National Semiconductor
Corporation.(16)............................................
10.13 Lease Agreement dated November 17, 1997 for facility at 3965
Freedom Circle, Santa Clara, California by and between
Informix Corporation and McAfee Associates, Inc.(4).........
10.14 Consent to Assignment Agreement dated December 19, 1997 by
and among Birk S. McCandless, LLC, Guaranty Federal Bank,
F.S.B., Informix Corporation and Networks Associates,
Inc.(4).....................................................
10.15 Subordination, Nondisturbance and Attornment Agreement dated
December 18, 1997, between Guaranty Federal Bank, F.S.B.,
Networks Associates, Inc. and Birk S. McCandless, LLC.(4)...
10.16 Lease dated November 22, 1996 by and between Birk S.
McCandless, LLC and Informix Corporation for facility at
3965 Freedom Circle, Santa Clara, California.(4)............
10.17 Quota Purchase Agreement, dated as of April 14, 1997 by and
among McAfee Associates, Inc. and McAfee Do Brasil Ltda.,
Compusul-Consultoria E Comercio De Informatica Ltda., and
the stockholders of Compusul-Consultoria E Comercio De
Informatica Ltda.(17).......................................
10.18* 1997 Stock Incentive Plan.(17)..............................
10.19* Stock Option Plan for Outside Directors(18).................
</TABLE>
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<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER EXHIBIT TITLE NUMBER
- ------- ------------- ------
<C> <S> <C>
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.....................................
</TABLE>
- ---------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on October 31, 1997.
(2) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on September 24, 1996.
(3) Incorporated by reference from the Registrants Current Report on Form 8-K
filed with the Commission on March 14, 1997.
(4) Incorporated by reference from the Registrant's Registration Statement on
Form S-3, filed with the Commission on February 12, 1998.
(5) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on December 11, 1997.
(6) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on March 25, 1998.
(7) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on April 2, 1998.
(8) Incorporated by reference from the Registrant's Registration Statement on
Form S-3 filed with the Commission on May 26, 1998.
40
<PAGE> 41
(9) Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended September 30, 1996, filed with the Commission on November 4,
1997.
(10) Incorporated by reference from the Registrant's Registration Statement on
Form S-3 filed with the Commission on May 6, 1998.
(11) Incorporated by reference from the Registrant's Registration Statement on
Form S-3 filed with the Commission on August 5, 1998.
(12) Incorporated by reference from the Network General Corporation's Report on
Form 10-K for the year ended March 31, 1992. Network General's filings with
the Commission were made under File Number 0-17431.
(13) Incorporated by reference from the Network General Corporation's Report on
Form 10-Q for the quarter ended December 31, 1994. Network General's
filings with the Commission were made under File Number 0-17431.
(14) Incorporated by reference from the Network General Corporation's Report on
Form 10-Q for the quarter ended June 30, 1995. Network General's filings
with the Commission were made under File Number 0-17431.
(15) Incorporated by reference from the Network General Corporation's Report on
Form 10-Q for the quarter ended June 30, 1996. Network General's filings
with the Commission were made under File Number 0-17431.
(16) Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended June 30, 1997, filed with the Commission on August 14, 1997.
(17) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on July 31, 1995.
(18) Incorporated by reference from the Registrant's Report on Form S-8 filed
with the Commission on December 2, 1997.
(19) Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended June 30, 1996, filed with the Commission on August 13, 1996.
(20) Incorporated by reference from the Registrant's Report on Form 10-Q for the
quarter ended March 31, 1998, filed with the Commission on May 15, 1998.
(21) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on June 16, 1998.
(22) Incorporated by reference from CyberMedia Inc.'s Schedule 13D filed by the
Registrant with the Commission on August 7, 1998. CyberMedia Inc.'s filings
with the Commission were made under File Number 0-21289.
(23) Incorporated by reference from the Registrant's Report on Form 8-A filed
with the Commission on October 22, 1998.
(24) Incorporated by reference from the registrant's report on form 10-Q for the
quarter ended September 30, 1998, filed with the Commission on November 13,
1998.
(25) Incorporated by reference from the Registrant's report on Form 10-Q for the
quarter ended March 31, 1999, filed with the Commission on May 13, 1999.
(26) Incorporated by reference from the Form S-1 filed by McAfee.com Corporation
with the Commission on September 23, 1999, under File Number 333-87609.
(27) Incorporated by reference from the registrants' 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.
41
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