-----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, EHBvgzuEYRzQKBPmfuyI+9l1iqqXvx2CCP12s/EziS8oBTTIZtoUgbZDOUSYfag7 8fnbia4k1eZKTKlQE3iaHw== 0000891618-99-005246.txt : 19991117 0000891618-99-005246.hdr.sgml : 19991117 ACCESSION NUMBER: 0000891618-99-005246 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 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 SEC ACT: SEC FILE NUMBER: 000-20558 FILM NUMBER: 99756276 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 1 FORM 10-Q 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q ------------------------ [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999 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 [ ] 139,216,131 shares of the registrant's common stock, $0.01 par value, were outstanding as of September 30, 1999. THIS DOCUMENT CONTAINS 45 PAGES. THE EXHIBIT INDEX IS ON PAGE 42. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 NETWORKS ASSOCIATES, INC. FORM 10-Q, SEPTEMBER 30, 1999 ------------------------ CONTENTS
ITEM NUMBER PAGE - ------ ---- PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Statements of Operations: Three and nine months ended September 30, 1999 and 1998..... 3 Condensed Consolidated Balance Sheets: September 30, 1999 and December 31, 1998.................... 4 Condensed Consolidated Statements of Cash Flows: Nine months ended September 30, 1999 and 1998............... 5 Notes to Condensed Consolidated Financial Statements........ 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................... 14 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS........................................... 40 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................ 40 SIGNATURES........................................................... 41 EXHIBIT INDEX........................................................ 42
2 3 NETWORKS ASSOCIATES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- --------------------- 1999 1998 1999 1998 -------- -------- --------- -------- Net revenues: Product........................................ $149,141 $203,620 $ 303,351 $607,744 Services & support........................... 46,060 38,824 162,238 110,110 -------- -------- --------- -------- Total revenues....................... 195,201 242,444 465,589 717,854 Cost of revenues: Product...................................... 23,718 33,047 64,138 106,422 Services & support........................... 9,619 11,509 27,996 31,273 -------- -------- --------- -------- Total cost of revenues............... 33,337 44,556 92,134 137,695 Operating expenses: Research and development..................... 38,921 33,077 109,833 102,217 Marketing and sales.......................... 88,926 66,007 273,337 210,189 General and administrative................... 24,218 16,022 100,226 65,195 Amortization of intangibles and stock compensation charge....................... 21,000 11,216 58,194 27,946 Acquisition and related charges.............. (10,373) 63,399 (18,732) 135,616 -------- -------- --------- -------- Total operating expenses............. 162,692 189,721 522,858 541,163 -------- -------- --------- -------- Income (loss) from operations........ (828) 8,167 (149,403) 38,996 Interest and other income and expense, net... 1,909 4,099 5,381 13,946 -------- -------- --------- -------- Income (loss) before provision for income taxes....................... 1,081 12,266 (144,022) 52,942 Provision for income taxes..................... 1,322 26,710 25,763 73,189 -------- -------- --------- -------- Net loss............................. $ (241) $(14,444) $(169,785) $(20,247) ======== ======== ========= ======== Other comprehensive income (loss): Unrealized gain (loss) on investments.......... $ 897 $ 2,409 $ (2,412) $ 2,196 Foreign currency translation gain (loss)....... 2,855 (850) (4,531) (3,484) -------- -------- --------- -------- Comprehensive income (loss).................... $ 3,511 $(12,885) $(176,728) $(21,536) ======== ======== ========= ======== Net loss per share -- basic.................... $ 0.00 $ (0.11) $ (1.23) $ (0.15) ======== ======== ========= ======== Shares used in per share calculation --basic... 139,038 133,531 137,906 131,973 ======== ======== ========= ======== Net loss per share -- diluted.................. $ 0.00 $ (0.11) $ (1.23) $ (0.15) ======== ======== ========= ======== Shares used in per share calculation -- diluted....................... 139,038 133,531 137,906 131,973 ======== ======== ========= ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 NETWORKS ASSOCIATES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------- ------------ (UNAUDITED) Current assets: Cash and cash equivalents................................... $ 249,426 $ 418,899 Marketable securities..................................... 50,138 98,515 Accounts receivable, net of allowances for doubtful accounts and returns of $128,285 at September 30, 1999 and $97,342 at December 31, 1998....................... 190,829 260,784 Prepaid expenses, income taxes and other current assets... 32,145 59,554 Deferred taxes............................................ 80,965 65,866 ---------- ---------- Total current assets.............................. 603,503 903,618 Marketable securities....................................... 352,370 216,457 Fixed assets, net........................................... 47,639 54,489 Deferred taxes.............................................. 46,323 38,205 Intangibles and other assets................................ 291,117 323,952 ---------- ---------- Total assets...................................... $1,340,952 $1,536,721 ========== ========== LIABILITIES Current liabilities: Accounts payable.......................................... $ 15,485 $ 20,881 Accrued liabilities....................................... 193,229 210,070 Deferred revenue.......................................... 119,124 132,409 Long term debt, current portion........................... 411 3,202 ---------- ---------- Total current liabilities......................... 328,249 366,562 Deferred taxes............................................ 11,484 13,000 Deferred revenue, less current portion.................... 29,692 60,189 Long term debt and other liabilities...................... 380,362 374,132 ---------- ---------- Total liabilities................................. 749,787 813,883 ---------- ---------- STOCKHOLDERS' EQUITY Preferred stock, $.01 par value; authorized: 5,000,000 shares; Common stock, $.01 par value; authorized: 300,000,000 shares; issued: 139,316,131 shares at September 30, 1999 and 137,123,562 shares at December 31, 1998...................................................... 1,393 1,371 Treasury stock.............................................. (1,606) -- Additional paid-in capital.................................. 574,503 527,862 Cumulative other comprehensive income -- unrealized loss on investments and foreign currency translation.............. (8,477) (1,534) Retained earnings........................................... 25,352 195,139 ---------- ---------- Total stockholders' equity........................ 591,165 722,838 ---------- ---------- Total liabilities and stockholders' equity........ $1,340,952 $1,536,721 ========== ==========
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)
NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 1999 1998 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss.................................................... $(169,785) $ (20,247) Adjustments to reconcile net loss to net cash provided (used) from operating activities: Acquired in-process research and development.............. -- 49,843 Depreciation and amortization............................. 61,551 53,703 Write down of owned facility.............................. -- 1,177 Allowance for doubtful accounts........................... 36,867 6,658 Interest on convertible notes............................. 12,934 11,055 Unrealized gain (loss) on investments..................... (2,412) 2,252 Deferred taxes............................................ (24,733) 13,025 Stock compensation charges................................ 14,806 -- Changes in assets and liabilities: Accounts receivable.................................... 33,092 (70,012) Prepaid expenses, taxes and other...................... 16,797 (22,462) Accounts payable and accrued liabilities............... (28,943) (24,838) Deferred revenue....................................... (43,782) 35,392 --------- --------- Net cash provided by (used in) operating activities...................................... (93,608) 35,546 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of CyberMedia, Inc............................ -- (119,958) Acquisition of Magic Solutions, Inc....................... -- (109,717) Purchase of investment securities, net.................... (87,535) (19,138) Additions to fixed assets................................. (17,778) (33,453) Proceeds from sale of fixed assets........................ 6,518 -- --------- --------- Net cash used in investing activities............. (98,795) (282,266) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Effect of exchange rate fluctuations...................... (4,531) (3,827) Sale of convertible debentures............................ -- 337,624 Repayment of notes payable................................ (2,791) (186) Issuance of common stock under stock option and stock purchase plans......................................... 26,149 94,300 Tax benefit from exercise of nonqualified stock options... -- 25,154 Repurchase of common stock................................ (1,606) -- Exercise of warrants...................................... 459 463 Proceeds from sale of put options......................... 5,250 -- --------- --------- Net cash provided by financing activities......... 22,930 453,528 --------- --------- Net increase (decrease) in cash and cash equivalents........ (169,473) 206,808 Cash and cash equivalents at beginning of period............ 418,899 157,031 --------- --------- Cash and cash equivalents at end of period.................. $ 249,426 $ 363,839 ========= =========
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 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. The Company has two reportable segments consisting of computer security and management software ("Enterprise"), and consumer PC security and management software on the Internet ("McAfee.com"). In the opinion of management, all adjustments, consisting only of normal recurring adjustments considered necessary for a fair presentation, have been included. The results of operations for the three and nine month periods ended September 30, 1999 are not necessarily indicative of the results to be expected for the full year or for any future periods. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 15, 1999, as amended by Form 10-K/A filed on April 30, 1999. The balance sheet at December 31, 1998 has been derived from the audited financial statements as of and for the year ended December 31, 1998, but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. 2. RELATED PARTY TRANSACTIONS During the first quarter of 1999, the Company agreed to acquire 3,948,199 shares of Series A Preferred Stock of DirectWeb, Inc. for $2.5 million, and 4,615,385 shares of Series B Preferred Stock for $6.0 million. DirectWeb, Inc. is a subscription-based online service offering a complete turnkey Windows-98 based PC, unlimited Internet access and technical support for a fixed user only fee. In connection with the formation of DirectWeb, the Company received a warrant to acquire 3,175,000 shares of Direct Web common stock for total consideration of $317.50. As of September 30, 1999, on an as converted basis and excluding shares that may be acquired upon exercise of its warrant, the Company's total DirectWeb investment represented approximately 12.3% of DirectWeb's outstanding capital stock. With respect to the balance, approximately 35.2% is owned by William L. Larson, a DirectWeb founder and the Company's Chief Executive Officer; 35.4% is owned by Dennis Cline, a DirectWeb founder and the Company's former Vice President of Worldwide Sales; and 17.1% is owned by unrelated third party investors who, along with the Company, invested in DirectWeb's Series A and Series B Preferred Stock. 3. MCAFEE.COM McAfee.com is an Internet destination dedicated to updating, upgrading, and managing PCs over the web for single use retail, non-corporate, consumers. In December 1998, the Company incorporated McAfee.com Corporation in Delaware as a wholly owned subsidiary. Since January 1, 1999, the Company has contributed certain assets and liabilities to McAfee.com and has entered into certain inter-company arrangements including technology, licenses, shared facilities, functions, services and tax sharing agreements. In September 1999, McAfee.com filed an S-1 with the Securities and Exchange Commission ("SEC') for an initial public offering. Upon the completion of the offering, if at all, the Company will own all of the outstanding Class B common stock, representing approximately 85% of McAfee.com's outstanding common stock, assuming no exercise of the underwriter's over-allotment option. In January 1999, executives of Network Associates were granted options to purchase 1,710,000 shares (after restatement for the effects of a two for one stock split in June 1999, a reverse 3 for 5 stock split in July 1999, and share reduction/cancellation in September 1999) of McAfee.com common stock. As of September 30, 1999, all these options were fully vested. In connection with these options, the Company recorded total 6 7 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) compensation expense for the three and nine months ended September 30, 1999 of approximately $5.0 million and $6.6 million, respectively. 4. SEGMENT REPORTING The Company has adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, effective for fiscal years beginning after December 15, 1997. In fiscal year 1998, the Company determined that it had a single reporting segment consisting of the development, sale, and support of computer security and management software. Since then, the Company established one of its subsidiaries, McAfee.com, as a separate business entity. As of September 30, 1999, the Company evaluated its product segments in accordance with SFAS 131 and concluded that its reportable segments are computer security and management software ("Enterprise"), and consumer PC security and management software on the Internet ("McAfee.com"). The Enterprise segment is organized into two product suites: Net Tools Secure and Net Tools Manager. These product suites are marketed and sold through a direct sales force to distributors, retailers, and end users in the United States, Europe, Asia Pacific and Latin America. The McAfee.com segment is a one-stop destination for consumer PC security and management needs on the Internet. The McAfee.com website provides a suite of online products and services personalized for the user based on the user's PC configuration, attached peripherals and resident software. Summarized pre-tax financial information concerning the Company's reportable segments is provided as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- --------------------- 1999 1998 1999 1998 -------- -------- --------- -------- Enterprise: Net revenues................... $188,438 $240,762 $ 449,494 $713,586 Segment profit (loss)........ 10,895 (13,404) (147,987) (19,424) McAfee.com: Net revenues................. 6,763 1,682 16,095 4,268 Segment loss................. (11,136) (1,040) (21,798) (823)
SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------- ------------ Enterprise: Total assets....................................... $1,330,883 $1,534,283 McAfee.com: Total assets.................................. 10,069 2,438
5. STOCK OPTION REPRICING AND STOCK REPURCHASE PLAN On April 22, 1999, the Company offered to substantially all of its employees, excluding executive officers, the right to cancel certain outstanding stock options and receive new options with exercise prices at the current fair market value of the stock. Options to purchase a total of 10.3 million shares were canceled and the same number of new options were granted at an exercise price of $11.063, which was based on the closing price of the Company's common stock on April 22, 1999. The new options vest at the same rate that they would have vested under previous option plans. As a result, options to purchase approximately 3.0 million shares at $11.063 were vested at September 30, 1999, however the new options cannot be exercised for a period of twelve months regardless of vesting status. 7 8 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) In accordance with Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," the Company incurred an initial stock based compensation charge in connection with this repricing. This charge was calculated based on the difference between the exercise price of the new options and their market value on the date of acceptance by employees. Approximately $1.6 million and $8.2 million were expensed in the three and nine months ended September 30, 1999, respectively, and approximately $14.5 million will be expensed over the remaining vesting period. On March 31, 1999, the Financial Accounting Standards Board ("FASB") issued an exposure draft of its Proposed Interpretation, "Accounting for Certain Transactions involving Stock Compensation -- an interpretation of APB Opinion No. 25" (the "Proposed Interpretation"). Under the Proposed Interpretation, stock options repriced after December 15, 1998 will be subject to variable plan accounting treatment. If adopted, this proposed guidance will require the Company to remeasure compensation cost for outstanding repriced options each reporting period based on changes in the market value of the underlying common stock after the date of adoption. The FASB currently expects to approve the release of this interpretation in the first quarter of 2000. Depending upon movements in the market value of the Company's common stock, this proposed accounting treatment may result in significant additional compensation charges in future periods. In May 1999, the Board of Directors authorized the Company to repurchase up to $100 million of its common stock in the open market. In the quarter ended September 30, 1999, the Company repurchased 100,000 shares of its common stock for a total cash outlay of approximately $1.6 million. The timing and size of any future stock repurchases are subject to market conditions, stock prices, the Company's cash position and other cash requirements going forward. On August 3, 1999, Network Associates sold "European style" put options for 1,000,000 shares of the Company's common stock as part of its stock repurchase plan. European style put options can only be exercised on the expiry date, which is August 3, 2000. The strike price for these put options is $20.00, and the Company received total proceeds of $5,250,000 from the sale. 6. RECENT ACCOUNTING PRONOUNCEMENTS Effective January 1, 1998, the Company adopted Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition" and SOP No. 98-4, "Deferral of the Effective Date of a Provision of SOP No. 97-2." Prior to 1998, the Company recognized revenues in accordance with SOP No. 91-1, "Software Revenue Recognition." In December 1998, the American Institute of Certified Public Accountants ("AICPA") issued SOP No. 98-9, "Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions." SOP No. 98-9 clarifies certain provisions of SOP No. 97-2 that were previously deferred by SOP No. 98-4, and effectively defers the required adoption of those provisions until the Company's fiscal year beginning January 1, 2000. The adoption of SOP No. 98-9 is not expected to have a material impact on the Company's results of operations, financial position or cash flows. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through net income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. SFAS 133 is effective for years beginning after June 15, 2000, 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. 8 9 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 7. NET LOSS PER SHARE In accordance with the disclosure requirements of SFAS 128, a reconciliation of the numerator and denominator of basic and diluted net loss per share calculations is provided as follows (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- --------------------- 1999 1998 1999 1998 -------- -------- --------- -------- Numerator -- basic Net loss....................................... $ (241) $(14,444) $(169,785) $(20,247) ======== ======== ========= ======== Numerator -- diluted Net loss....................................... $ (241) $(14,444) $(169,785) $(20,247) ======== ======== ========= ======== Interest on convertible debentures, net of tax(1)....................................... -- -- -- -- Denominator -- basic Basic weighted average common shares outstanding.................................. 139,038 133,531 137,906 131,973 ======== ======== ========= ======== Denominator -- diluted Basic weighted average common shares outstanding.................................. 139,038 133,531 137,906 131,973 -------- -------- --------- -------- Effect of dilutive securities: Convertible debt............................. -- -- -- -- Common stock options......................... -- -- -- -- Diluted weighted average shares................ 139,038 133,531 137,906 131,973 ======== ======== ========= ======== Net loss per share -- basic.................... $ 0.00 $ (0.11) $ (1.23) $ (0.15) ======== ======== ========= ======== Net loss per share -- diluted.................. $ 0.00 $ (0.11) $ (1.23) $ (0.15) ======== ======== ========= ========
- --------------- (1) Convertible debt interest and related as-if converted shares are excluded from both the 1998 and 1999 calculations as the Company incurred a net loss for all periods. 8. LITIGATION On April 7, 1999, a putative securities class action, captioned Knisley v. Network Associates, Inc., et al., Civil Action No. C-99-1729-SBA, was filed against Network Associates and several of its officers in the United States District Court for the Northern District of California. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and seeks unspecified damages on behalf of a purported class of purchasers of common stock between January 20, 1998 and April 6, 1999. Twenty-four similar actions asserting virtually identical allegations have been filed by other plaintiffs. The Court has consolidated these cases. Certain of the plaintiffs have filed motions seeking to be appointed lead plaintiff. The Company has not responded to the complaints. On May 12, 1999, a purported derivative action, captioned Dow Jones Investment Club v. Network Associates, Inc. et al., Civil Action No. CV-781854, was filed against nominal defendant Network Associates, Inc. and certain of its officers and directors in the Superior Court of California, County of Santa Clara. The complaint alleges violations of Sections 25402 and 1507 of the California Corporations Code, breach of fiduciary duty, insider trading, gross negligence, and unjust enrichment. The complaint seeks unspecified damages. Two similar derivative actions have been filed by other plaintiffs in the Superior Court of California, County of Santa Clara, including Leighton v. Network Associates, Inc. et al., Civil Action No. CV-781947, and Katz v. Network Associates, Inc., Civil Action No. CV-782194. On January 21, 1999, the court ordered 9 10 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) these three actions consolidated for pretrial and trial proceedings and deemed the complaint filed in the Leighton action the operative complaint. Defendants have filed a motion to dismiss the operative complaint. A similar case, captioned Gage v. Network Associates, Inc., et al., Civil Action No. B C211552, has been filed in the Superior Court of California, County of Los Angeles. Plaintiffs allege violations of Sections 25400 et seq. of the California Corporations Code, Section 17200 of the California Business and Professions Code, and breach of fiduciary duty. The parties have stipulated to transfer the action to Santa Clara County Superior Court. On April 24, 1997, Network Associates was served by Symantec with a suit filed in the United States District Court, Northern District of California, San Jose Division, alleging copyright infringement and unfair competition by Network Associates. Symantec alleges that Network Associates' 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 Network Associates' "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 Network Associates from shipping any product containing either an approximately 30-line routine found in Crash Guard or an approximately 100-line routine found in a Symantec DLL. The Court's order expressly stated that "the court is not enjoining the sale or distribution of [McAfee's] current product." On December 19, 1997, the Court denied Symantec's motion to enjoin sale or distribution of Network Associates' current PC Medic product. On April 1, 1998, Symantec filed an amended complaint including additional allegations of trade secret misappropriation, unfair competition, interference with economic advantage and contractual relations and violations of the Racketeer Influenced and Corrupt Organization Act ("RICO"), in connection with the alleged use by Network Associates employees of 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 Network Associates from making use of any Symantec customer list data. On September 4, 1998, Symantec's time for amending its complaint expired; Symantec did not refile its RICO claims. On October 8, 1998, the Court granted partial summary judgment in Network'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. On October 22, the Court consolidated this case for purposes of trial with an action originally brought on February 4, 1998 by CyberMedia Inc. (acquired by Network Associates in September 1998) against Symantec (described below) and the action brought by Symantec against Network Associates on September 4, 1998 (described below). Trial is currently set for May 22, 2000. On September 4, 1998, Symantec filed suit in United States District Court for the Northern District of California, San Jose Division, against Network Associates, alleging copyright infringement, unfair competition, and trade secret misappropriation. Symantec alleges that an unidentified Network Associates employee copied and transported to Network Associates certain proprietary Symantec files, including files containing Norton Antivirus software. On January 20, 1999, the Court dismissed those portions of Symantec's claims relating to Network Associates' PC Medic and VirusScan products. Symantec also alleges that another unidentified Network Associates employee located in Canada copied and transported to Network Associates certain other unidentified files containing Symantec confidential information. On May 13, 1997, Trend Micro, Inc. ("Trend") filed suit in United States District Court for the Northern District of California against both Network Associates and Symantec. Trend alleges that Network Associates' "WebShield," "GroupShield," and "Gauntlet Firewall" products infringe a Trend patent, which 10 11 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) was issued on April 22, 1997. Trend's complaint seeks injunctive relief and unspecified money damages. On June 6, 1997, Network Associates filed its answer denying any infringement. Network Associates also filed counterclaims against Trend alleging unfair competition, false advertising, trade libel, and interference with prospective economic advantage. On September 19, 1997, Symantec filed a motion to sever Trend's action against Network Associates from its action against Symantec. Network Associates did not oppose Symantec's motion to sever, other than to recommend a joint hearing on patent claim interpretation. On December 19, 1997, the Court granted Symantec's motion to sever and adopted Network Associates' recommendation regarding a joint hearing on patent claim interpretation. As a result of the Court's decision, Trend's actions against Network Associates and Symantec were to proceed separately. Symantec has since settled out of the lawsuit. The Court held a patent claim interpretation hearing on September 1, 1998. The Court issued a ruling on claim interpretation on or about December 29, 1998. In addition, Trend filed a supplemental complaint on October 5, 1998, adding the Gauntlet product to the products accused of infringing Trend's patent. At a case management conference held on October 2, 1998, the Court set a new trial date of November 8, 1999. Since then, the parties have stipulated to a postponement of various dates, including postponement of the trial date until February, 2000. The parties are still engaged in completing discovery. On September 15, 1997, Network Associates was named as a defendant in a patent infringement action filed by Hilgraeve Corporation ("Hilgraeve") in the United States District Court, Eastern District of Michigan. Hilgraeve alleges that Network Associates' VirusScan product infringes a Hilgraeve patent, which was issued on June 7, 1994. Hilgraeve's action seeks injunctive relief and unspecified money damages. All discovery has been completed. The Court heard Network Associates' motions for summary judgment of non-infringement on May 20, 1999 and granted the motion in a written opinion dated June 10, 1999. The Court entered judgment in favor of Network Associates on July 7, 1999. Hilgraeve has filed an appeal from the judgment to the United States Court of Appeals for the Federal Circuit. That appeal is pending. On July 30, 1998, CyberMedia, Network Associates 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 merger. On December 16, 1998, plaintiffs filed a stipulation of voluntary dismissal. 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 did not specify damages. Defendants filed a demurrer to the complaint on September 25, 1998. On January 13, 1999, the court (Commissioner Bruce E. Mitchell) sustained Defendants' demurrer with prejudice and allowed plaintiff to amend its complaint within 30 days only if a new named plaintiff was added. On February 12, 1999, plaintiffs filed an amended complaint alleging the same causes of action with the same named plaintiff. On February 26, 1999, Defendants filed an ex parte application for an order to show cause why plaintiffs should not be held in violation of the Court's Order. At the hearing on March 8, 1999, the Court dismissed the action with prejudice. 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. 11 12 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) CyberMedia, Inc., et al., No. 98-2210 CM (MCx), filed on March 26, 1998, Liu v. CyberMedia, Inc., et al., No. 98-2617, filed on April 8, 1998, Kerr, et al. v. CyberMedia, Inc., et al., No. 98-3104 RJK (Anx), filed on April 23, 1998, and Barker v. CyberMedia, Inc., et al., No. SA CV98-401 AHS (ANx), filed on May 6, 1998. Plaintiffs filed a second consolidated amended complaint on March 8, 1999. It alleges that the defendants violated federal securities laws by artificially inflating the price of CyberMedia stock to the detriment of a purported class of investors who purchased or otherwise acquired CyberMedia stock between March 31, 1997 and March 12, 1998. CyberMedia and certain of its former officers and directors were also named as defendants in three securities class action lawsuits filed in the Superior Court of Los Angeles County. Such complaints have been ordered consolidated, although a consolidated amended complaint has not yet been filed. The consolidated complaints include: Brown v. CyberMedia, Inc., et al., No. B C187898, filed on March 19, 1998, Smith v. CyberMedia, Inc., et al. No. B C188527, filed on March 31, 1998, and Stockwell v. CyberMedia, Inc., et al., No. B C189020, filed on April 8, 1998. The complaints allege that defendants violated California state securities laws and common law by artificially inflating the price of CyberMedia stock to the detriment of a purported class of investors who purchased or otherwise acquired CyberMedia stock between March 31, 1997 and March 13, 1998. Network Associates has reached an agreement in principle with plaintiffs to settle the state and federal securities class actions. The settlement provides for a payment of $11.5 million plus interest from approximately May 6, 1999, $1.5 million (and interest on that amount) of which is to be paid by Network Associates and the remainder of which is to be paid by the Company's insurers. The parties memorialized the agreement in principle in a Memorandum of Understanding and are negotiating a final Stipulation of Settlement. Once a final Stipulation of Settlement has been negotiated and signed, the parties will seek judicial approval of the settlement. Consummation of the proposed settlement is contingent on a number of factors including agreement on settlement language and judicial approval. 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. On September 3, 1998, the United States District Court for the Northern District of California issued a preliminary injunction preventing the defendants from manufacturing, marketing or distributing any existing version of their competing program, and requiring defendants to issue a "Notice of Recall" to all distributors regarding existing versions of the program. The injunction was effective throughout the United States. On November 30, 1998, the Court issued a further order pursuant to an agreement of the parties, prohibiting Symantec from manufacturing, distributing or advertising Norton Uninstall Deluxe anywhere in the world. The defendants have filed counterclaims against CyberMedia for slander, libel, product disparagement and related state law claims, seeking unspecified money damages. On April 27, 1999, Network Associates was served by Symantec with a suit filed in the Superior Court of California, County of Santa Clara. The suit alleges malicious prosecution in connection with an earlier suit Network Associates brought against Symantec for defamation and related claims, and which was dismissed in December 1997. Symantec has agreed that no response to the Complaint in this action need be filed until further notice. 12 13 NETWORKS ASSOCIATES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 9. FIXED ASSETS SALE-LEASEBACK On September 20, 1999, the Company sold approximately $6.5 million of fixed assets to a third party and leased them back under an operating lease. The initial term of the lease is 12 months, with an option to renew the lease for an additional 12 months. 13 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report. The results shown herein are not necessarily indicative of the results to be expected for the full year or any future periods. This Report on Form 10-Q contains forward-looking statements, including but not limited to those specifically identified as such, that involve risks and uncertainties. The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including without limitation statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this Report on Form 10-Q are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including, but not limited to, those set forth in "Risk Factors" and elsewhere in this Report on Form 10-Q. OVERVIEW We are a leading developer and provider of software products that address two of the most important concerns of information technology or IT professionals: network security and network management. In the network security arena, the majority of our revenue has historically been derived from our McAfee anti-virus product line. In the network management arena, the majority of our revenue has historically been derived from our Sniffer network fault and performance management product line. These two flagship product lines form the customer base and product base from which the balance of our product line has developed. To continue expanding our revenue base, we have focused our efforts on building a full line of complementary network security and network management solutions. On the network security side, during 1998 we strengthened our anti-virus lineup by adding complementary products in the firewall, intrusion protection, encryption, and virtual private networking categories. On the network management side, during 1998 we built upon our Sniffer line by adding products in the help desk, asset management, network monitoring, and network reporting categories. We continuously seek to expand our product line. We have combined complementary products into "suites", offering customers the ability to license multiple products at the same time. Our products are currently organized into four primary product suites: McAfee Total Virus Defense and PGP Total Network Security, which combine to form "Net Tools Secure" and Sniffer Total Network Visibility and Magic Total Service Desk, which combine to form "Net Tools Manager". These four product suites together form a single integrated mega-suite called "Net Tools". We organize our products for sale to corporate customers into four product suites: NET TOOLS
NET TOOLS SECURE - -------------------------------------------- MCAFEE TOTAL VIRUS PGP TOTAL NETWORK DEFENSE SECURITY ------------------ --------------------- - - Total Virus Defense - Total Network - - Suite Security Suite - - VirusScan Security - PGP Virtual Private Suite Network (VPN) - - GroupShield Suite Security Suite - PGP Data Security Suite - Gauntlet Active Firewall Suite - Cybercop Intrusion Protection Suite
NET TOOLS MANAGER - -------------------------------------------- SNIFFER TOTAL NETWORK MAGIC TOTAL SERVICE VISIBILITY DESK - --------------------- --------------------- - - Total Network - Total Service Visibility Suite Desk Suite - - Sniffer Distributed - Magic HelpDesk Analysis Suite Suite - - Sniffer Pro 98 - SupportMagic Portable Analysis - Zero Admin Client Suite Suite - - Network Informant - Zero Admin Client Suite 2001 Suite
14 15 Many of our network security and management products are also available as stand-alone products or as part of smaller product suites. Electronic software distribution is one of the principal means by which we distribute our software products to our customers. We generally license our products to corporate customers, our primary customer base, under either a one-year or a two-year product license. In addition to our corporate customer base, our primary customer base, we also offer a full range of consumer-oriented security and management software products to retail customers, both through traditional retail stores and via the Internet. Products offered to consumers via the Internet are sold by our subsidiary, McAfee.com. Our retail products for sale to consumers and small business customers are organized into three categories: - Anti-virus; - Internet security/privacy; and - Desktop utilities. Our retail products are available as stand-alone products or bundled together as part of a suite. For example, our VirusScan anti-virus software is sold both as a stand-alone product and as part of various product suites, such as McAfee Office 2000 and McAfee Office Pro. We generally utilize a perpetual or unlimited license for products sold in the retail channel. McAfee.com sells our retail products to consumers over the Internet. Through the McAfee.com web site, consumers can secure, repair, update and upgrade their PC's online. The web site provides a suite of online products and services, including the McAfee Clinic, Anti-Virus Center and PC Checkup Center, personalized for consumers based on their PC configurations, software and attached peripherals, such as scanners, printers and modems. As of November 2, 1999 McAfee.com had over 100,000 paid subscribers for their McAfee Clinic service. 15 16 RESULTS OF OPERATIONS The following table sets forth, for the period's indicated, the percentage of net revenues represented by certain items in our statements of operations for the three months and nine months ended September 30, 1999 and 1998.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------ 1999 1998 1999 1998 ----- ----- ------ ----- Net revenues: Product............................................. 76.4 84.0 65.2 84.7 Services & support................................ 23.6 16.0 34.8 15.3 ---- ---- ----- ---- Total revenues............................ 100% 100% 100% 100% Cost of revenues: Product........................................... 12.2 13.6 13.8 14.8 Services & support................................ 4.9 4.8 6.0 4.4 ---- ---- ----- ---- Total cost of revenues.................... 17.1 18.4 19.8 19.2 Operating Expenses: Research and development.......................... 19.9 13.6 23.6 14.2 Marketing and sales............................... 45.6 27.3 58.7 29.3 General and administrative........................ 12.4 6.6 21.5 9.1 Stock compensation charge......................... 3.4 -- 3.2 -- Amortization of intangibles....................... 7.4 4.6 9.3 3.9 Acquisition and other related costs............... (5.3) 26.1 (4.0) 18.9 ---- ---- ----- ---- Total operating expenses.................. 83.3 78.2 112.3 75.4 ---- ---- ----- ---- Income (loss) from operations..................... (0.4) 3.4 (32.1) 5.4 Interest and other income and expense, net........ 1.0 1.7 1.1 2.0 ---- ---- ----- ---- Income (loss) before provision for income taxes... 0.6 5.1 (30.9) 7.4 Provision for income taxes.......................... 0.7 11.1 5.5 10.2 ---- ---- ----- ---- Net loss.......................................... (0.1)% (6.0)% (36.5)% (2.8)% ==== ==== ===== ====
Net revenues. Net revenues includes product revenues, revenues from software support, maintenance contracts, education and consulting services as well as revenues from those customer support and maintenance contracts that are deferred and recognized over the related service period. Net revenues was $195.2 million in the three months ended September 30, 1999, a decrease of 19.5% from $242.4 million in the three months ended September 30, 1998. For the nine-month period ended September 30, 1999, net revenues decreased 35.1% to $465.6 million from $717.9 million in the same period in 1998. This decrease relates to our decision to limit distributor orders in an effort to realign channel inventory levels as a result of Year 2000 concerns and increasing sales cycles for our products. International revenue accounted for approximately 35% and 34% of net revenues for the three months ended September 30, 1999 and 1998, respectively. For the nine-month periods ended September 30, 1999 and 1998, international revenue was approximately 40% and 36%, respectively. The increase in international net revenues as a percentage of net revenues was due primarily to increased acceptance of our products in international markets and a decrease in revenue to our distributors, especially in the United States. We expect that international revenue will continue to account for a significant percentage of net revenues.* We also expect that a significant portion of our international revenue will be denominated in local currencies.* To reduce the impact of foreign currency fluctuations we engage in financial risk management activities. However, future results of income may be adversely affected by currency fluctuations or by costs associated - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that our actual performance will meet our current expectations. See the Risk Factors on page 24 for a discussion of certain factors that could affect future performance. 16 17 with currency risk management strategies. Other risks inherent in international revenue generally include the impact of longer payment cycles, greater difficulty in accounts receivable collection, unexpected changes in regulatory requirements, seasonality due to the slowdown in European business activity during the third quarter, tariffs and other trade barriers, uncertainties relative to regional economic circumstances, political instability in emerging markets and difficulties in staffing and managing foreign operations. There can be no assurance that these factors will not have a material adverse affect on our future international revenue. In addition, there can be no assurance that the macroeconomic issues currently being experienced in Asia will not spread to Europe, the U.S. or Latin America, and/or have a material adverse impact on our revenue or revenue growth in the future. Further, in countries with a high incidence of software piracy, we may experience a higher rate of piracy of our products.* There are a number of additional risks related to the export outside of the United States of our encryption and security products. Cost of 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 $33.3 million in the three months ended September 30, 1999, a decrease of 25.2% from $44.6 million in the three months ended September 30, 1998. Cost of revenue was $92.1 million in the nine months ended September 30, 1999, a decrease of 33.1% from $137.7 million in the nine months ended September 30, 1998. Our cost of revenue decreased, in absolute dollars, primarily as a result of our decrease in revenue. We expect cost of revenue in absolute dollar terms to increase slightly in Q4 1999, but may fluctuate as a percentage of net revenues.* Research and Development. Research and development expenses consist primarily of salary and benefits for our development and technical support staff. Research and development expenses were $38.9 million in the three months ended September 30, 1999, an increase of 17.7% from $33.1 million in the three months ended September 30, 1998. Research and development expenses were $109.8 million in the nine months ended September 30, 1999, an increase of 7.5% from $102.2 million in the nine months ended September 30, 1998. As a percentage of net revenue, research and development expenses were 19.9% and 13.6% in the three-month periods ended September 30, 1999 and September 30, 1998, respectively. The increase in actual spending was a result of increased staffing and equipment expense to support growth in our product and service offerings. We anticipate that research and development expenses will increase slightly in absolute dollars in Q4 1999, but may fluctuate as a percentage of net revenues.* We believe that our ability to maintain our competitiveness will depend in large part upon our ability to enhance existing products and develop new products and develop and integrate acquired products. The market for computer software is characterized by low barriers to entry and rapid technological change, and is highly competitive with respect to timely product introductions. The timing and amount of research and development expenses may vary significantly based upon the number of new products and significant upgrades under development during a given period.* Marketing and Sales. Marketing and sales expenses consist primarily of salary, commissions and benefits for marketing, sales and customer support personnel and costs associated with advertising and promotions. Marketing and sales expenses were $88.9 million in the three months ended September 30, 1999, an increase of 34.7% from $66.0 million in the three months ended September 30, 1998. Marketing and sales expenses were $273.3 million in the nine months ended September 30, 1999, an increase of 30.0% from $210.2 million in the nine months ended September 30, 1998. As a percentage of net revenues, marketing and sales expense was 45.6% and 27.3% in the three-month periods ended September 30, 1999 and 1998, - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that our actual performance will meet our current expectations. See the Risk Factors on page 24 for a discussion of certain factors that could affect future performance. 17 18 respectively. As a percentage of net revenues, marketing and sales expense was 58.7% and 29.3% in the nine-month periods ended September 30, 1999 and 1998, respectively. The increase was primarily due to continued investment in the marketing of our products and services, hiring and training of our enterprise level sales force, and advertising and promotions for the McAfee.com business segment. We expect sales and marketing to increase in Q4 1999, particularly as McAfee.com continues with its efforts to build brand recognition and its development of strategic relationships with a variety of Internet companies, and will fluctuate as a percentage of net revenues.* 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 $24.2 million in the three months ended September 30, 1999, an increase of 51.2% from $16.0 million in the three months ended September 30, 1998. General and administrative costs were $100.2 million in the nine months ended September 30, 1999, an increase of 53.7% from $65.2 million in the nine months ended September 30, 1998. As a percentage of net revenues, general and administrative expenses were 12.4% and 6.6% in the three months periods ended September 30, 1999 and 1998. As a percentage of net revenues, general and administrative expenses were 21.5% and 9.1% in the nine months periods ended September 30, 1999 and 1998, respectively. The increase was due to a $31.8 million charge to cover doubtful accounts for the nine months ended September 30, 1999. Excluding this charge, general and administrative expenses were $68.4 million in the nine months ended September 30, 1999, which increased slightly from the nine months ended September 30, 1998. This increase was largely due to the development of our E-commerce business systems, expansion of our IT infrastructure and the implementation of our new SAP Human Resources module. We expect general and administrative expenses to remain relatively flat in Q4 1999, but they may fluctuate as a percentage of net revenues.* Amortization of Intangibles and Stock Compensation Charges. We expensed $21.0 million and $11.2 million of amortization related to intangibles and stock compensation charges in the three months ended September 30, 1999 and 1998, respectively. We expensed $58.2 million and $27.9 million of amortization related to intangibles and stock compensation charges in the nine months ended September 30, 1999 and 1998, respectively. Intangibles consist of purchased goodwill and certain technology acquired through acquisitions. Stock compensation charges relate to the repricing of employee stock options and the issuance of McAfee.com stock options to our executives. We do not expect to incur charges related these McAfee.com option grants in future periods. The increase in amortization related to intangibles is due to the acquisitions of Magic Solutions, Inc. ("Magic Solutions"), CyberMedia and 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, we incurred direct transaction costs and other restructuring and related charges in the amount of $85.8 million in the year ended December 31, 1998. In connection with the acquisitions accounted for as purchase transactions, we incurred charges of $49.8 million in the year ended December 31, 1998, consisting principally of the write-off of acquired in-process research & development. - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that our actual performance will meet our current expectations. See the Risk Factors on page 24 for a discussion of certain factors that could affect future performance. 18 19 The following table summarizes the activity during the nine months ended September 30, 1999, in the reserves for acquisition and other costs established in the second and third quarters of 1998 (in thousands):
DIRECT ASSET TRANSACTION SEVERANCE LEASE WRITE COSTS & BENEFITS COSTS DOWNS OTHER TOTAL ----------- ---------- ------- ------- ------- -------- Balance, December 31, 1998........... $ 9,900 $ 8,338 $ 5,508 $ 1,405 $ 2,144 $ 27,295 Paid Out or Charged against the related assets....................... (5,712) (1,549) (804) (140) (104) (8,309) Adjustment to liability.............. (4,188) (6,789) (4,704) (1,265) (2,040) (18,986) ------- ------- ------- ------- ------- -------- Balance, September 30, 1999.......... $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 ======= ======= ======= ======= ======= ========
For the nine months ended September 30, 1999, activity with respect to these reserves consisted principally of the payment of accrued direct transaction costs and severance benefits, and adjustments to remaining accruals. All expenditures related to these accruals have been completed and the excess reserves were credited to Acquisition and related charges. The following table summarizes the activity during the nine months ended September 30, 1999, in the reserves for acquisition and other costs established in the year ended December 31, 1997 (in thousands):
DIRECT ASSET TRANSACTION SEVERANCE LEASE WRITE COSTS & BENEFITS COSTS DOWNS OTHER TOTAL ----------- ---------- ---------- ------- ------- -------- Balance, December 31, 1998........... $ (36) $ 539 $ (422) $ 484 $ 374 $ 939 Paid Out or Charged against the related assets....................... (193) (58) (942) 0 0 (1,193) Adjustment to liability.............. 229 (481) 1,364 (484) (374) 254 ------- ------- ------- ------- ------- -------- Balance, September 30, 1999.......... $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 ======= ======= ======= ======= ======= ========
For the nine months ended September 30, 1999, activity with respect to these reserves consisted principally of expenditures related to accrued lease termination costs and adjustments to remaining accruals. All expenditures related to these accruals have been completed and the excess reserves were credited to Acquisition and related charges. Interest and Other Income and Expense, Net. Interest and other income and expense, net, decreased to $1.9 million in the three months ended September 30, 1999 from $4.1 million in the three months ended September 30, 1998. Interest and other income and expense, net, decreased to $5.4 million in the nine months ended September 30, 1999 from $13.9 million in the nine months ended September 30, 1998. The decrease was primarily due to the increase of interest expense related to the Zero Coupon Convertible Subordinated Debentures (the "Debentures"), issued in February 1998, and a decrease in interest income. Interest income decreased due to reduced cash balances resulting from the acquisitions of Magic and CyberMedia and cash used to fund operating activities during the nine months ended September 30, 1999. Provision for Income Taxes. Our provision for income taxes of $1.3 million for the three-month period ended September 30, 1999 and $25.8 million for the nine-month period ended September 30, 1999 primarily relates to income taxes currently payable in foreign jurisdictions. Liquidity and Capital Resources At September 30, 1999, we had $249.4 million in cash and cash equivalents and $402.5 million in marketable securities, for a combined total of $651.9 million. Net cash used in operating activities was $93.6 million in the nine months ended September 30, 1999 and net cash provided by the operating activities for nine months ended September 30, 1998 was $35.5 million. Net cash used in operating activities in the nine months ended September 30, 1999, consisted primarily of net loss before depreciation and amortization, plus a decrease in accounts payable and accrued liabilities and deferred revenue, and an increase in deferred taxes, which were partially offset by a decrease in accounts 19 20 receivable and prepaid and other assets. In the nine months ended September 30, 1998, net cash provided by operating activities consisted primarily of net income before depreciation and amortization and acquired in process research and development, 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. Our accounts receivable balance as a percentage of sales may increase due to our increased emphasis on server/enterprise based sales; a higher percentage of indirect sales through our channel partners and expanding international sales, both of which typically have longer payment terms. With an increase in business through indirect channels, our receivable collection experience has become more dependent on the longer payment cycle for VARs, distributors and system integrators. To address this increase in accounts receivable and to improve cash flow, we may from time to time take actions to encourage earlier payment of receivables and sell receivables. To the extent that our receivable balance increases, we will be subject to greater general credit risks with respect thereto. Net cash used in investing activities was $98.8 million in the nine months ended September 30, 1999 consisting primarily of the purchase of marketable securities and additions to fixed assets. 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 acquisitions of Magic Solutions and CyberMedia. Net cash provided by financing activities was $22.9 million in the nine months ended September 30, 1999, consisting primarily of the proceeds associated with the exercise of non qualified stock options and sale of put options, which was partially offset by the effect of exchange rate fluctuations. 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. We believe that our available cash and anticipated cash flow from operations will be sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months.* EURO On January 1, 1999, the "euro" was introduced. On that day, the exchange ratios of the currencies of the eleven countries participating in the first phase of the European Economic and Monetary Union were fixed. The euro became a currency in its own right and the currencies of the participating countries, while continuing to exist for a three-year transition period, are now fixed denominations of the euro. The introduction of the euro will have significant effects on the foreign exchange markets and bond markets and is requiring significant changes in the operations and systems within the European banking industry. Our information system is designed to accommodate multi-currency environments. As a result we have the flexibility to transact business with vendors and customers in either euro or traditional national currency units. Financial Risk Management As a result of the continued expansion of our business in Europe, we expect to see an increase over time in exposures related to nonfunctional currency denominated sales in several European currencies.* Currently, we hedge only those currency exposures associated with certain assets and liabilities denominated in nonfunctional currencies and we do not generally hedge anticipated foreign currency cash flows. The hedging activity we have undertaken is intended to offset the impact of currency fluctuations on certain non-functional currency assets and liabilities. The success of this activity depends upon forecasts of transaction activity denominated in various currencies, primarily the US dollar, British pound, Canadian dollar, Australian dollar - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that our actual performance will meet our current expectations. See the Risk Factors on page 24 for a discussion of certain factors that could affect future performance. 20 21 and New Zealand dollar. To the extent that these forecasts are over or understated during periods of currency volatility, we could experience unanticipated currency gains or losses.* Year 2000 YEAR 2000 ISSUE DESCRIBED Many currently installed computer systems and software products are coded to accept, store, or report only two digit entries in date code fields. Beginning in the Year 2000, these date code fields will need to be enabled to distinguish 21st century dates from 20th century dates. This is the "Year 2000 issue." As a result, computer systems and/or software used by many companies, including us, our vendors and our customers, will need to be upgraded to comply with these Year 2000 requirements. We could be impacted by Year 2000 issues occurring in our own infrastructure or the infrastructure of our major distributors, suppliers, customers, vendors and financial service organizations. These Year 2000 issues could include information errors and significant information system failures. Any disruption in our operations as a result of Year 2000 issues could have a material adverse effect on our business, results of operations and financial conditions. OUR STATE OF READINESS Overview. To address Year 2000 readiness, we have implemented a corporate program to coordinate efforts across all business functions and geographic areas, including addressing risks associated with business partners and other third-party relationships. Our internal Year 2000 readiness program is divided into four program areas: Commercial Product Compliance; Internal Systems and Technology Compliance; Supplier and Business Partner Compliance; and Facilities and Safety Compliance. For each of these areas, we are using a four-step approach that includes: Awareness (ownership and task assignment); Inventory (listing of all items to be assessed); Assessment (prioritizing inventoried items, assessing compliance, planning corrective actions, making initial contingency plans); and Corrective Action (implementing corrective actions, verifying implementation, and finalizing contingent plans). We have formed a Year 2000 Steering Team to coordinate this corporate program. We have substantially completed the assessment phase and corrective actions for all areas as of September 30, 1999.* There can be no assurance that we will be able to complete all four phases in a timely manner, if at all, or that the process will adequately address the Year 2000 Issue. Commercial Product Compliance. Our currently licensed products are designed to be Year 2000 compliant. Year 2000 compliant means that our products will continue to operate substantially in accordance with published documentation on and after January 1, 2000. We use the British Standards Institute's DISC PD-2000 as our standard for assessing Year 2000 compliance. We have evaluated and tested all our products for Year 2000 Compliance and believe that all our products released since November 1998 or currently under development are Year 2000 compliant. For non-compliant products introduced prior to November 1998, we have identified and provided customer's migration paths in the form of update and upgrade options. To date, the number of these products and the related cost associated with our product compliance program have not been significant. Internal Systems and Technology Compliance. Core IT Systems. We have implemented the R/3 system from SAP. The R/3 system from SAP is a version of the industry standard SAP enterprise resource planning system that we have implemented to more fully automate our business processes and it is certified by SAP as Year 2000 compliant. The implementation was completed in late 1997 and early 1998 and included most of the major functional areas of our business. A major upgrade of the R/3 installation was completed in 1999. Our core web IT infrastructure, which is maintained by McAfee.com, is substantially Microsoft-based and we have received certificates of Year 2000 compliance from Microsoft. We have also obtained compliance certificates from all other significant third - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that our actual performance will meet our current expectations. See the Risk Factors on page 24 for a discussion of certain factors that could affect future performance. 21 22 party software vendors. Our hardware infrastructure is based on Compaq, Cisco and HP systems that are less than two years old and which have also been certified to be Year 2000 compliant. Other Information Technology Systems. Our other information technology systems include telephone switches and equipment and software; network, desktop and server hardware and related operating systems and applications software and electronic data interchange systems. We have substantially completed our assessment of these systems and have replaced, upgraded, or planned to replace or upgrade, those systems that were not Year 2000 compliant. The most significant non-compliant system was in human resources. We have undertaken to implement SAP's Human Resources module across all regions of the company to ensure compliance. All other system compliance projects were substantially completed as of September 30, 1999. Testing and minor compliance will continue into the fourth quarter of 1999.* Facilities and Safety Compliance. Our facilities and safety technology systems include building systems such as heating, cooling, and air purification, fire and sprinkler systems, security systems and elevators. Our commitment is to minimize the business risks attributable to Year 2000 problems in these systems. We have actively worked with each facilities and safety systems vendor to identify and resolve any Year 2000 compliance issues and contingency plans have been formulated for all critical sites, regardless of whether they have been shown to be compliant or not. Included in these contingency plans are backup web sites as well as backup organizations, such as call centers. We have substantially completed the repair or replacement of non-compliant items that affect our product development, distribution and support operations. All landlords and facility and safety system providers were included in the Year 2000 compliance assessment. Supplier and Business Partner Compliance. Our suppliers and business partners include the sources of the equipment and supplies we use in the conduct of our business, as well as our financial institutions, and other service providers. The following steps were taken to determine their Year 2000 compliance: - we began our vendor, facilities and business partners' Year 2000 validation program in 1998. - All were assessed to determine their criticality level relating to our ongoing business. Each vendor was classified as critical, medium or low importance. - All of these organizations received and were asked to complete a Year 2000 readiness questionnaire. Approximately 60% responded in writing, including over 90% of critical vendors. - All of our critical vendors, or medium importance vendors of highest priority, regardless of their answers to the questionnaire, were the subjects of in-depth audits to determine in detail their ability to support us and our business needs without date-related interruptions. Every vendor that showed significant flaws or shortcomings in Year 2000 preparedness became the subject of an intensive set of meetings and tests to ensure each of these organizations brought their programs up to satisfactory standards. The few organizations that would or could not do so were replaced with compliant alternate vendors. We have now rated our critical vendors as Year 2000 compliant. - All compliance information from these organizations is in writing and on file at our Year 2000 office. - Contingency plans have been developed to ensure business operations can continue and customer support will be available throughout the Year 2000 rollover period. The Cost to Address Our Year 2000 Issues Historic or period costs incurred in connection with the resolution of Year 2000 Issues to date have consisted principally of internal labor costs of compliance planning and assessment and have not been significant. During 1999, we expect to incur an estimated $4.5 million of compliance related expenditures, of which approximately $4.0 million has been incurred as of September 30, 1999.* These expenditures relate primarily to the replacement of certain internal systems hardware and software, the most significant being new - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that our actual performance will meet our current expectations. See the Risk Factors on page 24 for a discussion of certain factors that could affect future performance. 22 23 human resource systems. We do not expect expenditures related to Year 2000 compliance in future years to be significant.* OUR CONTINGENCY PLANS As part of the four-step process outlined above, specific contingency plans have been developed in connection with the assessment and resolution of the risks identified. We are continuing to refine contingency plans for each specific area of risk associated with the Year 2000 Issue. Staffing models have been developed and personnel have been identified for on-site and on-call support. In addition, we have a comprehensive plan to test and ensure each key office is ready for business in the New Year and after the Leap Year rollover. THE RISKS OF OUR YEAR 2000 ISSUES Our expectations as to our efforts to ensure and achieve Year 2000 compliance are forward-looking statements. Actual results may vary materially as a result of a number of risks and uncertainties, including the following: - We may not successfully complete our Year 2000 contingency program. - We may be unable to successfully and timely modify non-Year 2000 compliant products, services and systems. - Our contingency plans may not address all Year 2000 risks that may actually arise. - Our contingency plans will only be effective if timely and properly implemented. - We do not have, and do not anticipate obtaining, any insurance policy providing material coverage for potential injuries or damages related to or caused by the Year 2000 Issue. - Actual costs of our Year 2000 compliance efforts may exceed our estimates. We have initiated communications with third party suppliers of the major computers, software, and other equipment used, operated, or maintained by us to identify and, to the extent possible, to resolve issues involving the Year 2000 problem. However, we have limited or no control over the actions of these third party suppliers. These suppliers may fail to resolve any or all Year 2000 problems with their respective systems before the occurrence of a material disruption to our business or any of their other customer's business. Any of the above risks could have a material adverse effect on our business, results of operations and financial condition. Like a number of other enterprise-wide software providers, we have recently identified and expect a continued slowing or reduction in customer capital spending as a result of the Year 2000 Issue. If the purchasing patterns of our current or potential customers, particularly those to whom we market broader enterprise solutions, are meaningfully impacted by Year 2000 concerns, we could experience a significant reduction in our net revenues, net income and related growth. Lastly, it has been widely predicted that a significant amount of litigation surrounding business interruptions will arise out of Year 2000 issues. It is uncertain whether, or to what extent, we may be affected by such litigation. Because our products are able to operate in the Year 2000 and beyond, we do not anticipate exposure to material product defect or similar litigation. Any such litigation, however, could have a material adverse effect on our business, results of operations and financial condition. We also may not receive any assistance, damages or other relief as a result of our initiation of any litigation related to the Year 2000 issue. Our inability to implement our Year 2000 plans or to otherwise address Year 2000 issues in a timely manner could have a material adverse effect on our business, results of operations and financial condition. - --------------- * This statement is a forward-looking statement reflecting current expectations. There can be no assurance that our actual performance will meet our current expectations. See the Risk Factors on page 24 for a discussion of certain factors that could affect future performance. 23 24 RISK FACTORS Investing in our common stock involves a high degree of risk. Any of the following risks could materially adversely affect our business, operating results and financial condition and could result in a complete loss of your investment. OUR QUARTERLY FINANCIAL RESULTS WILL LIKELY FLUCTUATE Our quarterly operating results have varied greatly in the past and will likely vary greatly in the future depending upon a number of factors. Many of these factors are beyond our control. Our revenues, gross margins and operating results may fluctuate significantly from quarter to quarter due to, among other things: - volume, size and timing of new licenses and renewals of existing licenses; - our distributor inventory levels and product return rates; - our inventory levels; - introduction of new products, product upgrades or updates by us or our competitors; - the mix of products we sell; - the success of our Net Tools product suite and related pricing model; - our continued evolution as an enterprise-wide software provider and the related impact on the length of our sales cycle; - the size and timing of our non-cash stock-based charges; - changes in product prices by us or our competitors; - trends in the computer industry; - delays or reductions in customer software purchases related to their Year 2000 compliance issues; - costs related to acquisitions of technology or businesses; - fluctuations in McAfee.com's expenditure levels related to its efforts to build brand awareness, and establish strategic relationships with various Internet companies; - our investment experience related to our strategic minority equity investments; - our investment in expanding our European Sniffer organization may not pay off; - the effectiveness of our channel strategy and our mix of direct and indirect revenues; - pressure on employee wages as competition for skilled employee's increases; and - costs related to extraordinary events including litigation and acquisitions. Our business is impacted by the seasonal trends and global or regional macroeconomic trends. For example, our net revenues is typically higher in the fourth quarter, as many customers complete annual budgetary cycles, and lower in the summer months when many businesses experience lower sales, particularly in the European market. Our business in Japan, Asia generally and Latin America has been adversely impacted by the adverse economic conditions there. If these conditions were to spread to Europe or the U.S., our business, results of operations and financial condition would be adversely impacted. IN THE NEAR-TERM, WE EXPECT LIMITED GROWTH IN NET INCOME AND NET REVENUES We have historically experienced significant growth in net income (before acquisition and related costs) and net revenues. However, our rate of growth has slowed due to increased price competition, a maturing anti-virus market and an increasingly higher base from which to grow and changes in customer purchasing patterns related to Year 2000 concerns. Like a number of other enterprise-wide software providers, we have recently identified and expect a continued slowing or reduction in customer capital spending related to Year 2000 24 25 compliance issues. Also, our strategy of up-selling existing licenses to higher level product suites and the increasing complexity of our products has resulted in longer sales cycles for our products. These factors have caused us to realign our channel inventory levels, which has caused our revenues to decrease. We could continue to experience pressure on our net revenues, net income and related growth as the purchasing patterns of our current or potential customers, particularly those to whom we market broader enterprise solutions, are meaningfully impacted by Year 2000 concerns. Our growth rate and net revenues also depend significantly on renewals of existing orders. If our renewal or up-sale rates slow or decline, our net revenues and operating results would be adversely affected. THE TIMING AND AMOUNT OF OUR REVENUES ARE SUBJECT TO A NUMBER OF FACTORS THAT MAKE IT DIFFICULT TO ESTIMATE OPERATING RESULTS PRIOR TO THE END OF A QUARTER We do not expect to maintain a significant level of backlog. As a result, product revenues in any quarter are dependent on contracts entered into or orders booked and shipped in that quarter. We have generally experienced a trend toward higher order receipt, and therefore a higher percentage of revenue shipments, toward the end of the last month of a quarter. This trend makes predicting revenues more difficult. The timing of closing larger orders increases the risk of quarter-to-quarter fluctuation. As we have evolved as an enterprise-wide software provider and continued with our efforts to license larger product suites under the Net Tools umbrella, the size of our orders and the length of our sales cycle have increased and may increase further. If orders forecasted for a specific customer for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, our operating results for that quarter could be materially adversely affected. OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE During the first nine months of 1999, our stock price ranged from a per-share high of $67.50 to a low of $10.06. Announcements, litigation developments, and our ability to meet the expectations of brokerage firms, industry analysts or investors with respect to our operating and financial results may contribute to this volatility. We may not discover, or be able to confirm, revenue or earnings shortfalls until the end of a quarter, which could result in an immediate drop in our stock price. In addition, similar events with respect to McAfee.com and fluctuations in its stock price may also contribute to the volatility of our stock price. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against companies with public traded securities. A number of putative class actions were brought against us, our officers and our directors. See "Note 8 of the Notes to Condensed Consolidated Financial Statements." This litigation, and any other litigation if instituted, could result in substantial costs and a diversion of management's attention and resources. COMPETITORS MAY INCLUDE PRODUCTS SIMILAR TO OURS IN THEIR HARDWARE OR SOFTWARE AND RENDER OUR PRODUCTS OBSOLETE Vendors of hardware and of operating system software or other software (such as firewall or e-mail software) may enhance their products or bundle separate products to include network security and management software similar to our products. For example, Cisco incorporated a firewall in its hardware products and Microsoft Corporation introduced limited anti-virus functionality into versions of MS-DOS in 1993. The widespread inclusion of products that perform the same or similar function as our products within computer hardware or other software could render our products obsolete and unmarketable. Furthermore, even if these incorporated products are inferior or more limited than our products, customers may elect to accept the incorporated products rather than purchase our products. If we are unable to develop new network security and management products to further enhance operating systems or other software and to successfully replace any obsolete products, our business could suffer. WE EXPECT SIGNIFICANT STOCK BASED COMPENSATION CHARGES In light of the recent decline in our stock price and in an effort to retain our employee base, in April 1999, we offered to reprice options held by all employees, other than directors and executive officers. In exchange for 25 26 their agreeing to not exercise any of the repriced options for a period of twelve months, the exercise price of all eligible employee options with an exercise price in excess of $11.0625 was reduced to $11.0625, the closing market price on the NASDAQ on April 22, 1999. Option holders electing to have their options repriced were required to acknowledge their acceptance by April 28, 1999. As a result of the increase in price between the date on which the options were repriced, April 22, 1999, and the date on which the employees elected to reprice their option grants, April 28, 1999, we have and will continue to incur a stock-based compensation charge. The total compensation charge expensed for the three and nine months ended September 30, 1999 was approximately $1.6 million and $8.2 million, respectively, and approximately $14.5 million will be expensed over the remaining vesting period of the repriced options. On March 31, 1999, the FASB issued an exposure draft of its Proposed Interpretation, "Accounting for Certain Transactions involving Stock Compensation -- an interpretation of APB Opinion No. 25" (the "Proposed Interpretation"). Under the Proposed Interpretation, stock options repriced after December 15, 1998 will be subject to variable plan accounting treatment. If adopted, this proposed guidance will require us to remeasure compensation cost for outstanding repriced options each reporting period based on changes in the market value of the underlying common stock after the date of adoption. The FASB currently expects to approve the interpretation in the fourth quarter of 1999. Depending upon movements in the market value of our common stock, this accounting treatment may result in significant additional compensation charges in future periods. In the first and third quarters of 1999, McAfee.com, our subsidiary, granted options to individuals, including Network Associates executive officers and non-executive employees, who are not employed by McAfee.com. The total compensation charge expensed for the three and nine months ended September 30, 1999 was approximately $5.0 million and $6.6 million, respectively. As these options are all fully vested, we do not expect to incur, on a consolidated basis, additional future charges related to these option grants. See "Management's Discussion and Analysis of Operating Results and Financial Condition." WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE TRANSACTIONS The software industry has experienced, and is expected to continue to experience, a significant amount of consolidation. As part of our growth strategy, we may buy or make investments in, complementary companies, products and technologies. Since 1994 we have completed a large number of significant acquisitions involving both public and private companies, including: - CyberMedia in September 1998; - Dr Solomon's in August 1998; - Magic Solutions and TIS in April 1998; - Network General, PGP and Helix Software in December 1997; - Cinco Networks in August 1997 (acquired by Network General); - Vycor Corporation in February 1996; and - Saber Software in August 1995; We have also completed a number of smaller acquisitions and acquired a number of our international distributors. Recently, we began making strategic minority investments in complementary Internet related companies. As of September 30, 1999, these minority investments totaled $28.5 million. We are currently investigating acquisitions of additional foreign distributors and other strategic minority investments. Our acquisitions and strategic investments involve a number of risks and we may not realize the expected benefits of these transactions. We may lose all or a portion of our investment, particularly in the case of our strategic minority investments. The integration of transactions involves a complex, time consuming and expensive process. Prior to any acquisition, each company has its own business, culture, clients, employees and systems. Following any 26 27 acquisition, we must operate as a combined organization utilizing common information communication systems, operating procedures, financial controls and human resource practices. In order to successfully integrate acquired companies, we must, among other things, successfully: - attract and retain key management and other personnel; - integrate, both from an engineering and a sales and marketing perspective, the acquired products into our suite of product offerings; - coordinate research and development efforts; - integrate sales forces; and - consolidate duplicate facilities. The difficulties of integrating an acquired company may be worsened by the geographic distance between the companies, the complexity of the technologies and operations being integrated, and the disparate corporate cultures being combined. Successful acquisitions may be more difficult to accomplish in the high technology industry than in other industries, and will require the dedication of our management resources. Management's focus on the integration of operations may distract attention from our day-to-day business, and may disrupt key research and development, marketing or sales efforts. In addition, it is common in the technology industry for aggressive competitors to attract customers and recruit key employees away from companies during the integration phase of an acquisition. If we cannot successfully integrate any acquisition, our business could suffer. In 1997 and 1998, we incurred significant nonrecurring charges associated with our previous acquisitions. Our available cash and our securities may be used to buy or invest in companies or products, which could result in significant acquisition-related charges to earnings and dilution to our stockholders. Moreover, if we buy a company, we may have to incur or assume that company's liabilities, including liabilities that are unknown at the time of acquisition, which may result in a material adverse effect on us. WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT In connection with our previous acquisitions accounted for under the purchase method of accounting, in future periods we will experience significant charges related to the amortization of purchased technology and goodwill. In addition, if we later determine that this purchased technology and goodwill is impaired, we will be required to take a related non-recurring charge to earnings. WE FACE RISKS RELATED TO OUR NET TOOLS MEGA-SUITE BUSINESS STRATEGY Historically, a majority of our revenues resulted from the licensing of our flagship anti-virus products and Sniffer products. Over the last year we have been focusing our efforts on broadening our revenue base by providing network security and management solutions to enterprise customers, targeting in particular the Windows NT/Intel platform. To this end, we organized our products into four product suites -- McAfee Total Virus Defense, PGP Total Active Security, Sniffer Total Network Visibility and McAfee Total Service Desk -- which form our integrated "Net Tools" mega-suite solution. The Net Tools product suite model involves a modified product pricing structure. Potential customers may not respond favorably to this modified pricing structure and the lack of a favorable response could materially adversely affect our operating results. In addition, as part of the Net Tools concept, we are 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. We face significant engineering challenges related to these efforts. Success of our Net Tools suite strategy will also depend, in part, on the following factors: - successful development and coordination of our enterprise sales force; - successful development of a national accounts sales force; and - the development and expansion of an effective professional services organization. 27 28 WE FACE RISKS RELATED TO OUR SNIFFER PRODUCT STRATEGY Although we will continue to offer perpetual licenses with annual support and maintenance contracts for our Sniffer products, we have recently developed a subscription-licensing model for these products. We are also seeking to increase our total Sniffer unit sales through recently developed software-only versions of some of our Sniffer products, which we would mean that we would no longer sell the hardware components contained in those products. However, there is a risk that customers will continue to require that we provide the hardware platform and components currently contained in our Sniffer products. Despite our efforts, total unit license of Sniffer products may not increase and customers may not accept the subscription-pricing model for Sniffer products. To the extent that customers do license Sniffer products on a two-year subscription basis or license significant amounts of software-only Sniffer products, our operating results and financial condition would be likely be affected in the following ways: - in the case of subscription licenses, we would expect an increase in deferred revenues related to the service portion of the two-year Sniffer license that would be capitalized on our balance sheet; - in the initial year of the subscription license, the corresponding revenue would be lower than if the license were perpetual; and - in the case of the software-only Sniffer product license, we would expect lower total revenues and a higher overall gross margin related to that license, as we would not be selling the corresponding hardware component (currently the hardware component generates a lower gross margin than the total product gross margin). We recently began investing significant resources to increase the European Sniffer sales organization in an effort to increase brand awareness in Europe. There is no guarantee that this investment will produce the desired results. WE FACE RISKS RELATED TO OUR MCAFEE.COM STRATEGY In December 1998, we incorporated McAfee.com, our wholly owned subsidiary, as our Internet destination dedicated to updating, upgrading and managing personal computers, or PCs, over the Internet for single use retail, non-corporate, consumers. Effective January 1, 1999, we contributed certain assets and liabilities to McAfee.com and in connection therewith have entered into various inter-company arrangements including technology, licenses, shared facilities, functions, services and tax sharing agreements. In September 1999, McAfee.com filed a registration statement with the Securities and Exchange Commission in connection with its proposed initial public offering of 6.25 million shares of its Class A common stock, which is entitled to one vote per share. We currently own all 36.0 million shares of McAfee.com's Class B common stock, which is generally entitled to three votes per share and converts to shares of McAfee.com Class A common stock if sold by us to a third party. The offering is expected to close, if at all, in the fourth quarter of 1999. Assuming no exercise of the underwriter's over-allotment option, upon completion of the offering we will own approximately 85% of McAfee.com's outstanding capital stock and approximately 95% of its total voting power. Pursuant to our cross license agreement with McAfee.com, we have licensed all our technology to McAfee.com for use in the markets specified below and McAfee.com has licensed its technology to us for our use outside of McAfee.com's markets. Under our license and other agreements with McAfee.com, among other things: - McAfee.com has the exclusive right to use the licensed technology for providing single-user consumer licenses for our products and services sold over the Internet or for Internet-based products and licensing the technology to original equipment manufacturers for sale to individual consumers; - we are permitted to continue to sell our consumer products through non-online channels, such as traditional retail stores, however McAfee.com's sales of online products and services could significantly reduce sales of these products; - we may not offer a product incorporating third party technology if those products are competitive with products offered by McAfee.com; 28 29 - McAfee.com is required to pay us a license fee of 20% of net revenue derived from product sales that include the licensed technology commencing on January 1, 1999 and declining 1.625% per quarter until the rate is 7% in the quarter beginning January 1, 2001; - the license agreement is perpetual and may only be terminated by us if McAfee.com fails to cure a material breach of the license within 30 days after we notify it of the breach, subject to mandatory dispute resolution prior to the effectiveness of any proposed termination; - we are required to indemnify McAfee.com with respect to existing litigation related to the licensed technology to which we are a party, including the litigation described in Note 8 of the Notes to the Consolidated Financial Statements; - McAfee.com has agreed to provide the infrastructure and technical support for our web site; - generally, we are required to cause to be elected at least two independent directors to the McAfee.com board of directors, which term would exclude any serving Network Associates officer or director; and - if, without the prior approval of our continuing directors (being our current directors and directors approved or not objected to by our current directors), someone acquires 15% or more of our outstanding capital stock or our continuing directors cease to constitute a majority of our board (1) we are required to vote our shares of McAfee.com common stock and otherwise seek to cause to the McAfee.com board of directors to consist of at least a majority of independent directors and (2) our shares of McAfee.com Class B common stock will be entitled to only one vote per share instead of three. In addition to selling traditional software licenses and related maintenance for our consumer products over the Internet, McAfee.com has developed an application service provider, or ASP, model providing consumers with online access to PC security and management products and services hosted on McAfee.com's servers. This web-based model is a relatively new concept, and to build awareness and demand for subscription products and services, McAfee.com initially offered its hosted product, McAfee Clinic, for free. On September 2, 1999 McAfee.com began charging a subscription fee for McAfee Clinic. In July 1999, we began a national marketing campaign to build brand awareness for the McAfee.com web site and McAfee.com products. We expect that the McAfee.com business will incur significant losses for the foreseeable future. These losses will be funded by us and will impact our consolidated financial results. The growth and market acceptance of McAfee.com's online PC security and management products and services is highly uncertain and subject to a number of factors, including: - potential unwillingness of consumers to pay for McAfee.com's subscription based products and services and its ability to properly price its products and services to generate the greatest revenue opportunities; - consumer reluctance to change their software purchasing behavior in favor of services hosted on the McAfee.com's servers; and - consumer concerns about whether the Internet is fast and reliable enough to deliver critical PC security and management functions effectively. McAfee.com's services are designed to protect consumer privacy by ensuring that all PC scans are done locally at the PC, all information about the user's PC is transmitted to it anonymously and no scanned data is stored by it. However, consumers' misconceptions about this process could prevent McAfee.com's ASP model from achieving market acceptance. WE FACE RISKS RELATED TO OUR STRATEGY OF ACQUIRING INDEPENDENT AGENTS AND DISTRIBUTORS We have acquired existing independent agents and distributors of our products in certain strategic markets. We may be required to provide customers the same level of technical support that was previously provided by the acquired agents and distributors. We may be unable to provide technical support or operate any acquired distributor or agent as well as previous operators or at all. The acquisition of any distributor or agent may not result in increased foreign revenues. 29 30 OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISKS ASSOCIATED WITH PRODUCT DEVELOPMENT The network security and management market is highly fragmented and characterized by ongoing technological developments, evolving industry standards and rapid changes in customer requirements. Our success will depend on our ability to: - offer a broad range of network security and management software products; - continue to enhance existing products and expand product offerings; - develop and introduce in a timely manner new products with technological advances; - respond promptly to new customer requirements; - comply with evolving industry standards without delays in compliance; - provide upgrades and updates to users frequently and at low cost; and - remain compatible with popular operating systems such as Windows 95, Windows NT and NetWare. We may not be able to successfully develop and market, on a timely basis, enhancements to our existing products or new products. Our product enhancements or new products may not adequately address the changing needs of the marketplace. New products with new technological capabilities could replace or shorten the life cycle of our products or cause our customers to defer or cancel purchases of our products. We may continue to experience delays in software development as we have at times in the past. Complex software products like ours may contain undetected errors or version compatibility problems, particularly when first released, which could delay or cost us our market acceptance. For example, we experienced compatibility issues in connection with our recent NetShield upgrade, and our anti-virus software products have in the past falsely detected viruses that did not actually exist. Difficulties and delays associated with new product introductions, performance or enhancements could have a material adverse effect on our business, financial condition and results of operation. Our product development efforts are impacted by the adoption or evolution of industry standards. For example, no uniform industry standard has developed in the market for encryption security products. As industry standards are adopted or evolve, we may have to modify existing products or develop and support new versions of existing products. In addition, if no industry standard develops, our products and our competitors' products could be incompatible, which could prevent or delay overall development of the market for a particular product. If our products fail to comply with existing or evolving industry standards in a timely fashion, our business, results of operation and financial condition could be materially and adversely affected. Our long-term success depends on our ability to upgrade and update existing product offerings, modify and enhance acquired products and introduce new products, which meet our customers' needs. Future upgrades and updates may include additional functionality, respond to user problems or address compatibility problems with changing operating systems and environments. We believe that our ability to provide these upgrades and updates frequently and at low costs is key to our success. For example, the proliferation of new and changing viruses makes it imperative to update anti-virus products frequently to avoid obsolescence. Failure to release upgrades and updates could have a material adverse effect on our business, results of operations and financial condition. We may not be successful in these efforts. In addition, future changes in Windows 95, Windows NT, NetWare or other popular operating systems could cause compatibility problems with our products. Further, delays in the introduction of future versions of operating systems or lack of market acceptance of these future versions would delay or reduce demand for our future products which were designed to operate with these future operating systems. Our failure to introduce in a timely manner new products that are compatible with operating systems and environments preferred by desktop computer users would have a material adverse effect on our business, results of operation and financial condition. 30 31 WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS We have historically derived a majority of our net revenues from our flagship McAfee anti-virus software products and Sniffer network fault and performance management products. These products are expected to continue to account for a significant portion of our net revenues for the foreseeable future. Because of this concentration of revenue, a decline in demand for or in the prices of these products as a result of competition, technological change, a change in our pricing model, inclusion of anti-virus or network management and analysis software as a standard part of hardware or operating system software or other software, or a maturation in the markets for these products, could harm our business. IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE ANTICIPATE, OUR BUSINESS COULD SUFFER The markets for our network management and network security products are evolving, and their growth depends upon broader market acceptance of this software, including help desk software. Although the number of personal computers, or PCs, attached to large-area networks has increased dramatically, the network management and network security markets continue to be emerging markets. These markets may not continue to develop or may not develop rapidly enough to benefit our business significantly. In addition, there are a number of potential approaches to network management and network security, including the incorporation of management and security tools into network operating systems. Therefore, even if network management and network security tools gain broader market acceptance, our products may not be selected by potential purchasers. To the extent that either the network management or network security market does continue to develop, we expect that competition will increase. WE ARE SUBJECT TO INTENSE COMPETITION IN THE NETWORK MANAGEMENT AND SECURITY MARKETS AND WE EXPECT TO FACE INCREASED COMPETITION IN THE FUTURE The markets for our products are intensely competitive, and we expect competition to increase in the near-term. We believe that the principal competitive factors affecting the markets for our products include: - performance; - functionality; - quality; - customer support; - breadth of product line; - frequency of upgrades and updates; - integration of products; - manageability of products; - brand name recognition; - company reputation; and - price. Performance and quality of our anti-virus software products are measured by number and type of viruses detected, the speed at which the products run and ease of use. Some of our competitors have longer operating histories, greater name recognition, larger technical staffs, established relationships with hardware vendors, and/or greater financial, technical and marketing resources. These factors may provide our competitors with an advantage in penetrating the original equipment manufacturer, or OEM, market with their network security and management products. As is the case in many segments of the software industry, we have been encountering, and we expect to further encounter, increasing competition. This increased competition could reduce average selling prices and, therefore, profit margins. Competitive pressures could result not only in 31 32 price reductions but also in a decline in sales volume, which could cause our business to suffer. In addition, competitive pressures may make it difficult for us to maintain or exceed our historic 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 companies. Our principal competitors in the anti-virus market include Symantec, Computer Associates/Cheyenne Software, IBM, and Trend Micro, 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, our principal competitors are Security Dynamics, Cylink, Entrust Technologies and VeriSign. Our principal competitors in the help desk market are Remedy and Software Artistry, recently acquired by Tivoli Systems/ IBM. Our principal competitor in the software-based network fault and performance management market is Hewlett-Packard with other competitors including Azure Technologies, Concord Communications, DeskTalk Systems, Kaspia Systems, Shomiti Systems, and Wandel & Goltermann. We also face competition in the security market from Cisco, Security Dynamics, Checkpoint Software, Internet Security Systems and Axent, and other vendors in the encryption/firewall/intrusion detection market. In addition, we face 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, we 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 companies who are able to provide the necessary software and support capabilities. In addition, to the extent that we are successful in developing our Net Tools suite of products designed around a centralized management and administration console for the Windows NT platform, we will likely compete with large computer systems management companies such as Tivoli Systems and Computer Associates. We may be unable to 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 we do. In addition, software companies who currently use traditional distribution methods may in the future decide to compete more directly with us by utilizing electronic software distribution. OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH COULD ADVERSELY AFFECT OUR BUSINESS; OUR SALES CYCLE IS LONG, WHICH COULD ADVERSELY AFFECT OUR QUARTERLY RESULTS Our products may be considered to be capital purchases by certain customers or prospective customers. Capital purchases are often discretionary and, therefore, are canceled or delayed if the customer experiences a downturn in its business or prospects or as a result of economic conditions in general. Any cancellation or delay could adversely affect our results of operations. In addition, as we have continued to evolve as an enterprise-wide software provider and continue to focus on the sale of product suites under the Net Tools umbrella, our sales cycle has lengthened and may continue to lengthen. Sales of large complex products, particularly product suites, frequently require a long education process and significant technical evaluation and commitment of capital and other resources. Moreover, these sales 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 network and testing and accepting new technologies that affect key operations. Because of these longer sales cycles and the potential large size of such orders, if anticipated orders are not realized or revenues are not otherwise recognized in a particular quarter, our operating results for that quarter could suffer. WE HAVE ONLY RECENTLY DEVELOPED OUR LARGE ACCOUNTS SALES FORCE; WE FACE RISKS RELATED TO OUR SALES FORCE STRUCTURE Our North American direct sales force is divided into three tiers. The first tier focuses on the sale of all of our product suites under the Net Tools umbrella to enterprise and national account customers. The second tier consists of two separate sales groups focused on the sale of the two product supersuites (Net Tools Secure and Net Tools Manager) to the departmental level. The third tier consists of four separate outbound corporate 32 33 telesales forces that actively market our individual product suites to customers with less than 1,000 end users. Historically, we have not had a large enterprise or national account's sales force and only recently developed a direct sales group focused on these larger accounts. To succeed in the direct sales channel for the enterprise and national accounts market and for the sale of the separate security product suite, we must build a significant direct sales organization and must attract and retain qualified personnel. These individuals will require training about, and knowledge of, product attributes for our various product suites. We may not succeed in building the necessary sales organization or in attracting, retaining or training these individuals. Historically, we sold our products at the departmental level. To succeed in the enterprise and national accounts market requires, among other things, our establishing relationships and contacts with senior technology officers at these accounts. Our sales force may not succeed in these efforts. Our sales organization structure may result in multiple customer contacts by our different sales representatives, particularly in circumstances where the customer has multiple facilities and offices. These multiple contacts may likely result from a lack of coordination between our 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 our business, results of operations and financial condition. In addition, while the development of a direct sales channel reduces our 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 our gross margin and operating profit. WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES, WHO MAY NOT VIGOROUSLY MARKET OUR PRODUCTS, HAVE RIGHTS OF RETURN OR MAY HAVE DIFFICULTY IN TIMELY PAYING FOR PURCHASED PRODUCTS We market a significant portion of our products to end-users through intermediaries, including distributors, resellers and value-added resellers. Beginning in 1998, our dependence on these indirect sales channels increased significantly with the development of a software-only version of our Sniffer product and the acquisition of CyberMedia in September 1998. The Sniffer product was previously only a combined software/hardware product with a limited number of resellers. CyberMedia sold its products only through indirect channels. Our distributors sell other products that are complementary to, or compete with, our products. While we encourage our distributors to focus on our products through market and support programs, these distributors may give greater priority to products of other suppliers, including competitors. Our agreements with our distributors generally permit our distributors to return our product to us in the event of end user returns to the distributor, inaccurate estimates of end user demand by the distributor, increased purchases by distributors in response to sales incentives or transitions to new products. We record sales to distributors as revenue and at the same time establish a reserve for returns. Returns could exceed reserves as a result of distributors holding excessive amounts of our product in inventory. Our current or future reserves for returns could be inadequate which would adversely impact our operating results. Many of our distributors are experiencing economic difficulties worldwide, which may adversely impact our collection of accounts receivable. For example, one of our major European distributors recently experienced significant cash flow issues. As a result, in the quarter ended June 30, 1999 we recorded a $31.8 million reserve for payment default. We regularly review the collectibility and credit worthiness of our distributors to determine an appropriate allowance for doubtful accounts' reserve. Our uncollectible accounts could exceed our current or future allowance for doubtful accounts' reserve, which would adversely impact our operating results. 33 34 WE NEED TO EXPAND AND DEVELOP AN EFFECTIVE PROFESSIONAL SERVICES ORGANIZATION; WE RELY ON THIRD-PARTY PROFESSIONAL SERVICES As our products and computer networks in general increase in complexity, customers require greater professional assistance to design, install, configure and implement our products. To date, we have relied on our limited professional services capabilities and increasingly on outside professional service providers, including our distributors, resellers and system integrators. These third party service providers may provide inadequate levels of professional services. Moreover, reliance on these third parties both places a greater burden on them and reduces our ability to control and establish standards for providing these support services. Our reliance on these third parties could, delay our recognition of product revenue, harm our relationships or reputation with these third parties or the end users of our products or result in decreased future sales of, or prices for, our products. To more effectively service our customer's evolving needs, we intend to significantly expand and develop our worldwide professional service organization. We may not succeed in these efforts. Effectively expanding and developing our professional services organization will require that we hire and train more service professionals who must be continually trained and educated to ensure that they possess sufficient technical skills and product knowledge. The market for qualified professionals is intensely competitive, making hiring and retention difficult. We expect significant competition in this market from existing providers of professional services and future entrants. We must also properly price our services to attract customers, while maintaining sufficient margins for these services. We therefore expect that we will have lower profit margins on our service revenues. The failure to develop an effective professional services organization could have a material adverse effect on our business, results of operations and financial condition. WE RELY ON THE CONTINUED PROMINENCE OF MICROSOFT TECHNOLOGY Although we intend to support other operating systems, our mission is to be the leading supplier of network security and management products for Windows NT/Intel based Network. Sales of our products would be materially and adversely affected by market developments, which are adverse to the Windows operating environments, including the failure of users and application developers to accept Windows NT. In addition, our ability to develop products using the Windows operating environments is dependent on our ability to gain timely access to, and to develop expertise in, current and future developments by Microsoft. We may not be able to gain the necessary access from Microsoft. WE MUST EFFECTIVELY MANAGE OUR GROWTH Our business has grown rapidly, both internally and through acquisitions. This growth has placed, and any future growth would continue to place, a significant strain on our limited personnel, management and other resources. Our ability to manage any future growth, particularly with the anticipated expansion of our international business and growth in distribution business, will require us to: - attract, train, retain, motivate and manage new employees successfully; - effectively integrate new employees into our operations; and - continue to improve our operational, financial, management and information systems and controls. If we continue to grow, our management systems currently in place may be inadequate or we may not be able to effectively manage this growth. We are currently investing in our Internet infrastructure in anticipation of expected growth from the Internet, which may fail to materialize. WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WHICH OFFER ONLY LIMITED PROTECTION AGAINST POTENTIAL INFRINGERS; WE MAY FACE LITIGATION RELATED TO OUR PROPRIETARY TECHNOLOGY AND RIGHTS Our success depends significantly upon our proprietary software technology. We rely on a combination of contractual rights, trademarks, trade secrets, patents and copyrights to establish and protect proprietary rights in our software. However, these protections may be inadequate or competitors may independently develop 34 35 technologies or products that are substantially equivalent or superior to our products. We do not typically obtain signed license agreements from our corporate, government and institutional customers who license products directly from us. Rather, we include an electronic version of a shrink-wrap license in all of our electronically distributed software and a printed license in the box for our products distributed through traditional distributors in order to protect our copyrights and trade secrets in those products. Since none of these licenses are signed by the licensee, many legal authorities believe that such licenses may not be enforceable under the laws of many states and foreign jurisdictions. In addition, the laws of some foreign countries either do not protect these rights at all or offer only limited protection for these rights. The steps taken by us to protect our proprietary software technology may be inadequate to deter misuse or theft of this technology. For example, we are aware that a substantial number of users of our anti-virus products have not paid any registration or license fees to us. Changing legal interpretations of liability for unauthorized use of the our software, or lessened sensitivity by corporate, government or institutional users to avoiding infringement of intellectual property, could have a material adverse effect on our business, results of operations and financial condition. There has been substantial litigation regarding intellectual property rights of technology companies. In the past we have been, and we currently are, subject to litigation related to our intellectual property, including a pending unfair trade practice case and separate patent infringement cases involving each of Symantec, Hilgraeve and Trend Micro. See "Note 8, Notes to the Condensed Consolidated Financial Statements." Although we intend to defend ourselves vigorously against claims asserted against us in the foregoing actions or matters, developments arising out of this pending litigation or any other litigation to which we are or may become a party could have a material adverse effect on our business, results of operation and financial condition. Adverse determinations in litigation could: - result in the loss of our proprietary rights; - subject us to significant liabilities; - require us to seek licenses from third parties; or - prevent us from manufacturing or selling our products. The litigation process is subject to inherent uncertainties and we may not prevail in these matters, or we may be unable to obtain licenses with respect to any patents or other intellectual property rights that may be held valid or infringed upon by us or our 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 us. In addition, as we may acquire a portion of software included in its products from third parties, our exposure to infringement actions may increase because we must rely upon such third parties as to the origin and ownership of any software being acquired. Similarly, exposure to infringement claims will increase to the extent that we employ or hire additional software engineers previously employed by competitors, notwithstanding measures taken by these competitors to protect their intellectual property. In the future, litigation may be necessary to enforce and protect trade secrets and other intellectual property rights that we own. We may also be subject to litigation to defend against claimed infringement of the rights of others or determine the scope and validity of the proprietary rights of others. This litigation could be costly and cause diversion of management's attention, either of which could have a material adverse effect on our business, results of operations and financial condition. OUR INTERNATIONAL OPERATIONS SUBJECT US TO FOREIGN CURRENCY FLUCTUATIONS AND OTHER INHERENT RISKS RELATED TO DOING BUSINESS IN FOREIGN COUNTRIES In the first nine months of 1999 and in 1998, 1997 and 1996, net revenues from international licenses represented approximately 40%, 36%, 36% and 32%, respectively, of our net revenues. Historically, we have relied upon independent agents and distributors to market our products internationally. We expect that international revenues will continue to account for a significant percentage of net revenues. We also expect that a significant portion of this international revenue will be denominated in local currencies. To reduce the 35 36 impact of foreign currency fluctuations, we use nonleveraged forward currency contracts. However, our future results of operations may be adversely affected by currency fluctuations or by costs associated with currency risk management strategies. Other risks inherent in international revenue generally include: - the impact of longer payment cycles; - greater difficulty in accounts receivable collection; - unexpected changes in regulatory requirements; - seasonality due to the slowdown in European business activities during the third quarter; - tariffs and other trade barriers; - export restrictions on our encryption and other security products; - uncertainties relative to regional economic circumstances, including the current economic turbulence in Asia; - political instability in emerging markets and difficulties in staffing; and - managing foreign operations. These factors may have a material adverse effect on our future international license revenue. Further, in countries with a high incidence of software piracy, we may experience a higher rate of piracy of our products. In addition, a portion of our international revenue is expected to continue to be generated through independent agents. Since these agents are not our employees and are not required to offer our products exclusively, they may discontinue marketing our products entirely. Also, we may have limited control over these agents, limited access to the names of the customers to whom these agents sell its products and limited knowledge of the information provided by, or representations made by, these agents to its customers. COMPUTER "HACKERS" MAY DAMAGE OUR PRODUCTS Given our high profile in the security software market, we have been a target of computer hackers who have, among other things, created viruses to sabotage or otherwise attack our products. While to date these efforts have been discovered quickly and their adverse impact has been limited, similar viruses or efforts may be created or replicated in the future. In this event, users' computer systems could be damaged and demand for our software products may suffer as a result. In addition, since we do not control diskette duplication by distributors or our independent agents, diskettes containing our software may be infected with viruses. FALSE DETECTION OF VIRUSES AND ACTUAL OR PERCEIVED SECURITY BREACHES COULD ADVERSELY AFFECT OUR BUSINESS Our anti-virus software products have in the past and may at times in the future falsely detect viruses that do not actually exist. These false alarms, while typical in the industry, may impair the perceived reliability of our products and may therefore adversely impact market acceptance of our products. In addition, we have in the past been subject to litigation claiming damages related to a false alarm, and there can be no assurance that similar claims will not be made in the future. Similarly, an actual or perceived breach of network or computer security at one of our customers, regardless of whether the breach is attributable to our products, could adversely affect the market's perception of our security products. This could adversely effect our business, results of operations and financial condition. OUR CRYPTOGRAPHY TECHNOLOGY IS SUBJECT TO EXPORT RESTRICTIONS AND MAY BECOME OBSOLETE All of our products are subject to the U.S. Export Administration Regulations, governed by the U.S. Department of Commerce. Certain of our network security products, technology and associated technical assistance, particularly products and technology incorporating encryption, may be subject to export restrictions. Network Associates may be required to obtain export licenses, reviews or approvals from the U.S. Government prior to exporting these products to certain customers. As result of this regulatory regime, foreign competitors facing less stringent controls may be able to compete more effectively than we can in the global 36 37 market. While we have obtained approval from the Department of Commerce to export certain products, the U.S. Government may or may not approve pending or future export license requests. Further, the list of products and end users for which export approval is required, and the regulatory policies with respect thereto, are subject to revision by the U.S. Government at any time. Inability to obtain the required licenses, the cost of compliance with U.S. and international export laws, and changes in existing laws could affect our ability to sell certain products in certain markets, and could have a material adverse effect on our international revenues. While the U.S. Department of State has announced its intentions to significantly relax the restrictions on the export of encryption products, information regarding the pending regulations indicates that significant restrictions will still exist on exports to certain foreign customers and to certain foreign jurisdictions In addition, some of our network security products are dependent on the use of public key cryptography technology. This technology depends in part upon the application of certain mathematical principles known as factoring and discrete logarithms. The security afforded by public key cryptography technology is based on our belief that the factoring of large prime numbers and solving the discrete log problem is not computationally practical. Should an easy factoring method be developed or the discrete log problem be solved, the security afforded by encryption products using public key cryptography technology would be reduced or eliminated. Furthermore, any significant advance in techniques for attacking cryptographic systems could also render some or all of our existing products and services obsolete or unmarketable. Moreover, the cryptographic algorithms used in our products can theoretically be solved by computer systems significantly faster and more powerful than those presently available. If these improved techniques for attacking cryptographic systems were ever developed, our business would be adversely affected. PRODUCT LIABILITY CLAIMS ASSERTED AGAINST US IN THE FUTURE COULD ADVERSELY AFFECT OUR BUSINESS Our network security and management software products are used to protect and manage computer systems and networks that may be critical to organizations. As a result, our sale and support of these products involves the risk of potential product liability and related claims. Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions contained in these license agreements may not be effective under the laws of certain jurisdictions, particularly in circumstances involving unsigned licenses. A product liability claim brought against us could have a material adverse effect on our business, results of operations and financial condition. OUR MANAGEMENT AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, THESE INDIVIDUALS MAY NOT REMAIN WITH US IN THE FUTURE We rely, and will continue to rely, on a number of key technical and management employees. While employees are required to sign standard agreements concerning confidentiality and ownership of inventions, our employees are generally not otherwise subject to employment agreements or to noncompetition covenants. If any of our key employees leave, our business, results of operations and financial condition could suffer. Furthermore, we do not maintain life insurance policies on our key employees. Our ability to achieve our revenue and operating performance objectives will depend in large part on our ability to attract and retain technically qualified and highly skilled sales, consulting, technical, marketing and management personnel. Competition for these employees is intense and is expected to remain so for the foreseeable future. We have seen upward pressure on wages as a result of this intense competition for employees, which could cause an increase in our operating expenses. We may not be successful in retaining our existing key personnel and in attracting and retaining the personnel we require, and our failure to retain and hire key employees could adversely affect our business and operating results. For example, in April 1998, Mr. Leslie Denend resigned from his position as president of the Company, although he remains on the Company's Board of Directors. Additions of new and departures of existing employees, particularly in key positions, can be disruptive and can result in departures of existing employees, which could adversely affect our business. 37 38 WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING We are currently engaged in several research and development contracts with agencies of the U.S. government. We believe that the willingness of these government agencies to enter into future contracts with us will in part be dependent upon our continued ability to meet their expectations. Minimum fee awards for companies entering into government contracts are generally between 3% and 7% of the costs incurred by them in performing their duties under the related contract. However, these fee awards may be as low as 1% of the contract costs. Furthermore, these contracts are subject to cancellation at the convenience of the governmental agencies. Although we have been awarded contract fees of more than 1% of the contract costs in the past, minimum fee awards or cancellations may occur in the future. Reductions or delays in federal funds available for projects we are performing could also have an adverse impact on our government business. Contracts involving the U.S. government are also subject to the risks of disallowance of costs upon audit, changes in government procurement policies, required competitive bidding and, with respect to contracts involving prime contractors or government-designated subcontractors, the inability of those parties to perform under their contracts. Any of the foregoing events could adversely affect our results of operations or financial conditions. POTENTIAL YEAR 2000 PROBLEMS COULD ADVERSELY IMPACT OUR BUSINESS Many currently installed computer systems and software products experience difficulty in functionality with respect to distinguishing between twenty-first century dates and twentieth century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to function properly in the future. We have tested our current products for Year 2000 compliance and believe that they are Year 2000 compliant. However, the failure of our current or prior products to operate properly with regard to Year 2000 requirements could cause us to incur unanticipated expenses to remedy any problems, cause a reduction in sales and expose us to related litigation by our customers, each of which could harm our business. In addition, we and the third parties with whom we conduct business may utilize equipment or software that may not be Year 2000 compliant. Failure of our or any of these third party's equipment or software to operate properly with regard to the Year 2000 requirements could result in, among other things, unanticipated expenses or efforts to remedy any problems, which could harm our or such third party's respective business. Furthermore, the purchasing patterns of customers, or potential customers, may be affected by Year 2000 issues. Companies may expend significant resources to evaluate and correct their own equipment or software for Year 2000 compliance while 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 us, which could adversely affect our business. See Management's Discussion and Analysis of Financial Condition and Results of Operations. WE RELY ON A LIMITED NUMBER OF SUPPLIERS AND THIRD-PARTY MANUFACTURERS, WHO MAY NOT CONSISTENTLY MEET OUR BUSINESS NEEDS Some of our products contain critical components supplied by a single or a limited number of third parties. We have been required to purchase certain computer platforms around which we design our network fault and performance management products to ensure an available supply of these products for our customers. Any significant shortage of these platforms or other components or the failure of the third party supplier to maintain or enhance these products could lead to cancellations of customer orders or delays in placement of orders, which could materially adversely affect our results of operations. In addition, if our purchase of these components or platforms exceeds demand, we could incur losses or other charges in disposing of excess inventory, which could also materially adversely affect our results of operations. Our manufacturing operations consist primarily of assembly, testing and quality control of materials, components, subassemblies and systems for our Sniffer based products. We use third party manufacturers for these manufacturing operations. Reliance on third party manufacturers involves a number of risks, including the lack of control over the manufacturing process and the absence or unavailability of adequate capacity. In 38 39 the event that any third party manufacturers cannot or will not continue to manufacture the Sniffer based products in required volumes, on a cost effective basis, in a timely manner or at all, we will have to secure additional manufacturing capacity. Even if such additional capacity is available at commercially acceptable terms, the qualification process could be lengthy and could create delay in product shipments. DELAWARE LAW, OUR CERTIFICATE OF INCORPORATION AND BYLAWS, OUR ADOPTION OF A RIGHTS PLAN AND OUR STOCKHOLDERS AGREEMENT WITH MCAFEE.COM MAY INHIBIT POTENTIAL ACQUISITION BIDS; THIS MAY ADVERSELY AFFECT THE MARKET PRICE FOR OUR COMMON STOCK AND PREVENT CHANGES IN OUR MANAGEMENT Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote of action by its stockholders. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock. In October 1998, our board of directors adopted shareholders rights plan. Each right under this plan entitles the record holder to buy 1/1000 of a share of our series B participating preferred stock at an exercise price of $200.00. The rights will become exercisable following the tenth day after a person or group announces acquisition of 15% or more of our common stock or announces commencement of a tender or exchange offer the consummation of which would result in ownership by the person or group of 15% or more of our common stock. We are entitled to redeem the rights at $0.01 per right at any time on or before the tenth day following acquisition by a person or group of 15% or more of our common stock. In October 1999, we entered into a stockholders agreement with McAfee.com. Under this agreement we agreed that if (1) without the prior approval of our continuing directors, as defined below, any person acquires or agrees to acquire 15% or more of our outstanding common stock or (2) our continuing directors cease to constitute a majority of Network Associates serving directors, then for so long but only for so long as that condition exists: - our shares of McAfee.com Class B common stock we be entitled to only one vote per share instead of three votes per share; and - we will be obligated to vote our McAfee.com shares to cause, and to take such actions reasonably within our control to cause, and shall seek to cause the McAfee.com directors appointed by us to cause, our board of directors to consist of at least a majority of independent directors. Network Associates continuing directors will consist of our current directors and any subsequent directors approved or not objected to by a majority of our then-continuing directors. Certain provisions of Delaware law and our certificate of incorporation and bylaws, such as a classified board, could delay or make a merger, tender offer or proxy contest involving Network Associates more difficult. While these provisions and our rights plan are intended to enable our board of directors to maximize stockholder value, and the provisions of the McAfee.com stockholders agreement are, among other things, intended to preserve McAfee.com's independence, they may have the effect of discouraging takeovers, which may not be in the best interest of certain stockholders. Our rights plan and these provisions could have an adverse effect on the market value of our common stock. 39 40 NETWORKS ASSOCIATES, INC. FORM 10-Q, SEPTEMBER 30, 1999 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS: Information with respect to this item is incorporated by reference to Note 8 of the Notes to the Consolidated Financial Statements included herein on page 9 of this Report on Form 10-Q. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K: (a) Exhibits. The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Report. (b) No reports on Form 8-K were filed during the quarter: 40 41 NETWORKS ASSOCIATES, INC. FORM 10-Q, SEPTEMBER 30, 1999 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: November 15, 1999 41 42 NETWORKS ASSOCIATES, INC. FORM 10-Q, SEPTEMBER 30, 1999 EXHIBIT INDEX
EXHIBIT PAGE NUMBER EXHIBIT TITLE NUMBER - ------- ------------- ------ 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)...........................................
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EXHIBIT PAGE NUMBER EXHIBIT TITLE NUMBER - ------- ------------- ------ 4.7 Indenture dated as of February 13, 1998 between the Registrant and State Street Bank and Trust Company of California, N.A., as Trustee.(10)........................... 4.10 Registration Rights Agreement dated May 8, 1998, by and between the Registrant and the stockholders of Secure Networks, Inc.(8)........................................... 4.11 Registration Rights Agreement, dated June 29, 1998, by and between the Registrant and certain stockholders of CSB Consulenza Software di Base S.r.l. ("CSB").(11)............. 4.12 Registration Rights Agreement, dated July 30, 1998, by and between the Registrant and certain stockholders of Anyware Seguridad Informatica S.A.(11).............................. 4.13 Registration Rights Agreement, dated August 31, 1998, by and between the Registrant and certain stockholders of QA Information Security Holding AB(24)......................... 10.1 Standard Business Lease (Net) for Network General's principal facility dated June 19, 1991, between Network General and Menlo Oaks Partners, L.P.(12)................... 10.2 First Amendment to Lease dated June 10, 1992, between Network General and Menlo Parks Partners, L.P.(12).......... 10.3 Standard Business Lease (Net) for Network General's principal facility dated March 11, 1992, between Network General and Menlo Oaks Partners L.P.(13).................... 10.4 First Amendment to Lease dated June 18, 1992, between Network General and Menlo Oaks Partners, L.P.(12)........... 10.5 Lease dated March 31, 1992, between Network General and Equitable Life Assurance Society of the United States.(12)................................................. 10.6 Second Amendment to Lease dated February 1, 1995, between Network General and Menlo Oaks Partners, L.P.(13)........... 10.7 Third amendment to Lease dated February 1, 1995 between Network General and Menlo Oaks Partners L.P.(13)............ 10.8 Fourth Amendment to Lease dated May 31, 1995, between Network General and Menlo Oaks Partners, L.P.(14)........... 10.9 Fifth Amendment to Lease dated June 13, 1995, between Network General and Menlo Oaks Partners, L.P.(14)........... 10.10 Lease dated July 3, 1996 between Network General and Campbell Avenue Associates.(15)............................. 10.11 Sixth Amendment to Lease dated November 29, 1996, between Network General and Menlo Oaks Partners, L.P.(15)........... 10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa Clara, California, dated as of February 20, 1997, by and between McAfee Associates, Inc. and National Semiconductor Corporation.(16)............................................ 10.13 Lease Agreement dated November 17, 1997 for facility at 3965 Freedom Circle, Santa Clara, California by and between Informix Corporation and McAfee Associates, Inc.(4)......... 10.14 Consent to Assignment Agreement dated December 19, 1997 by and among Birk S. McCandless, LLC, Guaranty Federal Bank, F.S.B., Informix Corporation and Networks Associates, Inc.(4)..................................................... 10.15 Subordination, Nondisturbance and Attornment Agreement dated December 18, 1997, between Guaranty Federal Bank, F.S.B., Networks Associates, Inc. and Birk S. McCandless, LLC.(4)... 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)............
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EXHIBIT PAGE NUMBER EXHIBIT TITLE NUMBER - ------- ------------- ------ 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)................. 10.21* Change in control agreement between the Company and Peter Watkins dated May 11, 1999(25).............................. 10.22* Change in control agreement between the Company and William S. Larson dated May 11, 1999(25)............................ 10.23* Change in control agreement between the Company and Prabhat K. Goyal dated May 11, 1999(25)............................. 10.24* Change in control agreement between the Company and Zachary Nelson, dated May 11, 1999(25).............................. 10.25 Corporate Management Services Agreement between the Registrant and McAfee.com Corporation, dated as of January 1, 1999(26)................................................. 10.26 Technology Cross License Agreement between the Registrant and McAfee.com Corporation dated as of January 1, 1999(26).................................................... 10.27 Registration Rights Agreement between the Registrant and McAfee.com Corporation, dated as of January 1, 1999(26)..... 10.28 Asset Contribution and Receivables Settlement Agreement between the Registrant and McAfee.com Corporation, dated as of January 1, 1999(26)...................................... 10.29 Intercompany Revolving Loan Agreement between the Registrant and McAfee.com Corporation, dated as of January 1, 1999(26).................................................... 10.30 Tax Sharing Agreement between McAfee.com and Networks Associates, Inc., dated as of January 1, 1999(26)........... 10.31 Indemnification and Voting Agreement between the Registrant and McAfee.com Corporation, dated as of January 1, 1999(26).................................................... 10.32 Joint Cooperation and Master Services Agreement between the Registrant and McAfee.com Corporation, dated as of January 1, 1999(26)................................................. 27.1 Financial Data Schedule.....................................
- --------------- * Management contracts or compensatory plans or arrangements covering executive officers or directors of Networks Associates, Inc. (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 Company'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. 45 (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. (25) Incorporated by reference from the Registrant's report on Form 10-Q for the quarter ended March 31, 1999, filed with the Commission on May 13, 1999. (26) Incorporated by reference from the Form S-1 filed by McAfee.com Corporation with the Commission on September 23, 1999, under File Number 333-87609. EX-27.1 2 FINANCIAL DATA SCHEDULE
5 9-MOS DEC-31-1999 SEP-30-1999 249,426 402,508 317,114 (126,285) 14,266 603,503 127,055 (79,416) 1,340,952 328,249 0 0 0 1,393 591,165 1,340,952 0 465,589 92,134 522,858 0 0 5,381 (144,022) 25,763 (169,785) 0 0 0 (169,785) (1.23) (1.23)
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