-----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, Gs25Iw6bFbVAzEMWr6JfUUjkTWoBz/xxY98O9JoTDZwiZTvKI7jxULHEdoJrgdIp bU9pHUtsBJ/UqulFp5YIdQ== 0000891618-99-001590.txt : 19990416 0000891618-99-001590.hdr.sgml : 19990416 ACCESSION NUMBER: 0000891618-99-001590 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 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: 99595015 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 FORM 10-Q/A DATED 9/30/98 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 0-20558 ---------------- NETWORKS ASSOCIATES, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 77-0316593 (STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER) 3965 FREEDOM CIRCLE SANTA CLARA, CALIFORNIA 95054 (408) 988-3832 (ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES) ---------------- Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] 135,090,442 shares of the registrant's common stock, $0.01 par value, were outstanding as of October 31, 1998. THIS DOCUMENT CONTAINS 51 PAGES. THE EXHIBIT INDEX IS ON PAGE 49. ================================================================================ 2 NETWORKS ASSOCIATES, INC. FORM 10-Q/A, SEPTEMBER 30, 1998 ---------------- CONTENTS
ITEM NUMBER PAGE - ----------- ---- PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets: September 30, 1998 and December 31, 1997.................. 3 Condensed Consolidated Statements of Operations: Three and nine months ended September 30, 1998 and 1997... 4 Condensed Consolidated Statements of Cash Flows: Nine months ended September 30, 1998 and 1997............. 5 Notes to Condensed Consolidated Financial Statements......... 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........................................... 23 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS.............................................. 46 ITEM 2. CHANGES IN SECURITIES........................................... 46 ITEM 5. OTHER INFORMATION............................................... 47 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................ 47 SIGNATURES............................................................... 48 EXHIBIT INDEX............................................................ 49
2 3 NETWORKS ASSOCIATES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
(AS RESTATED NOTE 2.) SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------ (UNAUDITED) (UNAUDITED) Current assets: Cash and cash equivalents ............................. $ 363,839 $ 157,031 Marketable securities ................................. 133,098 151,580 Accounts receivable, net of allowances for doubtful accounts of $7,842 and $5,107 at September 30, 1998 and December 31, 1997 .............. 226,362 156,197 Prepaid expenses, taxes and other current assets ...... 57,337 72,971 ---------- ---------- Total current assets .......................... 780,636 537,779 Marketable securities ................................... 146,804 109,184 Fixed assets, net ....................................... 58,281 48,328 Deferred taxes .......................................... 93,471 16,173 Intangibles and other assets ............................ 330,229 93,886 ---------- ---------- Total assets .................................. $1,409,421 $ 805,350 ========== ========== LIABILITIES Current liabilities: Accounts payable ...................................... $ 34,333 $ 26,444 Accrued liabilities ................................... 172,409 152,772 Deferred taxes ........................................ 41,704 1,413 Deferred revenue ...................................... 125,794 109,029 Long term debt, current portion ....................... 3,540 310 ---------- ---------- Total current liabilities ..................... 377,780 289,968 Deferred taxes, less current portion .................. 20,969 2,135 Deferred revenue, less current portion ................ 56,656 18,393 Long term debt and other liabilities .................. 363,420 2,353 ---------- ---------- Total liabilities ............................. 818,825 312,849 ---------- ---------- STOCKHOLDERS' EQUITY Preferred stock, $.01 par value; authorized: 5,000,000 shares Common stock, $.01 par value; authorized: 350,000,000 shares; issued and outstanding: 134,378,883 shares at September 30, 1998 and 128,435,232 shares at December 31, 1997 ............... 1,344 1,281 Additional paid-in capital ............................. 450,866 332,519 Retained earnings ....................................... 138,386 158,701 ---------- ---------- Total stockholders' equity .................... 590,596 492,501 ---------- ---------- Total liabilities and stockholders' equity .... $1,409,421 $ 805,350 ========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 NETWORKS ASSOCIATES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
(AS RESTATED NOTE 2.) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 1998 1997 1998 1997 --------- --------- --------- --------- Net revenue ............................................ $ 242,444 $ 188,407 $ 717,854 $ 537,566 Operating costs and expenses: Cost of net revenue .................................. 44,556 34,012 137,695 97,410 Research and development ............................. 33,077 26,534 102,217 74,032 Marketing and sales .................................. 66,007 54,061 210,189 155,479 General and administrative ........................... 16,022 21,269 65,195 60,613 Amortization of intangibles .......................... 11,216 2,775 27,946 8,621 Acquisition and other related costs .................. 63,399 5,234 135,616 24,738 --------- --------- --------- --------- Total operating costs and expenses ........... 234,277 143,885 678,858 420,893 --------- --------- --------- --------- Income from operations ....................... 8,167 44,522 38,996 116,673 Interest and other income and expense, net ............. 4,099 6,481 13,946 16,144 --------- --------- --------- --------- Income before provision for income taxes...... 12,266 51,003 52,942 132,817 Provision for income taxes ............................. 26,710 22,221 73,189 61,854 --------- --------- --------- --------- Net income (loss) ............................ $ (14,444) $ 28,782 $ (20,247) $ 70,963 ========= ========= ========= ========= Net income (loss) per share -- basic .................. $ (0.11) $ 0.23 $ (0.15) $ 0.56 ========= ========= ========= ========= Shares used in per share calculation -- basic ....... 133,531 127,100 131,973 126,128 ========= ========= ========= ========= Net income (loss) per share -- diluted ................. $ (0.11) $ 0.22 $ (0.15) $ 0.54 ========= ========= ========= ========= Shares used in per share calculation -- diluted...... 133,531 132,436 131,973 132,429 ========= ========= ========= =========
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.) NINE MONTHS ENDED SEPTEMBER 30, ------------------------- 1998 1997 --------- --------- Cash flows from operating activities: Net income (loss) ....................................... $ (20,247) $ 70,963 Adjustments to reconcile net income to net cash provided from operating activities: Acquired in-process research and development ....... 49,843 43,192 Depreciation and amortization ...................... 53,703 25,966 Write down of owned facility ....................... 1,177 -- Interest on convertible notes ...................... 11,055 -- Unrealized gain (loss) on investments .............. 2,252 (1,947) Deferred taxes ..................................... 13,025 (3,653) Changes in assets and liabilities: Accounts receivable .............................. (63,354) (40,390) Prepaid expenses, taxes and other ................ (22,462) (5,297) Accounts payable and accrued liabilities ......... (24,838) 10,457 Deferred revenue ................................. 35,392 30,370 Other ............................................ -- (197) --------- --------- Net cash provided by operating activities ..... 35,546 129,464 Cash flows from investing activities: Purchase of investment securities, net ................ (19,138) (23,576) Additions to fixed assets ............................. (33,453) (33,217) Acquisition of CyberMedia ............................. (119,958) -- Acquisition of Magic Solutions, Inc. .................. (109,717) -- Acquisition of Compusul ............................... -- (2,709) Acquisition of 3DV Technology, Inc. ................... -- (20,000) Acquisition of Cinco .................................. -- (25,079) Other ................................................. -- (922) --------- --------- Net cash used in investing activities ......... (282,266) (105,503) Cash flows from financing activities: Effect of exchange rate fluctuations .................. (3,827) (1,333) Issuance of common stock .............................. 2,248 -- Proceeds from borrowing under line of credit .......... -- 990 Repayments of notes payable .......................... (186) (117) Sale of convertible debentures ........................ 337,624 -- Stock option exercises ................................ 92,052 35,262 Tax benefit from exercise of nonqualified stock options 25,154 35,128 Exercise of warrants .................................. 463 -- Repurchase of common stock ............................ -- (39,738) --------- --------- Net cash provided by financing activities ..... 453,528 30,192 --------- --------- Net increase in cash and cash equivalents ............... 206,808 54,153 Cash and cash equivalents at beginning of period ........ 157,031 159,170 --------- --------- Cash and cash equivalents at end of period .............. $ 363,839 $ 213,323 ========= =========
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 nine months ended September 30, 1998, the Company completed the acquisitions of Trusted Information Systems ("TIS"), Dr. Solomon's Group PLC ("Dr Solomon's"), Anyware Seguridad Informatica S.A. ("Anyware"), QA Information Security Holding AB ("QA"), Syscon (Proprietary) Limited ("Syscon"), Nordic Lantools OY and Nordic Lantools AB (together "Nordic"), Secure Networks, Inc. ("Secure") and CSB Consulenza Software di Base S.r.l. ("CSB"). All of these acquisitions were accounted for under the pooling of interests method of accounting. Financial data of the Company has been restated to reflect these acquisitions for all periods presented. The unaudited consolidated financial statements have been prepared by the Company without audit in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments, consisting only of normal recurring adjustments considered necessary for a fair presentation, have been included. The results of operations for the three and nine month periods ended September 30, 1998 are not necessarily indicative of the results to be expected for the full year or for any future periods. 2. RESTATEMENT After discussions with the Staff of the Securities and Exchange Commission (the "SEC"), the Company has restated the accompanying consolidated financial statements as of September 30, 1998 and for the three and nine month periods ended September 30, 1998. The financial statements have been restated to reflect a change in the purchase price allocation and related amortization of intangibles for acquisitions accounted for by the purchase method of accounting in 1997 (Cinco Networks, Inc., and Pretty Good Privacy, Inc.) and 1998 (Magic Solutions, Inc., and CyberMedia, Inc.), as well as two smaller acquisitions in 1995 and 1996 (AIM Technology and Vycor Corporation, respectively). The Company has also revised the original accounting for several previously reported small acquisitions accounted for under the poolings of interests method of accounting and for certain other adjustments to the Acquisition and other related costs charge taken in the fourth quarter of 1997. The following schedules summarize these restatements. 6 7 NETWORKS ASSOCIATES, INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
SEPTEMBER 30, 1998 ------------------------------------------------ AS PREVIOUSLY REPORTED OTHER AS RESTATED ------------- ----------- ----------- Current assets: Cash and cash equivalents ................................. $ 360,729 $ 3,110 $ 363,839 Short term marketable securities .......................... 133,098 -- 133,098 Accounts receivable, net of allowance for doubtful accounts of $7,842 ......................................... 225,232 1,130 226,362 Prepaid expenses, taxes and other current assets .......... 59,324 (1,987) 57,337 ----------- ----------- ----------- Total current assets .............................. 778,383 2,253 780,636 Long term marketable securities ............................. 146,804 -- 146,804 Fixed assets, net ........................................... 64,513 (6,232) 58,281 Deferred taxes .............................................. 93,471 -- 93,471 Intangible and other assets ................................. 100,330 229,899 330,229 ----------- ----------- ----------- Total assets ...................................... $ 1,183,501 $ 225,920 $ 1,409,421 =========== =========== =========== LIABILITIES Current liabilities: Accounts payable .......................................... $ 34,333 $ -- 34,333 Accrued liabilities ....................................... 184,876 (12,467) 172,409 Deferred taxes ............................................ 41,704 -- 41,704 Deferred revenue .......................................... 125,794 -- 125,794 Long term debt, current portion ........................... 3,540 -- 3,540 ----------- ----------- ----------- Total current liabilities ......................... 390,247 (12,467) 377,780 Deferred taxes, less current portion ...................... 20,969 -- 20,969 Deferred revenue, less current portion .................... 56,656 -- 56,656 Long term debt and other liabilities ...................... 363,420 -- 363,420 ----------- ----------- ----------- Total liabilities ................................. 831,292 (12,467) 818,825 STOCKHOLDERS' EQUITY Preferred stock, $.01 par value: Authorized: 5,000,000 shares; Issued and outstanding: one share Common stock, $.01 par value: Authorized: 350,000,000 shares; Issued and outstanding: 134,378,883 shares ................ 1,344 1,344 Additional paid-in capital .................................. 450,866 450,866 Retained earnings ........................................... (100,001) 238,387 138,386 ----------- ----------- ----------- Total stockholders' equity ........................ 352,209 238,387 590,596 ----------- ----------- ----------- Total liabilities and stockholders' equity ........ $ 1,183,501 $ 225,920 $ 1,409,421 =========== =========== ===========
7 8 NETWORKS ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED SEPTEMBER 30, 1998 --------------------------------------------- AS PREVIOUSLY REPORTED OTHER AS RESTATED ------------- --------- ------------- Net revenue ............................................. $ 242,444 $ -- $ 242,444 Operating costs and expenses: Cost of net revenue ................................... 44,556 -- 44,556 Research and development .............................. 33,077 -- 33,077 Marketing and sales ................................... 66,007 -- 66,007 General and administrative ............................ 16,022 -- 16,022 Amortization of intangibles ........................... 3,392 7,824 11,216 Acquisition and other related costs ................... 188,862 (125,463) 63,399 --------- --------- --------- Total operating costs and expenses ............... 351,916 (117,639) 234,277 --------- --------- --------- Income from operations ........................ (109,472) 117,639 8,167 Interest and other income, net .......................... 4,099 4,099 --------- --------- --------- Income before provision for income taxes ...... (105,373) 117,639 12,266 Provision for income taxes .............................. 26,710 26,710 --------- --------- Net income (loss) ............................. $(132,083) $ 117,639 $ (14,444) ========= ========= ========= Net income (loss) per share - basic ..................... $ (0.99) $ (0.11) ========= ========= Shares used in per share calculation - basic ............ 133,531 133,531 ========= ========= Net income (loss) per share - diluted .................. $ (0.99) $ (0.11) ========= ========= Shares used in per share calculation - diluted..... 133,531 133,531 ========= =========
8 9 NETWORKS ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED SEPTEMBER 30, 1998 -------------------------------------------------------------- RESTATEMENT AS PREVIOUSLY FOR POOLING REPORTED TRANSACTIONS OTHER AS RESTATED ------------- -------------- --------- -------------- Net revenue .......................................... $ 699,850 $ 18,004 $ -- $ 717,854 Operating costs and expenses: Cost of revenue .................................... 132,245 5,450 -- 137,695 Research and development ........................... 95,202 7,015 -- 102,217 Marketing and sales ................................ 198,677 4,194 7,318 210,189 General and administrative ......................... 53,557 6,638 5,000 65,195 Amortization of intangibles ........................ 9,932 503 17,511 27,946 Acquisition and other related costs ................ 339,772 -- (204,156) 135,616 --------- --------- --------- --------- Total operating costs and expenses ............ 829,385 23,800 (174,327) 678,858 --------- --------- --------- --------- Income from operations ..................... (129,535) (5,796) 174,327 38,996 Interest and other income, net ....................... 13,689 257 -- 13,946 --------- --------- --------- --------- Income before provision for income taxes.... (115,846) (5,539) 174,327 52,942 Provision for income taxes ........................... 77,241 271 (4,323) 73,189 --------- --------- --------- --------- Net income (loss) .......................... $(193,087) $ (5,810) 178,650 $ (20,247) ========= ========= ========= ========= Net income (loss) per share - basic .................. $ (1.47) $ (0.15) ========= ========= Shares used in per share calculation - basic ......... 131,428 545 131,973 ========= ========= ========= Net income (loss) per share - diluted ............... $ (1.47) $ (0.15) ========= ========= Shares used in per share calculation - diluted ....... 131,428 545 131,973 ========= ========= =========
9 10 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 ............................ $155,391 $ 1,640 $ -- $157,031 Short term marketable securities ..................... 151,042 538 -- 151,580 Accounts receivable, net of allowance for doubtful accounts of $5,107 ........................ 163,779 2,718 (10,300) 156,197 Prepaid expenses, taxes and other current assets ..... 35,789 5,768 31,414 72,971 -------- -------- -------- -------- Total current assets ......................... 506,001 10,664 21,114 537,779 Long term marketable securities ........................ 109,184 -- -- 109,184 Fixed assets, net ...................................... 46,845 1,483 -- 48,328 Deferred taxes ......................................... 46,262 -- (30,089) 16,173 Intangible and other assets ............................ 45,128 44 48,714 93,886 -------- -------- -------- -------- Total assets ................................. $753,420 $ 12,191 $ 39,739 $805,350 ======== ======== ======== ======== LIABILITIES Current liabilities: Accounts payable ..................................... $ 24,920 $ 1,524 $ -- $ 26,444 Accrued liabilities .................................. 164,377 3,795 (15,400) 152,772 Deferred taxes ....................................... -- 1,724 (311) 1,413 Deferred revenue ..................................... 108,718 -- 311 109,029 Long term debt, current portion ...................... 153 157 -- 310 -------- -------- -------- -------- Total current liabilities .................... 298,168 7,200 (15,400) 289,968 Deferred taxes, less current portion ................. 2,117 18 -- 2,135 Deferred revenue, less current portion ............... 18,393 -- -- 18,393 Long term debt and other liabilities ................. 2,353 -- -- 2,353 -------- -------- Total liabilities ............................ 321,031 7,218 (15,400) 312,849 -------- -------- -------- -------- STOCKHOLDERS' EQUITY Preferred stock, $.01 par value: Authorized: 5,000,000 shares; Issued and outstanding: one share Common stock, $.01 par value: Authorized: 350,000,000 shares; Issued and outstanding: 128,435,232 shares at December 31, 1997 ...................................... 1,273 8 -- 1,281 Additional paid-in capital ............................. 331,800 719 -- 332,519 Retained earnings ...................................... 99,316 4,246 55,139 158,701 -------- -------- -------- -------- Total stockholders' equity ................... 432,389 4,973 55,139 492,501 -------- -------- -------- -------- Total liabilities and stockholders' equity.... $753,420 $ 12,191 $ 39,739 $805,350 ======== ======== ======== ========
10 11 NETWORKS ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED SEPTEMBER 30, 1997 ------------------------------------------------------- RESTATEMENT AS PREVIOUSLY FOR POOLING REPORTED TRANSACTIONS OTHER AS RESTATED ------------- ------------ -------- ----------- Net revenue .......................................... $182,041 $ 6,366 $ -- 188,407 Operating costs and expenses: Cost of revenue .................................... 32,600 1,412 -- 34,012 Research and development ........................... 25,920 614 -- 26,534 Marketing and sales ................................ 52,076 1,985 -- 54,061 General and administrative ......................... 20,201 1,068 -- 21,269 Amortization of intangibles ........................ 1,013 -- 1,762 2,775 Acquisition and other related costs ................ 23,688 -- (18,454) 5,234 -------- -------- -------- -------- Total operating costs and expenses ............ 155,498 5,079 (16,692) 143,885 -------- -------- -------- -------- Income from operations ..................... 26,543 1,287 16,692 44,522 Interest and other income, net ....................... 6,356 125 -- 6,481 -------- -------- -------- -------- Income before provision for income taxes.... 32,899 1,412 16,692 51,003 Provision for income taxes ........................... 21,423 798 -- 22,221 -------- -------- -------- -------- Net income ................................. $ 11,476 $ 614 $ 16,692 $ 28,782 ======== ======== ======== ======== Net income per share - basic ......................... $ 0.09 $ 0.23 ======== ======== Shares used in per share calculation - basic ......... 125,339 1,761 127,100 ======== ======== ======== Net income per share - diluted ....................... $ 0.09 $ 0.22 ======== ======== Shares used in per share calculation - diluted ....... 130,675 1,761 132,436 ======== ======== ========
11 12 NETWORKS ASSOCIATES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED SEPTEMBER 30, 1997 ---------------------------------------------------------- RESTATEMENT AS PREVIOUSLY FOR POOLING REPORTED TRANSACTIONS OTHER AS RESTATED ------------- ------------ --------- ----------- Net revenue .......................................... $ 518,468 $ 19,098 $ -- $ 537,566 Operating costs and expenses: Cost of revenue .................................... 93,174 4,236 -- 97,410 Research and development ........................... 72,190 1,842 -- 74,032 Marketing and sales ................................ 149,524 5,955 -- 155,479 General and administrative ......................... 57,412 3,201 -- 60,613 Amortization of intangibles ........................ 4,359 -- 4,262 8,621 Acquisition and other related costs ................ 43,192 -- (18,454) 24,738 --------- --------- --------- --------- Total operating costs and expenses ............ 419,851 15,234 (14,192) 420,893 --------- --------- --------- --------- Income from operations ..................... 98,617 3,864 14,192 116,673 Interest and other income, net ....................... 15,769 375 -- 16,144 --------- --------- --------- --------- Income before provision for income taxes.... 114,386 4,239 14,192 132,817 Provision for income taxes ........................... 59,460 2,394 -- 61,854 --------- --------- --------- --------- Net income ................................. $ 54,926 $ 1,845 $ 14,192 $ 70,963 ========= ========= ========= ========= Net income per share - basic ......................... $ 0.44 $ 0.56 ========= ========= Shares used in per share calculation - basic ......... 124,367 1,761 126,128 ========= ========= ========= Net income per share - diluted ....................... $ 0.42 $ 0.54 ========= ========= Shares used in per share calculation - diluted ....... 130,668 1,761 132,429 ========= ========= =========
DESCRIPTION OF ADJUSTMENTS RESTATEMENT FOR POOLING TRANSACTIONS - NOT PREVIOUSLY RECORDED The above adjustments reflect the acquisitions of Anyware, QA, Syscon, Nordic, Secure, CSB 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. In addition, the Company's original restatement of the nine months ended September 30, 1998 for the acquisition of Dr. Solomon's included Dr. Solomon's results for the two pre-acquisition fiscal quarters ended February 28, 1998 and May 31, 1998 together with its post-acquisition fiscal quarter ended September 30, 1998. As previously disclosed, the results of operations of Dr. Solomon's for the month of June were not included in the consolidated results for the nine months ended September 30, 1998 and were separately disclosed in the Company's Form 10-Q for such period. The above adjustments include the June 1998 results of operations for Dr. Solomon's and, as a result, include the results of Dr. Solomon's for a ten-month period. Revenue and net loss for Dr. Solomon's for June 1998 was $7.3 million and $3.8 million, respectively. RESTATEMENT FOR ACQUISITION AND OTHER RELATED COSTS: In-process research and development charges: During 1997 and 1998, the Company completed a number of acquisitions in transactions accounted for by the purchase method. Purchase price allocations performed at the time of these acquisitions resulted in substantial allocations to in-process research and development for projects underway by the acquired companies which had not reached technological feasibility and which had no 12 13 alternative future use. These allocations were performed following methods generally in use by technology companies based on appraisals at the time. Recent guidance published by the SEC has resulted in a general re-evaluation of the methodology used in such appraisals. Following a review of its Form 10-Q for the nine months ended September 30, 1998 and its Form 10-K for the year ended December 31, 1997 by the SEC and subsequent discussions with the SEC, the Company has re-evaluated its allocations for purchase transactions in 1997 and 1998. The restatements included above reflect the adjustments to the in-process research and development write-offs resulting from such re-evaluations as follows:
As Additional Originally As Restated Amount Reported Capitalized $'000 $'000 $'000 ---------- ----------- ----------- Magic Solutions $ 97,001 $ 27,014 $ 69,987 (acquired by Network Associates in 1998) CyberMedia 122,228 22,830 99,398 (acquired by Network Associates in 1998) Cinco 23,688 5,234 18,454 (acquired by Network General in 1997) Pretty Good Privacy 30,878 3,937 26,941 (acquired by Network Associates in 1997) Vycor 7,800 -- 7,800 (acquired by McAfee in 1996) AIM 7,200 -- 7,200 (acquired by Network General in 1995)
Restatements relating to other acquisition charges: The Company has also made a number of other adjustments relating to its Acquisition and other related costs recorded during the nine months ended September 30, 1998 and to Amortization of intangibles recorded as a result of the in-process research and development related restatements. The table below shows these adjustments together with the adjustments to acquired in-process research and development:
--------------------------------------------------------------------------------------------------------------- NINE MONTHS THREE MONTHS DESCRIPTION OF RECLASSIFICATION ENDED ENDED ------------------------------- SEPTEMBER 30, SEPTEMBER 30, 1998 1998 -------------------------------------------------------------------------------------------------------------- $'000 $'000 --------- --------- Reclassification of severance and benefits for terminated employees of companies acquired in transactions accounted for by the purchase method of accounting to goodwill, previously charged to earnings in the period of acquisition. This adjustment increased intangible and other assets by the same amount $ (7,729) $ (5,319) Reclassification of facility cost write downs and reserves relating to facilities and assets of companies acquired in transactions accounted for by the purchase method of accounting to goodwill, previously charged to earnings in the period of acquisition. This adjustment increased intangible and other assets by the same amount (14,321) (8,025) Reversal of excess acquisition and other related costs reserves (12,721) (12,721) Restatement of acquired in-process research and development This adjustment increased intangible and other assets by the same amount (169,385) (99,398) --------- --------- ------------------------------------------------------------------------------------------------------------
13 14 ------------------------------------------------------------------------------------------------------------ $(204,156) $(125,463) ========= ========= Total adjustments to Acquisition and other related costs $ 5,000 -- ========= Reclassification of the write-off of uncollectable receivables associated with the acquisition of Network General to general and administrative expenses. 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. 2,493 -- --------- Total adjustments to Marketing and sales expense $ 7,318 ========= Additional amortization resulting adjustments to purchase price allocations. This adjustment reduced intangible and other assets. $ 17,511 $ 7,824 ========= ========= ------------------------------------------------------------------------------------------------------------
The net increase to Intangible and other assets of $229.9 million is comprised of the above reclassifications of severance and benefits and facilities and asset write downs of $22.0 million, adjustments to in-process research and development for 1998 acquisitions of $173.4 million, adjustments for prior year acquisitions of $60.4 million reduced by the total accumulated amortization of $29.1 million plus capitalization of trademark costs of $3.2 million. The Company reclassified $3.1 million from retained earnings to cash in connection with the acquisition of a foreign subsidiary. As a result of the re-evaluations of the purchase transactions above, amortization of goodwill and other intangibles resulting from these acquisitions for the three and nine months ended September 30, 1998 was increased from amounts previously reported by $7.8 million and $17.5 million respectively, and future amortization will be increased for the next 7 years as follows:
Year Ended December 31, Amount $'000 ------------ ------------ Q4 1998 $ 9,908 1999 37,680 2000 37,030 2001 37,030 2002 36,585 2003 30,042 2004 27,930 2005 13,694
3. RECENT ACCOUNTING PRONOUNCEMENTS In October 1997, the AICPA issued Statement of Position No. 97-2 ("SOP 97-2") "Software Revenue Recognition," which the Company has adopted for transactions entered into during the year beginning January 1, 1998. SOP 97-2 provides guidance for recognizing revenue on software transactions and supersedes previous guidance provided by SOP 91-1, "Software Revenue Recognition." Under SOP 97-2, revenue from product licenses is recognized when a signed agreement or other persuasive evidence of an arrangement exists, the software or system has been shipped (or software has been electronically delivered), the license fee is fixed and determinable, and collection of the resulting receivable is probable. For contracts with multiple elements/obligations, (e.g. 14 15 software products, upgrades/enhancements, maintenance and services), revenue is allocated to each element of the arrangement based on the Company's evidence of fair value as determined by the amount charged when the element is sold separately. Maintenance revenue for providing product updates and customer support is deferred and recognized ratably over the service period. Revenue on rental units under operating leases and service agreements is recognized over the term of the rental agreement or the period during which services are expected to be performed. Revenue generated from products sold through traditional channels where the right of return exists is reduced by reserves for estimated sales returns. In March 1998, the AICPA issued Statement of Position No. 98-4 ("SOP 98-4"), "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition." SOP 98-4 defers, for one year, the application of certain passages in SOP 97-2, which limit what is considered vendor-specific objective evidence ("VSOE") necessary to recognize revenue for software licenses in multiple-element arrangements when undelivered elements exist. Additional guidance is expected prior to adoption of any resulting final amendments related to the deferred provisions of SOP 97-2. Because of the uncertainties related to the outcome of these proceedings, the impact, if any, on future financial results of the Company is not currently determinable. Adoption of the remaining provisions of SOP 97-2, as amended, did not have a material impact on revenue recognition during the first three quarters of 1998. In March 1998, the AICPA issued an Exposure Draft for Statement of Position No. 98-9 ("SOP 98-9") "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions" which clarifies guidance regarding VSOE and multiple element arrangements. SOP 98-9 which is expected to be issued by December 1998, amends SOP 98-4 to extend the deferral of guidance in SOP 97-2 as it relates to these matters through fiscal years beginning after March 15, 1999. The adoption of SOP 97-2, as amended by SOP 98-4, in the first quarter of 1998 did not have a material effect on the Company's revenue recognition practices. The Company has evaluated the amendments expected to be issued under SOP 98-9 and does not expect their adoption will have a material effect on its revenue recognition practices. 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 Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an Enterprise and Related Information", which requires companies to report certain information about operating segments, including certain information about their products, services, the geographic areas in which they operate and their major customers. This statement supersedes FASB Statements Nos. 14, 18, 24 and 30. SFAS 131 is effective for financial statements for fiscal years beginning after December 15, 1997. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through net income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. SFAS 133 is effective for years beginning after June 15, 1999, but companies can early adopt as of the beginning of any fiscal quarter that begins after June 1998. The Company is evaluating the requirements of SFAS 133, but does not expect this pronouncement to materially impact the Company's results of operations. 4. NET INCOME (LOSS) PER SHARE In accordance with the disclosure requirements of SFAS 128, a reconciliation of the numerator and denominator of basic and diluted net income (loss) per share calculations is provided as follows (in thousands, except per share amounts): 15 16
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- 1998 1997 1998 1997 --------- --------- --------- --------- Numerator -- basic Net income (loss) ............................ $ (14,444) $ 28,782 $ (20,247) $ 70,963 ========= ========= ========= ========= Numerator -- diluted Net income (loss) ............................ $ (14,444) $ 28,782 $ (20,247) $ 70,963 Interest on convertible debentures, net of tax -- -- -- -- --------- --------- --------- --------- Net income (loss) available to common stockholders .......................... $ (14,444) $ 28,782 $ (20,247) $ 70,963 ========= ========= ========= ========= Denominator -- basic Basic weighted average common shares outstanding .................................. 133,531 127,100 131,973 126,128 ========= ========= ========= ========= Denominator -- diluted Basic weighted average common shares outstanding .................................. 133,531 127,100 131,973 126,128 Effect of dilutive securities: Common stock options ......................... -- 5,336 -- 6,301 --------- --------- --------- --------- Diluted weighted average shares .............. 133,531 132,436 131,973 132,429 ========= ========= ========= ========= Net income (loss) per share -- basic ......... $ (0.11) $ 0.23 $ (0.15) $ 0.56 ========= ========= ========= ========= Net income (loss) per share -- diluted ....... $ (0.11) $ 0.22 $ (0.15) $ 0.54 ========= ========= ========= =========
5. ACQUISITIONS CyberMedia, Inc. On September 9, 1998, the Company obtained control of CyberMedia, Inc. ("CyberMedia"), a provider of desktop utility software solutions, when CyberMedia's stockholders tendered approximately 97% of the outstanding shares to the Company for $9.50 per share in cash. On September 10, 1998, a subsidiary of the Company merged into CyberMedia in a transaction in which CyberMedia shares not tendered were converted into the right to receive the same per share cash price paid in the tender offer. Total cash paid to stockholders was $130.4 million. The transaction was accounted for as a purchase transaction. The total purchase price including transaction costs and assumed net liabilities was approximately $174.3 million. As the Company had assessed and formulated its plans to terminate certain CyberMedia employees and close certain CyberMedia facilities as of the acquisition date, the total purchase price includes related liabilities of $13.3 million. Of the total purchase price, $22.8 million was allocated to in-process research and development. In addition, $12.2 million was allocated to existing technology and other intangibles and $139.3 million to goodwill, to be amortized over 3 and 7 years, respectively. To determine the value of the in-process research and development, the Company considered, among other factors, the stage of development of each project at the time of acquisition, the time and cost needed to complete each project, expected income from the projects, and the projected incremental cash flows from the projects when completed and any associated risks. Associated risks include the inherent difficulties and uncertainties in completing a project and thereby achieving technological feasibility and risks related to the impact of potential changes in future target markets. This analysis resulted in $22.8 million being assigned to in-process research and development projects which had not yet reached technological feasibility and did not have alternative future use. Dr Solomon's Group PLC On August 13, 1998, the Company acquired Dr Solomon's Group PLC ("Dr Solomon's"), (the "Acquisition"), a European-based publicly-held provider of anti-virus software products for approximately 15.3 million shares of the Company's Common Stock (including 1.7 million shares held in trust pending the exercise of certain outstanding and fully vested Dr Solomon's options). In the Acquisition, each outstanding ordinary share of Dr Solomon's was exchanged for 0.27625 shares of Common Stock of the Company. The Company assumed all outstanding options to acquire Dr Solomon's ordinary shares. The Acquisition was accounted for as a pooling of interests and therefore all prior period financial statements have been restated to include the results of Dr Solomon's for all periods presented. Financial statements for the years ended December 31, 1997, 1996 and 1995, reflect the combination of the statements of operations of the Company for the years ended December 31, 1997, 1996 and 1995 16 17 and the aggregation of the unaudited quarterly statements of operations of Dr. Solomon's for the years ended November 31, 1997, 1996 and 1995. The results of operations for the nine months ended September 30, 1997 reflect the results of operations of the Company for the nine months ended September 30, 1997 and the results of operations of Dr. Solomon's for the nine months ended August 31, 1997. Separate and combined results of operations for the periods prior to the merger are as follows (in thousands, except per share data):
Year Ended December 31, Six Months Ended June 30, ------------------------ ---------------------------------------- 1997 1996 1995 1998 1997 --------- --------- --------- --------- --------- Revenues: Networks Associates $ 656,322 $ 478,587 $ 314,051 $ 419,512 $ 313,992 Dr. Solomon's 79,370 44,275 23,335 55,898 35,167 --------- --------- --------- --------- --------- Combined $ 735,692 $ 522,862 $ 337,386 $ 475,410 $ 349,159 ========= ========= ========= ========= ========= Net income (loss) Networks Associates $ 10,635 $ 67,447 $ 52,890 $ (6,305) $ 44,145 Dr. Solomon's 4 (56,736) 862 502 3,678 --------- --------- --------- --------- --------- Combined $ 10,639 $ 10,711 $ 53,752 $ (5,803) $ 47,823 ========= ========= ========= ========= ========= Net income (loss) per share - diluted Networks Associates $ 0.09 $ 0.59 $ 0.48 $ (0.05) $ 0.38 ========= ========= ========= ========= ========= Dr. Solomon's $ 0.00 $ (6.34) $ 0.10 $ 0.03 $ 0.24 ========= ========= ========= ========= ========= Combined $ 0.08 $ 0.09 $ 0.45 $ (0.04) $ 0.36 ========= ========= ========= ========= =========
Secure Networks, Inc. On May 15, 1998, the Company acquired Secure Networks, Inc. ("Secure"). The aggregate consideration payable in the acquisition was 567,000 shares of the Company's Common Stock. The acquisition was accounted for as a pooling of interests and therefore all prior period financial statements have been restated to include the results of Secure for all periods presented. Secure is a developer and licensor of network security auditing software based in Canada. Trusted Information Systems On April 28, 1998, the Company acquired Trusted Information Systems ("TIS"), a publicly-held provider of comprehensive security systems for computer networks. The acquisition was accounted for as a pooling of interests and therefore all prior period financial statements have been restated to include the results of TIS for all periods presented. In the acquisition, a wholly owned subsidiary of the Company merged with and into TIS; TIS became a wholly owned subsidiary of the Company; and all outstanding common stock of TIS was converted into approximately 6.8 million shares of Common Stock of the Company, at an exchange ratio of 0.4845. The Company also assumed all outstanding options and other rights to acquire TIS capital stock. Magic Solutions International, Inc. On April 1, 1998, the Company acquired all of the outstanding capital stock and options of Magic Solutions International, Inc. ("Magic Solutions"), a privately held provider of internal help desk and asset management solutions, for approximately $109.8 million in cash. The acquisition was accounted for using the purchase method of accounting and the total purchase price was $140.3 million, including transaction costs and assumed net liabilities. As the Company had assessed and formulated its plans to terminate certain Magic Solutions employees and close the Magic Solutions facilities as of the acquisition date, the total purchase price includes related liabilities of $8.7 million. Approximately $27.0 million of the total purchase price was expensed as purchased in-process research and development. The remaining excess of the purchase price over the net assets acquired was $113.3 million of which, $20.3 million has been recorded as purchased technology and trademarks and $92.9 million as goodwill which are being amortized on a straight-line basis over 5 and 7 17 18 years, respectively. To determine the value of the in-process research and development, the Company considered, among other factors, the stage of development of each project at the time of acquisition, the time and cost needed to complete each project, expected income from the projects, and the projected incremental cash flows from the projects when completed and any associated risks. Associated risks include the inherent difficulties and uncertainties in completing a project and thereby achieving technological feasibility and risks related to the impact of potential changes in future target markets. This analysis resulted in $27.0 million being assigned to in-process research and development projects which had not yet reached technological feasibility and did not have alternative future use. As of September 30, 1998 the purchase price allocation is final. The following summary, prepared on a pro forma basis, combines the results of operations as if CyberMedia and Magic Solutions had been acquired as of the beginning of the periods presented, after including the impact of certain adjustments, such as amortization of intangibles, the write-off of in-process technology and the related income tax effects (dollars in thousands, except per share amounts):
Nine Months Ended September 30 ------------------------- 1998 1997 --------- --------- (unaudited) Revenue ............................... $ 731,445 $ 627,542 Net income (loss) ..................... (99,241) 14,051 Net income (loss) per share ........... $ (0.75) $ 0.11
The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the entire periods presented. In addition, they are not intended to be a projection of future results and do not reflect any synergies that might be achieved from combined operations. Other Acquisitions On August 31, 1998, the Company acquired QA Information Security Holding AB ("QA"). The consideration payable in the acquisition was 305,557 shares of the Company's Common Stock in a transaction accounted for as a pooling of interests. QA, based in Sweden, is a distributor of network security products. On July 30, 1998, the Company acquired Anyware Seguridad Informatica S.A. ("Anyware"). The aggregate consideration payable in the acquisition was 228,204 shares of the Company's Common Stock in a transaction accounted for as a pooling of interests. Anyware, based in Madrid, Spain, is a developer and distributor of anti-virus software products. The Company's financial statements have been restated for these poolings, the effect of which was not material. In connection with the acquisitions accounted for as a pooling of interests, the Company incurred direct transaction costs and other restructuring and related charges in the amount of $40.6 million and $85.8 million in the three and nine months ended September 30, 1998. In connection with the acquisitions accounted for as purchase transactions, the Company incurred charges of $22.8 million and $49.8 million in the three and nine months ended September 30, 1998, consisting principally of the write off of in-process research and development acquired. The following is a summary of these charges for the nine months ended September 30, 1998 together with charges for certain restructuring activities taken by the Company ($ 000's): 18 19
Direct Lease Costs Transaction Severance and Asset In-Process Costs & Benefits Write downs R&D Other Total ----------- ---------- ----------- ---------- --------- --------- TIS $ 15,023 $ 3,818 $ 4,414 $ (924) $ 22,331 Dr. Solomon's 19,898 11,425 18,312 0 49,635 Secure 500 500 1,200 100 2,300 Magic 27,014 27,014 CyberMedia 22,830 22,830 Restructuring Costs-Q2 11,318 8,644 610 20,572 Restructuring Costs-Q3 -- 3,285 370 -- -- 3,655 Reversal of excess reserves (6,750) (2,276) (3,909) -- 214 (12,721) --------- --------- --------- --------- --------- --------- Total Charges $ 28,671 $ 28,070 $ 29,031 $ 49,844 $ -- $ 135,616 --------- --------- --------- --------- --------- ---------
Direct transaction costs included $18.0 million in investment banking fees, $9.2 million in legal and accounting fees, and $1.5 million in filing fees, travel and other costs. Lease costs and asset writedowns include the costs of closing approximately 33 facilities throughout the world ($12.2 million), the disposal of excess and obsolete assets (generally computer equipment which did not comply with the Company's standards ($12.0 million), and the write-off of goodwill and intangibles associated with discontinued Dr. Solomon's products ($4.8 million). The Dr. Solomon's write-off related to two minor products--NetOctopus (a software distribution product for MacIntosh computers) and Audit (an asset inventory product). These products were duplications of existing Company products and had limited sales subsequent to the Dr. Solomon's acquisition. The Company has not and does not plan to incorporate these products into its products. The following table summarizes the activity in the reserves for severance and benefits, lease costs and asset write downs established in the second and third quarters of 1998 ($000's):
Direct Transaction Severance Asset Costs & Benefits Lease Costs Write Downs Other Total ----------- ---------- ----------- ----------- -------- -------- Charged in Three Months ended June 30, 1998 $ 15,523 $ 15,636 $ 6,485 $ 7,773 $ (214) $ 45,203 Paid Out or Charged against the related assets (5,254) (9,053) (596) (1,310) -- (16,213) -------- -------- -------- -------- -------- -------- Balance, June 30, 1998 10,269 6,583 5,889 6,463 (214) 28,990 Charged in three months ended September 30, 1998 19,898 14,710 5,764 12,918 53,290 Paid Out or charged against the related assets (9,363) (10,334) (5,904) (11,067) (36,668) Reversal of excess reserves (6,750) (2,276) -- (3,909) 214 (12,721) -------- -------- -------- -------- -------- -------- Balance, September 30, 1998 $ 14,054 $ 8,683 $ 5,749 $ 4,405 $ -- $ 32,891 -------- -------- -------- -------- -------- --------
The severance and benefits charges for the nine months ended September 30, 1998 related to company-wide reductions in force following the Company's major acquisitions in the second and third quarters of approximately 784 employees of which 107 were in research and development functions, 302 were in sales and marketing functions and the remainder were in administrative and other support functions. Substantially all terminated employees left 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, exclusive of the intangible assets of Dr. Solomon described above, comprised $5.6 million in losses on Company owned buildings (which were written down to estimated values determined by appraisals) and $10.3 million in net losses of computer and other miscellaneous assets. In general, this equipment was discarded or sold for nominal value. Due to the immediate consolidation of facilities, depreciation allocable to these facilities and the related assets, during the transition period, was not material. Of the facilities acquired in its 1998 acquisitions identified for closure, the Company has 17 facilities worldwide which have not been disposed of or subleased (16 leased; 1 owned). These facilities are insignificant to the Company's operations and, other than a portion of a leased facility which the Company has decided to retain, each is intended for disposal or sublease in 1999. 19 20 The following table summarizes the activity in the reserves for severance and benefits, lease costs and asset and write downs established in the year ended December 31, 1997 ($000's):
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 (8,083) (6,725) (2,853) (4,381) (2,521) (24,563) Adjustment to liability -- (3,000) -- 3,000 -- -- -------- -------- -------- -------- -------- -------- Balance, September 30, 1998 $ (33) $ 972 $ 989 $ 484 $ 372 $ 2,784 ======== ======== ======== ======== ======== ========
The Company believes that the reserve balances remaining at September 30, 1998 are adequate to cover any additional benefits or losses yet to be paid or realized. Any reserves not used will be recorded as a credit to Acquisition and Related Charges in future periods. 6. CONVERTIBLE DEBENTURES On February 13, 1998, the Company completed a private placement of zero coupon convertible subordinated Debentures due in 2018 (the "Debentures"). The Debentures, with an aggregate face amount at maturity of $885.5 million, generated net proceeds to the Company of approximately $337.6 million. The initial price to the public for the Debentures was $391.06 per $1,000 of face amount at maturity, which equates to a yield to maturity over the term of the bonds of 4.75% (on a semi-annual bond equivalent basis). The debentures are convertible into Common Stock at the rate of 8.538 shares per $1,000 of face amount at maturity, which equates to an initial conversion price of $45.80 per share. The Debentures are subordinated in right of payment to all existing and future Senior Indebtedness (as defined) and effectively subordinated in right of payment to all indebtedness and other liabilities of the Company's subsidiaries. The Debentures may be redeemed for cash at the option of the Company beginning on February 13, 2003. At the option of the holder, the Company will purchase the Debentures on February 13, 2003, February 13, 2008 and February 13, 2013 at purchase prices (to be paid in cash or Common Stock or any combination thereof, at the election of the Company and subject to certain conditions) equal to the initial issue price plus accrued original issue discount to such dates. The Debentures may also be redeemed at the option of the holder if there is a Fundamental Change (as defined) at a price equal to the issue price plus accrued original issue discount to the date of redemption, subject to adjustment. 7. LITIGATION In December 1997, the Company changed its legal name to "Networks Associates, Inc." and has since been conducting business as "Network Associates." Network Associates, Inc. in Oregon ("NAI-Oregon") and Ronald L. Myers ("Myers"), a California resident doing business as The Network Associates, have made unresolved claims (including various trademark claims) or demands with respect to the Company's use of the name Network Associates. On March 26, 1998, the Company commenced a declaratory judgement action in the United States District Court, Northern District of California against the above-cited claimants. The Company seeks a declaration that its use of the Network Associates title does not violate the federal, state or common law rights of any of the defendants. Defendant NAI-Oregon has not yet answered the complaint; defendant Myers has not yet been served. On April 24, 1997, the Company was served by Symantec Corporation ("Symantec") with a suit filed in the United States District Court, Northern District of California, San Jose Division, alleging copyright infringement and unfair competition by the Company. Symantec alleges that the Company's computer software program called "PC Medic" copied portions of Symantec's computer software program entitled "CrashGuard." Symantec's complaint sought injunctive relief and unspecified money damages. On July 20, 1997, Symantec sought leave to amend its complaint to include additional allegations of copyright infringement and trade secret misappropriation pertaining to the Company's "VirusScan" product. Symantec sought injunctive relief and unspecified money damages. On October 6, 1997, the Court issued an order granting Symantec's motion to amend its complaint and enjoining the Company from shipping any product containing either an approximately 30-line routine found in CrashGuard or an approximately 100-line routine found in a Symantec DLL. The Court's order expressly stated that "the court is not enjoining the sale or distribution of [McAfee's] current product." On December 19, 1997, the Court denied Symantec's motion to enjoin sale or distribution of the Company's current PC Medic product. On April 1, 1998, Symantec filed an amended complaint including additional allegations of 20 21 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 a proprietary Symantec customer database. On June 9, 1998, the Court dismissed Symantec's RICO claims without prejudice and dismissed Symantec's unfair competition claims relating to alleged use of source code with prejudice. On June 15, 1998, the Court entered a stipulated preliminary injunction prohibiting the Company from making use of any Symantec customer list data. On September 4, 1998, Symantec's time for amending its complaint expired; Symantec did not re-file its RICO claims. On October 8, 1998, the Court granted partial summary judgment in the Company's favor dismissing with prejudice Symantec's claims for interference with economic and contractual relations, Symantec's trade secret claims relating to alleged misappropriation of source code and portions of Symantec's copyright claims. In September 1998, the Company acquired CyberMedia. On October 22, the Court consolidated the above case for purposes of trial with an action originally brought on February 4, 1998 by CyberMedia against Symantec (described below) and the action brought by Symantec against the Company on September 4, 1998 (described below). There is currently no trial date set for the consolidated case. The Court will hold a status conference on the matter on November 19, 1998. On September 4, 1998, Symantec filed suit in United States District Court for the Northern District of California, San Jose Division, against the Company, alleging copyright infringement, unfair competition, and trade secret misappropriation. Symantec alleges that an unidentified Company employee copied and transported to the Company certain proprietary Symantec files, including files containing Norton Antivirus software. Symantec also alleges that another unidentified Company employee located in Canada copied and transported to the Company certain other unidentified files containing Symantec confidential information. Symantec has not yet served the Company in this case. 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 was 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 were to proceed separately. Symantec has since settled out of the lawsuit. The Court held a patent claim interpretation hearing on September 1, 1998. The Court has not yet issued a ruling on claim interpretation. At a case management conference held on October 2, 1998, the Court set a new trial date of November 8, 1999. In addition, Trend filed a supplemental complaint on October 5, 1998, adding the Gauntlet product to the products accused of infringing Trend's patent. 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. Discovery is presently scheduled to be completed by January 1999. A trial date has been set for June 1999. On July 30, 1998, CyberMedia, the Company and certain of CyberMedia's officers and directors were named as defendants in a purported class action entitled Schneider v. Patil, et al., No. 16565NC (Del. Ch.). The complaint, in a subsequent amendment, alleges that the individual defendants breached their fiduciary duties by failing to obtain an adequate price for CyberMedia in the Network Associates/CyberMedia transaction. The complaint also alleged that the relevant merger documents failed to disclose material information. The complaint sought injunctive relief. As of the date of this Form 10-Q, it appears plaintiffs will not pursue this action. On August 10, 1998, CyberMedia and two of its officers were named as defendants in a purported securities class action entitled Daugherty v. CyberMedia, Inc. et al., No. BC195733 (Los Angeles Cty. Superior Ct.). The complaint alleges that defendants violated California state securities laws and common law by artificially deflating the price of CyberMedia stock to the detriment of a purported class of investors who sold CyberMedia stock between March 13, 1998 and July 28, 1998. The complaint does not specify damages. Defendants filed a demurrer to the complaint on September 25, 1998. The hearing on the demurrer is scheduled for December 8, 21 22 1998. Defendants also have filed a motion to stay discovery pending resolution of the demurrer and class certification. The motion to stay discovery is scheduled to be heard on December 8, 1998. On September 14, 1998, CyberMedia and certain of its former officers and directors were named as defendants in a consolidated amended securities class action complaint filed in the United States District Court for the Central District of California. The consolidated amended complaint consolidated the following previously filed cases: Ong v. CyberMedia, Inc., et al., No. 98-1811 CBM (Ex), filed on March 12, 1998, St. John v. CyberMedia, Inc., et al., No. 98-2085 MRP (SHx), filed on March 24, 1998, Zier v. CyberMedia, Inc., et al., No. 98-2210 CM (MCx), filed on March 26, 1998, Liu v. CyberMedia, Inc., et al., No. 98-2617, filed on April 8, 1998, Kerr, et al. v. CyberMedia, Inc., et al., No. 98-3104 RJK (Anx), filed on April 23, 1998, and Barker v. CyberMedia, Inc., et al., No. SA CV98-401 AHS (ANx), filed on May 6, 1998. The consolidated amended complaint alleges that the defendants violated federal securities laws by artificially inflating the price of CyberMedia stock to the detriment of a purported class of investors who purchased or otherwise acquired CyberMedia stock between March 31, 1997 and March 12, 1998. The consolidated amended complaint does not specify damages. In light of ongoing settlement negotiations, the parties have entered into a stipulation extending defendants' time to file a responsive pleading to and including November 16, 1998. CyberMedia and certain of its former officers and directors were named as defendants in three securities class action lawsuits filed in the Superior Court of Los Angeles County. Such complaints have been ordered consolidated, although a consolidated amended complaint has not yet been filed. The consolidated complaints include: Brown v. CyberMedia, Inc., et al., No. B C187898, filed on March 19, 1998, Smith v. CyberMedia, Inc., et al. No. B C188527, filed on March 31, 1998, and Stockwell v. CyberMedia, Inc., et al., No. B C189020, filed on April 8, 1998. The complaints allege that defendants violated California state securities laws and common law by artificially inflating the price of CyberMedia stock to the detriment of a purported class of investors who purchased or otherwise acquired CyberMedia stock between March 31, 1997 and March 13, 1998. The complaints do not specify damages. There is currently no schedule for the filing of a consolidated amended complaint. On February 4, 1998, CyberMedia filed a lawsuit against Symantec in United States District Court for the Northern District of California. Also named as defendants in the complaint are ZebraSoft, Inc. ("ZebraSoft") and three individual officers and directors of ZebraSoft. The complaint alleges that the defendants violated federal copyright laws and misappropriated CyberMedia's trade secrets in developing and distributing a computer software program, known as Norton Uninstall Deluxe, that is competitive with CyberMedia's UnInstaller program. The complaint seeks money damages and injunctive relief against the defendants. Although the Company intends to defend itself vigorously against the claims asserted against it (and its subsidiary CyberMedia) in the foregoing actions or matters, there can be no assurance that such pending litigation will not have a material adverse effect on the Company's business, financial condition or operating results. The litigation process is subject to inherent uncertainties and no assurance can be given that the Company will prevail in any such matters, or will be able to obtain licenses, on commercially reasonable terms, or at all, under any patents or other intellectual property rights that may be held valid or infringed by the Company or its products. Uncertainties inherent in the litigation process involve, among other things, the complexity of the technologies involved, potentially adverse changes in the law and discovery of facts unfavorable to the Company. 8. SUBSEQUENT EVENTS On October 19, 1998, pursuant to a Preferred Shares Rights Agreement between the Company and BankBoston, N.A. as Rights Agent, the Board of Directors of the Company announced that it had declared a dividend distribution of one preferred share purchase right (a "Right") on each outstanding share of the Company's Common Stock. Each right will entitle stockholders to buy one-one thousandth of a share of the Company's Series B Participating Preferred Stock at an exercise price of $200.00. The Rights will become exercisable following the tenth day after a person or group announces the acquisition of 15% or more of the Company's Common Stock or announces commencement of a tender or exchange offer, the consummation of which would result in ownership by the person or group of 15% or more of the Common Stock of the Company. The Company will be entitled to redeem the Rights at $0.01 per Right at any time on or before the tenth day following acquisition by a person or group of 15% or more of the Company's Common Stock. The dividend distribution was made on November 3, 1998, payable to the stockholders of record on November 3, 1998. The Rights will expire on October 20, 2008. 22 23 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. The Company has organized its products into four product suites -- McAfee Total Virus Defense and PGP Total Network Security (together comprising "Net Tools Secure") and Sniffer Total Network Visibility and McAfee Total Service Desk (together comprising "Net Tools Manager"). These four product suites together form an integrated solution called "Net Tools". The following table depicts the Company's product suites: NET TOOLS
NET TOOLS SECURE NET TOOLS MANAGER - --------------------------------------------------------------- ------------------------------------------------------------------ MCAFEE TOTAL PGP TOTAL NETWORK SNIFFER TOTAL NETWORK MCAFEE TOTAL SERVICE VIRUS DEFENSE (TVD) SECURITY (TNS) VISIBILITY (TNV) DESK (TSD) - ----------------------------- -------------------------------- ------------------------------------ ----------------------------- - - Total Virus Defense Suite - Total Network Security Suite - Total Network Visibility Suite - Total Service Desk Suite - - GroupShield Security Suite - PGP Enterprise Security Suite - Sniffer Portable Analysis Suite - McAfee Help Desk Suite - Gauntlet Active Firewall Suite - Sniffer Distributed Analysis Suite - Zero Administration Client - CyberCop Intrusion Protection - Sniffer Service Desk Suite - Self Service Desk Suite Suite - Support Magic SQL Suite
Net Tools Secure is designed to protect the enterprise from viruses, hackers, thefts, lost data and threats to data security at all points of entry. McAfee Total Virus Defense is a multi-tiered approach to virus protection covering the client, server and Internet gateway; and PGP Total Network Security combines security products with desktop encryption software and key management tools. Net Tools Manager is a network management and service desk solution designed to make computer networks more efficient and users more productive. Sniffer Total Network Visibility is a comprehensive set of products and services for network fault and performance management (also known as analysis and monitoring); and McAfee Total Service Desk is designed to integrate robust help desk applications with asset management software. The Company also provides product support, education and consulting services. - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 23 24 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 licensing model for its products to corporate clients. The Company also markets as a subset of its products to retail customers; McAfee Office combines ten PC diagnostic and utility tools into one integrated software package. 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, changes in customer budgets related to information technology spending, 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. More recently, the Company has adopted a strategy of up-selling existing licenses to higher level product suites. There can be no assurance that the Company will be able to sustain current renewal and/or up-selling rates in the future. In addition, revenue generated through distribution channels tends to be non-linear and this may cause the Company's revenue to fluctuate in the future. The Company's results for any given period should not be relied upon as indicative of future performance. See "Risk Factors -- Variability of Quarterly Operating Results." The Company's future earnings and stock price may be subject to volatility in any period. Any shortfall in various operating results, including licensing activity, product sales, net revenue, operating income, net income or net income per share from historical levels or expectations of securities analysts may have significant adverse effects on the trading price of the Company's stock. Furthermore, other factors such as acquisitions or unforeseen events in the technology or software industry or in the Company's day to day activities can have a material adverse effect on the Company's stock performance. See "Risk Factors -- Volatility of Stock Price" and "Risk Factors -- Risks Associated with Failure to Manage Growth; Potential Future Acquisitions." RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of net revenue represented by certain items in the Company's statements of operations for the three months and nine months ended September 30, 1998 and 1997:
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- -------------------- 1998 1997 1998 1997 ------ ------ ------ ------ Net revenue ................................. 100.0% 100.0% 100.0% 100.0% Operating costs and expenses: Cost of net revenue ....................... 18.4 18.1 19.2 18.1 Research and development .................. 13.6 14.1 14.2 13.8 Marketing and sales ....................... 27.3 28.6 29.3 28.9 General and administrative ................ 6.6 11.3 9.1 11.3 Amortization of intangibles ............... 4.6 1.5 3.9 1.6 Acquisition and other related costs ....... 26.1 2.8 18.9 4.6 ------ ------ ------ ------ Total operating costs and expenses ..... 96.6 76.4 94.6 78.3 ------ ------ ------ ------ Income (loss) from operations ..... 3.4 23.6 5.4 21.7 Interest and other income and expense net ... 1.7 3.5 2.0 3.0 ------ ------ ------ ------ Income (loss) before provision for income taxes ................ 5.1 27.1 7.4 24.7 Provision for income taxes .................. 11.1 11.8 10.2 11.5 ------ ------ ------ ------ Net income (loss) ................ (6.0)% 15.3% (2.8)% 13.2% ====== ====== ====== ======
- -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 24 25 Net Revenue. Net revenue includes product revenues, revenues from software support, maintenance contracts, education and consulting services as well as revenues from those warranty, customer support and maintenance contracts which are deferred and recognized over the related service period. Net revenue was $242.4 million in the three months ended September 30, 1998, an increase of 29% from $188.4 million in the three months ended September 30, 1997. In the nine months ended September 30, 1998, net revenue was $717.9 million, an increase of 34% from $537.6 million in the same period in 1997. The increase in net revenues is due to an increase in the breadth of product offerings largely due to the expansion of both the Net Tools Secure and Net Tools Manager product suites, and an increase in brand recognition, resulting in the growth of the installed customer base and the resulting renewal of maintenance contracts. Although the Company has had significant growth in net revenue and net income (before acquisition and other related charges), the Company's historic growth rate will be difficult to sustain or exceed.* The Company has experienced increased price competition for its products and the Company expects competition to increase in the near-term, which may result in reduced average selling prices 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. Historically, renewals have accounted for a significant portion of the Company's net revenue. More recently, the Company has adopted a strategy of up-selling existing licenses to higher level product suites. There can be no assurance that the Company will be able to sustain current renewal and/or up-selling rates for its products in the future.* Risks related to the Company's change in business strategies, including its newly introduced suite pricing model, two-year licensing model for the Company's Sniffer products and a software only version of the Company's Sniffer products, as well as up-selling and cross-selling new product suites to existing TNV and VirusScan customers, 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.* In addition, to the extent that companies incur costs related to Y2K issues, they may reassign budgets away from capital spending and the Company's products, which could have a material adverse impact on the Company's revenue or revenue growth in the future. 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 34% and 36% of net revenue for the three months ended September 30, 1998 and 1997, respectively. The percentage of international net revenue was 36% and 34%, respectively for the nine month periods ended September 30, 1998 and 1997. The increase in international net revenue as a percentage of net revenue between the nine month periods ended September 30, 1998 and 1997 was due primarily to increased acceptance of the Company's products in international markets and the continued investment in international operations, including the recent acquisition of Dr Solomon's. The Company expects that international revenue 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 engages in financial risk management activities. However, there can be no assurance that the Company's future results of operations will not be adversely affected by such fluctuations or by costs associated with currency risk management strategies. Other risks inherent in international revenue generally include the impact of longer payment cycles, greater difficulty in accounts receivable collection, unexpected changes in regulatory requirements, seasonality due to the slowdown in European business activity during the third quarter, tariffs and other trade barriers, uncertainties relative to regional economic circumstances, 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 revenue. In addition, there can be no assurance that the macroeconomic issues currently being experienced in Asia will not spread to Europe, the U.S. or Latin America, and/or have a material adverse impact on the Company's revenue or revenue growth in the future. 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 outside of the United States of the Company's PGP and TIS security products. - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 25 26 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 was $44.6 million in the three months ended September 30, 1998, an increase of 31% from $34.0 million in the three months ended September 30, 1997. For the nine months ended September 30, 1998, cost of revenue was $137.7 million, an increase of 41% from $97.4 million in the same period in 1997. These increases are due to an increase in net revenue (particularly product revenues) as well as the continued investment in the professional services organization. To the extent that the product mix fluctuates from quarter to quarter, the cost of revenue will increase or decrease accordingly. The Company continues 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 retail distribution (including through the recent CyberMedia acquisition), it will experience greater media, manual and packaging costs and may encounter problems related to product returns and limited shelf space availability.* Research and Development. Research and development expenses consist primarily of salary and benefits for the Company's development and technical support staff. Research and development expenses were $33.1 million in the three months ended September 30, 1998, an increase of 25% from $26.5 million in the three months ended September 30, 1997. In the nine months ended September 30, 1998 research and development expenses were $102.2 million, an increase of 38% from $74.0 million in the same period in 1997. These increases were primarily a result of the general expansion of the Company's product development and technical support staff. As a percentage of net revenue, research and development expenses decreased to 13.6% in the three months ended September 30, 1998 from 14.1% in the three months ended September 30, 1997 and increased to 14.2% in the nine months ended September 30, 1998 from 13.8% in the nine months ended September 30, 1997. The Company anticipates that research and development expenses will continue to increase in absolute dollars, but may fluctuate as a percentage of net revenue.* The Company believes that its ability to maintain its competitiveness will depend in large part upon its ability to enhance existing products and develop new products and develop and integrate acquired products. The market for computer software is characterized by low barriers to entry and rapid technological change, and is highly competitive with respect to timely product introductions. The timing and amount of research and development expenses may vary significantly based upon the number of new products and significant upgrades under development during a given period.* Marketing and Sales. Marketing and sales expenses consist primarily of salary, commissions and benefits for marketing, sales and customer support personnel and costs associated with advertising and promotions. Marketing and sales expenses were $66.0 million in the three months ended September 30, 1998, an increase of 22% from $54.1 million in the three months ended September 30, 1997. In the nine months ended September 30, 1998 marketing and sales expenses were $210.2 million, an increase of 35% from $155.5 million for the same period in 1997. This increase was primarily the result of an increase in advertising and promotional activities required to support increased sales volumes and expanding product lines. As a percentage of net revenue, marketing and sales expense was 27.2% and 28.7% in the three month periods ended September 30, 1998 and 1997 and 29.3% and 28.9% in the nine month periods ended September 30, 1998 and 1997. The decrease, quarter over quarter is due to the consolidation of staffing both domestically and internationally, including eliminating duplicate staff arising from the acquisition of Dr Solomon's. The Company is continuing to build brand identity under its new corporate name, which is expected to contribute to a further increase in marketing and sales expenses in absolute dollars, and 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 were $16.0 million in the three months ended September 30, 1998, a decrease of 25% from $21.3 million in the three months ended September 30, 1997. In the nine months ended September 30, 1998 general and administrative costs were $65.2 million, an increase of 8% from $60.6 million for the same period in 1997. The decrease quarter over quarter is a result of the continued consolidation of staffing both domestically and internationally, including - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 26 27 elimination of duplicate staff arising from the acquisition of Dr. Solomon's. The increase in the nine month period over the prior year is due largely to the write-off of uncollectable receivables associated with the acquisition of Network General. As a percentage of net revenue, general and administrative expenses were 6.6% and 11.3% in the three months periods ended September 30, 1998 and 1997 and 9.1% and 11.3% in the nine month periods ended September 30, 1998 and 1997. The decrease as a percentage of net revenue is also due in part to the significant increase in net revenue. To the extent that the Company makes future investments in its worldwide general and administrative infrastructure, general and administrative expenses will increase in absolute dollars but may fluctuate as a percentage of net revenue.* Amortization of Intangibles. The Company expensed $11.2 million and $2.8 million of amortization related to intangibles in the three months ended September 30, 1998 and 1997, respectively and $27.9 million and $8.6 million in the nine months ended September 30, 1998 and 1997, respectively. Intangibles consist of purchased goodwill and certain technology acquired through acquisitions. The increases are due to the acquisitions of Pretty Good Privacy, Inc. ("PGP"), Magic Solutions, Inc. ("Magic Solutions") and CyberMedia, as well as the acquisitions of the Virex and NetOctopus products by Dr. Solomon's. Acquisition and Other Related Costs. In connection with the acquisitions in 1998 accounted for as a pooling of interests, the Company incurred direct transaction costs and other restructuring and related charges in the amount of $40.6 million and $85.8 million in the three and nine months ended September 30, 1998. In connection with the acquisitions accounted for as purchase transactions, the Company incurred charges of $22.8 million and $49.8 million in the three and nine months ended September 30, 1998, consisting principally of the write-off of acquired in-process research & development. The following is a summary of these charges together with charges for certain restructuring activities taken by the Company during the nine months ended September 30, 1998 ($ 000's):
Direct Lease Costs Transaction Severance and Asset In-Process Costs & Benefits Write downs R&D Other Total ----------- ---------- ----------- ---------- --------- --------- TIS $ 15,023 $ 3,818 $ 4,414 $ (924) $ 22,331 Dr. Solomon's 19,898 11,425 18,312 0 49,635 Secure 500 500 1,200 100 2,300 Magic 27,014 27,014 CyberMedia 22,830 22,830 Restructuring Costs-Q2 11,318 8,644 610 20,572 Restructuring Costs-Q3 -- 3,285 370 -- -- 3,655 Reversal of excess reserves (6,750) (2,276) (3,909) -- 214 (12,721) --------- --------- --------- --------- --------- --------- Total Charges $ 28,671 $ 28,070 $ 29,031 $ 49,844 $ -- $ 135,616 --------- --------- --------- --------- --------- ---------
Direct transaction costs included $18.0 million in investment banking fees, $9.2 million in legal and accounting fees, and $1.5 million in filing fees, travel and other costs. Lease costs and asset write downs include the costs of closing approximately 33 facilities throughout the world ($12.2 million), the disposal of excess and obsolete assets (generally computer equipment which did not comply with the Company's standards ($12.0 million)), and the write-off of goodwill and intangibles associated with discontinued Dr. Solomon's products ($4.8 million). The Dr. Solomon's write-off related to two minor products which were discontinued by the Company and which had no sales subsequent to the Dr. Solomon's acquisition. The following table summarizes the activity in the reserves for severance and benefits and facilities write downs established in the second and third quarters ($000's): - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 27 28
Transaction Severance Asset Costs & Benefits Lease Costs Write Downs Other Total ----------- ---------- ----------- ----------- -------- -------- Charged in Three Months ended June 30, 1998 $ 15,523 $ 15,636 $ 6,485 $ 7,773 $ (214) $ 45,203 Paid Out or Charged against the related assets (5,254) (9,053) (596) (1,310) -- (16,213) -------- -------- -------- -------- -------- -------- Balance, June 30, 1998 10,269 6,583 5,889 6,463 (214) 28,990 Charged in three months ended September 30, 1998 19,898 14,710 5,764 12,918 53,290 Paid Out or charged against the related assets (9,363) (10,334) (5,904) (11,067) (36,668) Reversal of excess reserves (6,750) (2,276) -- (3,909) 214 (12,721) -------- -------- -------- -------- -------- -------- Balance, September 30, 1998 $ 14,054 $ 8,683 $ 5,749 $ 4,405 $ -- $ 32,891 -------- -------- -------- -------- -------- --------
The severance and benefits charges related to company-wide reductions in force following the Company's major acquisitions in the second and third quarters of approximately 784 employees of which 107 were in research and development functions, 302 were in sales and marketing functions and the remainder were in administrative and other support functions. Substantially all terminated employees left 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 expense during the period prior to re-leasing the property together with losses on subleases if any. The leased facilities were substantially vacated in the period in which the related accounting charges were recorded. The costs related to any facilities which were used by the Company during this period were charged to operations. However, such charges were not material. Asset write downs, exclusive of the intangible assets of Dr. Solomon's described above, comprised $5.6 million in losses on Company owned buildings (which were written down to estimated values ) and $10.3 million in net losses of computer and other miscellaneous assets. In general, this equipment was discarded or sold for nominal value. Due to the immediate consolidation of facilities, depreciation allocable to these facilities and the related assets, during the transition period, was not material. Of the facilities acquired in its 1998 acquisitions identified for closure, the Company has 17 facilities worldwide which have not been disposed of or subleased (16 leased; 1 owned). These facilities are insignificant to the Company's operations and, other than a portion of a leased facility which the Company has decided to retain, each is intended for disposal or sublease in 1999. The following table summarizes the activity in the reserves for severance and benefits and facilities write downs established in the year ended December 31, 1997 ($000's):
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 (8,083) (6,725) (2,853) (4,381) (2,521) (24,563) Adjustment to liability -- (3,000) -- 3,000 -- -- -------- -------- -------- -------- -------- -------- Balance, September 30, 1998 $ (33) $ 972 $ 989 $ 484 $ 372 $ 2,784 ======== ======== ======== ======== ======== ========
The Company believes that the balances remaining at September 30, 1998 are adequate to cover any additional benefits or losses yet to be paid or realized. Any reserves not used will be recorded as a credit to Acquisition and Related Charges in future periods. - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 28 29 The in-process research and development costs comprise approximately $22.8 million and $27.0 million in connection with the acquisitions of CyberMedia in the three months ended September 30, 1998 and Magic Solutions in the three months ended June 30, 1998, respectively. The following is a summary of the projects acquired and the assumptions used in determining the value of the in-process research and development costs. CyberMedia: The ongoing projects at CyberMedia at the time of the purchase included upgrade versions of four products (First Aid 6.0 and 7.0, UnInstaller 6.0, Guard Dog 3.0, and Oil Change 3.0) as well as work on technologies to be used in two of the Companies projects (a replacement product for PC Medic and McAfee Office). These upgrades will include new interfaces with the Internet, enhanced use of Active-X controls and Java and enhanced user interfaces. At the date we acquired CyberMedia, the Company estimated that, on average, 42% of the development effort had been completed and that the remaining 58% of the development effort would take approximately 12 months to complete and would cost $2.7 million. The efforts required to complete the development of these projects principally relate to additional design efforts to integrate the technologies into the Company's suite of products, finalization of coding, and completion of prototyping, verification, and testing activities required to establish that products associated with the technologies can be successfully introduced. The value of the in-process technologies was determined by estimating the projected net cash flows related to products, including costs to complete the development of the technologies or products, and the future net revenues that may be earned from the products, excluding the value attributed to integration with the Company's products or that may have been achieved due to efficiencies resulting from the combined sales force or the use of the Company's more effective distribution channel. In conformity with the SEC's revised guidelines, these cash flows were discounted back to their net present value using a discount rate of 28% (which represents a premium of approximately 5% over the Company's average weighted cost of capital) and excluding the value attributable to the use of the in-process technologies in future products. If the Company does not deploy commercially accepted products based on the acquired in-process technologies, operating results could be adversely affected in future periods. Additionally, the failure of any particular project would impair the value of other intangibles, particularly goodwill, acquired from CyberMedia. Magic Solutions: The ongoing projects at Magic Solutions at the time of the purchase comprised an upgrade version of Support Magic 4.0, Magic Solutions current product. This upgrade, known as Merlin Enterprise, represents new technologies with significant enhanced functionality, including increased scalability, a 32-bit browser-based technology, an enhanced user interface and integrated management features. At the date the Company acquired Magic Solutions, the Company estimated that, on average, 80% of the development effort had been completed and that the remaining 20% of the development effort would take approximately 12 months to complete and would cost $1.8 million. The efforts required to complete the development of these projects principally relate to additional design efforts to integrate the technologies into the Company's suite of products, finalization of coding, and completion of prototyping, verification, and testing activities required to establish that products associated with the technologies can be successfully introduced. The value of the in-process technologies was determined by estimating the projected net cash flows related to products, including costs to complete the development of the technologies or products, and the future net revenues that may be earned from the products, excluding the value attributed to integration with the Company's products or that may have been achieved due to efficiencies resulting from the combined sales force or the use of the Company's more effective distribution channel. In conformity with the SEC's revised guidelines, these cash flows were discounted back to their net present value using a discount rate of 28% (which represents a premium of approximately 5% over the Company's average weighted cost of capital) and excluding the value attributable to the use of the in-process technologies in future products. If the Company does not deploy commercially accepted products based on the acquired in-process technologies, operating results could be adversely affected in future periods. Additionally, the failure of any particular project would impair the value of other intangibles, particularly goodwill, acquired from Magic Solutions. Other Acquisitions: In addition to the above transactions, the Company acquired Cinco Networks, Inc. and Pretty Good Privacy, Inc. in 1997 which, in conformity with the SEC's revised guidelines, resulted in in-process research charges of $5.2 million and $3.9 million respectively. As of September 30, 1998, the projects related to the acquisitions of Cinco and PGP were substantially complete. - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 29 30 Finally, in conformity with the SEC's revised guidelines, Acquisition and other related costs for the nine months ended September 30, 1997 consisted of $19.5 million and $5.2 million of acquired in-process technology in connection with the acquisitions of 3DV and Cinco, respectively. Subsequent to the Network General merger in December 1997, all 3DV projects were terminated. Interest and Other Income and Expense, Net. Interest and other income and expense decreased to $4.1 million in the three months ended September 30, 1998 from $6.5 million in the three months ended September 30, 1997. Interest and other income and expense decreased from $13.9 million in the nine months ended September 30, 1998 from $16.1 million in the nine months ended September 30, 1997. The decrease from quarter to quarter was primarily due to the increase of interest expense to $4.2 million in the three months ended September 30, 1998 from zero in the three months ended September 30, 1997, primarily as a result of the Company's Zero Coupon Convertible Subordinated Debentures (the "Debentures"), issued in February 1998, partially offset by increased interest income from the increased funds invested. Provision for Income Taxes. The Company's effective tax rate, before acquisition and other related costs, was 35% and 40% for the three month periods ended September 30, 1998 and 1997, respectively, and 39% for the nine month periods ended September 30, 1998 and 1997. The reduction in the effective tax rate quarter over quarter is the result of the implementation of various domestic and international tax strategies. The Company's effective tax rate for the three month periods ended September 30, 1998 and 1997 was 31% and 38%, respectively, and for the nine month periods ended September 30, 1998 and 1997 was 30% and 34%, respectively, excluding the effect of one-time non-deductible in-process research and development, merger and other acquisition costs and amortization of intangibles. Liquidity and Capital Resources At September 30, 1998, the Company had $363.8 million in cash and cash equivalents and $279.9 million in marketable securities, for a combined total of $643.7 million. Net cash provided by operating activities was $35.5 million and $129.5 million in the nine months ended September 30, 1998 and 1997, respectively. Net cash provided by operating activities in the nine months ended September 30, 1998, consisted primarily of net income before acquisition costs and depreciation and amortization, plus increases in deferred revenue and deferred taxes which were offset primarily by an increase in accounts receivable and prepaid and other assets and a decrease in accounts payable and accrued liabilities. In the nine months ended September 30, 1997, net cash provided by operating activities consisted primarily of net income before acquisition costs and depreciation and amortization, plus increases in deferred revenue and accounts payable and accrued liabilities, offset primarily by increases in accounts receivable, prepaid and other assets and deferred taxes. The Company expects that its accounts receivable balances as a percentage of sales will increase in the foreseeable future due to various factors, including its recent acquisitions of companies with longer payment cycles (particularly its acquisitions of Dr Solomon's and CyberMedia) and its increased emphasis on international sales, typically having longer payment terms.* In addition, the longer payment cycles associated with licensing enterprise-wide network security and management product suites and with licensing products through indirect channels, such as systems integrators and VARs, are also expected to contribute to an increase in the Company's receivables balances.* Lastly, development of a two-year licensing model for the Company's Sniffer products, which as compared to product sales typically results in lower current revenue and a corresponding increase in deferred revenue, is expected to result in an increase in accounts receivable balances as a percentage of sales.* To address the increased level of the Company's accounts receivables and to improve cash flow, the Company continuously evaluates available options, including actions to encourage earlier payment of receivables and receivable sales.* To the extent the Company's receivable balances increase, the Company will be subject to increased general credit risks with respect thereto.* There can be no assurance that the Company will be successful in mitigating the impact which such increased receivable levels may have on its financial conditions and operating results. Net cash used in investing activities was $282.3 million in the nine months ended September 30, 1998 consisting primarily of the purchase of marketable securities, additions to fixed assets and the acquisition of Magic Solutions and CyberMedia. Net cash used in investing activities was $105.5 million in the nine months ended September 30, 1997, primarily reflecting the acquisitions of Compusul, 3DV Technology and Cinco, purchases of marketable securities and additions to fixed assets. - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 30 31 Net cash provided by financing activities was $453.5 million in the nine months ended September 30, 1998, consisting primarily of net proceeds from the issuance of the Debentures, and the proceeds and tax benefits associated with the exercise of non-qualified stock options. Net cash provided by financing activities was $30.2 million in the nine months ended September 30, 1997, consisting primarily of the proceeds and tax benefits associated with the exercise of non-qualified stock options partially offset by the repurchase of common stock under the Network General stock repurchase program. The Company believes that its available cash and anticipated cash flow from operations will be sufficient to fund the Company's working capital and capital expenditure requirements for at least the next twelve months.* Financial Risk Management As a result of the continued expansion of the Company's business in Europe, the Company expects to see an increase over time in exposures related to nonfunctional currency denominated sales in several European currencies.* Currently, the Company hedges only those currency exposures associated with certain assets and liabilities denominated in nonfunctional currencies and does not generally hedge anticipated foreign currency cash flows. The hedging activity undertaken by the Company is intended to offset the impact of currency fluctuations on certain non-functional currency assets and liabilities. The success of this activity depends upon forecasts of transaction activity denominated in various currencies, primarily the Canadian dollar, Australian dollar and certain European currencies.* To the extent that these forecasts are over or understated during periods of currency volatility, the Company could experience unanticipated currency gains or losses.* Year 2000 Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such "Year 2000" or "Y2K" requirements. The Company has established a corporate-wide program to address the Y2K issue. This program encompasses commercial product, internal systems and technology, supplier and business partner and facilities and life safety compliance. The project is comprised of identification of risks, assessment of risks, development of remediation or contingency plans and implementation and testing. Based on the assessments to date, all products currently under development and the majority of products released are Y2K compliant. For any released products which are not Y2K compliant, the Company is working with its customers to provide migration paths for those products. The Company's internal systems and technology are relatively new and as a result the majority are already Y2K compliant. The Company is in the process of upgrading systems and technology that are not currently Y2K compliant, and expects to have this process completed by the third quarter of 1999. In addition, the Company is working with its suppliers and business partners to identify at what stage they are at in the process of identifying and addressing the Y2K issue and to assess the resulting risks and develop appropriate contingency plans. The Company will continue to perform compliance reviews and tests to ensure compliance on an ongoing basis. In connection with the resolution of Y2K issues, the Company has not to date incurred material costs and does not anticipate that such costs will be material in the future. Although the Company has established and commenced its program to address Y2K issues, the failure of the Company's current or prior products to operate properly with regard to the Year 2000 requirements could (i) cause the Company to incur unanticipated expenses to remedy any problems, (ii) cause a reduction in sales and (iii) expose the Company to related litigation by its customers, each of which could have a material adverse effect on the Company's business, operating results and financial condition. In addition, the Company and third parties with whom it conducts business may utilize equipment or software that may not be Y2K compliant. Failure of the Company's or any such third party software to operate properly with regard to the Year 2000 requirements could cause, among other things, the Company or any such third party to incur unanticipated expenses or efforts to remedy any problems, which could have a material adverse effect on its or their respective business, operation results and financial condition. Furthermore, the - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 31 32 purchasing patterns of customers or potential customers may be affected by Y2K issues as companies expend significant resources to evaluate and to correct their equipment or software for Y2K compliance and as they simultaneously evaluate the preparedness of the third parties with whom they deal. These expenditures may result in reduced funds available to purchase products and services such as those offered by the Company, which could have a material adverse effect on the Company's business, operating results and financial condition. - -------- * This statement is a forward looking statement reflecting current expectations. There can be no assurance that the Company's actual performance will meet the Company's current expectations. See the Risk Factors on page 33 for a discussion of certain factors that could affect future performance. 32 33 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, changes in customer budgets related to information technology spending, 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. In addition, there can be no assurance that the macroeconomic issues currently being experienced in Asia will not spread to Europe, the U.S. or Latin America, and/or have a material adverse impact on the Company's revenue or revenue growth in the future. Further, to the extent that companies incur costs related to Y2K issues, they may reassign budgets away from capital spending and the Company's products, which could have a material adverse impact on the Company's revenue or revenue growth in the future. Although the Company has experienced significant growth in net revenue and net income (before acquisition and other related costs) in absolute terms, the Company has experienced increased price competition for its products and the Company expects competition to increase in the near-term, which may result in reduced average selling prices for the Company's products. Due to these and other factors (such as a maturing anti-virus market and an increasingly higher base from which to grow), the Company's historic revenue growth rate will be difficult to sustain or increase. To the extent these trends continue, the Company's results of operations could be materially adversely affected. Historically, renewals have accounted for a significant portion of the Company's net revenue. More recently, the Company has adopted a strategy of up-selling existing licenses to higher level product suites. There can be no assurance that the Company will be able to sustain current renewal and/or up-selling 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 nine months ended September 30, 1998 and the year ended December 31, 1997, the Company generally experienced a trend toward higher order receipt, and therefore a higher percentage of revenue shipments, toward the end of the last month of a quarter, which makes predicting revenues more difficult. The timing of closing larger orders increases the risks of quarter-to-quarter fluctuation. To the extent that the Company is successful in licensing larger product suites under the Net Tools umbrella (particularly to large enterprise and national accounts), the size of its orders and the length of its sales cycle are likely to increase. If orders forecasted for a specific customer for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, the Company's operating results for that quarter could be materially adversely affected. See "Potentially Longer Sales and Implementation Cycles for Certain Products." The trading price of the Company's Common Stock has historically been subject to wide fluctuations, with factors such as earnings announcements, acquisition announcements and litigation developments contributing to this volatility. Failure to achieve periodic revenue, earnings and other operating and financial results as forecasted or anticipated by brokerage firms, industry analysts or investors could result in an immediate and adverse effect on the market price of the Company's Common Stock. The Company may not discover, or be able to confirm, revenue or earnings shortfalls until the end of a quarter, which could result in an immediate and adverse effect on the price of the Company's Common Stock. Risk of Inclusion of Network Management and Security Functionality in Hardware and Other Software. In the future, vendors of hardware and of operating system software or other software (such as firewall or electronic mail software) may continue to enhance their products or bundle separate products to include functionality that currently is provided primarily by network security and 33 34 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 acquisitions (including the acquisitions of Dr Solomon's, CyberMedia, Secure, TIS, Magic Solutions, Network General, PGP and Helix Software Company ("Helix")). There can be no assurance that the Company will realize the desired benefits of these transactions. In order to successfully integrate these companies, the Company must, among other things, continue to attract and retain key management and other personnel; integrate, both from an engineering and a sales and marketing perspective, the acquired products (including Dr Solomon's anti-virus products, TIS' firewall products, Magic Solutions' helpdesk products, Network General's Sniffer and CyberCop products, PGP's encryption products and CyberMedia and Helix's utilities products) into its suite of product offerings; integrate and develop a cohesive focused direct and indirect sales force for its product offerings; consolidate duplicate facilities; implement standardized accounting and reporting systems and develop name recognition for its new name. The diversion of the attention of management from the day-to-day operations of the Company, or difficulties encountered in the integration process, could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Need to Develop Enterprise and Major Accounts Sales Expertise and Security Products Sales Expertise; Risks Related to Direct Sales Force" and "-- Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and TIS 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 and third quarters of 1998, the Company incurred additional significant non-recurring charges associated with the acquisitions of TIS, Magic Solutions, Dr Solomon's and CyberMedia. There can be no assurance that the Company will not incur additional material charges in subsequent quarters to reflect additional costs associated with these transactions and with respect to its name change and the marketing of its products under the "Network Associates" name. Risks Related to Certain Business Strategies. The Company has historically derived a significant majority of its revenues from the licensing of its flagship anti-virus products and Sniffer products. See "-- Dependence on Revenue from Flagship Anti-Virus and Sniffer Products." The Company is currently focusing its efforts on broadening its revenue base by providing network security and management solutions to enterprise customers, targeting in particular the Windows NT/Intel platform. In furtherance of this strategy, the Company recently organized its products into four product suites -- McAfee Total Virus Defense, PGP Total Network Security, and Sniffer Total Network Visibility and McAfee Total Virus Defense. These four product suites together form an integrated solution called "Net Tools" which utilizes a new pricing model. There can be no assurance that potential customers (including the installed customer base of acquired companies) will respond favorably to the modified pricing structure and the lack of a favorable response could materially adversely affect the Company's operating results. Although the Company will continue to offer perpetual licenses with annual support and maintenance contracts for its Sniffer products, it is recently developed a licensing model for those products. In addition, in an effort to increase total Sniffer unit sales, the Company has developed software only versions of certain of its Sniffer products. To the extent that customers do license Sniffer products on a two-year 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 licenses, the Company would, among other things, expect an increase in deferred revenues related to the service portion of the two-year Sniffer license that would be capitalized on the Company's balance sheet. In the initial year of the license, the corresponding revenue would be lower than if the license were perpetual. In the case of the software only Sniffer product, for any individual license, the Company would expect lower total revenues and a higher overall gross margin related to the transaction, as the Company would not be selling the corresponding hardware component. Currently, the hardware component has a lower gross margin than the total product gross margin. Furthermore, the increase in license revenue as a percentage of revenue will have a negative impact on the Company's receivable balance as a percentage of sales, due to more revenue being deferred with no impact on the related receivables. 34 35 The Company has been acquiring (and is continuing to investigate the acquisition of) existing independent agents and distributors of its products in certain strategic markets or has been converting these independent agents into resellers who must purchase Company products from Company approved distributors. These actions may require, among other things, that the Company provide the technical support to customers that was previously provided by such agents and distributors. There can be no assurance that the Company can provide such support as effectively or on a timely basis or at all, that the Company will operate any acquired distributor or agent as successfully as the previous operators, that the acquisition of any distributor or agent or the conversion of any agent into a reseller will result in the desired increased foreign revenues or that the Company will be able to identify and retain suitable distributors in any market in which it converts an independent agent. See "-- Risks Associated with Acquisitions Generally" and "-- Risks Related to International Revenue and Activities." As part of the Net Tools concept, the Company is in the process of designing a centralized console from which the various component suites can be operated, administered and maintained utilizing a common look and feel. The Company faces significant engineering challenges related to these efforts. In addition, the Company faces significant engineering and other challenges related to the integration of its various products (such as its recently acquired Dr Solomon's anti-virus products, PGP encryption products, Network General CyberCop product and TIS firewall products) into marketable product. 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 Major Accounts Sales Expertise and Security Products Sales Expertise; Risks Related to Direct Sales Force," "-- Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and TIS 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 CyberMedia in September 1998, Dr Solomon's in August 1998 and TIS and Magic Solutions in April 1998, the Company has consummated a series of significant acquisitions since 1994, including the combination with Network General in December 1997, the acquisitions of PGP and Helix in December 1997, Cinco Networks, Inc. in August 1997, 3DV Technology, Inc. in March 1997, FSA Corporation of Canada in August 1996, Vycor Corporation in February 1996, Saber Software Corporation, Inc. in August 1995 and ProTools, Inc. in January 1994. In addition, since 1995 the Company has acquired a number of international distributors, including distributors in Australia, Brazil, Finland, Japan, South Africa, Sweden 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 35 36 the dedication of management resources that may distract attention from the day-to-day business, and may disrupt key research and development, marketing or sales efforts. The inability of management to successfully integrate any acquisition could have a material adverse effect on the business, operating results and financial condition of the Company. In addition, as commonly occurs, during the pre-acquisition and integration phases of technology company acquisitions, aggressive competitors may undertake initiatives to attract customers and to recruit key employees through various incentives. Rapid Technological Change; Risks Associated with Product Development. The network security and management market is highly fragmented and is characterized by ongoing technological developments, evolving industry standards and rapid changes in customer requirements. The Company's success depends upon its ability to offer a broad range of network security and management software products, to continue to enhance existing products, to develop and introduce in a timely manner new products that take advantage of technological advances, and to respond promptly to new customer requirements. While the Company believes that it offers one of the broadest product lines in the network management and security market, this market is continuing to evolve and customer requirements are continuing to change. As the market evolves and competitive pressures increase, the Company believes that it will need to further expand its product offerings. There can be no assurance that the Company will be successful in developing and marketing, on a timely basis, enhancements to its existing products or new products, or that such enhancements or new products will adequately address the changing needs of the marketplace. In addition, from time to time, the Company or its competitors may announce new products with new or additional capabilities or technologies. Such announcements of new products could have the potential to replace, or shorten the life cycles of, the Company's existing products and to cause customers to defer or cancel purchases of the Company's existing products. The Company has in the past experienced delays in software development, and there can be no assurance that the Company will not experience delays in connection with its current or future product development activities. Complex software products such as those offered by the Company may contain undetected errors or version compatibility issues, particularly when first introduced or when new versions are released, resulting in loss of or delay in market acceptance. For example the Company'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 and 97, Windows NT, NetWare, the introduction of Windows 2000 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. 36 37 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 anti-virus software products and Sniffer network fault and performance management products. These products are expected to continue to account for a significant portion of the Company's net revenue for the foreseeable future. Because of this concentration of revenue, a decline in demand for, or in the prices of, these anti-virus and network management products as a result of competition, technological change, a change in the Company's pricing model for such products, the inclusion of anti-virus or network management and analysis functionality in system hardware or operating system software or other software or otherwise, or a maturation in the respective markets for these products could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Emergence of Network Management and Network Security Markets. The markets for the Company's network management and network security products are evolving, and their growth depends upon broader market acceptance of network management and network security software, including help desk software. Although the number of LAN-attached personal computers ("PCs") has increased dramatically, the network management and network security markets continue to be emerging markets and there can be no assurance that such markets will continue to develop or that further market development will be rapid enough to benefit the Company significantly. In addition, there are a number of potential approaches to network management and network security, including the incorporation of management and security tools into network operating systems. Therefore, even if network management and network security tools gain broader market acceptance, there can be no assurance that the Company's products will be chosen by organizations which acquire network management and network security tools. Furthermore, to the extent that either the network management or network security market does continue to develop, the Company expects that competition will increase. See "-- Competition" and "-- Risk of Inclusion of Network Security and Management Functionality in Hardware and Other Software." Competition. The markets for the Company's products are intensely competitive and the Company expects competition to increase in the near-term. The Company believes that the principal competitive factors affecting the markets for its products include performance, functionality, quality, customer support, breadth of product line, frequency of upgrades and updates, integration of products, manageability of products, brand name recognition, company reputation and price. Certain of the criteria upon which the performance and quality of the Company's anti-virus software products compete include the number and types of viruses detected, the speed at which the products run and ease of use. Certain of the Company's competitors have been in the network management market longer than the Company, and other competitors, such as Symantec Corporation ("Symantec"), Intel Corporation ("Intel") and Hewlett-Packard Company ("HP"), are larger and/or have greater name recognition than the Company. The Company will also need to develop name recognition for its new name, "Network Associates." In addition, certain larger competitors such as Intel, Microsoft and Novell, Inc. ("Novell") have established relationships with hardware vendors related to their other product lines. These relationships may provide them with a competitive advantage in penetrating the OEM market with their network security and management products. As is the case in many segments of the software industry, the Company has been encountering, and expects to further encounter, increasing competition. This increased competition is due in part to the Company's recent increased size and visibility. Increased competition could reduce average selling prices and, therefore, profit margins. Competitive pressures could result not only in sustained price reductions but also in a decline in sales volume, which events would materially adversely affect the Company's business, financial condition and results of operations. In addition, competitive pressures may make it difficult for the Company to maintain or exceed its growth rate. Although there is a trend toward consolidation in the network security and management market, the market is currently highly fragmented with products offered by many vendors. The Company's principal competitor is the Peter Norton Group of Symantec in the network security market and Intel's LanDesk in the network management market. The Company's other competitors include Computer Associates/Cheyenne Software, IBM, Axent Technologies, Inc. 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., ISS Group, Inc. 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 37 38 provide the necessary software and support capabilities. In addition, to the extent that the Company is successful in developing its Net Tools suite of products designed around a centralized management and administration console for the Windows NT platform, the Company will likely compete with large computer systems management companies such as Tivoli Systems (TME) and Computer Associates (Unicenter). There can be no assurance that the Company will continue to compete effectively against existing and potential competitors, many of whom have substantially greater financial, technical, marketing and support resources and name recognition than the Company. In addition, there can be no assurance that software vendors who currently use traditional distribution methods will not in the future decide to compete more directly with the Company by utilizing electronic software distribution. The competitive environment for anti-virus software internationally is similar to that in North America, although local competitors in specific foreign markets often present stronger competition and shareware authors control a more significant portion of the European market. The international market for network management software has developed more slowly than the North American market, although larger competitors such as Intel and Symantec have begun to penetrate European markets. Asian markets have lagged significantly behind North America and Europe in their adoption of networking technology. There can be no assurance that the Company will be able to compete successfully in international markets. Need to Develop Enterprise and Major Accounts Sales Expertise and Security Products Sales Expertise; 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 major account customers. The second tier consists of geographically aligned sales groups focused on the sale of the NetTools and 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 outbound corporate telesales forces who actively market the Company's individual product suites to customers with less 2,500 nodes. The Company historically has not had a large enterprise or major 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 major accounts market and for the sale of its various product suites, (including its security product suite), the Company will be required to build a significant direct sales organization and will be required to attract and retain qualified personnel, which personnel will require continuous training about, and knowledge of, product attributes for the Company's suite of products. The need for continuous product training results, in part, from new developments and enhancements (including those products acquired in the Company's various acquisitions). There can be no assurance that the Company will be successful in building the necessary sales organization or in attracting, retaining or training these individuals. Historically, the Company has sold its products at the departmental level. To succeed in the enterprise and major accounts market will require, among other things, establishing relationships and contacts with senior technology officers at these accounts. There can be no assurance that the Company or its sales force will be successful in these efforts. The Company's sales organization structure may result in multiple customer contacts by different Company sales representatives (particularly in circumstances where the customer has multiple facilities and offices), a lack of coordination between the Company's various sales organizations and a lack of focus by the individual sales representatives on their designated customers or products. The occurrence of these events could lead to customer confusion, disputes in the sales force and lost revenue opportunities which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, while the development of a direct sales channel reduces the Company's dependence on resellers and distributors, it may lead to conflicts for the same customers and further customer confusion, pressure by current and prospective customers for price reductions on products and, consequently, in reductions in the Company's gross margin and operating profit. Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for Sniffer and TIS and PGP Security Products. The Company markets a significant portion of its products to end-users through distributors, resellers, system integrators, OEMs and VARs. The Company's distributors sell other products that are complementary to, or compete with, those of the Company. While the Company encourages its distributors to focus on its products through market and support programs, there can be no assurance that these distributors will not give greater priority to products of other suppliers, including competitors. In addition, to the extent the Company is successful in building its professional services organization, its ability to establish and maintain relationships with distributors, resellers, systems integrators, OEMs and VARs who market their services along with third party products may be adversely impacted. 38 39 The Company does not have an extensive indirect sales channel for its Network Sniffer products or its PGP and TIS security products. To succeed in the indirect sales channel, the Company will be required to build a more extensive network of distributors, resellers, system integrators, OEMs 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. The Company has historically sold a significant portion of its anti-virus and other products through distributors indirectly into the retail channel. With the acquisitions of Dr. Solomon's, CyberMedia and Helix, the amount of products sold into the retail channel has and is expected to continue to increase in absolute dollars, although not as a percentage of net revenue. Retailers of the Company's products typically have a limited amount of shelf space and promotional resources, and there is intense competition for high quality and adequate levels of shelf space and promotional support from retailers. There can be no assurance that retailers will continue to purchase the Company's products or provide the Company's products with adequate levels of shelf space and promotional support, the lack of which could have a material adverse impact on the Company's business, financial condition and results of operations. The Company recently introduced its retail product suites, including McAfee Office, which combines ten PC diagnostic and utility tools into one integrated software package. There can be no assurance that these suites will gain acceptance in the market place and/or that the Company will obtain the anticipated revenues. No customer accounted for more than 10% of net revenue during the years ended December 31, 1997, 1996 and 1995. In the quarter ended September 30, 1998, Ingram Micro Devices accounted for 17% of net revenue. No other customers accounted for more than 10% of net revenue during the quarter ended September 30, 1998. Need to Expand and Develop An Effective Professional Services Organization; Risks Related to Third-Party Professional Services. As computer networks become more complex and as the Company's products become more complex and are more broadly targeted at the enterprise and at mission-critical applications, customers will increasingly require greater professional assistance in the design, installation, configuration, implementation and support of their networks and acquired products. To date, the Company has relied on its limited professional services capabilities and increasingly on outside professional service providers (including its distributors, resellers and system integrators). There can be no assurance that third party service providers can or will continue to be willing to provide adequate levels (both in terms of time and quality) of professional services. Moreover, reliance on these third parties reduces the Company's control over the provision of support services for its products and places a greater burden on these third parties, which, in turn, could delay the Company's recognition of product revenue, could harm the Company's relationships or reputation with such third parties or the end users of its products and could result in decreased future sales of, or prices for, its products. To more effectively service its customer's evolving needs (including the need for product support), the Company intends to significantly expand and develop its worldwide professional service organization. There can be no assurance that the Company will be successful in its efforts to expand and develop an effective professional services organization. This will require that the Company hire and train additional service professional who must be continually trained and educated to ensure that they possess sufficient technical skills and product knowledge. In particular, the market for qualified professionals is intensely competitive, making hiring and retention difficult. The Company expects significant competition in this market from existing providers of professional services and future entrants. The Company must also properly price its services to attract customers, while maintaining sufficient margins for its services. The Company expects that it will have lower profit margins on its service revenues. The failure to develop an effective professional services organization could have a material adverse effect on the Company's business, financial condition and results of operations. Reliance on Microsoft Technology. Although the Company intends to support other operating systems, the Company's mission is to be the leading supplier of network security and management products for Windows NT/Intel based networks. Sales of the Company's products would be materially and adversely affected by market developments which are adverse to the Windows operating 39 40 environments, including the failure of users and application developers to accept Windows NT. In addition, the Company's ability to develop products using the Windows operating environments is substantially dependent on its ability to gain timely access to, and to develop expertise in, current and future developments by Microsoft, of which there can be no assurance. Risks Associated with Failure to Manage Growth. The Company's growth internally and through its numerous acquisitions has placed, and any further expansion would continue to place, a significant strain on its limited personnel, management and other resources. In the future, the Company's ability to manage any growth, particularly with the anticipated expansion of the Company's international business, growth in indirect channel business and increased focus on the enterprise and mission critical applications, will require it to attract, train, motivate and manage new employees successfully, to effectively integrate new employees into its operations, provide adequate levels of product support and to continue to improve its operational, financial, management and 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. Given the Company's current size and growth rate, the Company will need to make investments in its general and administrative infrastructure to maintain adequate controls and systems and meet worldwide statutory reporting requirements. Failure to make sufficient investment in the general and administrative infrastructure 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. In December 1997, the Company changed its legal name to "Networks Associates, Inc." and has since been conducting business as "Network Associates." Network Associates, Inc. in Oregon ("NAI-Oregon") and Ronald L. Myers ("Myers"), a California resident doing business as The Network Associates, have made unresolved claims (including various trademark claims) or demands with respect to the Company's use of the name Network Associates. On March 26, 1998, the Company commenced a declaratory judgement action in the United States District Court, Northern District of California against the above-cited claimants. The Company seeks a declaration that its use of the Network Associates title does not violate the federal, state or common law rights of any of the defendants. Defendant NAI-Oregon has not yet answered the complaint; defendant Myers has not yet been served. The Company does not typically obtain signed license agreements from its corporate, government and institutional customers who license products directly from it. The Company includes an electronic version of a "shrink-wrap" license in all of its electronically distributed software and a printed license in the box for its products distributed through traditional distribution channels in order to protect its copyrights and trade secrets in those products. Since none of these licenses are signed by the licensee, many authorities believe that such licenses may not be enforceable under the laws of many states and foreign jurisdictions. In addition, the laws of some foreign countries either do not protect proprietary rights or offer only limited protection for those rights. There can be no assurance that the steps taken by the Company to protect its proprietary software technology will be adequate to deter misappropriation of this technology. For example, the Company is aware that a substantial number of users of its anti-virus products have not paid any registration or license fees to the Company. Changing legal interpretations of liability for unauthorized use of the Company's software, or lessened sensitivity by corporate, government or institutional users to avoiding copyright infringement, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's principal assets are its intellectual property, and the Company competes in an increasingly competitive market. There has been substantial litigation regarding intellectual property rights of technology companies. The Company has in the past been, and currently is, subject to litigation related to its intellectual property. There can be no assurance that there will be no developments arising out of such pending litigation or any other litigation to which the Company is or may become party which could have a material adverse effect on the Company's business, financial condition and results of operation. See Note 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 40 41 software engineers of intellectual property used or developed by them while employed by a competitor. In the future, litigation may be necessary to enforce and protect trade secrets and other intellectual property rights owned by the Company. The Company may also be subject to litigation to defend it against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. Any such litigation could be costly and cause diversion of management's attention, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its products, any one of which could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, there can be no assurance that any necessary licenses will be available on reasonable terms, or at all. Risks Related to International Revenue and Activities. In 1997, 1996 and 1995, international net revenue represented 36%, 31% and 31%, respectively, of the Company's net revenue. In the quarter ended September 30, 1998, international net revenue represented approximately 34% 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, with that percentage increasing as a result of the recent Dr Solomon's acquisition. The Company also expects that a significant portion of such international revenue will be denominated in local currencies. To reduce the impact of foreign currency fluctuations, the Company has engaged in various financial risk management activities. However, there can be no assurance that the Company's future results of operations will not be adversely affected by such fluctuations or by costs associated with financial risk management strategies. Other risks inherent in international revenue generally include the impact of longer payment cycles, greater difficulty in accounts receivable collection, unexpected changes in regulatory requirements, seasonality due to the slowdown in European business activity during the third quarter, tariffs and other trade barriers, uncertainties relative to regional economic circumstances, 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. In addition, there can be no assurance that the macroeconomic issues currently being experienced in Asia will not spread to Europe, the U.S. or Latin America, and/or have a material adverse impact on the Company's revenue or revenue growth in the future. Further, in countries with a high incidence of software piracy, the Company may experience a higher rate of piracy of its products. There are a number of additional risks related to the export of the Company's encryption products. See "-- Risks Relating to Cryptography Technology." In addition, a portion of the Company's international revenue is expected to continue to be generated through independent agents. Since these agents will not be employees of the Company and will not be required to offer the Company's products exclusively, there can be no assurance that they will continue to market the Company's products. Also, the Company is likely to have limited control over its agents, limited access to the names of the customers to whom the agents sell its products and limited knowledge of the information provided by, or representations made by, these agents to its customers. Risk of Sabotage. Given the Company's high profile in the security software market, the Company has been a target of computer "hackers" who have, among other things, created viruses to sabotage its products or otherwise attack the Company's products. While to date these efforts have been discovered quickly and their adverse impact has been limited, there can be no assurance that similar viruses or efforts will not be created or replicated in the future, that they will not cause damage to users' computer systems and that demand for the Company's software products will not suffer as a result. In addition, since the Company does not control diskette duplication by distributors or its independent agents, there can be no assurance that diskettes containing the Company's software will not be infected with viruses. Risk of False Detection of Viruses and of Actual or Perceived Security Breaches. The Company's anti-virus software products have in the past and may at times in the future falsely detect viruses that do not actually exist. Such "false alarms," while typical in the industry, may impair the perceived reliability of the Company's products and may therefore adversely impact market acceptance of the Company's products. In addition, the Company has in the past been subject to litigation claiming damages related to a false alarm, and there can be no assurance that similar claims will not be made in the future. Similarly, while a well-publicized actual or perceived breach of network or computer security could trigger a heightened awareness of computer abuse (resulting in a potential increase in demand for security products), an actual or perceived breach of network or computer security at one of the Company's customers, regardless of whether such breach is attributable to the Company's products, could adversely affect the market's perception of such products. 41 42 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 a 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. See "-- Risks Associated with the Export or Import of Technology." Certain of the Company's PGP and TIS network security products are dependent on the use of public key cryptography technology, which depends in part on the application of certain mathematical principles known as "factoring." The security afforded by public key cryptography technology is predicated on the assumption that the factoring of the composite of large prime numbers is difficult. Should an easy factoring method be developed, then the security afforded by encryption products utilizing public key 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. Risks Associated with the Export or Import of Technology. The Company is a developer and distributor of technologies subject the export or import rules and regulations of the United States government and other foreign jurisdictions. Given the continuous development of new technologies and products, and the evolving worldwide rules and regulations regarding the export or import of high-technology software products, the Company is subject to continued scrutiny and review of the development and distribution of its products. There can be no assurance that the Company will continually be in compliance with the evolving and complex United States and foreign governments import or export laws, and such failure of compliance could result in a material adverse effect on the Company's business, financial condition and results of operations. See "-- Risks Relating to Cryptography Technology." Product Liability. The Company's security and network management software products are used to protect and manage computer systems and networks that may be critical to organizations and, as a result, the sale and support of these products by the Company may entail the risk of product liability and related claims. The Company's license agreements with its customers typically contain provisions designed to limit the Company's exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in these license agreements may not be effective under the laws of certain jurisdictions, particularly in circumstances involving unsigned licenses. A product liability claim brought against the Company could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence upon Key Personnel. The success of the Company will depend to a significant extent upon a number of key technical and management employees. While employees are required to sign standard agreements concerning confidentiality and ownership of inventions, Company employees are generally not otherwise subject to employment agreements or to noncompetition covenants. The loss of the services of any key employees could have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not maintain life insurance policies on its key employees. The ability of the Company to achieve its revenue and operating performance objectives will depend in large part on its ability to attract and retain technically qualified and highly skilled sales, consulting, technical, marketing and management personnel. Competition for such personnel is intense and is expected to remain so for the foreseeable future. There can be no assurance the Company will be successful in retaining its existing key personnel and in attracting and retaining the personnel it requires, and failure of the Company to retain and grow its key employee population could adversely affect the Company's business and operating results. 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. 42 43 Customer Purchase Decisions; Potentially Longer Sales and Implementation Cycles for Certain Products Suites. The products offered by the Company may be considered to be capital purchases by certain customers or prospective customers. Capital purchases are often considered discretionary and, therefore, are canceled or delayed if the customer experiences a downturn in its business or prospects or as a result of economic conditions in general. Any such cancellation or delay could adversely affect the Company's results of operations. In addition, as the Company proceeds with its strategy of selling product suites under the Net Tools umbrella (particularly to larger enterprise and national accounts), its sales cycle is likely to lengthen. Such sales may involve a lengthy education process and a significant technical evaluation and commitment of capital and other resources and may be subject to the risk of delays associated with customers' internal budget and other procedures for approving large capital expenditures, deploying new technologies within their networks and testing and accepting new technologies that affect key operations. Because of the potentially lengthy sales cycle and the potentially large size of such orders, if orders forecasted for a specific customer for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, the Company's operating results for that quarter could be materially adversely affected. See "--Variability of Quarterly Operating Results" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks of Doing Business with the U.S. Government. As a result of its recent acquisition of TIS, the Company expects that, in the near term, a meaningful portion of its revenues will result from existing and future research and development contracts with agencies of the U.S. government. Network Associates believes that the awarding to it of future government contracts will in part be dependent upon the continued favorable reaction of government agencies to the Company's research, development and consulting capabilities. There can be no assurance that Network Associates will be able to procure additional government contracts. Minimum fee awards for government contracts are usually 3% to 7% of the contract costs, but may be as low as 1% of the contracts costs, and the contracts are subject to cancellation for the convenience of the governmental agencies. Although the Company has been awarded contract fees of more than 1% in the past, there can be no assurance that minimum fee awards will not occur in the future. Reductions or delays in federal funds available for projects the Company is performing could also have an adverse impact on its government business. Contracts involving the U.S. government are also subject to the risks of disallowance of costs upon audit, changes in government procurement policies, the necessity to participate in competitive bidding, de-funding of government contracts and, with respect to contracts involving prime contractors or government-designated subcontractors, the inability of such parties to perform under their contracts. Any of the foregoing events could have a material adverse effect on the Company's financial condition or results of operations. Year 2000 Compliance. Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such "Year 2000" or "Y2K" requirements. The Company has established a corporate-wide program to address the Y2K issue. This program encompasses commercial product, internal systems and technology, supplier and business partner and facilities and life safety compliance. The project is comprised of identification of risks, assessment of risks, development of remediation or contingency plans and implementation and testing. Based on the assessments to date, all products currently under development and the majority of products released are Y2K compliant. For any released products which are not Y2K compliant, the Company is working with its customers to provide migration paths for those products. The Company's internal systems and technology are relatively new and as a result the majority are already Y2K compliant. The Company is in the process of upgrading systems and technology that are not currently Y2K compliant, and expects to have this process completed by the third quarter of 1999. In addition, the Company is working with its suppliers and business partners to identify at what stage they are at in the process of identifying and addressing the Y2K issue and to assess the resulting risks and develop appropriate contingency plans. The Company will continue to perform compliance reviews and tests to ensure compliance on an ongoing basis. The Company will continue to perform compliance reviews and tests to ensure compliance on an ongoing basis. In connection with the resolution of Y2K issues, the Company has not to date incurred material costs and does not anticipate that such costs will be material in the future. Although the Company has established and commenced its program to address Y2K issues, the failure of the Company's current or prior products to operate properly with regard to the Year 2000 requirements could (i) cause the Company to incur unanticipated expenses to remedy any problems, (ii) cause a reduction in sales and (iii) expose the Company to related litigation by its customers, each of which could have a material adverse effect on the Company's business, operating results and financial condition. In addition, 43 44 the Company and third parties with whom it conducts business may utilize equipment or software that may not be Y2K compliant. Failure of the Company's or any such third party software to operate properly with regard to the Year 2000 requirements could cause, among other things, the Company or any such third party to incur unanticipated expenses or efforts to remedy any problems, which could have a material adverse effect on its or their respective business, operation results and financial condition. Furthermore, the purchasing patterns of customers or potential customers may be affected by Y2K issues as companies expend significant resources to evaluate and to correct their equipment or software for Y2K compliance and as they simultaneously evaluate the preparedness of the third parties with whom they deal. These expenditures may result in reduced funds available to purchase products and services such as those offered by 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. Historically, the Company's manufacturing operations consisted primarily of final assembly, testing and quality control of materials, components, subassemblies and systems for its Sniffer based products. The Company outsourced these manufacturing operations in 1998. There can be no assurance that the Company will be able to continue to qualify and secure on commercially acceptable terms satisfactory third party manufacturers on a timely basis or at all. In addition, reliance on third party manufacturers will involve a number of risks, including the lack of direct control over the manufacturing process, the absence or unavailability of adequate capacity and reduced control over delivery schedules, quality control and costs. In the event that, once initially secured, the Company's third party manufacturers are unable or unwilling to continue to manufacture the Sniffer based products in required volumes, on a cost effective basis, in a timely manner or at all, the Company will have to secure additional manufacturing capacity. Even if such additional capacity is available at commercially acceptable terms, the qualification process could be lengthy and could create delay in product shipments. Possible Price Volatility of Common Stock. The trading price of the Company's Common Stock has historically been, and is expected to be, subject to wide fluctuations. The market price of the Common Stock may be significantly impacted by quarterly variations in financial performance, shortfalls in revenue or earnings from levels forecast by securities analysts, changes in estimates by such analysts, market conditions in the computer software or hardware industries, product introductions by the Company or its competitors, announcements of extraordinary events such as acquisitions or litigation or general economic conditions. Statements or changes in opinions, ratings, or earnings estimates made by brokerage firms or industry analysts relating to the market in which the Company does business or relating to the Company specifically could result in an immediate and adverse effect on the market price of the Common Stock. In addition, in recent years the stock market has experienced extreme price and volume fluctuations. These fluctuations have had a substantial effect on the market prices for many high technology and emerging growth companies, often unrelated to the operating performance of the specific companies. There can be no assurances that the market price of the Common Stock will not decline below the levels prevailing at the time of this offering. Securities class action lawsuits are often brought against companies following periods of volatility in the market price of their securities. Any such litigation against the Company could result in substantial costs and a diversion of resources and management attention. 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. In this regard, on October 19, 1998, the Board of Directors of the Company declared a dividend of one Preferred Share Purchase Right on each outstanding share of Company Common Stock which was paid to stockholders of record on November 3, 1998. 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 44 45 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, SEPTEMBER 30, 1998 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS: Information with respect to this item is incorporated by reference to Note 7 of the Notes to the Consolidated Financial Statements included herein on page 20 of this Report on Form 10-Q/A. ITEM 2. CHANGES IN SECURITIES Preferred Shares Purchase Rights On October 19, 1998, the Network Associates Board of Directors declared a dividend distribution of one preferred share purchase right (a "Right") on each outstanding share of the Company's Common Stock. Each Right entitles the record holder to buy one-one thousandth of a share of the Company's Series B Participating Preferred Stock, $0.01 par value per share, at an exercise price of $200.00. The Rights will become exercisable following the tenth day after a person or group announces acquisition of 15% or more of the Company's Common Stock or announces commencement of a tender or exchange offer the consummation of which would result in ownership by the person or group of 15% or more of the Common Stock. The Company will be entitled to redeem the Rights at $0.01 per Right at any time on or before the tenth day following acquisition by a person or group of 15% or more of the Company's Common Stock. The dividend distribution was paid on November 3, 1998, to stockholders of record on that day. The Rights will expire on October 20, 2008. Issuances of Securities On August 31, 1998, the Company acquired QA Information Security Holding AB ("QA"). In connection therewith, the Company issued an aggregate of 305,557 shares of Company Common Stock to the shareholders of QA. The transaction was exempt from the registration requirements of Section 5 of the Securities Act pursuant to Section 4(2) thereof and Regulation S promulgated thereunder. The recipients of the securities represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates issued in such transaction. All recipients had adequate access to information regarding the Company. In addition, the offer and sale of such securities by the Company occurred outside of the United States. On August 13, 1998, the Company acquired Dr. Solomon's Group Plc ("Dr. Solomon's"). In connection therewith, the Company issued approximately 15.3 million shares of Company Common Stock (including approximately 1.7 million shares held in trust pending the exercise of certain outstanding and fully vested Dr. Solomon's options) to the shareholders of Dr. Solomon's. The securities were exempt from the registration requirements of Section 5 of the Securities Act pursuant to Section 3(a)(10) thereof. The High Court of Justice of England and Wales approved the fairness of such acquisition. On July 30, 1998, the Company acquired Anyware Seguridad Informatica S.A. ("Anyware"). In connection therewith, the Company issued an aggregate of 228,204 shares of Company Common Stock to the shareholders of Anyware. The transaction was exempt from the registration requirements of Section 5 of the Securities Act pursuant to Section 4(2) thereof and Regulation S promulgated thereunder. The recipients of the securities represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates issued in such transaction. All recipients had adequate access to information regarding the Company. In addition, the offer and sale of such securities by the Company occurred outside of the United States. 46 47 ITEM 5. OTHER INFORMATION Pursuant to Rule 14a-4(c)(1) under the Securities Exchange Act of 1934, the proxies provided to management would allow management to use its discretionary voting authority with respect to any non-Rule 14a-8 stockholder proposal (i.e., a stockholder proposal not included in a company's proxy) raised at the Company's annual meeting of stockholders, without any discussion of the matter in the proxy statement, unless the stockholder has notified the Company of such proposal at least 45 days prior to the month and day on which the Company mailed its prior year's proxy statement. Since the Company mailed its proxy statement for the 1998 annual meeting of stockholders on May 8, 1998, the deadline for receipt of any such non-Rule 14a-8 stockholder proposal for the 1999 annual meeting of stockholders is March 24, 1999. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K: (a) The Company filed the following reports on Form 8-K: In a report on Form 8-K filed with the Commission on October 22, 1998, the Company reported the declaration of a dividend distribution of a Preferred Share Purchase Right. The dividend distribution is expected to be made on November 3, 1998. In a report on Form 8-K filed with the Commission on August 4, 1998, the Company reported the closing and principal terms of the acquisition of Dr Solomon's Group Plc, a corporation duly organized and existing under the laws of England and Wales, which acquisition was consummated on August 12, 1998. In a report on Form 8-K/A filed with the Commission on July 1, 1998, the Company reported the agreement as to terms of the proposed acquisition of Dr Solomon's Group Plc, a corporation duly organized and existing under the laws of England and Wales, which agreement was executed on June 9, 1998. (b) Exhibits. The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Report. 47 48 NETWORKS ASSOCIATES, INC. FORM 10-Q/A, SEPTEMBER 30, 1998 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, and the results and regulations promulgated thereunder, the registrant has duly caused this amended report to be signed on its behalf by the undersigned thereunto duly authorized. NETWORKS ASSOCIATES, INC. /s/ PRABHAT K. GOYAL --------------------------------------------- Name: Prabhat K. Goyal Title: Vice President Administration, Chief Financial Officer and Secretary Date: April 15, 1999 48 49 NETWORKS ASSOCIATES, INC. FORM 10-Q/A, SEPTEMBER 30, 1998 EXHIBIT INDEX
EXHIBIT NO. EXHIBIT TITLE PAGE NO. - ----------- ------------- -------- 2.1 Agreement and Plan of Reorganization, dated October 13, 1997, among McAfee Associates, Inc., Mystery Acquisition Corp. and Network General Corporation, as amended by the First Amendment dated as of October 22, 1997.(1)............................................. 2.2 Combination Agreement dated August 16, 1996 among the Registrant, FSA Combination Corp., FSA Corporation and Daniel Freedman.(2)................................................. 2.3 Stock Exchange Agreement dated January 13, 1996 among the Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and the shareholders of Jade.(3)........................... 2.4 Agreement and Plan of Reorganization dated December 1, 1997 between the Registrant, Helix Software Company an DNA Acquisition Corp.(4)...................................... 2.5 Agreement and Plan of Reorganization dated December 1, 1997 between the Registrant, PGP and PG Acquisition Corp.(5)............................................................. 2.6 Agreement and Plan of Reorganization dated February 22, 1998, between the Registrant, TIS and Thor Acquisition Corp.(6)....................................................... 2.7 Agreement and Plan of Reorganization by and among the Registrant, Magic Solutions International, Inc., Merlin Acquisition Corp. and Igal Lichtman, Amendment Agreement by and among the Registrant, Magic Solutions International, Inc., Merlin Acquisition Corp., and Igal Lichtman dated March 24, 1998. Second Amendment Agreement by and among the Registrant, Magic Solutions International, Inc., Merlin Acquisition Corp., and Igal Lichtman dated April 1, 1998.(7)........................................................ 2.8 Stock Purchase Agreement, dated as of February 26, 1998, by and between FSA Combination Corp., and Brenda Joyce Cook.(8)........................................................ 2.9 Share Purchase Agreement, dated as of March 30, 1998, among FSA Combination Corp., and Irina Karlsson and Jarmo Rouvinen.(8)................................................... 2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA Combination Corp., and Secure Networks, Inc.(8)................................................................ 2.11 Transaction Agreement, dated June 9, 1998, by and between the Registrant and Dr Solomon's Group Plc(21) ................................................................ 2.12 Agreement and Plan of Merger, dated July 28, 1998, by and between the Registrant and CyberMedia, Inc.(22) ................................................................... 3.1 Second Restated Certificate of Incorporation of Networks Associates, Inc., as amended on December 1, 1997.(6)................................................................. 3.2 Restated Bylaws of Networks Associates, Inc.(6)......................................... 3.3 Certificate of Designation of Series A Preferred Stock of Networks Associates, Inc.(9).. 3.4 Certificate of Designation of Series B Participating Preferred Stock of the Registrant (23) ................................................................................... 4.2 Registration Rights Agreement dated August 30, 1996 between the Registrant and Daniel Freedman.(1)............................................................................ 4.5 Registration Rights Agreement dated December 9, 1997 between the Registrant and certain shareholders of PGP.(4)................................................................. 4.6 Registration Rights Agreement, dated as of February 13, 1998, by and between the Registrant and Morgan Stanley & Co. Incorporated.(10)................................... 4.7 Indenture dated as of February 13, 1998 between the Registrant and State Street Bank and Trust Company of California, N.A., as Trustee.(10)...................................... 4.10 Registration Rights Agreement dated May 8, 1998, by and between the Registrant and the stockholders of Secure Networks, Inc.(8)................................................
49 50
EXHIBIT NO. EXHIBIT TITLE PAGE NO. - ----------- ------------- -------- 4.11 Registration Rights Agreement, dated June 29, 1998, by and between the Registrant and certain stockholders of CSB Consulenza Software di Base S.r.l. ("CSB").(11) ................. 4.12 Registration Rights Agreement, dated July 30, 1998, by and between the Registrant and certain stockholders of Anyware Seguridad Informatica S.A.(11) ............................. 4.13 Registration Rights Agreement, dated August 31, 1998, by and between the Registrant and certain stockholders of QA Information Security Holding AB.(24) ............................ 10.1 Standard Business Lease (Net) for Network General's principal facility dated June 19, 1991, between Network General and Menlo Oaks Partners, L.P.(12)............................ 10.2 First Amendment to Lease dated June 10, 1992, between Network General and Menlo Parks Partners, L.P.(12).......................................................................... 10.3 Standard Business Lease (Net) for Network General's principal facility dated March 11, 1992, between Network General and Menlo Oaks Partners L.P.(13).............................. 10.4 First Amendment to Lease dated June 18, 1992, between Network General and Menlo Oaks Partners, L.P.(12).......................................................................... 10.5 Lease dated March 31, 1992, between Network General and Equitable Life Assurance Society of the United States.(12)................................................................... 10.6 Second Amendment to Lease dated February 1, 1995, between Network General and Menlo Oaks Partners, L.P.(13).......................................................................... 10.7 Third amendment to Lease dated February 1, 1995 between Network General and Menlo Oaks Partners L.P.(13)........................................................................... 10.8 Fourth Amendment to Lease dated May 31, 1995, between Network General and Menlo Oaks Partners, L.P.(14).......................................................................... 10.9 Fifth Amendment to Lease dated June 13, 1995, between Network General and Menlo Oaks Partners, L.P.(14).......................................................................... 10.10 Lease dated July 3, 1996 between Network General and Campbell Avenue Associates.(15)........ 10.11 Sixth Amendment to Lease dated November 29, 1996, between Network General and Menlo Oaks Partners, L.P.(15).......................................................................... 10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa Clara, California, dated as of February 20, 1997, by and between McAfee Associates, Inc. and National Semiconductor Corporation.(16).............................................................. 10.13 Lease Agreement dated November 17, 1997 for facility at 3965 Freedom Circle, Santa Clara, California by and between Informix Corporation and McAfee Associates, Inc.(4)........ 10.14 Consent to Assignment Agreement dated December 19, 1997 by and among Birk S. McCandless, LLC, Guaranty Federal Bank, F.S.B., Informix Corporation and Networks Associates, Inc.(4)... 10.15 Subordination, Nondisturbance and Attornment Agreement dated December 18, 1997, between Guaranty Federal Bank, F.S.B., Networks Associates, Inc. and Birk S. McCandless, LLC.(4)... 10.16 Lease dated November 22, 1996 by and between Birk S. McCandless, LLC and Informix Corporation for facility at 3965 Freedom Circle, Santa Clara, California.(4)............... 10.17 Quota Purchase Agreement, dated as of April 14, 1997 by and among McAfee Associates, Inc. and McAfee Do Brasil Ltda., Compusul-Consultoria E Comercio De Informatica Ltda., and the stockholders of Compusul-Consultoria E Comercio De Informatica Ltda.(17) ........... 10.18* 1997 Stock Incentive Plan.(17).............................................................. 10.19* Stock Option Plan for Outside Directors(18)................................................. 10.20* Change in control agreement between the Company and Dennis Cline dated April 14, 1995.(17)................................................................................... 10.21* Change in control agreement between the Company and Peter Watkins May 1, 1995.(17).......... 10.22* Change in control agreement between the Company and William S. Larson dated April 14, 1995.(17)................................................................................... 10.23* Change in control agreement between the Company and Prabhat K. Goyal dated April 18, 1996.(19)................................................................................... 10.27* Change in control agreement between the Company and Zachary Nelson, dated May 12, 1998.(20)................................................................................... 27.1 Financial Data Sheet........................................................................
50 51 - ---------- (1) Incorporated by reference from the Registrant's Registration Statement on Form S-4 filed with the Commission on October 31, 1997. (2) Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Commission on September 24, 1996. (3) Incorporated by reference from the Registrants Current Report on Form 8-K filed with the Commission on March 14, 1997. (4) Incorporated by reference from the Registrant's Registration Statement on Form S-3, filed with the Commission on February 12, 1998. (5) Incorporated by reference from the Registrant's Report on Form 8-K filed with the Commission on December 11, 1997. (6) Incorporated by reference from the Registrant's Registration Statement on Form S-4 filed with the Commission on March 25, 1998. (7) Incorporated by reference from the Registrant's Report on Form 8-K filed with the Commission on April 2, 1998. (8) Incorporated by reference from the Registrant's Registration Statement on Form S-3 filed with the Commission on May 26, 1998. (9) Incorporated by reference from the Registrant's Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Commission on November 4, 1997. (10) Incorporated by reference from the Registrant's Registration Statement on Form S-3 filed with the Commission on May 6, 1998. (11) Incorporated by reference from the Registrant's Registration Statement on Form S-3 filed with the Commission on August 5, 1998. (12) Incorporated by reference from the Network General Corporation's Report on Form 10-K for the year ended March 31, 1992. Network General's filings with the Commission were made under File Number 0-17431. (13) Incorporated by reference from the Network General Corporation's Report on Form 10-Q for the quarter ended December 31, 1994. Network General's filings with the Commission were made under File Number 0-17431. (14) Incorporated by reference from the Network General Corporation's Report on Form 10-Q for the quarter ended June 30, 1995. Network General's filings with the Commission were made under File Number 0-17431. (15) Incorporated by reference from the Network General Corporation's Report on Form 10-Q for the quarter ended June 30, 1996. Network General's filings with the Commission were made under File Number 0-17431. (16) Incorporated by reference from the Registrant's Report on Form 10-Q for the quarter ended June 30, 1997, filed with the Commission on August 14, 1997. (17) Incorporated by reference from the Registrant's Registration Statement on Form S-4 filed with the Commission on July 31, 1995. (18) Incorporated by reference from the Registrant's Report on Form S-8 filed with the Commission on December 2, 1997. (19) Incorporated by reference from the Registrant's Report on Form 10-Q for the quarter ended June 30, 1996, filed with the Commission on August 13, 1996. (20) Incorporated by reference from the Registrant's Report on Form 10-Q for the quarter ended March 31, 1998, filed with the Commission on May 15, 1998. (21) Incorporated by reference from the Registrant's Report on Form 8-K filed with the Commission on June 16, 1998. (22) Incorporated by reference from CyberMedia Inc.'s Schedule 13D filed by the Registrant with the Commission on August 7, 1998. CyberMedia Inc.'s filings with the Commission were made under File Number 0-21289. (23) Incorporated by reference from the Registrant's Report on Form 8-A filed with the Commission on October 22, 1998. (24) Incorporated by reference from the Registrant's Report on Form 10-Q for the quarter ended September 30, 1998, filed with the Commission on November 13, 1998. * Management contracts or compensatory plans or arrangements covering executive officers or directors of Networks Associates, Inc. 51 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ACCOMPANYING CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 363,839 279,902 234,204 7,842 0 780,636 58,281 0 1,409,421 377,780 0 0 0 1,344 589,252 1,409,421 717,854 717,854 137,695 137,695 678,858 0 0 52,942 73,189 (20,247) 0 0 0 (20,247) (0.15) (0.15) For Purposes of this Exhibit, Primary means Basic.
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