-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IXzGDCMAQGj+P1KE0omCKW7nu28z55nYuu/bubiY1nm4NR8JU+S3liN1RaqkyJvP W96J/owpHxYfOYx7UVRd+g== 0000891618-99-001588.txt : 19990416 0000891618-99-001588.hdr.sgml : 19990416 ACCESSION NUMBER: 0000891618-99-001588 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19990415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NETWORKS ASSOCIATES INC/ CENTRAL INDEX KEY: 0000890801 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 770316593 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-20558 FILM NUMBER: 99594994 BUSINESS ADDRESS: STREET 1: 3963 FREEDOM CIRCLE CITY: SANTA CLARA STATE: CA ZIP: 95054 BUSINESS PHONE: 4083463832 MAIL ADDRESS: STREET 1: 3963 FREEDOM CIRCLE CITY: SANTA CLARA STATE: CA ZIP: 95054 FORMER COMPANY: FORMER CONFORMED NAME: MCAFEE ASSOCIATES INC DATE OF NAME CHANGE: 19930328 10-Q/A 1 QUARTERLY REPORT FOR THE PERIOD ENDED 03/31/1998 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON DC 20549 FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____________ TO _____________ Commission file number 0-20558 NETWORKS ASSOCIATES, INC. (Exact name of registrant as specified in its charter) Delaware 77-0316593 (State of incorporation) (IRS Employer Identification Number) 3965 Freedom Circle Santa Clara, California 95054 (408) 988-3832 (Address and telephone number of principal executive offices) 2805 Bowers Avenue Santa Clara, California 95054 (408) 988 3832 (Former address, if changed since last report) 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 [ ] 114,732,687 shares of the registrant's common stock, $0.01 par value, were outstanding as of April 30, 1998 (after giving effect to a 3:2 stock split to be effected by a stock dividend payable on or about May 20, 1998) THIS DOCUMENT CONTAINS 52 PAGES. THE EXHIBIT INDEX IS ON PAGE 48. 2 NETWORKS ASSOCIATES, INC. FORM 10-Q/A, March 31, 1998 C O N T E N T S
Item Number Page - ----------- ---- PART I: FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets: March 31, 1998 and December 31, 1997............................................3 Condensed Consolidated Statements of Income: Three months ended March 31, 1998 and 1997......................................4 Condensed Consolidated Statements of Cash Flows: Three months ended March 31, 1998 and 1997 .....................................5 Notes to Condensed Consolidated Financial Statements..............................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................19 PART II: OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K...................................................46 SIGNATURES ...................................................................................47 EXHIBIT INDEX ................................................................................48
2 3 NETWORKS ASSOCIATES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
ASSETS (AS RESTATED NOTE 2.) March 31, December 31, 1998 1997 ---------- ---------- (Unaudited) Current assets: Cash and cash equivalents $ 190,983 $ 124,288 Marketable securities 436,474 124,012 Accounts receivable, net of allowances for doubtful accounts and returns of $4,129 and $3,662 at March 31, 1998 and December 31, 1997 132,633 115,388 Prepaid expenses, taxes and other 72,506 58,945 ---------- ---------- Total current assets 832,596 422,633 Marketable securities 155,001 109,184 Fixed assets, net 37,241 28,684 Deferred taxes 12,633 16,173 Intangibles and other assets 62,277 66,446 ---------- ---------- Total assets $1,099,748 $ 643,120 ========== ========== LIABILITIES Current liabilities: Accounts payable $ 22,682 $ 18,879 Accrued liabilities 118,231 125,888 Deferred revenue 77,420 69,464 ---------- ---------- Total current liabilities 218,333 214,231 Deferred revenue and taxes, less current portion 14,512 13,186 Long term debt and other liabilities 354,663 -- ---------- ---------- Total liabilities 587,508 227,417 ---------- ---------- STOCKHOLDERS' EQUITY Preferred stock, $.01 par value; authorized: 5,000,000 shares Common stock, $.01 par value; authorized: 300,000,000 shares; issued and outstanding: 107,504,225 shares at March 31, 1998 and 104,913,063 shares at December 31, 1997 1,075 1,049 Additional paid-in capital 253,396 190,659 Retained earnings 257,769 223,995 ---------- ---------- Total stockholders' equity 512,240 415,703 ---------- ---------- Total liabilities and stockholders' equity $1,099,748 $ 643,120 ========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 NETWORKS ASSOCIATES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (in thousands, except per share data)
(AS RESTATED NOTE 2.) Three Months Ended March 31, ------------------------- 1998 1997 -------- -------- Net revenue $188,415 $143,471 Operating costs and expenses: Cost of net revenue 34,163 25,928 Research and development 25,525 18,125 Marketing and sales 63,309 41,169 General and administrative 11,172 9,886 Amortization of intangibles 4,158 1,354 Acquisition and other related costs -- 19,504 -------- -------- Total operating costs and expenses 138,327 115,966 -------- -------- Income from operations 50,088 27,505 Interest and other income and expense, net 4,765 2,907 -------- -------- Income before provision for income taxes 54,853 30,412 Provision for income taxes 20,959 18,053 -------- -------- Net income $ 33,894 $ 12,359 ======== ======== Net income per share - basic $ 0.32 $ 0.12 -------- -------- Shares used in per share calculation - basic 106,952 102,032 ======== ======== Net income per share - diluted $ 0.30 $ 0.11 ======== ======== Shares used in per share calculation - diluted 112,304 109,481 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 5 NETWORKS ASSOCIATES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands)
(AS RESTATED NOTE 2.) Three Months Ended March 31, ---------------------------- 1998 1997 --------- --------- Cash flows from operating activities: Net income $ 33,894 $ 12,359 Adjustments to reconcile net income to net cash provided from operating activities: Acquired in-process research and development -- 19,504 Depreciation and amortization 7,872 5,854 Interest on convertible notes 2,498 -- Unrealized gain/loss on investments 1,252 (242) Deferred taxes 3,540 (3,307) Changes in assets and liabilities: Accounts receivable (17,245) (11,187) Prepaid expenses, taxes and other (4,890) 4,165 Accounts payable and accrued liabilities 2,027 4,425 Deferred revenue 9,282 8,604 Other -- (197) --------- --------- Net cash provided by operating activities 38,230 39,978 --------- --------- Cash flows from investing activities: Purchase of intangibles -- (9) Purchases of investment securities, net (358,279) (17,587) Additions to fixed assets (12,202) (9,740) --------- --------- Net cash used in investing activities (370,481) (27,336) --------- --------- Cash flows from financing activities: Effect of exchange rate fluctuations (2,920) (250) Sale of convertible debentures 337,624 -- Stock option exercises 43,244 14,839 Tax benefit from exercise of nonqualified stock options 20,998 13,825 Repurchase of common stock -- (16,378) --------- --------- Net cash provided by financing activities 398,946 12,036 --------- --------- Net increase in cash and cash equivalents 66,695 24,678 Cash and cash equivalents at beginning of period 124,288 121,365 --------- --------- Cash and cash equivalents at end of period $ 190,983 $ 146,043 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 6 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation: During the three months ended March 31, 1998, the Company completed the acquisitions of Syscon (Proprietary) Limited ("Syscon") and Nordic Lantools OY and Nordic Lantools AB (together "Nordic"). All of these acquisitions were accounted for under the pooling of interests method of accounting. Financial data of the Company has been restated to reflect these acquisitions for all periods presented. The unaudited consolidated financial statements have been prepared by the Company without audit in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments, consisting only of normal recurring adjustments considered necessary for a fair presentation, have been included. The results of operations for the three months ended March 31, 1998 are not necessarily indicative of the results to be expected for the full year or for any future periods. 2. Restatement After discussions with the Staff of the Securities and Exchange Commission (the "SEC"), the Company has restated the accompanying consolidated financial statements as of March 31, 1998 and for the three months ended March 31, 1998. The financial statements have been restated to reflect a change in the purchase price allocation and related amortization of intangibles for acquisitions accounted for by the purchase method of accounting in 1997 (Cinco Networks, Inc., and Pretty Good Privacy, Inc), as well as two smaller acquisitions in 1995 and 1996 (AIM Technology and Vycor Corporation, respectively). The Company has also revised the original accounting for several previously reported small acquisitions accounted for under the poolings of interests method of accounting and for certain other adjustments to the acquisition and related costs charge taken in the fourth quarter of 1997. The following schedules summarize these restatements. 6 7 NETWORKS ASSOCIATES, INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS MARCH 31, 1998 -------------------------------------------------- AS PREVIOUSLY REPORTED OTHER AS RESTATED ---------- ---------- ---------- Current assets: Cash and cash equivalents ........................... $ 190,983 $ -- $ 190,983 Short term marketable securities .................... 436,474 -- 436,474 Accounts receivable, net of allowance for doubtful accounts of $4,129 ................... 139,624 (6,991) 132,633 Prepaid expenses, taxes and other current assets .... 74,555 (2,049) 72,506 ---------- ---------- ---------- Total current assets ........................ 841,636 (9,040) 832,596 Long term marketable securities ....................... 155,001 -- 155,001 Fixed assets, net ..................................... 37,241 -- 37,241 Deferred taxes ........................................ 12,633 -- 12,633 Intangible and other assets ........................... 16,925 45,352 62,277 ---------- ---------- ---------- Total assets ................................ $1,063,436 $ 36,312 $1,099,748 ========== ========== ========== LIABILITIES Current liabilities: Accounts payable .................................... $ 22,682 $ -- 22,682 Accrued liabilities ................................. 129,374 (11,143) 118,231 Deferred revenue .................................... 77,420 -- 77,420 ---------- ---------- ---------- Total current liabilities ................... 229,476 (11,143) 218,333 Deferred revenue and taxes less current portion ..... 14,512 -- 14,512 Long term debt and other liabilities ................ 354,663 -- 354,663 ---------- ---------- ---------- Total liabilities 598,651 (11,143) 587,508 STOCKHOLDERS' EQUITY Preferred stock, $.01 par value: Authorized: 5,000,000 shares; Issued and outstanding: one share Common stock, $.01 par value: Authorized: 300,000,000 shares; Issued and outstanding: 107,504,225 shares .......... 1,075 -- 1,075 Additional paid-in capital ............................ 253,396 -- 253,396 Retained earnings ..................................... 210,314 47,455 257,769 ---------- ---------- ---------- Total stockholders' equity .................. 464,785 47,455 512,240 ---------- ---------- ---------- Total liabilities and stockholders' equity .. $1,063,436 $ 36,312 $1,099,748 ========== ========== ==========
7 8 NETWORKS ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED MARCH 31, 1998 ---------------------------------------------- AS PREVIOUSLY REPORTED OTHER AS RESTATED -------------- -------- ----------- Net revenue ................................................... $188,415 $ -- $188,415 Operating costs and expenses: Cost of net revenue ......................................... 34,163 -- 34,163 Research and development .................................... 25,525 -- 25,525 Marketing and sales ......................................... 56,556 6,753 63,309 General and administrative .................................. 11,172 -- 11,172 Amortization of intangibles ................................. 792 3,366 4,158 Acquisition and other related costs ......................... -- -- -------- -------- -------- Total operating costs and expenses . ................... 128,208 10,119 138,327 -------- -------- -------- Income from operations .............................. 60,207 (10,119) 50,088 Interest and other income, net ................................ 4,765 4,765 -------- -------- -------- Income before provision for income taxes .................................................. 64,972 (10,119) 54,853 Provision for income taxes .................................... 23,390 (2,431) 20,959 -------- -------- -------- Net income (loss) ................................... $ 41,582 $ (7,688) $ 33,894 ======== ======== ======== Net income (loss) per share - basic ........................... $ 0.39 $ 0.32 ======== ======== Shares used in per share calculation - basic .................. 106,952 106,952 ======== ======== Net income (loss) per share - diluted ........................ $ 0.37 $ 0.30 ======== ======== Shares used in per share calculation - diluted ................ 116,084 112,304 ======== ========
8 9 NETWORKS ASSOCIATES, INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
DECEMBER 31, 1997 -------------------------------------------------------------- RESTATEMENT AS PREVIOUSLY FOR POOLING REPORTED TRANSACTIONS OTHER AS RESTATED -------- -------- -------- -------- Current assets: Cash and cash equivalents ............................. $123,494 $ 794 $ -- $124,288 Short term marketable securities ...................... 123,882 130 -- 124,012 Accounts receivable, net of allowance for doubtful accounts of $3,662 ..................... 125,284 404 (10,300) 115,388 Prepaid expenses, taxes and other current assets .......................................... 57,612 8 1,325 58,945 -------- -------- -------- -------- Total current assets .......................... 430,272 1,336 (8,975) 422,633 Long term marketable securities ......................... 109,184 -- -- 109,184 Fixed assets, net ....................................... 28,570 114 -- 28,684 Deferred taxes .......................................... 16,173 -- -- 16,173 Intangible and other assets ............................. 17,732 -- 48,714 66,446 -------- -------- -------- -------- Total assets .................................. $601,931 $ 1,450 $ 39,739 $643,120 ======== ======== ======== ======== LIABILITIES Current liabilities: Accounts payable ...................................... $ 18,439 $ 440 $ -- 18,879 Accrued liabilities ................................... 141,083 205 (15,400) 125,888 Deferred revenue ...................................... 69,464 -- -- 69,464 -------- -------- -------- -------- Total current liabilities ..................... 228,986 645 (15,400) 214,231 Deferred revenue and taxes, less current portion ...... 13,186 -- -- 13,186 -------- -------- -------- -------- Total liabilities ............................. 242,172 645 (15,400) 227,417 STOCKHOLDERS' EQUITY Preferred stock, $.01 par value: Authorized: 5,000,000 shares; Issued and outstanding: one share Common stock, $.01 par value: Authorized: 300,000,000 shares; Issued and outstanding: 104,913,063 shares ............ 1,049 -- -- 1,049 Additional paid-in capital .............................. 190,643 16 -- 190,659 Retained earnings ....................................... 168,067 789 55,139 223,995 -------- -------- -------- -------- Total stockholders' equity .................... 359,759 805 55,139 415,703 -------- -------- -------- -------- Total liabilities and stockholders' equity .... $601,931 $ 1,450 $ 39,739 $643,120 ======== ======== ======== ========
9 10 NETWORKS ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED MARCH 31, 1997 ----------------------------------------------------------------- RESTATEMENT AS PREVIOUSLY FOR POOLING REPORTED TRANSACTIONS OTHER AS RESTATED --------- --------- --------- --------- Net revenue ............................................. $ 141,362 2,109 -- $ 143,471 Operating costs and expenses: Cost of net revenue ................................... 25,514 414 -- 25,928 Research and development .............................. 17,908 217 -- 18,125 Marketing and sales ................................... 40,613 556 -- 41,169 General and administrative ............................ 9,534 352 -- 9,886 Amortization of intangibles ........................... 104 -- 1,250 1,354 Acquisition and other related costs ................... 19,504 -- -- 19,504 --------- --------- --------- --------- Total operating costs and expenses . ............. 113,177 1,539 1,250 115,966 --------- --------- --------- --------- Income from operations ........................ 28,185 570 (1,250) 27,505 Interest and other income, net .......................... 2,897 10 -- 2,907 --------- --------- --------- --------- Income before provision for income taxes ...... 31,082 580 (1,250) 30,412 Provision for income taxes .............................. 17,811 242 -- 18,053 --------- --------- --------- --------- Net income (loss) ............................. $ 13,271 $ 338 $ (1,250) $ 12,359 ========= ========= --------- --------- Net income (loss) per share - basic ..................... $ 0.13 $ 0.12 ========= ========= Shares used in per share calculation - basic............. 101,450 582 102,032 ========= ========= ========= Net income (loss) per share - diluted .................. $ 0.12 $ 0.11 ========= ========= Shares used in per share calculation - diluted .......... 108,899 582 109,481 ========= ========= =========
DESCRIPTION OF ADJUSTMENTS RESTATEMENT FOR POOLING TRANSACTIONS - NOT PREVIOUSLY RECORDED The above adjustments reflect the acquisitions of Syscon and Nordic (acquired in 1998) and Helix Software Company (acquired in December 1997), for all periods presented. The Company originally included the financial statements of the acquired entities only in the quarter in which they were acquired, with an adjustment to retained earnings for prior periods. At the request of the SEC, the Company has restated all periods to reflect the historical financial statements of all these acquisitions. RESTATEMENT FOR ACQUISITION AND OTHER RELATED COSTS: 10 11 In-process research and development charges: During 1997, the Company completed a number of acquisitions in transactions accounted for by the purchase method. Purchase price allocations performed at the time of these acquisitions resulted in substantial allocations to in-process research and development for projects underway by the acquired companies which had not reached technological feasibility and which had no alternative future use. These allocations were performed following methods generally in use by technology companies based on appraisals at the time. Recent guidance published by the SEC has resulted in a general re-evaluation of the methodology used in such appraisals. Following a review of its Form 10-K for the year ended December 31, 1997 by the SEC and subsequent discussions with the SEC, the Company has re-evaluated its allocations for purchase transactions in 1997. The restatements included above reflect the adjustments to the in-process research and development write-offs resulting from such re-evaluations as follows:
As Additional Originally As Amount Reported Restated Capitalized $'000 $'000 $'000 ------ ------- ---------- Cinco (acquired by Network General in 1997) 23,688 5,234 18,454 Pretty Good Privacy (acquired by Network Associates in 1997) 30,878 3,937 26,941 Vycor (acquired by McAfee in 1996) 7,800 -- 7,800 AIM (acquired by Network General in 1995) 7,200 -- 7,200
Restatements relating to other acquisition charges: The Company has also made a number of other reclassifications relating to acquisitions made in 1997 as follows:
THREE MONTHS ENDED DESCRIPTION OF RECLASSIFICATION MARCH 31, 1998 ------------------------------- $'000 -------------- Reclassification of TV advertising costs incurred in 1998 related to the Network General merger and related name change, previously charged to acquisition and other related costs in 1997, to marketing expense in 1998. 4,825 Reclassification of TV advertising costs incurred in 1998 related to the Network General merger and related name change, previously charged to acquisition and other related costs in the quarter ended March 31, 1998, to marketing expense in 1998. 1,928 -------- Total adjustments to marketing and sales expense $6,753 ========
11 12 The net increase to Intangible and other assets of $45.4 million is comprised of the adjustments to in-process research and development for 1997, 1996 and 1995 of $60.4 million reduced by the total accumulated amortization of $15.0 million. As a result of the re-evaluations of the purchase transactions above, amortization of goodwill and other intangibles resulting from these acquisitions for the three months ended March 31, 1998 was increased from amounts previously reported by $3.4 million, and future amortization will be increased for the next 5 years as follows:
Year Ended Amount December 31, $'000 ------------ ----- Nine months ended 12/31/98 9,502 1999 9,114 2000 8,464 2001 8,464 2002 8,015 2003 1,793
3. Recent Accounting Pronouncements In October 1997, the AICPA issued Statement of Position No. 97-2 ("SOP 97-2") "Software Revenue Recognition, " which the Company has adopted for transactions entered into during the year beginning January 1, 1998. SOP 97-2 provides guidance for recognizing revenue on software transactions and supersedes previous guidance provided by SOP91-1, "Software Revenue Recognition." Under SOP 97-2, revenue from product licenses are recognized when a signed agreement or other persuasive evidence of an arrangement exists, the software or system has been shipped (or software has been electronically delivered), the license fee is fixed and determinable, and collection of the resulting receivable is probable. For contracts with multiple elements/obligations, (e.g. software products, upgrades/enhancements, maintenance and services), revenue is allocated to each element of the arrangement based on the Company's evidence of fair value as determined by the amount charged when the element is sold separately. Maintenance revenue for providing product updates and customer support is deferred and recognized ratably over the service period. Revenue on rental units under operating leases and service agreements is recognized over the term of the rental agreement or the period during which services are expected to be performed. Revenue generated from products sold through traditional channels where the right of return exists is reduced by reserves for estimated sales returns. In March 1998, the AICPA issued Statement of Position No. 98-4 ("SOP 98-4"), "Deferral of the Effective Date a Provision of SOP 97-2, Software Revenue Recognition." SOP 98-4 defers, for one year, the application of certain passages in SOP 97-2, which limit what is considered vendor-specific objective evidence ("VSOE") necessary to recognize revenue for software licenses in multiple-element arrangements when undelivered elements 12 13 exist. Additional guidance is expected to be provided prior to adoption of any resulting final amendments related to the deferred provisions of SOP 97-2. Because of the uncertainties related to the outcome of these proceedings, the impact, if any, on future financial results of the Company is not currently determinable. Adoption of the remaining provisions of SOP 97-2 as amended, did not have a material impact on revenue recognition during the first quarter of 1998. The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," effective January 1, 1998. This statement requires the disclosure of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as net income plus revenues, expenses, gains and losses that, under generally accepted accounting principles, are excluded from net income. The components of comprehensive income, which are excluded from net income, are not significant individually or in aggregate, and therefore, no separate statement of comprehensive income has been presented. In July 1997, the Financial Accounting Standards Board issued Statement of Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an Enterprise and Related Information", which requires companies to report certain information about operating segments, including certain information about their products, services, the geographic areas in which they operate and their major customers. This statement supersedes FASB Statements Nos. 14, 18, 24 and 30. SFAS 131 is effective for financial statements for fiscal years beginning after December 15, 1997. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures. 4. 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): 13 14
Three Months Ended March 31, ------------------------- 1998 1997 -------- -------- Numerator - basic Net income $ 33,894 $ 12,359 ======== ======== Numerator - diluted Net income $ 33,894 $ 12,359 Interest on convertible debentures, net of tax (1) -- -- -------- -------- Net income available to common stockholders $ 33,894 $ 12,359 ======== ======== Denominator - basic Basic weighted average common shares outstanding 106,952 102,032 ======== ======== Denominator - diluted Basic weighted average common shares outstanding 106,952 102,032 Effect of dilutive securities: Common stock options 5,352 7,449 Diluted weighted average shares 112,304 109,481 ======== ======== Net income per share - basic $ 0.32 $ 0.12 ======== ======== Net income per share - diluted $ 0.30 $ 0.11 ======== ========
(1) Convertible debt interest and related as-if converted shares are excluded from the restated calculation as they are anti-dilutive. 5. Convertible Debentures On February 13, 1998, the Company completed a private placement of zero coupon convertible subordinated Debentures due in 2018 (the "Debentures"). The Debentures, with an aggregate face amount at maturity of $885.5 million, generated net proceeds to the Company of approximately $337.6 million. The initial price to the public for the Debentures was $391.06 per $1,000 of face amount at maturity, which equates to a yield to maturity over the term of the bonds of 4.75% (on a semi-annual bond equivalent basis). The debentures are convertible into Common Stock at the rate of 8.538 shares per $1,000 of face amount at maturity, which equates to an initial conversion price of $45.80 per share. The Debentures are subordinated in right of payment to all existing and future Senior Indebtedness (as defined) and effectively subordinated in right of payment to all indebtedness and other liabilities of the Company's subsidiaries. The Debentures may be redeemed for cash at the option of the Company beginning on February 13, 2003. At the option of the holder, the Company will purchase the Debentures on February 13, 2003, February 13, 2008 and February 13, 2013 at purchase prices (to be paid in cash or Common Stock or any combination thereof, at the election of the Company and subject to certain conditions) equal to the initial issue price plus accrued original issue discount to such dates. The Debentures may also be redeemed at the option of the holder if there is a Fundamental Change (as defined) at a price equal to the issue price plus accrued original issue discount to the date of redemption, subject to adjustment. 14 15 6. Acquisitions On February 28, 1998, the Company acquired two distributors, Nordic Lantools OY, a Finnish company and Syscon, a South African company. Both companies have been accounted for as pooling of interest transactions. Financial information has been restated for all periods presented. The following table summarizes the activity in the reserves for severance and benefits, lease costs and asset and write downs established in the year ended December 31, 1997, relating to the acquisitions of Network General and Helix ($000's):
Direct Asset Transaction Severance & Lease Write Costs Benefits Costs Downs Other Total -------- -------- -------- -------- -------- -------- Balance, December 31, 1997 $ 8,050 $ 10,697 $ 3,842 $ 1,865 $ 2,893 $ 27,347 Paid Out or Charged against the related assets (1,394) (1,854) (207) (886) (1,106) (5,447) -------- -------- -------- -------- -------- -------- Balance, March 31, 1998 $ 6,656 $ 8,843 $ 3,635 $ 979 $ 1,787 $ 21,900 ======== ======== ======== ======== ======== ========
The severance and benefits charges related to company-wide reductions in force following the Company's 1997 acquisitions. Substantially all terminated employees left the Company in the period the related accounting charge was recorded. A limited number of employees from each acquisition were retained for short transition periods. The cost of these employees was charged to operating expenses during the transition period. The lease costs represent an estimate of lease expenses during the period prior to re-leasing the property together with losses on sub-leases, if any. The leased facilities were substantially vacated in the period in which the related accounting charges were recorded. The costs related to any facilities which were used by the Company during this period were charged to operations, however, such charges were not material. Other asset write downs comprised $1.9 million in net losses of computer and other miscellaneous assets. In general, this equipment was discarded or sold for nominal value. Due to the immediate consolidation of facilities, depreciation allocable to these facilities and the related assets, during the transition period, was not material. Of the facilities acquired in its 1997 acquisitions identified for closure, the Company has 23 facilities worldwide which have not been disposed of or subleased. These facilities are insignificant to the Company's operations and each is intended for disposal or sublease in 1998. The Company believes that the reserve balances remaining at March 31, 1998 are adequate to cover any additional benefits or losses yet to be paid or realized. Any reserves not used will be recorded as a credit to Acquisition and other related costs in future periods. 7. Litigation On April 24, 1997, the Company was served by Symantec with a suit filed in the United States District Court, Northern District of California, San Jose Division, alleging copyright infringement and unfair competition by the Company. Symantec alleges that the 15 16 Company's computer software program called "PC Medic" copied portions of Symantec's computer software program entitled "CrashGuard." Symantec's complaint sought injunctive relief and unspecified money damages. On July 20, 1997, Symantec sought leave to amend its complaint to include additional allegations of copyright infringement and trade secret misappropriation pertaining to the Company's "VirusScan" product. Symantec sought injunctive relief and unspecified money damages. On October 6, 1997, the Court issued an order granting Symantec's motion to amend its complaint and enjoining the Company from shipping any product containing either an approximately 30-line routine found in Crash Guard or an approximately 100-line routine found in a Symantec DLL. The Court's order expressly stated that "the court is not enjoining the sale or distribution of [McAfee's] current product." On December 19, 1997, the Court denied Symantec's motion to enjoin sale or distribution of the Company's current PC Medic product. On February 11, 1998, Symantec filed another motion seeking leave to again amend its complaint to include additional allegations of trade secret misappropriation, unfair competition, interference with economic advantage and contractual relations and violations of the Racketeer Influenced and Corrupt Organization Act ("RICO"), in connection with the alleged use by Company employees of proprietary Symantec customer information. The Company will move to dismiss the RICO claim. Symantec also filed a motion for a preliminary injunction relating to these new allegations, and has scheduled both motions for hearing on June 5, 1998. Trial is currently set for September 1998. On May 13, 1997, Trend Micro, Inc. ("Trend") filed suit in United States District Court for the Northern District of California against both the Company and Symantec. Trend alleges that the Company's "WebShield" and "GroupShield" products infringe a Trend patent which issued on April 22, 1997. Trend's complaint seeks injunctive relief and unspecified money damages. On June 6, 1997, the Company filed its answer denying any infringement. The Company also filed counterclaims against Trend alleging unfair competition, false advertising, trade libel, and interference with prospective economic advantage. On September 19, 1997, Symantec filed a motion to sever Trend's action against the Company from its action against Symantec. The Company did not oppose Symantec's motion to sever, other than to recommend a joint hearing on patent claim interpretation. On December 19, 1997, the Court granted Symantec's motion to sever and adopted the Company's recommendation regarding a joint hearing on patent claim interpretation. As a result of the Court's decision, Trend's actions against the Company and Symantec will proceed separately. The Court has set the date for the joint patent claim interpretation hearing for September 1998. Thirty days after the joint patent claim interpretation hearing, the Court has indicated it will set further dates for discovery and trial. Trend and Symantec have stated that they have settled the case between them, although no formal dismissal notice has been received by the Company. On May 6, 1997, RSA Data Security, Inc. ("RSA") filed a lawsuit against PGP, a wholly owned subsidiary of the Company since December 9, 1997, in San Mateo County Superior Court. RSA seeks a declaration from the court that certain paragraphs of a license agreement between PGP and Public Key Partners (the "License Agreement") have been terminated and certain other paragraphs have survived RSA's purported termination of the License Agreement. RSA, which purports to act on behalf of Public Key Partners, also seeks an accounting of PGP's sales of products subject to the License Agreement. PGP denies that 16 17 RSA has the authority to act on behalf of Public Key Partners, and denies that the License Agreement has been breached or terminated in whole or in part. On May 22, 1997, PGP filed a motion to compel arbitration of the action pursuant to an arbitration clause in the License Agreement. PGP's motion was granted on October 9, 1997. The Court stayed the state court proceedings and ordered the action to arbitration. The arbitration proceedings are in the preliminary stages. On October 14, 1997, RSA filed a patent infringement lawsuit against PGP in the United States District Court for the Northern District of California. RSA alleges PGP has infringed one of the patents which was licensed to PGP under the License Agreement. On November 4, 1997, PGP moved to stay the federal action, or, in the alternative, compel it to arbitration. On December 23, 1997, RSA filed a motion to amend its complaint to include the Company as defendant. On March 2, 1998, the court granted PGP's motion to stay the federal patent action. A status conference is scheduled for September 14, 1998, at which time RSA may ask the court to lift the stay if the case has not been arbitrated or settled by that time. On April 15, 1998, RSA filed a third lawsuit on the same patent against the Company. Counsel for the Company intend to ask the Court to stay this action also. On September 15, 1997, the Company was named as a defendant in a patent infringement action filed by Hilgraeve Corporation ("Hilgraeve") in the United States District Court, Eastern District of Michigan. Hilgraeve alleges that the Company's "VirusScan" product infringes a Hilgraeve patent which was issued on June 7, 1994. Hilgraeve's action seeks injunctive relief and unspecified money damages. The case is in discovery. The Court had originally set a fact discovery cut-off date of July 15, 1998 and an expert discovery cut-off date of September 15, 1998, with a status conference on September 22, 1998. Because of a recent change in its counsel, the Company intends to ask the Court to continue those dates. No trial date has been set. The Company has changed its legal name to "Networks Associates, Inc." and has begun conducting business as "Network Associates." Four companies (Network Associates Corporation and The Network Associates in California; Network Associates, Inc. in Kansas; and Network Associates, Inc. in Oregon) have made claims (including various trademark claims) or demands with respect to the Company's use of the name Network Associates. Network Associates Corporation filed suit in Superior Court of California for the county of Santa Clara on February 25, 1998, seeking among other things, a preliminary and permanent injunction restraining the Company from using in California, the name "Network Associates" or "Network Associates, Inc." and unspecified compensatory and punitive damages. A preliminary injunction hearing is scheduled for June 4, 1998, but the parties have reached an agreement in principle to settle the matter. While there can be no assurance that the above litigation will not have a material adverse effect on the Company, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company's consolidated financial position, results of operations, or cash flow. 17 18 8. Subsequent Events Magic Solutions, Inc. On April 1, 1998, the Company acquired all of the outstanding capital stock and options of Magic Solutions, Inc. ("Magic Solutions"), a privately held provider of internal help desk and asset management solutions, for approximately $112 million in cash. The acquisition will be accounted for using the purchase method of accounting and the Company expects that a substantial portion of this price will be expensed as purchased in-process research and development in the quarter ended June 30, 1998. Trusted Information Systems On April 28, 1998, the Company completed the acquisition of Trusted Information Systems ("TIS"), a publicly-held provider of comprehensive security systems for computer networks in an acquisition accounted for as a pooling of interests. In the acquisition, a wholly owned subsidiary of the Company merged with and into TIS; TIS became a wholly owned subsidiary of the Company; and all outstanding common stock of TIS was converted into approximately 6.8 million shares of Common Stock of the Company, at an exchange ratio of 0.4845. The Company also assumed all outstanding options and other rights to acquire TIS capital stock. Stock Dividend On April 30, 1998, the Company declared a 3: 2 stock split effected through a stock dividend, payable to all holders of record of Common Stock on May 12, 1998, as one share of Common Stock for every two shares of Common Stock outstanding. The stock dividend will be distributed on or about May 29, 1998. All per share data contained herein (including information as to the convertibility of the Debentures into Common Stock) has been restated to reflect the increased number of shares outstanding. 18 19 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report. The results shown herein are not necessarily indicative of the results to be expected for the full year or any future periods. This Report on Form 10-Q contains forward-looking statements, including but not limited to those specifically identified as such, that involve risks and uncertainties. The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including without limitation statements regarding the Company's 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 the Company on the date hereof, and the Company assumes no obligation to update any such forward-looking statements. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including, but not limited to, those set forth in "Risk Factors" and elsewhere in this Report on Form 10-Q. OVERVIEW The Company is a leading developer and provider of network security and management software products. The Company has historically derived a significant majority of its revenues from the licensing of its flagship McAfee anti-virus products and Sniffer network fault and performance management products. The Company is currently focusing its efforts on broadening its revenue base by providing network security and management solutions to enterprise customers, targeting in particular the Windows NT/Intel platform. In furtherance of this strategy, the Company recently organized its products into four product suites - --McAfee Total Virus Defense and PGP Total Network Security (together comprising "Net Tools Secure") and Sniffer Total Network Visibility and McAfee Total Service Desk (together comprising "Net Tools Manager"). These four product suites together form an integrated solution called "Net Tools". The following table depicts the Company's product suites: - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 19 20 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
NET TOOLS - ------------------------------------------------------------------------------------------------------- NET TOOLS SECURE NET TOOLS MANAGER - ------------------------------------------------- --------------------------------------------------- McAfee Total Virus PGP Total Network Sniffer Total Network McAfee Total Service Defense Security Visibility Desk - -------------------------- ------------------- ------------------------ ------------------------- - ------------------------------------------------------------------------------------------------------- - - VirusScan Security Suite - PGP Desktop Suite - Sniffer Portable - McAfee Help Desk Suite - - Net Shield Security - PGP Server Suite Analysis Suite - Zero Administration Suite - CyberCop - Sniffer Distributed Client Suite - - Internet Security Suite Analysis Suite
Many of the Company's network security and management products, including its industry-leading network security products for anti-virus protection and Sniffer software-based fault and performance solutions for managing computer networks, are also available as stand-alone products or as part of smaller product suites. The Company is also a leader in electronic software distribution, which is the principal means by which it markets its products and one of the principal ways it distributes its software products to its customers. The Company generally utilizes a two-year subscription model for licensing its non-Sniffer products to corporate clients and is in the process of developing a two-year subscription model for licensing its Sniffer products as well. The Company's results of operations can fluctuate significantly on a quarterly basis. Causes of such fluctuations may include the volume and timing of new orders and renewals, the introduction of new products, distributor inventory levels and return rates, Company inventory levels, product upgrades or updates released by the Company or its competitors, changes in product prices, the impact of competitive pricing or products, timely availability and acceptance of new products, changes in product mix, changes in the market for anti-virus or network management software, inclusion of network security or management software functionality in system software, failure to manage growth and/or potential acquisitions, seasonality, trends in the computer industry, general economic conditions, extraordinary events such as acquisitions or litigation and the occurrence of unexpected events. Historically, renewals have accounted for a significant portion of the Company's net revenue, however, there can be no assurance that the Company will be able to sustain current renewal rates in the future. In addition, revenue generated through distribution channels tends to be non-linear and this may cause the Company's revenue to fluctuate in the future. The Company's results for any given period should not be relied upon as indicative of future performance. See "Risk Factors -- Variability of Quarterly Operating Results. The Company's future earnings and stock price may be subject to volatility in any period. Any shortfall in various operating results, including licensing activity, product sales, net revenue, operating - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 20 21 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS income, net income or net income per share from historical levels or expectations of securities analysts may have significant adverse effects on the trading price of the Company's stock. Furthermore, other factors such as acquisitions or unforeseen events in the technology or software industry or in the Company's day to day activities can have a material adverse effect on the Company's stock performance. See "Risk Factors -- Volatility of Stock Price" and "Risk Factors -- Risks Associated with Failure to Manage Growth; Potential Future Acquisitions." RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of net revenue represented by certain items in the Company's statements of operations for the three months ended March 31, 1998 and 1997:
Three months ended March 31, ------------------- 1998 1997 ------ ------ Net revenue 100.0% 100.0% Operating costs and expenses: Cost of net revenue 18.1 18.1 Research and development 13.6 12.6 Marketing and sales 33.6 28.7 General and administrative 5.9 6.9 Amortization of intangibles 2.2 0.9 Acquisition and other unusual costs -- 13.6 ------ ------ Total operating costs and expenses 73.4 80.8 ------ ------ Income from operations 26.6 19.2 Other income 2.5 2.0 ------ ------ Income before income taxes 29.1 21.2 Provision for income taxes 11.1 12.6 ------ ------ Net income 18.0% 8.6% ====== ======
- -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 21 22 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net Revenue. Net revenue includes product, revenues from software support, maintenance contracts, education and consulting services as well as revenues from those warranty, customer support and maintenance contracts which are deferred and recognized over the related service period. Net revenue increased 31% to $188.4 million in the three months ended March 31, 1998 from $143.5 million in the three months ended March 31, 1997. The increase was primarily due to increases in the licensing of anti-virus software products to new customers, renewing expiring anti-virus licenses, continued acceptance of the Company's Sniffer products, continued acceptance of the Company's consulting and support services as well as the growth of the installed customer base and the resulting renewal of maintenance contracts. The increase is also attributable to a lessor extent to the licensing of products (other than anti-virus and Sniffer products) to new and existing customers as well as expansion into indirect product distribution channels and international markets. Although the Company has had significant growth in net revenue and net income (before acquisition and other related charges), the Company's growth rate has slowed in recent periods. The Company has experienced increased price competition for its products and the Company expects competition to increase in the near-term, which may result in reduced average selling prices for the Company's products.* Due to these and factors such as a maturing anti-virus market and an increasingly higher base from which to grow, the historic revenue growth rate will be difficult to sustain or increase.* To the extent these trends continue, the Company's results of operations could be materially adversely affected. Renewals have historically accounted for a significant portion of the Company's net revenue; however, there can be no assurance that the Company will be able to sustain historic renewal rates for its products in the future.* Risks related to the Company's change in business strategies, including its newly introduced suite pricing model and its development of a two-year subscription licensing model for the Company's Sniffer products and a software only version of the Company's Sniffer products, could also cause fluctuations in the Company's operating results and could make comparisons with historic operating results and balances difficult. To more effectively service its customer's evolving needs, the Company also intends to significantly expand and develop its worldwide professional service organization. The Company expects that it will have lower profit margins on its service revenues relative to licensing revenues. See "Risk Factors -- Variability of Quarterly Operating Results," "-- Risks Related to Certain Business Strategies" and "-- Need to Expand and Develop An Effective Professional Services Organization; Risks Related to Third-Party Professional Services". International revenue accounted for approximately 32% and 27% of net revenue for the three months ended March 31, 1998 and 1997, respectively. The increase in international net revenue as a percentage - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 22 23 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS of net revenue was due primarily to increased acceptance of the Company's products in international markets and the continued investment in international operations. The Company also expects that a significant portion of such international revenue will be denominated in local currencies. To reduce the impact of foreign currency fluctuations, the Company uses non-leveraged forward currency contracts. However, there can be no assurance that the Company's future results of operations will not be adversely affected by such fluctuations or by costs associated with currency risk management strategies. Other risks inherent in international revenue generally include the impact of longer payment cycles, greater difficulty in accounts receivable collection, unexpected changes in regulatory requirements, seasonality due to the slowdown in European business activity during the third quarter, tariffs and other trade barriers, uncertainties relative to regional economic circumstances (such as the current economic turbulence in Asia), political instability in emerging markets and difficulties in staffing and managing foreign operations. There can be no assurance that these factors will not have a material adverse affect on the Company's future international license revenue. Further, in countries with a high incidence of software piracy, the Company may experience a higher rate of piracy of its products.* There are a number of additional risks related to the export of the Company's PGP and TIS security products. Cost of Revenue. Cost of revenue is comprised of cost of product revenue and cost of services and support revenue. Cost of product revenue consists primarily of the cost of media, manuals and packaging for products distributed through traditional channels, royalties and, with respect to certain Sniffer products, computer platforms and other hardware components. Cost of services and support revenue consists principally of salaries and benefits related to employees providing customer support and consulting and education services. Cost of revenue increased 31.8% to $34.2 million in the three months ended March 31, 1998 from $25.9 million in the three months ended March 31, 1997. This increase is due to an increase in net revenue (particularly product revenues) as well as the initial investment in the anti-virus professional services organization. The Company continued to expand its professional services organization which is expected to cause the cost of services and support revenue to increase in absolute dollars and may cause such expenses as a percentage of net revenue to increase. To the extent that the percentage of the Company's net revenue which is generated through traditional distribution channels increases, the Company's cost of net revenue will increase and, accordingly, gross margins will decrease.* In addition, to the extent that the Company increases its reliance on retail distribution, it may encounter problems related to product returns and limited shelf space availability.* - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 23 24 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Research and Development. Research and development expenses consist primarily of salary and benefits for the Company's development and technical support staff. Research and development expenses increased 41% to $25.5 million in the three months ended March 31, 1998 from $18.1 million in the three months ended March 31, 1997. This increase was primarily a result of the expansion of the Company's product development and technical support staff and, to a lesser extent, the increased use of independent contractors. As a percentage of net revenue, research and development expenses increased to 14% in the three months ended March 31,1998 from 13% in the three months ended March 31, 1997. The Company anticipates that research and development expenses will continue to increase in absolute dollars, but may fluctuate as a percentage of net revenue.* The Company believes that its ability to maintain its competitiveness will depend in large part upon its ability to enhance existing products, develop and acquire new products and develop and integrate acquired products. The market for computer software is characterized by low barriers to entry and rapid technological change, and is highly competitive with respect to timely product introductions. The timing and amount of research and development expenses may vary significantly based upon the number of new products and significant upgrades under development and products acquired during a given period.* Marketing and Sales. Marketing and sales expenses consist primarily of salary, commissions and benefits for marketing, sales and customer support personnel and costs associated with advertising and promotions. Marketing and sales expenses increased 54% to $63.3 million in the three months ended March 31, 1998 from $41.2 million in the three months ended March 31, 1997. This increase was primarily the result of an increase in marketing and sales personnel and, to a lesser extent, increased advertising and promotional activities required to support increased sales volumes and expanding product lines. As a percentage of net revenue, marketing and sales expense was 34% in the three months ended March 31, 1998 and 29% in the three months ended March 31, 1997. The Company is seeking to expand the breadth and depth of its product suites. Such expansion, together with the Company's efforts to build brand identity under its new corporate name are expected to contribute to a further increase in marketing and sales expenses in absolute dollars, which may cause expenses to fluctuate as a percentage of net revenue.* General and Administrative. General and administrative expenses consist principally of salary and benefit costs for administrative personnel and general operating costs. General and administrative costs increased 13% to $11.2 million in the three months ended March 31, 1998 from $9.9 million in the three months ended March 31, 1997. The increase is largely a result of a increased staffing to support operations both domestically and internationally and to accommodate the growth in revenue. As a - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 24 25 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS percentage of net revenue, general and administrative expenses were 6% in the three months ended March 31, 1998 and 7% in the three months ended March 31, 1997. The Company intends to continue to make investments in its finance and administrative infrastructure, and, as a result, expects general and administrative expenses will increase in absolute dollars, but may fluctuate as a percentage of net revenue. Acquisition and Other Related Costs. The following table summarizes the activity in the reserves for severance and benefits, lease costs and asset and write downs established in the year ended December 31, 1997, relating to the acquisitions of Network General and Helix ($000's):
Direct Asset Transaction Severance & Lease Write Costs Benefits Costs Downs Other Total -------- -------- -------- -------- -------- -------- Balance, December 31, 1997 $ 8,050 $ 10,697 $ 3,842 $ 1,865 $ 2,893 $ 27,347 Paid Out or Charged against the related assets (1,394) (1,854) (207) (886) (1,106) (5,447) -------- -------- -------- -------- -------- -------- Balance, March 31, 1998 $ 6,656 $ 8,843 $ 3,635 $ 979 $ 1,787 $ 21,900 ======== ======== ======== ======== ======== ========
The severance and benefits charges related to company-wide reductions in force following the Company's 1997 acquisitions. Substantially all terminated employees left the Company in the period the related accounting charge was recorded. A limited number of employees from each acquisition were retained for short transition periods. The cost of these employees was charged to operating expenses during the transition period. The lease costs represent an estimate of lease expenses during the period prior to re-leasing the property together with losses on sub-leases, if any. The leased facilities were substantially vacated in the period in which the related accounting charges were recorded. The costs related to any facilities which were used by the Company during this period were charged to operations, however, such charges were not material. Other asset write downs comprised $1.9 million in net losses of computer and other miscellaneous assets. In general, this equipment was discarded or sold for nominal value. Due to the immediate consolidation of facilities, depreciation allocable to these facilities and the related assets, during the transition period, was not material. Of the facilities acquired in its 1997 acquisitions identified for closure, the Company has 23 facilities worldwide which have not been disposed of or subleased. These - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 25 26 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS facilities are insignificant to the Company's operations and each is intended for disposal or sublease in 1998. The Company believes that the balances remaining at March 31, 1998 are adequate to cover any additional benefits or losses yet to be paid or realized. Any reserves not used will be recorded as a credit to Acquisition and other related costs in future periods. In March 1997, the Company wrote off $19.5 million of acquired in-process technology in connection with the acquisition of 3DV Technology, Inc. Subsequent to the Network General merger in December 1997, all 3DV projects were terminated. The software industry has experienced and is expected to continue to experience a significant amount of consolidation. In addition, it is expected that the Company will grow internally and through strategic acquisitions in order, among other things, to expand the breadth and depth of its product suites and to build its professional services organization. The Company continually evaluates potential acquisitions of complementary businesses, products and technologies. Any acquisition, depending on its size, could result in the use of a significant portion of the Company's available cash or, if such acquisition is made utilizing the Company's securities, could result in significant dilution to the Company's stockholders, and could result in the incurrence of significant acquisition related charges to earnings. For example, in the three months ended June 30, 1998, the Company expects to take significant acquisition related charges in connection with the TIS Acquisition and the Magic Solutions acquisition which were both consummated in the second quarter. Acquisitions by the Company may result in the incurrence or the assumption of liabilities, including liabilities that are unknown or not fully known at the time of acquisition, which could have a material adverse effect on the Company. Furthermore, there can be no assurance that any products acquired in connection with any acquisition will gain acceptance in the Company's markets or that the Company will obtain the anticipated or desired benefits of such transactions.* See "Risk Factors -- Risks Associated with Recent Acquisitions" and "-- Risks Associated with Acquisitions Generally." Interest and Other Income and Expense, Net. Interest and other income and expense increased to $4.8 million in the three months ended March 31, 1998 from $3.0 million in the three months ended March 31, 1998. This increase was due to the investment of cash generated from operating activities and the issuance, in February 1998, of Debentures with net proceeds of approximately $337.6 million. Interest expense increased to $2.5 million in the three months ended March 31, 1998 from zero in the three months ended March 31, 1997. Interest expense relates to the Debentures issued in February 1998. - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 26 27 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Provision for Income Taxes. The Company's effective tax was 38% and 59% for the three months ended March 31, 1998 and 1997, respectively. The Company's effective tax rate for the three months ended March 31, 1998 and 1997, was 36% and 35%, respectively, excluding the effect of one-time non-deductible in-process research and development, merger and acquisition costs and amortization of intangibles. LIQUIDITY AND CAPITAL RESOURCES At March 31, 1998, the Company had $191.0 million in cash and cash equivalents and $591.5 million in marketable securities, for a combined total of $782.5 million. Net cash provided by operating activities was $38.2 million and $40.0 million in the three months ended March 31, 1998 and 1997, respectively. Net cash provided by operating activities in the three months ended March 31, 1998, consisted primarily of net income, an increase in deferred revenue and a decrease in accounts payable and accrued liabilities which were offset primarily by an increase in accounts receivable and prepaid and other assets. In the three months ended March 31, 1997, net cash provided by operating activities consisted primarily of net income before acquisition costs, plus increases in deferred revenue, prepaid and other assets and a decrease in accounts payable and accrued liabilities, offset primarily by increases in accounts receivable and deferred taxes. The Company expects its accounts receivable balance as a percentage of sales to increase due to the Company's increased emphasis on international sales (typically having longer payment terms) and the Company's emphasis on licensing its network security and management product suites to enterprise customers (which complex products may require longer installation and implementation cycles, in turn resulting in potentially longer payment cycles). Increased licensing through the indirect channel may also impact the Company's receivable collection experience due to the longer payment cycle for VARs and system integrators. To address this increase in accounts receivable and to improve cash flow, the Company may, among other things, take actions to encourage earlier payment of receivables or sell receivables. To the extent that the Company's receivable balance increases, the Company will be subject to greater general credit risks with respect thereto. Net cash used in investing activities was $370.5 million and $27.3 million in the three months ended March 31, 1998 and 1997, respectively, primarily reflecting purchases of marketable securities and additions to fixed assets and intangible assets. - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 27 28 NETWORKS ASSOCIATES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net cash provided by financing activities was $398.9 million in the three months ended March 31, 1998, consisting primarily of net proceeds from the issuance of the Debentures, and the proceeds and tax benefits associated with the exercise of non-qualified stock options. Net cash provided by financing activities was $12.0 million in the three months ended March 31, 1997, consisting primarily of the proceeds and tax benefits associated with the exercise of non-qualified stock options partially offset by the repurchase of common stock under the Network General stock repurchase program. The Company believes that its available cash and anticipated cash flow from operations will be sufficient to fund the Company's working capital and capital expenditure requirements for at least the next twelve months. - -------------------------------------------------------------------------------- *This statement is a forward looking statement reflecting current expectations. There can be no assurance that Network's actual future performance will meet Network's current expectations. See the Risk Factors on page 29 for a discussion of certain factors that could affect future performance. 28 29 RISK FACTORS The following risk factors should be considered in conjunction with the information in this Report on Form 10-Q/A. Variability of Quarterly Operating Results. The Company's results of operations have been subject to significant fluctuations, particularly on a quarterly basis, and the Company's future results of operations could fluctuate significantly from quarter to quarter and from year to year. Causes of such fluctuations may include the volume and timing of new orders and renewals, distributor inventory levels and return rates, Company inventory levels, the introduction of new products, product upgrades or updates by the Company or its competitors, changes in product mix, changes in product prices and pricing models, seasonality, trends in the computer industry, general economic conditions (such as the recent economic turbulence in Asia), extraordinary events such as acquisitions or litigation and the occurrence of unexpected events. The operating results of many software companies reflect seasonal trends, and the Company's business, financial condition and results of operations may be affected by such trends in the future. Such trends may include higher net revenue in the fourth quarter as many customers complete annual budgetary cycles, and lower net revenue in the summer months when many businesses experience lower sales, particularly in the European market. Although the Company has experienced significant growth in net revenue and net income (before acquisition and other related costs) in absolute terms, the Company's growth rate has slowed in recent periods. The Company has experienced increased price competition for its products and the Company expects competition to increase in the near-term, which may result in reduced average selling prices for the Company's products in the future. Due to these and other factors (such as a maturing anti-virus market and an increasingly higher base from which to grow), the Company's historic revenue growth rate will be difficult to sustain or increase. To the extent these trends continue, the Company's results of operations could be materially adversely affected. Renewals have historically accounted for a significant portion of the Company's net revenue; however, there can be no assurance that the Company will be able to sustain historic renewal rates for its products in the future. Risks related to the Company's recent change in business strategies could also cause fluctuations in operating results and could make comparisons with historic operating results and balances difficult or not meaningful. See "-- Risks Related to Certain Business Strategies." The timing and amount of the Company's revenues are subject to a number of factors that make estimating operating results prior to the end of a quarter uncertain. The Company does not expect to maintain a significant level of backlog and, as a result, product revenues in any quarter will be dependent on contracts entered into or orders booked and shipped in that quarter. During the three months ended March 31, 1998 and the year ended December 31, 1997, the Company generally experienced a trend toward higher order receipts toward the end of the last month of a quarter, resulting in a higher percentage of revenue shipments during the corresponding period in the prior year, which makes predicting revenues more difficult. The timing of closing larger orders increases the risks of quarter-to-quarter fluctuation. To the extent that the Company is successful in licensing larger product suites under the Net Tools umbrella (particularly to large enterprise and national accounts), the size of its orders and 29 30 the length of its sales cycle are likely to increase. If orders forecasted for a specific customer for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, the Company's operating results for that quarter could be materially adversely affected. See "Potentially Longer Sales and Implementation Cycles for Certain Products." The trading price of the Company's Common Stock has historically been subject to wide fluctuations, with factors such as earnings announcements, acquisition announcements and litigation developments contributing to this volatility. Failure to achieve periodic revenue, earnings and other operating and financial results as forecasted or anticipated by brokerage firms, industry analysts or investors could result in an immediate and adverse effect on the market price of the Company's Common Stock. The Company may not discover, or be able to confirm, revenue or earnings shortfalls until the end of a quarter, which could result in an immediate and adverse effect on the price of the Company's Common Stock. Risk of Inclusion of Network Management and Security Functionality in Hardware and Other Software. In the future, vendors of hardware and of operating system software or other software (such as firewall or electronic mail software) may continue to enhance their products or bundle separate products to include functionality that currently is provided primarily by network security and management software. Such enhancements may be achieved through the addition of functionality to operating system software or other software or the bundling of network security and management software with operating system software or other products. For example, Cisco Systems, Inc. ("Cisco") recently incorporated a firewall in certain of its hardware products and Microsoft introduced limited anti-virus functionality into its MS-DOS versions in 1993. The widespread inclusion of the functionality of the Company's products as standard features of computer hardware or of operating system software or other software could render the Company's products obsolete and unmarketable, particularly if the quality of such functionality were comparable to that of the Company's products. Furthermore, even if the network security and/or management functionality provided as standard features by hardware providers or operating systems or other software is more limited than that of the Company's products, there can be no assurance that a significant number of customers would not elect to accept such functionality in lieu of purchasing additional software. If the Company were unable to develop new network security and management products to further enhance operating systems or other software and to replace successfully any obsolete products, the Company's business, financial condition and results of operations would be materially adversely affected. Risks Associated with Recent Acquisitions. In addition to risks described under "-- Risks Associated with Acquisitions Generally," the Company faces significant risks associated with its recent combination with Network General and other recent acquisitions (including the acquisitions of TIS, Magic Solutions, Pretty Good Privacy, Inc. ("PGP") and Helix Software Company ("Helix"). There can be no assurance that the Company will realize the desired benefits of these transactions. In order to successfully integrate these companies, the Company must, among other things, continue to attract and retain key management and other personnel; integrate, both from an engineering and a sales and marketing perspective, the acquired products (including TIS' firewall products, Magic Solutions' helpdesk products, Network General's Sniffer and CyberCop products, PGP's encryption products and Helix's utilities products) into 30 31 its suite of product offerings; integrate and develop a cohesive focused direct and indirect sales force for its product offerings; consolidate duplicate facilities; and develop name recognition for its new name. The diversion of the attention of management from the day-to-day operations of the Company, or difficulties encountered in the integration process, could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Need to Develop Enterprise and National Accounts Sales Force and Security Products Sales Force; Risks Related to Direct Sales Force" and "-- Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and PGP Security Products." During 1997, the Company incurred significant non-recurring charges associated with the Network General combination and the acquisitions of PGP and Helix. During the second quarter of 1998, the Company expects to incur additional non-recurring charges associated with the acquisitions of TIS and Magic Solutions. There can be no assurance that the Company will not incur additional material charges in subsequent quarters to reflect additional costs associated with these transactions and with respect to its name change and the marketing of its products under the "Network Associates" name. Risks Related to Certain Business Strategies. The Company has historically derived a significant majority of its revenues from the licensing of its flagship anti-virus products and Sniffer products. See "-- Dependence on Revenue from Flagship Anti-Virus and Sniffer Products." The Company is currently focusing its efforts on broadening its revenue base by providing network security and management solutions to enterprise customers, targeting in particular the Windows NT/Intel platform. In furtherance of this strategy, the Company recently organized its products into four product suites -- McAfee Total Virus Defense, PGP Total Network Security, and Sniffer Total Network Visibility and McAfee Total Virus Defense. These four product suites together form an integrated solution called "Net Tools" which utilizes a new pricing model. There can be no assurance that potential customers will respond favorably to the modified pricing structure and the lack of a favorable response could materially adversely affect the Company's operating results. Although the Company will continue to offer perpetual licenses with annual support and maintenance contracts for its Sniffer products, it is currently developing a subscription licensing model for those products. In addition, in an effort to increase total Sniffer unit sales, the Company intends to develop software only versions of certain of its Sniffer products -- meaning that the Company would no longer sell the hardware components contained in these Sniffer products. There can be no assurance that the Company can produce a software only Sniffer product on a timely basis or at all, that customers will not continue to require that the Company provide the associated hardware platform and components, that total unit licenses of Sniffer products will increase over previous levels or that customers will react favorably to the subscription pricing model for Sniffer products. To the extent that customers do license Sniffer products on a two-year subscription basis or license significant amounts of software only Sniffer products, the Company's operating results and financial condition would likely be affected. In the case of subscription licenses, the Company would, among other things, expect an increase in deferred revenues related to the service portion of the two-year Sniffer license that would be capitalized on the Company's balance sheet. In the initial year of the license, the corresponding revenue would be lower than if the license were perpetual. In the case of the software only Sniffer product, for any individual license, the Company would expect lower total revenues and a higher overall gross margin related to the transaction, as the Company would not be 31 32 selling the corresponding hardware component. Currently, the hardware component has a lower gross margin than the total product gross margin. The Company has been acquiring (and is continuing to investigate the acquisition of) existing independent agents and distributors of its products in certain strategic markets or has been converting these independent agents into resellers who must purchase Company products from Company approved distributors. These actions may require, among other things, that the Company provide the technical support to customers that was previously provided by such agents and distributors. There can be no assurance that the Company can provide such support as effectively or on a timely basis or at all, that the Company will operate any acquired distributor or agent as successfully as the previous operators, that the acquisition of any distributor or agent or the conversion of any agent into a reseller will result in the desired increased foreign revenues or that the Company will be able to identify and retain suitable distributors in any market in which it converts an independent agent. See " -- Risks Associated with Acquisitions Generally" and " -- Risks Related to International Revenue and Activities." As part of the Net Tools concept, the Company is in the process of designing a centralized console from which the various component suites can be operated, administered and maintained utilizing a common look and feel. The Company faces significant engineering challenges related to these efforts. In addition, the Company faces significant engineering and other challenges related to the integration of its various security products (such as its recently acquired PGP encryption products, Network General CyberCop product and TIS firewall products) into a marketable suite of products and the development of a software only Sniffer product. Success of the Company's Net Tools suite strategy will also depend, in part, upon successful development and coordination of the Company's sales force; on successful development of a national accounts sales force and an effective indirect sales channel for the Company's Sniffer and PGP/TIS security products; and on the development and expansion of an effective professional services organization. See " -- Risks Associated with Recent Transactions," " -- Risks Associated with Acquisitions Generally," " -- Need to Develop Enterprise and National Accounts Sales Force and Security Products Sales Force; Risks Related to Direct Sales Force," " -- Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and PGP Security Products" and " -- Need to Expand and Develop An Effective Professional Services Organization." The foregoing factors, individually or in the aggregate, could materially adversely affect the Company's operating results and could make comparison of historic operating results and balances difficult or not meaningful. Risks Associated with Acquisitions Generally. The software industry has experienced and is expected to continue to experience a significant amount of consolidation. In addition, it is expected that the Company will grow internally and through strategic acquisitions in order, among other things, to expand the breadth and depth of its product suites and to build its professional services organization. The Company continually evaluates potential acquisitions of complementary businesses, products and technologies. In addition to the acquisitions of TIS and Magic Solutions in April 1998, the Company has consummated a series of significant acquisitions since 1994, including the combination with Network General in December 1997, the acquisitions of PGP and Helix in December 1997, Cinco Networks, Inc. 32 33 in August 1997, 3DV Technology, Inc. in March 1997, FSA Corporation of Canada in August 1996, Vycor Corporation in February 1996, Saber Software Corporation, Inc. in August 1995 and ProTools, Inc. in January 1994. In addition, since 1995 the Company has acquired a number of its international distributors, including distributors in Australia, Brazil, Finland, Japan, South Africa and The Netherlands and is currently investigating acquisitions of additional foreign distributors. Past acquisitions have consisted of, and future acquisitions will likely include, acquisitions of businesses, interests in businesses and assets of businesses. Any acquisition, depending on its size, could result in the use of a significant portion of the Company's available cash or, if such acquisition is made utilizing the Company's securities, could result in significant dilution to the Company's stockholders, and could result in the incurrence of significant acquisition related charges to earnings. Acquisitions by the Company may result in the incurrence or the assumption of liabilities, including liabilities that are unknown or not fully known at the time of acquisition, which could have a material adverse effect on the Company. Furthermore, there can be no assurance that any products acquired in connection with any such acquisition will gain acceptance in the Company's markets or that the Company will obtain the anticipated or desired benefits of such transactions. Achieving the anticipated benefits of an acquisition will depend, in part, upon whether the integration of the acquired business, products or technology is accomplished in an efficient and effective manner, and there can be no assurance that this will occur. Moreover, successful acquisitions in the high technology industry may be more difficult to accomplish than in other industries. Combining a merged or acquired company requires, among other things, integration of product offerings and coordination of sales and marketing and research and development efforts. There can be no assurance that such an integration can be accomplished smoothly or successfully. The difficulties of such integration may be increased by the necessity of coordinating geographically separated organizations, the complexity of the technologies being integrated, and the necessity of integrating personnel with disparate business backgrounds and combining two different corporate cultures. The integration of operations following an acquisition requires the dedication of management resources that may distract attention from the day-to-day business, and may disrupt key research and development, marketing or sales efforts. The inability of management to successfully integrate any acquisition could have a material adverse effect on the business, operating results and financial condition of the Company. In addition, as commonly occurs, during the pre-acquisition and integration phases of technology company acquisitions, aggressive competitors may undertake initiatives to attract customers and to recruit key employees through various incentives. Rapid Technological Change; Risks Associated with Product Development. The network security and management market is highly fragmented and is characterized by ongoing technological developments, evolving industry standards and rapid changes in customer requirements. The Company's success depends upon its ability to offer a broad range of network security and management software products, to continue to enhance existing products, to develop and introduce in a timely manner new products that take advantage of technological advances, and to respond promptly to new customer requirements. While the Company believes that it offers one of the broadest product lines in the network management and security market, this market is continuing to evolve and customer requirements are continuing to change. As the market evolves and competitive pressures increase, the Company believes that it will 33 34 need to further expand its product offerings. There can be no assurance that the Company will be successful in developing and marketing, on a timely basis, enhancements to its existing products or new products, or that such enhancements or new products will adequately address the changing needs of the marketplace. In addition, from time to time, the Company or its competitors may announce new products with new or additional capabilities or technologies. Such announcements of new products could have the potential to replace, or shorten the life cycles of, the Company's existing products and to cause customers to defer or cancel purchases of the Company's existing products. The Company has in the past experienced delays in software development, and there can be no assurance that the Company will not experience delays in connection with its current or future product development activities. Complex software products such as those offered by the Company may contain undetected errors or version compatibility issues, particularly when first introduced or when new versions are released, resulting in loss of or delay in market acceptance. For example, the Company experienced compatibility issues in connection with its recent NetShield upgrade, and the Company's anti-virus software products have in the past falsely detected viruses that did not actually exist. See " -- Risk of False Detection of Viruses." Delays and difficulties associated with new product introductions, performance or enhancements could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's development efforts are impacted by the adoption or evolution of industry standards related to its products and the environments in which they operate. For example, no uniform industry standard has developed in the market for encryption security products. As industry standards are adopted or evolve, the Company may be required to modify existing products or develop and support new versions of existing products. In addition, to the extent that no industry standard develops, the Company's products and those of its competitors may be incompatible if they use competing standards, which could prevent or significantly delay overall development of the market for a particular product or products. The failure of the Company's products to comply, or delays in compliance, with existing or evolving industry standards could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's long-term success will depend on its ability on a timely and cost--effective basis to develop upgrades and updates to its existing product offerings, to modify and enhance acquired products, and to introduce new products which meet the needs of current and potential customers. Future upgrades and updates may, among other things, include additional functionality, respond to user problems or address issues of compatibility with changing operating systems and environments. The Company believes that the ability to provide these upgrades and updates to users frequently and at a low cost is a key to success. For example, the proliferation of new and changing viruses makes it imperative to update anti-virus products frequently in order for the products to avoid obsolescence. Failure to release such upgrades and updates on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be successful in these efforts. In addition, future changes in Windows 95, Windows NT, 34 35 NetWare or other popular operating systems may result in compatibility problems with the Company's products. Further, delays in the introduction of future versions of operating systems or lack of market acceptance of future versions of operating systems would result in a delay or a reduction in the demand for the Company's future products and product versions which are designed to operate with such future versions of operating systems. The Company's failure to introduce in a timely manner new products that are compatible with operating systems and environments preferred by desktop computer users would have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Revenue from Flagship Anti-Virus and Sniffer Products. In recent years, the Company has derived a substantial majority of its net revenue from its flagship McAfee anti-virus software products and Sniffer network fault and performance management products. These products are expected to continue to account for a significant portion of the Company's net revenue for the foreseeable future. Because of this concentration of revenue, a decline in demand for, or in the prices of, these anti-virus and network management products as a result of competition, technological change, a change in the Company's pricing model for such products, the inclusion of anti-virus or network management and analysis functionality in system hardware or operating system software or other software or otherwise, or a maturation in the respective markets for these products could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Emergence of Network Management and Network Security Markets. The markets for the Company's network management and network security products are evolving, and their growth depends upon broader market acceptance of network management and network security software, including help desk software. Although the number of LAN-attached personal computers ("PCs") has increased dramatically, the network management and network security markets continue to be emerging markets and there can be no assurance that such markets will continue to develop or that further market development will be rapid enough to benefit the Company significantly. In addition, there are a number of potential approaches to network management and network security, including the incorporation of management and security tools into network operating systems. Therefore, even if network management and network security tools gain broader market acceptance, there can be no assurance that the Company's products will be chosen by organizations which acquire network management and network security tools. Furthermore, to the extent that either the network management or network security market does continue to develop, the Company expects that competition will increase. See "-- Competition" and "-- Risk of Inclusion of Network Security and Management Functionality in Hardware and Other Software." Competition. The markets for the Company's products are intensely competitive and the Company expects competition to increase in the near-term. The Company believes that the principal competitive factors affecting the markets for its products include performance, functionality, quality, customer support, breadth of product line, frequency of upgrades and updates, integration of products, manageability of products, brand name recognition, company reputation and price. Certain of the criteria upon which the performance and quality of the Company's anti-virus software products compete include the number and types of viruses detected, the speed at which the products run and ease of use. Certain of the Company's competitors have been in the network management market longer than the Company, and 35 36 other competitors, such as Symantec Corporation ("Symantec"), Intel Corporation ("Intel"), Seagate Technology, Inc. ("Seagate") and Hewlett-Packard Company ("HP"), are larger and have greater name recognition than the Company. The Company will also need to develop name recognition for its new name, "Network Associates." In addition, certain larger competitors such as Intel, Microsoft and Novell, Inc. ("Novell") have established relationships with hardware vendors related to their other product lines. These relationships may provide them with a competitive advantage in penetrating the OEM market with their network security and management products. As is the case in many segments of the software industry, the Company has been encountering, and expects to further encounter, increasing competition. This increased competition could reduce average selling prices and, therefore, profit margins. Competitive pressures could result not only in sustained price reductions but also in a decline in sales volume, which events would materially adversely affect the Company's business, financial condition and results of operations. In addition, competitive pressures may make it difficult for the Company to maintain or exceed its growth rate. Although there is a trend toward consolidation in the network security and management market, the market is currently highly fragmented with products offered by many vendors. The Company's principal competitor is the Peter Norton Group of Symantec in the network security market and Intel's LanDesk in the network management market. The Company's other competitors include Computer Associates/Cheyenne Software, IBM, Seagate, the Dr. Solomon Group and Trend Micro, Inc., as well as numerous smaller companies and shareware authors that may in the future develop into stronger competitors or be consolidated into larger competitors. In the encryption portion of the security market, the Company's principal competitors are Security Dynamics Technologies, Inc., Cylink Corporation, Entrust Technologies and VeriSign, Inc. The Company's principal competitors in the help desk market are Remedy Corporation and Software Artistry (recently acquired by Tivoli Systems/IBM). The Company's principal competitor in the software-based network fault and performance management market is HP, with other competitors including Azure Technologies Incorporated, Concord Communications, DeskTalk Systems, Kaspia Systems, Shomiti Systems, Inc. and Wandel & Goltermann, Inc. The Company also faces competition in the security market from Cisco, Security Dynamics Technologies, Inc., Checkpoint Software and other vendors in the encryption/firewall market. In addition, the Company faces competition from large and established software companies such as Microsoft, Intel, Novell and HP which offer network management products as enhancements to their network operating systems. As the network management market develops, the Company may face increased competition from these large companies, as well as other companies seeking to enter the market. The trend toward enterprise-wide network management and security solutions may result in a consolidation of the network management and security market around a smaller number of vendors who are able to provide the necessary software and support capabilities. In addition, to the extent that the Company is successful in developing its Net Tools suite of products designed around a centralized management and administration console for the Windows NT platform, the Company will likely compete with large computer systems management companies such as Tivoli Systems (TME) and Computer Associates (Unicenter). There can be no assurance that the Company will continue to compete effectively against existing and potential competitors, many of whom have substantially greater financial, technical, marketing and support resources and name recognition than the Company. In addition, there can be no assurance that software vendors who currently use traditional distribution 36 37 methods will not in the future decide to compete more directly with the Company by utilizing electronic software distribution. The competitive environment for anti-virus software internationally is similar to that in North America, although local competitors in specific foreign markets often present stronger competition and shareware authors control a more significant portion of the European market. The international market for network management software has developed more slowly than the North American market, although larger competitors such as Intel and Symantec have begun to penetrate European markets. Asian markets have lagged significantly behind North America and Europe in their adoption of networking technology. There can be no assurance that the Company will be able to compete successfully in international markets. Need to Develop Enterprise and National Accounts Sales Force and Security Products Sales Force; Risks Related to Direct Sales Force. In connection with its recent acquisitions and as part of its evolving strategy of offering product suites under the Net Tools umbrella, the Company has recently reorganized its direct sales force into three tiers. The first tier focuses on the sale of the full product suite under the Net Tools umbrella to enterprise and national account customers. The second tier consists of four separate sales groups focused on the sale of the individual product suites (i.e., McAfee Total Virus Defense; PGP Total Network Security; Sniffer Total Network Visibility; or McAfee Total Service Desk) to the departmental level. The third tier consists of four separate outbound corporate telesales forces who actively market the Company's individual product suites to customers with less than 1,000 nodes. The Company historically has not had a large enterprise or national accounts sales force and only recently developed a direct sales group focused on these larger accounts. In addition, the Company has not historically had a separate sales force focused on the sale of its suite of security products (many of which were only recently acquired and are currently being engineered into a common suite). To succeed in the direct sales channel for the enterprise and national accounts market and for the sale of the separate security product suite, the Company will be required to build a significant direct sales organization and will be required to attract and retain qualified personnel, which personnel will require training about, and knowledge of, product attributes for the Company's suite of products. There can be no assurance that the Company will be successful in building the necessary sales organization or in attracting, retaining or training these individuals. Historically, the Company has sold its products at the departmental level. To succeed in the enterprise and national accounts market will require, among other things, establishing relationships and contacts with senior technology officers at these accounts. There can be no assurance that the Company or its sales force will be successful in these efforts. The Company's sales organization structure may result in multiple customer contacts by different Company sales representatives (particularly in circumstances where the customer has multiple facilities and offices), a lack of coordination between the Company's various sales organizations and a lack of focus by the individual sales representatives on their designated customers or products. The occurrence of these events could lead to customer confusion, disputes in the sales force and lost revenue opportunities which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, while the development of a direct sales channel reduces the Company's dependence on resellers and distributors, it may lead to conflicts for the same customers and 37 38 further customer confusion, pressure by current and prospective customers for price reductions on products and, consequently, in reductions in the Company's gross margin and operating profit. Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and PGP Security Products. The Company markets a significant portion of its products to end-users through distributors, resellers and VARs. The Company's distributors sell other products that are complementary to, or compete with, those of the Company. While the Company encourages its distributors to focus on its products through market and support programs, there can be no assurance that these distributors will not give greater priority to products of other suppliers, including competitors. The Company does not have an extensive indirect sales channel for its Network Sniffer products or its PGP security products. To succeed in the indirect sales channel, the Company will be required to build a more extensive network of distributors, resellers and VARs who will support and market these products. These indirect channel participants will require significant training about, and knowledge of, product attributes for these products and the related product suites. There can be no assurance that the Company can successfully establish such an indirect channel on a timely basis or at all or that such a channel, once established, can be maintained. The Company's agreements with its distributors provide for a right of return. This right of return may be triggered by a number of events, including returns to distributors by end users, inaccurate estimates of end user demand by distributors, increased purchases by distributors in response to sales incentives or transitions to new products or versions of products. As a result of this right of return, revenue recognized by the Company upon sales to distributors is subject to a reserve for returns. Returns could exceed reserves as a result of distributors holding excessive Company product inventory. There can be no assurance that current or future reserves established by the Company will be adequate. Need to Expand and Develop An Effective Professional Services Organization; Risks Related to Third-Party Professional Services. As the Company's products and computer networks become more complex, customers will increasingly require greater professional assistance in the design, installation, configuration and implementation of their networks and acquired products. To date, the Company has relied on its limited professional services capabilities and increasingly on outside professional service providers (including its distributors, resellers and system integrators). There can be no assurance that third party service providers can or will continue to be willing to provide adequate levels (both in terms of time and quality) of professional services. Moreover, reliance on these third parties reduces the Company's control over the provision of support services for its products and places a greater burden on these third parties, which, in turn, could delay the Company's recognition of product revenue, could harm the Company's relationships or reputation with such third parties or the end users of its products and could result in decreased future sales of, or prices for, its products. To more effectively service its customer's evolving needs, the Company intends to significantly expand and develop its worldwide professional service organization. There can be no assurance that the Company will be successful in its efforts to expand and develop an effective professional services organization. This will require that the Company hire and train additional service professional who must 38 39 be continually trained and educated to ensure that they possess sufficient technical skills and product knowledge. In particular, the market for qualified professionals is intensely competitive, making hiring and retention difficult. The Company expects significant competition in this market from existing providers of professional services and future entrants. The Company must also properly price its services to attract customers, while maintaining sufficient margins for its services. The Company expects that it will have lower profit margins on its service revenues. The failure to develop an effective professional services organization could have a material adverse effect on the Company's business, financial condition and results of operations. Reliance on Microsoft Technology. Although the Company intends to support other operating systems, the Company's mission is to be the leading supplier of network security and management products for Windows NT/Intel based networks. Sales of the Company's products would be materially and adversely affected by market developments which are adverse to the Windows operating environments, including the failure of users and application developers to accept Windows NT. In addition, the Company's ability to develop products using the Windows operating environments is substantially dependent on its ability to gain timely access to, and to develop expertise in, current and future developments by Microsoft, of which there can be no assurance. Risks Associated with Failure to Manage Growth. The Company's growth internally and through its numerous acquisitions has placed, and any further expansion would continue to place, a significant strain on its limited personnel, management and other resources. In the future, the Company's ability to manage any growth, particularly with the anticipated expansion of the Company's international business and growth in indirect channel business, will require it to attract, train, motivate and manage new employees successfully, to effectively integrate new employees into its operations and to continue to improve its operational, financial, management and information systems and controls. The failure to effectively manage any further growth could have a material adverse effect on the Company's business, financial condition and results of operations. Proprietary Technology and Rights; Litigation. The Company's success is heavily dependent upon proprietary software technology. The Company relies on a combination of contractual rights, trademarks, trade secrets and copyrights to establish and protect proprietary rights in its software. There can be no assurance these protections will be adequate or that competitors will not independently develop technologies or products that are substantially equivalent or superior to the Company's products. Network Associates has changed its legal name to "Networks Associates, Inc." and has begun conducting business as "Network Associates." Four companies (Network Associates Corporation and The Network Associates in California; Network Associates, Inc. in Kansas; and Network Associates, Inc. in Oregon) have made claims (including various trademark claims) or demands with respect to Network Associates' use of the name Network Associates. Network Associates Corporation filed suit in Superior Court of California for the county of Santa Clara on February 25, 1998, seeking among other things, a preliminary and permanent injunction restraining Network Associates from using in California, the name "Network Associates" or "Network Associates, Inc." and unspecified compensatory and 39 40 punitive damages. A preliminary injunction hearing is scheduled for June 4, 1998, but the parties have reached an agreement in principle to settle the matter. The Company does not typically obtain signed license agreements from its corporate, government and institutional customers who license products directly from it. The Company includes an electronic version of a "shrink-wrap" license in all of its electronically distributed software and a printed license in the box for its products distributed through traditional distribution channels in order to protect its copyrights and trade secrets in those products. Since none of these licenses are signed by the licensee, many authorities believe that such licenses may not be enforceable under the laws of many states and foreign jurisdictions. In addition, the laws of some foreign countries either do not protect proprietary rights or offer only limited protection for those rights. There can be no assurance that the steps taken by the Company to protect its proprietary software technology will be adequate to deter misappropriation of this technology. For example, the Company is aware that a substantial number of users of its anti-virus products have not paid any registration or license fees to the Company. Changing legal interpretations of liability for unauthorized use of the Company's software, or lessened sensitivity by corporate, government or institutional users to avoiding copyright infringement, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's principal assets are its intellectual property, and the Company competes in an increasingly competitive market. There has been substantial litigation regarding intellectual property rights of technology companies. The Company has in the past been, and currently is, subject to litigation related to its intellectual property (including a pending unfair trade practice case and a patent infringement case involving Symantec and Trend Micro Inc., respectively). There can be no assurance that there will be no developments arising out of such pending litigation or any other litigation to which the Company is or may become party which could have a material adverse effect on the Company's business, financial condition and results of operation. See Note 7 to the Notes to the Condensed Consolidated Financial Statements. In addition, as the Company may acquire a portion of software included in its products from third parties, its exposure to infringement actions may increase because it must rely upon such third parties as to the origin and ownership of any software being acquired. Similarly, exposure to infringement claims exists and will increase to the extent that the Company employs or hires additional software engineers previously employed by competitors, notwithstanding measures taken by them to prevent usage by such software engineers of intellectual property used or developed by them while employed by a competitor. In the future, litigation may be necessary to enforce and protect trade secrets and other intellectual property rights owned by the Company. The Company may also be subject to litigation to defend it against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. Any such litigation could be costly and cause diversion of management's attention, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its products, any one of which could have a material adverse effect on the Company's business, financial condition and 40 41 results of operations. Furthermore, there can be no assurance that any necessary licenses will be available on reasonable terms, or at all. Risks Related to International Revenue and Activities. In 1997, 1996 and 1995, net revenue from international licenses represented approximately 28%, 24% and 25%, respectively, of the Company's net revenue. In the quarter ended March 31, 1998, net revenue from international licenses represented approximately 32% of the Company's net revenue. Historically, the Company has relied primarily upon independent agents and distributors to market its products internationally. The Company expects that international revenues will continue to account for a significant percentage of net revenue. The Company also expects that a significant portion of such international revenue will be denominated in local currencies. To reduce the impact of foreign currency fluctuations, the Company uses non-leveraged forward currency contracts. However, there can be no assurance that the Company's future results of operations will not be adversely affected by such fluctuations or by costs associated with currency risk management strategies. Other risks inherent in international revenue generally include the impact of longer payment cycles, greater difficulty in accounts receivable collection, unexpected changes in regulatory requirements, seasonality due to the slowdown in European business activity during the third quarter, tariffs and other trade barriers, uncertainties relative to regional economic circumstances (such as the current economic turbulence in Asia), political instability in emerging markets and difficulties in staffing and managing foreign operations. There can be no assurance that these factors will not have a material adverse effect on the Company's future international license revenue. Further, in countries with a high incidence of software piracy, the Company may experience a higher rate of piracy of its products. There are a number of additional risks related to the export of the Company's PGP and TIS security products. See "-- Risks Relating to Cryptography Technology." In addition, a portion of the Company's international revenue is expected to continue to be generated through independent agents. Since these agents will not be employees of the Company and will not be required to offer the Company's products exclusively, there can be no assurance that they will continue to market the Company's products. Also, the Company is likely to have limited control over its agents, limited access to the names of the customers to whom the agents sell its products and limited knowledge of the information provided by, or representations made by, these agents to its customers. Risk of Sabotage. Given the Company's high profile in the anti-virus software market, the Company has been a target of computer "hackers" who have created viruses to sabotage its products. While to date these viruses have been discovered quickly and their dissemination has been limited, there can be no assurance that similar viruses will not be created in the future, that they will not cause damage to users' computer systems and that demand for the Company's software products will not suffer as a result. In addition, since the Company does not control diskette duplication by distributors or its independent agents, there can be no assurance that diskettes containing the Company's software will not be infected. Risk of False Detection of Viruses. The Company's anti-virus software products have in the past and may at times in the future falsely detect viruses that do not actually exist. Such "false alarms," while typical in the industry, may impair the perceived reliability of the Company's products and may therefore adversely impact market acceptance of the Company's products. In addition, the Company has 41 42 in the past been subject to litigation claiming damages related to a false alarm, and there can be no assurance that similar claims will not be made in the future. Risks Relating to Cryptography Technology. Certain of the Company's PGP and TIS network security products, technology and associated assistance are subject to export restrictions administered by the U.S. Department of State and the U.S. Department of Commerce, which permit the export of encryption products only with the required level of export license. In addition, these U.S. export laws prohibit the export of encryption products to a number of countries deemed hostile by the U.S. government. U.S. export regulations regarding the export of encryption technology require either a transactional export license or the granting of Department of Commerce Commodity jurisdiction. As result of this regulatory regime, foreign competitors facing less stringent controls on their products may be able to compete more effectively than the Company in the global market. While the Company has obtained approval from the Department of Commerce to export to certain end users, there can be no assurance that the U.S. government will approve pending or future export license requests. Further, there can be no assurance that the list of products and countries for which export approval is required, and the regulatory policies with respect thereto, will not be revised from time to time. Failure to obtain the required licenses or the costs of compliance could have a material adverse effect on the Company's international revenues. The Company's PGP and TIS network security products are dependent on the use of public key cryptography technology, which depends in part on the application of certain mathematical principles known as "factoring." The security afforded by public key cryptography technology is predicated on the assumption that the factoring of the composite of large prime numbers is difficult. Should an easy factoring method be developed, then the security afforded by encryption products utilizing public key cryptography technology would be reduced or eliminated. Furthermore, any significant advance in techniques for attacking cryptographic systems could also render some or all of the Company's existing products and services obsolete or unmarketable. There can be no assurance that such developments will not occur. Moreover, even if no breakthroughs in factoring or other methods of attacking cryptographic systems are made, factoring problems can theoretically be solved by computer systems significantly faster and more powerful than those presently available. If such improved techniques for attacking cryptographic systems are ever developed, it could have a material adverse effect on the Company's business, operating results and financial condition. Product Liability. The Company's anti-virus and network management software products are used to protect and manage computer systems and networks that may be critical to organizations and, as a result, the sale and support of these products by the Company may entail the risk of product liability and related claims. The Company's license agreements with its customers typically contain provisions designed to limit the Company's exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in these license agreements may not be effective under the laws of certain jurisdictions, particularly in circumstances involving unsigned licenses. A product liability claim brought against the Company could have a material adverse effect on the Company's business, financial condition and results of operations. 42 43 Dependence upon Key Personnel. The success of the Company will depend to a significant extent upon a number of key technical and management employees. While employees are required to sign standard agreements concerning confidentiality and ownership of inventions, Company employees are generally not otherwise subject to employment agreements or to noncompetition covenants. The loss of the services of any key employees could have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not maintain life insurance policies on its key employees. The ability of the Company to achieve its revenue and operating performance objectives will depend in large part on its ability to attract and retain technically qualified and highly skilled sales, consulting, technical, marketing and management personnel. Competition for such personnel is intense and is expected to remain so for the foreseeable future. There can be no assurance the Company will be successful in retaining its existing key personnel and in attracting and retaining the personnel it requires, and failure of the Company to retain and grow its key employee population could adversely affect the Company's business and operating results. In early April, 1998, Messers. Leslie Denend, David Carver and John Stringer resigned from their positions as executive officers of the Company. Additions of new personnel and departures of existing personnel, particularly in key positions, can be disruptive and can result in departures of existing personnel, which could have a material adverse effect upon the Company's business, operating results and financial condition. Customer Purchase Decisions; Potentially Longer Sales and Implementation Cycles for Certain Products Suites. The products offered by the Company may be considered to be capital purchases by certain customers or prospective customers. Capital purchases are often considered discretionary and, therefore, are canceled or delayed if the customer experiences a downturn in its business or prospects or as a result of economic conditions in general. Any such cancellation or delay could adversely affect the Company's results of operations. In addition, as the Company proceeds with its strategy of selling product suites under the Net Tools umbrella (particularly to larger enterprise and national accounts), its sales cycle is likely to lengthen. Such sales may involve a lengthy education process and a significant technical evaluation and commitment of capital and other resources and may be subject to the risk of delays associated with customers' internal budget and other procedures for approving large capital expenditures, deploying new technologies within their networks and testing and accepting new technologies that affect key operations. Because of the potentially lengthy sales cycle and the potentially large size of such orders, if orders forecasted for a specific customer for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, the Company's operating results for that quarter could be materially adversely affected. See "-- Variability of Quarterly Operating Results" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Year 2000 Compliance. Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such "Year 2000" requirements. Although the Company believes that its products and systems are Year 2000 compliant, the Company utilizes third-party equipment and software that may not be Year 2000 compliant. Failure of such third-party equipment or software to operate properly with regard to the Year 2000 and thereafter could require the Company to incur unanticipated expenses to remedy any problems, 43 44 which could have a material adverse effect on the Company's business, operating results and financial condition. The business, operating results and financial condition of the Company's customers could be adversely affected to the extent that they utilize third-party software products which are not Year 2000 compliant. Furthermore, the purchasing patterns of customers or potential customers may be affected by Year 2000 issues as companies expend significant resources to correct their current systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase products and services such as those offered by the Company, which could have a material adverse effect on the Company's business, operating results and financial condition. Supplier Dependence; Third Party Manufacturing. Certain of the Company's products contain critical components supplied by a single or a limited number of third parties. The Company has been required to purchase and inventory certain of the computer platforms around which it designs its network fault and performance management products to ensure an available supply of the product for its customers. Any significant shortage of these platforms or other components or the failure of the third party supplier to maintain or enhance these products could lead to cancellations of customer orders or delays in placement of orders which could materially adversely affect the Company's results of operations. If the Company's purchase of such components or platforms exceeds demand, the Company could incur losses or other charges in disposing of excess inventory, which could also materially adversely affect the Company's results of operations. The Company's manufacturing operations consist primarily of final assembly, testing and quality control of materials, components, subassemblies and systems for its Sniffer based products. The Company intends to outsource these manufacturing operations in 1998. There can be no assurance that the Company will be able to qualify and secure on commercially acceptable terms satisfactory third party manufacturers on a timely basis or at all. In addition, reliance on third party manufacturers will involve a number of risks, including the lack of direct control over the manufacturing process, the absence or unavailability of adequate capacity and reduced control over delivery schedules, quality control and costs. In the event that, once initially secured, the Company's third party manufacturers are unable or unwilling to continue to manufacture the Sniffer based products in required volumes, on a cost effective basis, in a timely manner or at all, the Company will have to secure additional manufacturing capacity. Even if such additional capacity is available at commercially acceptable terms, the qualification process could be lengthy and could create delay in product shipments. Possible Price Volatility of Common Stock. The trading price of the Company's Common Stock has historically been, and is expected to be, subject to wide fluctuations. The market price of the Common Stock may be significantly impacted by quarterly variations in financial performance, shortfalls in revenue or earnings from levels forecast by securities analysts, changes in estimates by such analysts, market conditions in the computer software or hardware industries, product introductions by the Company or its competitors, announcements of extraordinary events such as acquisitions or litigation or general economic conditions. Statements or changes in opinions, ratings, or earnings estimates made by brokerage firms or industry analysts relating to the market in which the Company does business or relating to the Company specifically could result in an immediate and adverse effect on the market price of the Common Stock. In addition, in recent years the stock market has experienced extreme price and 44 45 volume fluctuations. These fluctuations have had a substantial effect on the market prices for many high technology and emerging growth companies, often unrelated to the operating performance of the specific companies. There can be no assurances that the market price of the Common Stock will not decline below the levels prevailing at the time of this offering. Securities class action lawsuits are often brought against companies following periods of volatility in the market price of their securities. Any such litigation against the Company could result in substantial costs and a diversion of resources and management attention. Effect of Certain Provisional Anti-Takeover Effects of Certificate of Incorporation, Bylaws and Delaware Law. The board of directors of the Company has the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by its stockholders. The rights of the holders of Company Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock. Further, certain provisions of Delaware law and the Company's Certificate of Incorporation and Bylaws, such as a classified board, could delay or make more difficult a merger, tender offer or proxy contest involving the Company. While such provisions are intended to enable the Company's Board to maximize stockholder value, they may have the effect of discouraging takeovers which could be in the best interest of certain stockholders. There is no assurance that such provisions will not have an adverse effect on the market value of the Company's Common Stock. 45 46 NETWORKS ASSOCIATES, INC. FORM 10-Q/A, March 31, 1998 PART II: OTHER INFORMATION Item 3. Legal Proceedings: Information with respect to this item is incorporated by reference to Note 7 of the Notes to the Consolidated Financial Statements included herein on page 15 of this Report on Form 10-Q/A. Item 6. Exhibits and Reports on Form 8-K: (a) The Company filed the following reports on Form 8-K: April 28, 1998 related to the acquisition of TIS. April 3, 1998 and March 25, 1998 related to the acquisition of Magic Solutions, Inc. February 25, 1998 related to the acquisition of PGP. February 12, 1998 related to the issuance of the Debentures. February, 1998 related to the press release for the fourth quarter and the year ended December 31, 1997. (b) Exhibits. The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Report. 46 47 NETWORKS ASSOCIATES, INC. FORM 10-Q/A, March 31, 1998 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, and the results and regulations promulgated thereunder, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NETWORKS ASSOCIATES, INC. /S/ PRABHAT K. GOYAL ---------------------------------------- Name: Prabhat K. Goyal Title: Vice President Administration, Chief Financial Officer and Secretary Date: April 15, 1999 47 48 NETWORKS ASSOCIATES, INC. Form 10-Q/A, March 31, 1998
EXHIBIT INDEX Exhibit No. Exhibit Title Page No. - ----------- ------------- -------- 2.1 Agreement and Plan of Reorganization, dated as of October 13, 1997, among McAfee Associates, Inc., Mystery Acquisition Corp. and Network General Corporation, as amended by the First Amendment dated as of October 22, 1997, incorporated by reference from the Registrant's Registration Statement on Form S-4 filed with the Commission on October 31, 1997 2.2 Combination Agreement dated August 16, 1996 among the Registrant, FSA Combination Corp., FSA Corporation and Daniel Freedman. (1) 2.3 Stock Exchange Agreement dated January 13, 1996 among the Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and the shareholders of Jade. (2) 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., incorporated by reference to the Report on Form 8-K of the Registrant as filed with the Securities and Exchange Commission on December 11, 1997 (the "December 11, 1997 Form 8-K). 2.6 Agreement and Plan of Reorganization dated February 22, 1998, between the Registrant, TIS and Thor Acquisition Corp., incorporated by reference to the Report on Form S-4 of the Registrant as filed with the Securities and Exchange Commission on March 25, 1998. 2.7 Agreement and Plan of Reorganization by and among the Company, Magic Solutions International, Inc., Merlin Acquisition Corp. and Igal Lichtman, Amendment Agreement by and among the Registrant, Magic Solutions International, Inc., Merlin Acquisition Corp., and Igal Lichtman, dated March 24, 1998. Second Amendment Agreement by and among the Registrant, Magic Solutions International, Inc., Merlin Acquisition Corp., and Igal Lichtman, dated April 1, 1998. Incorporated by reference to Exhibit 2.3 of the April 2, 1998 Form 8-K.
49 3.1 Second Restated Certificate of Incorporation of Networks Associates, Inc., as amended on December 1, 1997, incorporated by reference to the Registrant's Registration Statement on Form S-4, filed with the Commission on March 25, 1998. 3.2 Restated Bylaws of Networks Associates, Inc., incorporated by reference to the Registrant's Registration Statement on Form S-4, filed with the Commission on March 25, 1998. 3.3 Certificate of Designation of Series A Preferred Stock of Networks Associates, Inc., incorporated by reference to Exhibit 3.3 of the Registrant's Form 10-Q for the Quarter ended September 30, 1996. 4.1 Registration Rights Agreement, dated January 13, 1996 between the Registrant an all shareholders of Jade. (2) 4.2 Registration Rights Agreement dated August 30, 1996 between the Registrant and Daniel Freedman. (1) 4.3 Registration Rights Agreement dated February 27, 1997 between the Registrant and the shareholders of Schuijers, incorporated by reference from Exhibit 10.50 to the Registrant's Report on Form 10-K for the year ended December 31, 1996. 4.4 Registration Rights Agreement dated December 1, 1997 between the Registrant and the shareholders of Helix. (4) 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, incorporated by reference to Exhibit 4.6 of the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 6, 1998 (the "May 6, Form S-3"). 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, incorporated by reference to the May 6, Form S-3. 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., which is incorporated by reference to Exhibit 10.3 of Network General's Annual Report on Form 10-K for the year ended March 31, 1992 ("Network General 1992 From 10-K). (3)
49 50 10.2 First Amendment to Lease dated June 10, 1992, between Network General and Menlo Parks Partners, L.P., which is incorporated by reference to Exhibit 10.3 of Network General's Annual Report on Form 10-K for the year ended March 31, 1992 ("Network General 1992 Form 10-K"). (3) 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., which is incorporated by reference to Exhibit 10.4 of the Network General 1992 Form 10-K. (3) 10.4 First Amendment to Lease dated June 18, 1992, between Network General and Menlo Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.5 of the Network General 1992 Form 10-K. (3) 10.5 Lease dated March 31, 1992, between Network General and Equitable Life Assurance Society of the United States, which is incorporated by reference to Exhibit 10.4 of the Network General 1992 Form 10-K. (3) 10.6 Second Amendment to Lease dated February 1, 1995, between Network General and Menlo Oaks Partners, L.P., which is incorporated by reference to Exhiit 10.2 of Network General's Quarterly Report on Form 10-Q for the quarter ended December 31, 1994 ("Network General December 1994 From 10-Q"). (3) 10.7 Third amendment to Lease dated February 1, 1995 between Network General and Menlo Oaks Partners L.P., which is incorporated by reference to Exhibit 10.23 of the Network General December 1994 Form 10-Q. (3) 10.8 Fourth Amendment to Lease dated May 31, 1995, between Network General and Menlo Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.27 of Network General's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 ("Network General June 1995 Form 10-Q"). (3) 10.9 Fifth Amendment to Lease dated June 13, 1995, between Network General and Menlo Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.28 of the Network General June 1995 Form 10-Q. (3) 10.10 Lease dated July 3, 1996 between Network General and Campbell Avenue Associates, which is incorporated by reference to Exhibit 10.21 of Network General's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. (3) 10.11 Sixth Amendment to Lease dated November 29, 1996, between Network General and Menlo Oaks Partners, L.P., which is incorporated by
50 51 reference to Exhibit 10.22 of Network General's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. (3) 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, incorporated by reference to Exhibit 10.51 of the Form 10-Q of McAfee Associates, Inc. for the Quarter ended June 30, 1997. 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 Assignment 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., incorporated by reference to Exhibit 10.52 of the Form 10-Q of McAfee Associates, Inc. for the Quarter ended June 30, 1997. 10.18* 1997 Stock Incentive Plan, incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-8 of McAfee Associates, Inc., filed with the Securities and Exchange Commission on August 8, 1997. 10.19* Change in control agreement between the Company and Dennis Cline dated April 14, 1995 incorporated by reference to Exhibit 10.2 of the Company's Registration Statement No. 33-93296 on Form S-4 (the "S-4"). 10.20* Change in control agreement between the Company and Peter Watkins May 1, 1995 incorporated by reference to Exhibit 10.6 of the S-4. 10.21* Change in control agreement between the Company and William S. Larson dated April 14, 1995 incorporated by reference to Exhibit 10.7 of the S-4.
51 52 10.22* Change in control agreement between the Company and Prabhat K. Goyal incorporated by reference to Exhibit 10.43 of the Company's Form 10-Q for the quarter ended June 30, 1996. 10.23 Change in control agreement between the Company and Zach Nelson, dated May 12, 1998.(5) 27.1 Financial Data Sheet
- ----------------------------- (1) Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Commission on September 24, 1996. (2) Incorporated by reference from the Registrants Current Report on Form 8-K filed with the Commission on March 14, 1997. (3) Network General's filings with the Commission were made under File Number 0-17431 (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 Current Report on Form 10-Q for the quarter ended March 31, 1998, filed with the Commission on May 15, 1998. * Management contracts or compensatory plans or arrangements covering executive officers or directors of Networks Associates, Inc. 52 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1998 MAR-31-1998 190,983 591,475 132,633 0 0 832,596 76,573 (39,332) 1,099,748 218,333 0 0 0 1,075 511,165 1,099,748 188,415 188,415 34,163 138,327 0 0 0 54,853 0 54,853 0 0 0 33,894 0.32 0.30 Basic means Primary
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