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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the issuer as of March 27, 2000 was approximately $4,836,549,019. The number of
shares outstanding of the issuer's common stock as of March 27, 2000 was
139,430,034.
DOCUMENTS INCORPORATED BY REFERENCE: Items 10, 11, 12, and 13 of Part III
are incorporated by reference from the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held May 25, 2000.
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PART I
ITEM 1. BUSINESS
GENERAL
Some of the statements contained in this Annual Report on Form 10-K are
forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors, which may cause our actual results to differ
materially from those implied by the forward-looking statements. In some cases,
you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," or "continue" or the negative of these terms or other
comparable terminology. Although we believe that the expectations reflected in
the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance or achievements. Moreover, neither any
other person nor we assumes responsibility for the accuracy and completeness of
such statements. Important factors that may cause actual results to differ from
expectations include those discussed in "-- Risk Factors" and elsewhere in this
document.
Networks Associates, Inc. was formed in December 1997, by the combination
of McAfee Associates, Inc. and Network General Corporation. Following the
combination, McAfee, changed its legal name to Networks Associates, Inc. Since
then, we have acquired over 10 companies and in 1999 we publicly sold Class A
common stock of one of our subsidiaries as part of that subsidiaries initial
public offering.
OVERVIEW
We are a leading supplier of security and availability solutions for
e-business. Our products focus on two important area of e-business: network
security and network management. In the network security and network management
arenas, the majority of our revenue has historically been derived from our
McAfee anti-virus product line and our Sniffer network fault and performance
management product line, respectively. These two flagship product lines form the
customer base and product base from which the balance of our product line has
developed.
In recent years, we have focused our efforts on building a full line of
complementary network security and network management solutions. On the network
security side, we strengthened our anti-virus lineup by adding complementary
products in the firewall, intrusion protection, encryption, and virtual private
networking categories. On the network management side, we built upon our Sniffer
line by adding products in the help desk, asset management, network monitoring,
and network reporting categories. We continuously seek to expand our product
line. We have combined complementary products into "suites," offering customers
the ability to license multiple products at the same time. Our products are
organized into the suites described below.
In January 2000, we reorganized into four product groups based on our
product suites:
- McAfee, which primarily markets the McAfee Active Virus Defense (AVD)
product suite;
- Sniffer Technologies, which primarily markets the Sniffer Total Network
Visibility (TNV) product suite;
- PGP Security, which primarily markets the PGP Total Security Defense
(TSD) product suite; and
- Magic Solutions, which primarily markets the Magic Total Support Desk
(TSD) product suite.
The four individual product suites form our single Net Tools mega suite.
The reorganization around our product groups is designed to allow us to, among
other things, react faster to customers' changing needs and better specialize
our sales force so they know our products and their markets in greater depth. In
addition, although specialization between security (anti-virus and security
product suites) and manageability (availability and service product suites)
previously existed, with the reorganization we seek to better differentiate
anti-virus from security and availability from service desk.
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In addition, to our product groups, we also have two subsidiaries that are
applications service providers. McAfee.com, our publicly traded subsidiary, is a
consumer applications service provider, or ASP, and myCIO, our wholly owned
subsidiary, is a business applications service provider.
MCAFEE
McAfee sells anti-virus products to corporate customers. The McAfee Active
Virus Defense, or AVD, product suite incorporates the following products into a
multi-tier virus defense system: VirusScan for desktop protection, NetShield for
file server protection, GroupShield for groupware protection and WebShield for
Internet gateway protection. McAfee also provides tools to manage and enforce
corporate virus security policy, updates and reporting with ePolicy Orchestrator
and Anti-Virus Informant. McAfee products are backed by our anti-virus research
organization, McAfee AVERT (Anti-Virus Emergency Response Team), which protects
McAfee customers against virus attacks that have become increasingly complex and
frequent in recent years.
The following anti-virus products are part of the McAfee Active Virus
Defense product suite:
- VirusScan: Desktop Virus Security is designed to provide PCs with
protection against computer viruses, including macro viruses, malicious
Java and ActiveX attacks, and email intrusions. The corporate edition of
VirusScan is included as part of McAfee AVD. VirusScan is also available
in a retail version for home users.
- NetShield: Network Server Virus Security offers server-based virus
protection that is designed to prevent the spread of viruses at critical
servers in the corporate network.
- GroupShield: Groupware Virus Security is designed to prevent virus
proliferation in the groupware environment of an enterprise by scanning
files sent through Microsoft Exchange and Lotus Notes servers and
catching viruses before they can be passed on to other users. GroupShield
is both sold separately and is designed as part of AVD.
- E-Policy Orchestrator is a scaleable anti-virus tool designed to allow
corporate system administrators to manage and enforce anti-virus policies
by providing updates or upgrades to up to 20,000 users.
- Anti-Virus Informant provides detailed anti-virus coverage reports which
identify users that need updates and also provides infection reports that
track vulnerable system entry points.
- AutoUpdate is designed to keep anti-virus products running with the
latest versions and the most current virus signature files.
- Enterprise SecureCast is a free, optional Internet service designed to
automatically deliver to system administrators new upgrades, updates, and
security news bulletins after they are released from McAfee AVERT.
Enterprise SecureCast is included as part of AVD.
- Management Edition is an anti-virus software distribution and management
system that is designed to allow complete and centralized control over
the VirusScan and NetShield product line. Management Edition is included
as part of AVD.
Additional McAfee products sold separately from the Active Virus Defense product
suite include:
- WebShield: Internet Gateway Protection is designed to guard the perimeter
of computer networks by scanning vulnerable Internet traffic for viruses
and other hostile code before they enter the system.
- WebShield E-ppliance 100: Internet Gateway Protection; combines hardware
and software in an integrated appliance that protects Internet gateways
by scanning vulnerable SMTP, FTP or HTTP traffic for malicious code.
WebShield E-ppliance 100 is offered as a portable component that plugs
directly into servers.
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SNIFFER TECHNOLOGIES
Sniffer Technologies sells network monitoring, analysis, reporting and
capacity planning tools. Sniffer Technologies principal product suite, Total
Network Visibility, or TNV, is an integrated product that enables enterprises
and service providers to maintain the availability and performance of their
networks and applications. The TNV product suite consists of the Sniffer
Portable Analysis Suite, the Sniffer Distributed Analysis Suite, the Sniffer
Network Informant Suite and the Sniffer Pro for Packet over SONET.
- Sniffer Portable Analysis Suite, or Sniffer PAS, consists of portable
tools designed to automatically pinpoint and analyze network problems and
to recommend solutions. Products sold under the Sniffer PAS range from
products which capture data, monitor network traffic and collect key
network statistics for small networks, to products which optimize network
and application performance and increase network reliability by
uncovering and analyzing network problems and recommending solutions to
such problems, automatically and in real-time for mid-level and
high-speed networks.
- Sniffer Distributed Analysis Suite, or Sniffer DAS, is designed to allow
customers to proactively monitor and diagnose network and
application-level problems on complex, multi-segment networks from
centralized locations. The Sniffer DAS addresses a variety of network
needs ranging from high-speed backbones, wide area network, or WAN, links
and switched networks.
- Network Informant Suite, or Network Informant, is a web browser-based
network management suite that is designed to automate and manage the
process of resolving network problems proactively by identifying,
analyzing, tracking and resolving network and application problems and
assessing trends.
- Sniffer Pro for Packet Over SONET, is a portable system for monitoring
and troubleshooting high-speed telecommunications and Internet service
provider networks.
PGP SECURITY
PGP Security, or TNS, sells security products to corporate customers. PGP
Security's principal product suite, PGP Total Network Security includes
firewall, intrusion protection, encryption and virtual private network (VPN)
security products. The TNS product line features Gauntlet for firewall and VPN,
CyberCop for intrusion protection and PGP for encryption and VPN.
The following security products and product suites are part of the PGP
Total Network Security product suite:
- Gauntlet Firewall is the flagship product of our security product line.
Gauntlet is offered as an enterprise management console, designed to
enable large-scale configuration control over numerous firewalls
throughout a computer network, and allow for direct interface with
anti-virus scanning products. Gauntlet Firewall also has encryption
capabilities for VPN technology.
- Gauntlet Active Firewall Suite; integrates several of the individual TNS
products with Event Orchestrator, our event management system. This
design is intended to allow the individual TNS security products to
communicate with one another and provide automatic response and security
service level management.
- CyberCop Scanner is an integrated network-scanning tool designed to
locate system and network device vulnerabilities, exposing previously
undiscovered security threats via an easy-to-use graphical interface.
- CyberCop Monitor is a second-generation intrusion detection product
utilizing an intelligent agent architecture designed to provide a
multi-tiered detection system that can monitor networks, servers, and
applications with centralized event correlation and trend analysis.
- CyberCop Sting completes the CyberCop line by offering a new proprietary
approach to extend intrusion detection. CyberCop Sting utilizes
replication technology designed to simulate "virtual machines" in a
simulated environment, allowing any unauthorized activity to be logged
while at the same time not placing systems or data at risk.
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- PGP Desktop encrypts and authenticates e-mail, files and disks
automatically, ensuring that only the authorized recipient can read their
contents.
- PGP Policy Management Agent works in conjunction with PGP Desktop and is
designed to ensure that incoming and outgoing email adheres to the
appropriate corporate email security policies.
- PGP VPN Client adds a standards-compliant virtual private networking, or
VPN, client to the PGP suite. By encrypting and authenticating remote
communications, PGP VPN Client users can securely connect remotely over
inexpensive local Internet connections.
- PGP VPN Suite provides a standards-based infrastructure for end-to-end
VPN security. The PGP VPN suite is designed to offer secure networking
including server-to-server for supply chain and remote office extrants,
server-to-client for secure remote access, and client-to-client for
secure network communications.
- WebShield E-ppliance 300 combines hardware and software in an integrated
appliance that combines the Gauntlet Firewall and McAfee anti-virus
products with a Gauntlet VPN server. WebShield E-ppliance 300 is offered
as a portable component that plugs directly into servers and is sold
separately from TNS.
MAGIC SOLUTIONS
Magic Solutions sells help desk, network management and other service
tools. Magic Solutions' principal product suite, Magic Total Service Desk, or
Magic TSD, provides proactive network management and help desk technology in one
integrated service desk solution. Magic TSD is comprised of the following
suites:
- Magic HelpDesk Suite is designed to provide call management, problem
resolution, crisis management, change management and reporting for help
desks. The Magic HelpDesk Suite automates the process of entering caller
information and automatically displays information about a caller. In
addition, the Magic HelpDesk Suite is designed to provide automated
crisis management.
- Self ServiceDesk Suite provides applications designed to make all
supported PCs help desk ready. The Self ServiceDesk Suite integrates PC
diagnostic software with remote control and web-based access.
- Zero Administration Client Suite, or ZAC Suite is designed to provide
enterprise wide control of network software with integrated software
distribution, software and hardware inventory, desktop
management/menuing, license metering and remote control features. The ZAC
Suite is designed to automatically distribute, install and track new
software and updates throughout an enterprise and to perform an
enterprise-wide hardware, software and system file inventory without
having to visit each station.
MYCIO.COM
We launched our new wholly owned subsidiary, myCIO.com in January 2000.
myCIO.com is an infrastructure ASP targeted at business users. myCIO.com
delivers network security and availability services hosted on its servers to
businesses via the Internet. myCIO's products and services are designed to be
simple and cost-effective and more rapidly deployed than if the customer were to
install network security and availability applications internally. myCIO.com's
hosted services are also designed to remove the burden and cost of managing the
software, while seeking to ensure continuous protection against threats to a
company's e-business infrastructure. myCIO's products include:
- VirusScan ASaP is a computer virus service that allows users to scan
hardware and software systems and detect and eliminate viruses online.
The service is "versionless" or self updating as the most recent version
of the software is running on a server operated by myCIO.com with only a
small portion of the VirusScan ASaP Resident on the user's hardware.
- CyberCop ASaP is a vulnerability assessment service designed to remotely
assess the security of the customer's network perimeter. The service
operates at the myCIO.com website and the customer does
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not need to download any software. Vulnerability reports are delivered
over the Internet through a web interface at the myCIO.com website.
- Firewall ASaP is a remotely managed firewall service. The firewall unit
is shipped to the customer site, but is remotely configured and managed
by the myCIO.com staff from their data center. Firewall ASaP combines
Gauntlet Firewall, Gauntlet Virtual Private Network and gateway-based
McAfee anti-virus scanning for SMTP, HTTP, and FTP.
MCAFEE.COM
Effective January 1, 1999, we contributed our consumer e-commerce business
to our then wholly owned subsidiary, McAfee.com. In December 1999 McAfee.com
completed its initial public offering in which it sold to the public
approximately 7.2 million shares of its Class A common stock, entitled to one
vote per share. As of March 1, 2000, we owned 36,000,000 shares of the
McAfee.com Class B common stock, entitled to three votes per share and
representing approximately 83% of McAfee.com's outstanding common stock and 94%
of its total voting power.
McAfee.com is an online provider of PC security and management products and
services for consumers. Through the McAfee.com web site, consumers can secure,
repair, update and upgrade their PCs online. The McAfee.com web site provides a
suite of online products and services personalized for consumers based on their
PC configurations, software and attached peripherals, such as scanners, printers
and modems. McAfee.com began operations as one of the first consumer
applications service providers, or ASPs, hosting PC security and management
software applications. The McAfee.com applications allow consumers to detect and
eliminate viruses on their PCs, repair their PCs from damage caused by viruses,
optimize their hard drives and update their PCs with current software patches
and upgrades. The McAfee.com home page provides access to free product and
service centers, such as the Shopping Center, and subscriber services, such as
the McAfee Clinic. Subscribers to the McAfee Clinic service can access all of
McAfee.com's online centers including:
- McAfee Clinic -- the central access point for all of McAfee.com's hosted
online application services;
- Anti-Virus Center -- a computer virus protection and information service;
- PC CheckUp Center -- a PC optimization and maintenance service;
- Firewall Center -- a personal firewall service to protect against hackers
- Shopping Center -- a shopping resource where consumers can research and
purchase computer products, accessories and books;
- Download Center -- a service that allows users to download evaluation
software titles and browser plug-ins; and
- Support Center -- a product registration, technical support and customer
care service.
For the year ended December 31, 1999, on a segment basis McAfee.com
accounted for approximately $24.5 million in net revenues and a loss of $27.9
million. See Note 14 of the Notes to the Consolidated Financial Statements. In
addition, Network Associates and McAfee.com have entered into various inter-
company arrangements. See "Network Associates/McAfee.com Intercompany
Agreements."
NAI KK
Network Associates sells its product suites in Japan through NAI KK, our
Japanese subsidiary. NAI KK is also negotiating an agreement with McAfee.com to
act as its Japanese distributor. On February 4, 2000, several companies acquired
a less than 4% minority equity interest in NAI KK for a combined total of
approximately $11.9 million.
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PROFESSIONAL SERVICES & TECHNICAL SUPPORT
As our products and computer networks become more complex, customers
increasingly require greater professional assistance in the design,
installation, configuration and implementation of their networks and acquired
products. To meet these evolving customer needs, we have established
Professional Services and Technical Support. Professional Services is focused on
two service segments: Consulting Services and Education Services. Technical
Support consists primarily of one program called PrimeSupport, which is
described below.
Consulting Services supports product integrations, customization and
deployment with an array of standardized and custom offerings. Consulting
Services also offers other services ranging from proactive and emergency
troubleshooting to network design, planning and simulation. We supplement our
Consulting Service capabilities through the use of outside professional service
providers, including our distributors, resellers and system integrators. In
conjunction with our recent reorganization to establish product groups, in
January 2000 we reorganized our U.S. Consulting Services organization, in part,
to enable the service providers to become more specialized on individual
products and product suites.
Education Services represents the combined training organizations of
Sniffer University, TIS, McAfee University, and Magic University. Together,
these training organizations offer customers an extensive curriculum of computer
network technology courses, including protocol analysis and troubleshooting,
security, help-desk and network management tools. Education Services provides
public classes and customized on-site training at customer locations. To date we
have trained over 35,000 individuals in Fortune 500 and other companies.
The PrimeSupport program provides our customers online and telephone-based
technical support in an effort to ensure that our products are installed and
working properly. To meet customers' varying needs, PrimeSupport offers a choice
of the online KnowledgeCenter or the telephone-based Connect, Priority and
Enterprise. PrimeSupport is available to all customers on a worldwide basis from
a nearby global support center.
- PrimeSupport KnowledgeCenter -- Consisting of a searchable, intelligent
knowledge base of technical solutions and links to a variety of technical
documents such as product FAQ's and technical notes. The KnowledgeCenter
also allows users to submit questions by email if their answer is not
found in the KnowledgeCenter's technical resources.
- PrimeSupport Connect -- Providing toll-free telephone access to technical
support during regular business hours and access to the online
KnowledgeCenter.
- PrimeSupport Priority -- Providing support for critical operations with
priority, unlimited, toll-free telephone access to technical support 24
hours a day, 7 days a week and access to the online KnowledgeCenter.
- PrimeSupport Enterprise -- Offering proactive, personalized service for
the most business critical operations and including an assigned technical
support engineer from our elite Enterprise support team; proactive
support contact (telephone or email) with customer-defined frequency;
election of five designated customer contacts, and access to the online
KnowledgeCenter.
PRODUCT LICENSING MODEL; HOSTED APPLICATIONS SUBSCRIPTION MODEL
We typically license our products, together with the related maintenance,
to corporate and government customers for a period of two years. Upon expiration
of the two-year period, we contact customers to renew their license. We believe
that the two-year license and related maintenance offers several benefits to our
customers. For one initial fee, the customer receives the software and all
upgrades, updates and technical support for two years. In addition, the customer
only has to make a decision on its investment in the software every two years.
Since we are able to distribute our products and upgrades at a lower cost than
companies using traditional distribution methods, we also have the ability to
offer upgrades and updates and address user feature requirements on a more
regular basis. In addition, by offering a two-year license, as opposed to a
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traditional perpetual license, we are able to meet a lower initial cost
threshold for customers with annual budgetary constraints.
Our two-year licensing model creates the opportunity for recurring revenue
for us through the renewal of existing licenses. Since we typically license our
products on a per user basis, at the time of renewal we have the potential to
increase the number of computers licensed at existing sites and to expand our
licenses to new sites in an organization. The renewal process also provides an
opportunity to cross-sell new products and product suites to existing customers.
However, we may be unable to sustain current renewal rates in the future.
We also provide single user and corporate user licenses for our products
under traditional perpetual licenses with product updates, upgrades and support
available to customers under separate maintenance contracts.
For our hosted products and services customers "rent versus buy" the
software. McAfee.com, our consumer ASP, has and myCIO.com, our business
infrastructure ASP, is developing a related subscription model. Paid McAfee
Clinic subscribers receive a one year subscription to the service. Because the
McAfee Clinic service is "version-less" or self updating consumers using McAfee
Clinic are assured of using the most recent version of the software application,
eliminating the need to the purchase product updates or upgrades.
SALES AND MARKETING
To augment and capitalize upon our website based marketing efforts, our
sales and marketing efforts are directed primarily at large corporate and
government customers as well as to resellers, distributors and system
integrators worldwide through the following channels:
NORTH AMERICAN DIRECT SALES
The balance of our North American direct sales force, constituting the
majority of our sales force, is organized by product group; with four separately
focused sales organizations selling by product line. Each of these sales
organizations consists of field sales representatives who are located regionally
and outbound telesales representatives who actively market our individual
product suites, focusing on small customers and transactions. Our corporate
telesales representatives also respond to prospective customers who contact us
as a result of a particular marketing program or after electronically evaluating
one of our products. To augment our sales organization, our executives are
involved with sales to many major accounts.
All of our North American sales representatives are responsible for
developing new business as well as the renewal of our existing licenses. Prior
to expiration of a license, a sales representative contacts the customer and
encourages the customer to renew the expiring license and determines if the
number of computers licensed needs adjustment and, additionally, markets new
products and product suites to this existing customer.
McAfee.com and myCIO.com have independent sales organizations.
INTERNATIONAL SALES
We have sales and support operations in Europe, Asia, South America and
Australia. In 1999, international revenues accounted for approximately 40% of
our net revenues. We expect that international revenues will continue to account
for a significant percentage of net revenues. Historically, we have relied
primarily upon independent agents and distributors to market our products
internationally. In recent years we have focused our efforts on expanding
internationally including through distribution acquisitions. We expect to
continue using independent agents primarily in smaller markets where a direct
sales presence is not currently warranted. While our agents and distributors
include some large systems integrators, most are small companies that market our
software along with products of other companies that they represent. We
typically enter into agreements with our agents which obligate them to provide
technical support and the most current versions of our products to our customers
and to provide us with information about our licensees. These agreements permit
the agent or us to terminate the agreement upon proper prior written notice.
International
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agents invoice their own orders and collect payment, remitting the license fee,
net of commissions, to us in United States dollars.
RESELLERS AND DISTRIBUTORS
To complement our direct sales efforts, we market many of our products
through corporate resellers and distributors, and indirectly through retailers.
While historical sales through these distribution channels have generated a
relatively small portion of our net revenue, during the last three years our
presence in these channels has expanded. We currently utilize corporate
resellers, including Software Spectrum, ASAP Software, Softmart, Corporate
Software & Technology and Software House International, which focus primarily on
selling site licenses for our software to corporate customers.
Independent software distributors who market our products include Ingram
Micro, Merisel America, Pinacor, Inc., and Tech Data. These distributors stock
our products in inventory for redistribution primarily to large retailers, value
added resellers, or VARs, and mail order companies. Through our authorized
distributors, we sell our retail packaged products to several of the large
computer and software retailers in the United States, including Comp USA,
Staples, Best Buy, Office Max and Office Depot. Several members of our channel
sales force work closely with our major reseller and distributor accounts to
manage orders, inventory level, promotions and selling activities.
Our distributors generally are permitted stock balancing and stock rotation
rights but are typically required to place offsetting orders of equal value. We
often rely on resellers and distributors, including retail outlets, to market
and support our products. Our agreements with our distributors are not exclusive
and may be terminated by either party without cause. Terminated distributors may
not continue to represent our products.
ORIGINAL EQUIPMENT MANUFACTURERS
Original Equipment Manufacturers, or OEMs, license our products (mainly
anti-virus products licensed through McAfee.com) and bundle them with personal
computer hardware or software. OEMs typically sublicense a single version of our
products to end users who must contact us in order to license their updates. We
typically receive a per-copy royalty from our OEMs.
OTHER MARKETING ACTIVITIES
Our principal means of marketing our products and services is through the
Internet. In addition to the NAI.com website, each of our product groups,
McAfee.com and myCIO.com have their own individual websites. Not only do each of
these websites contain various marketing materials and information about our
products, but website visitors may download and purchase products or obtain free
trials or our products or trial subscriptions for hosted products and services.
We also promote our products and services through advertising activities in
trade publications and direct mail campaigns and strategic arrangements. For
example, in December 1999 McAfee.com entered into an agreement with America
Online, or AOL, under which McAfee.com is the premier anti-virus service
provider on AOL, AOL.COM, and AOL's Shop@AOL marketplace. AOL will also sponsor
on a number of AOL's properties an anti-virus center, a PC download center and a
software development center. We also attend trade shows, sponsor conferences and
publish a quarterly newsletter, which is mailed to existing and prospective
customers.
CUSTOMERS
We primarily market our products to large corporate and government
customers directly through our direct sales organization and indirectly through
resellers and distributors. In terms of number of products available for sale, a
majority of our products are distributed indirectly through resellers and
distributors. In the U.S., substantially all our indirect sales are through five
major distributors. In Europe, substantially all indirect sales are also made
through five major distributors. See Note 14 of Notes to Condensed Consolidated
Financial Statements for major customer information.
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We primarily market our products directly to individual consumers through
online distribution channels and indirectly through traditional distribution
channels, such as retail stores. McAfee.com is responsible for online
distribution of our products sold to individual consumers over the Internet or
for Internet-based products and for the licensing of technology to original
equipment manufacturers for sale to individual consumers.
PRODUCT DEVELOPMENT AND ACQUISITION
We believe that our ability to maintain our competitiveness will depend in
large part upon our ability to enhance existing products, develop and acquire
new products and develop and integrate acquired products. The market for
computer software includes low barriers to entry and rapid technological change,
and is highly competitive with respect to timely product introductions. Product
enhancements or new products may not be developed or acquired on a timely basis
or at all. As part of our growth strategy, we have made and expect to continue
to make investments in complementary businesses, products and technologies. In
addition, we have made, and will continue to make, strategic minority
investments in complementary Internet-related companies.
In addition to developing new products, our internal development staff is
also focused on developing updates to existing products and modifying and
enhancing any acquired products. 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 cost is key
to our success. For example, the proliferation of new and changing viruses makes
it imperative to update anti-virus products frequently to avoid obsolescence.
Failure to release upgrades and updates could have a material adverse effect on
our business, results of operations and financial condition. We may not be
successful in these efforts. In addition, future changes in Windows 98, Windows
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 operation 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 operations and financial
condition.
We expended $148.2 million, $135.5 million and $103.1 million in the years
ended December 31, 1999, 1998 and 1997, respectively, on research and
development.
MANUFACTURING AND SUPPLIERS
Our manufacturing operations consist primarily of assembly, testing and
quality control of materials, components, subassemblies and systems for our
Sniffer-based and E-ppliance 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.
We have developed software-only versions of some of our Sniffer products.
Purchasers of these Sniffer software products are required to already own or
purchase directly from the manufacturer or other vendors the necessary hardware
products, such as computer platforms and components. Customers may require that
we continue to provide the necessary hardware products.
COMPETITION
The markets for our products are intensely competitive we expect
competition to increase in the near-term. We believe that the principal
competitive factors affecting the markets for our products include:
- performance;
- functionality;
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- quality;
- customer support;
- breadth of product line;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
- brand name recognition;
- reputation; and
- price.
We may be unable to compete effectively against existing and potential
competitors. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources. As
is the case in many segments of the software industry, we have been
encountering, and we expect to further encounter, increasing competition. This
increased competition could reduce average selling prices and, therefore, profit
margins. Competitive pressures could result not only in price reductions but
also in a decline in sales volume. In addition, competitive pressures may make
it difficult for us to maintain or exceed our growth rate.
Performance and quality of our anti-virus software products are measured by
number and type of viruses detected, the speed at which the products run and
ease of use. Our principal competitor in the anti-virus market serviced by our
McAfee product group and McAfee.com is the Peter Norton Group of Symantec. Trend
Micro remains the strongest competitor in the Asian anti-virus market. Other
competitors include numerous smaller companies and shareware authors that may in
the future develop into stronger competitors or be consolidated into larger
competitors.
Our principal competitors in the security market generally varies by
product type. For firewalls, our principal competitors include CheckPoint,
Axent, particularly for Windows NT-based firewalls, and larger companies such as
Cisco Systems and Microsoft. For intrusion detection products, we compete with
ISS, Axent and Cisco. The markets for encryption and virtual private network, or
VPN, products are highly fragmented with numerous small and large vendors.
Public key infrastructure, or PKI, encryption vendors such as Entrust
Technologies offer some products that compete with our PGP products. VPN
competitors include hardware and software vendors, including telecommunications
companies and traditional networking suppliers.
Our principal competitor in the network management market is Agilent. Other
competitors include Cisco, Computer Associates, Compuware, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies, Shomiti Systems and Wavetek Wandel & Goltermann, Inc.
Our principal competitors in the help desk market are Computer Associates,
Heat, Peregrine and Remedy.
We also face competition from large software companies such as Microsoft,
Intel, Novell and HP, which may offer network security and management products
as enhancements to their operating system.
Finally, as the network management market develops, we may face increased
competition from a number of large companies, as well as other companies seeking
to enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and support capabilities. In addition, to the extent that we
continue to develop our Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
we will likely compete with large computer systems management companies such as
Tivoli Systems and Computer Associates.
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PROPRIETARY TECHNOLOGY
Our success depends significantly upon proprietary software technology. We
rely on a combination of contractual rights, trademarks, trade secrets and
copyrights to establish and protect proprietary rights in our software. However,
these protections may be inadequate or competitors may independently develop
technologies or products that are substantially equivalent or superior to our
products. We do not typically obtain signed license agreements from our
corporate, government and institutional customers who license products directly
from us. Rather we include an electronic version of a "shrink-wrap" license in
all of our electronically distributed software and a printed license in the box
for our products distributed through traditional distributors in order to
protect our copyrights and trade secrets in those products. Since 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 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.
NETWORK ASSOCIATES/MCAFEE.COM INTERCOMPANY AGREEMENTS
For the purposes of defining our ongoing relationship with McAfee.com, our
publicly traded subsidiary, we have entered into a number of ongoing agreements.
These agreements are filed as exhibits to the public disclosure documents that
we file with the Securities and Exchange Commission and are described briefly
below. The description is subject in all respects to the terms of the actual
agreements.
LICENSE AGREEMENT: Under the terms of this agreement:
Licensed Technology. Network Associates and McAfee.com granted to each
other limited rights to each others' patents, copyrights, trademarks and
trade secrets for use in defined markets. Network Associates has worldwide,
non-exclusive rights to McAfee.com's patents and exclusive rights to use
copyrights, trademarks and trade secrets to deliver products and services
to enterprise customers and individual consumers by any means other than
the Internet. Under the agreement, McAfee.com is granted worldwide,
non-exclusive rights to Network Associate's patents and exclusive rights to
use Network Associate's copyright, trademark and trade secret rights to
create and deliver products and services directly or indirectly to
individual consumers over the Internet or for Internet, based products.
Each party is also permitted to create products derived from the technology
licensed to it by the other. The creating party retains ownership of their
newly derived products but these derived products are licensed to the other
party subject to the terms of the license agreement.
Royalty Payments. In consideration for the rights granted under the
license agreement, Network Associates is required to pay McAfee.com a flat
quarterly royalty of $250,000. In consideration for the rights granted by
Network Associates to McAfee.com under the license agreement, McAfee.com is
required to pay Network Associates a royalty on revenues recognized from
product and subscription sales that include Network Associates' technology,
initially at a rate of 20% commencing on January 1, 1999 and declining
1.625% per quarter until the rate is 7% in the quarter beginning January 1,
2001, and remaining at 7% thereafter.
Limitations on Offered Products. During the term of the agreement,
each party has agreed that it will not offer products incorporating
third-party technology if those products are competitive with the products
offered by the other party.
Indemnification. Under the agreement, each party has agreed to
indemnify, defend and hold harmless the other for any losses incurred in
connection with claims arising in the covered countries if the technology
licensed under the agreement violates the patent, copyright, trademark or
trade secrets or other proprietary rights of a third party. Covered
countries are those countries that are party to the Berne
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Convention for the Protection of Literary and Artistic Works, which include
the U.S. and substantially all U.N. member nations.
Term and Termination. The license agreement will remain in effect
indefinitely, but may be terminated, among other circumstances, by the
non-defaulting party, in the event of a material breach by the other party
that remains uncured for 30 days following notice of the breach, subject to
mandatory dispute resolution prior to the effectiveness of any proposed
termination.
Services Agreement: Under this agreement, Network Associates provides
services relating to tax, insurance, employee benefits and administration,
corporate record keeping and information technology. For these services, Network
Associates charges a portion of the cost of our provision of the services to
McAfee.com, including all related expenses, which is allocated based on
headcount, plus a ten percent mark-up. In addition, Network Associates may
provide additional services, including legal and accounting services, from
time-to-time in the future. The services agreement may be terminated either by
McAfee.com on 30 days notice or by Network Associates when it ceases to own a
majority of the outstanding voting stock of McAfee.com.
Registration Rights Agreement: Under this agreement, Network Associates, or
any transferee of at least 10% of its McAfee.com shares, can include its shares
of McAfee.com common stock in any future registration of common stock made by
McAfee.com, other than any registration statement relating to an acquisition or
stock option plan. In addition, after June 1, 2000, Network Associates or any
transferees of at least 10% of its McAfee.com shares can request that McAfee.com
file a registration statement so it can publicly sell their shares of McAfee.com
stock.
Joint Cooperation Agreement: The joint cooperation and master services
agreement with McAfee.com governs the provision of technology services among the
parties. Under this agreement, the Network Associates' anti-virus emergency
response team, known as AVERT, will provide McAfee.com with research and
solutions for virus events. The agreement also contains standard terms and
conditions governing the provision of technology services from one party to the
other under statements of work that may be negotiated from time to time. We pay
McAfee.com a fee for these services in an amount equal to 10% of McAfee.com's
total quarterly technology costs plus a 10% service charge.
Tax Sharing Agreement: Under this agreement, McAfee.com pays federal, state
and local income tax liability amounts to Network Associates, determined on a
pro forma basis, as if McAfee.com filed its own separate income tax returns for
each year. Network Associates will not reimburse McAfee.com for McAfee.com's or
any other group member's use of their net operating loss or other tax benefits
in any consolidated or combined return. However, McAfee.com will be able, during
the term of the agreement, to take into account its past and future net
operating loss and other tax attributes for purposes of computing its
hypothetical separate income tax return liability payment to, or refund from,
Network Associates.
The tax sharing agreement will terminate if McAfee.com is no longer
eligible to join Network Associates in the filing of a consolidated federal
income tax return. In the event of such termination, any net operating losses or
other carryforward amounts would not be available to McAfee.com upon departure
from the group. Under the agreement, McAfee.com will not be reimbursed for any
such loss of tax benefits.
Indemnification and Voting Agreement: Under this agreement, except as
contemplated below, Network Associates will indemnify and defend McAfee.com
harmless for all losses related to any third party claims relating to events or
circumstances arising out of any action or inaction of Network Associates,
including its subsidiaries and officers and directors, on or prior to December
2, 1999, the date on which McAfee.com completed its initial public offering.
Matters for which Network Associates is not obligated to indemnify McAfee.com
include:
- any obligations assumed by McAfee.com, or payments required to be made by
McAfee.com, under its agreements with Network Associates;
- any losses resulting from third party claims that are related to
intellectual property developed by McAfee.com between August 20, 1999 and
December 2, 2000;
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- any obligations incurred by McAfee.com in the ordinary course of
business;
- any losses resulting from third parties claims made against McAfee.com
alleging infringement of intellectual property rights unknown as of the
closing of McAfee.com's initial public offering; and
- any losses resulting from third parties claims related to or arising from
a material misstatement contained in or material omission from the
prospectus or the registration statement for McAfee.com's initial public
offering.
As a result of the above indemnification, we are, for example, required to
hold McAfee.com harmless from our existing litigation related to the anti-virus
technology licensed under the cross license agreement. In the event of a claim
relating to a product that includes components supplied by McAfee.com and
components supplied by us, Network Associates has the right to determine whether
and to what extent McAfee.com is entitled to indemnification, after reasonable
consultation with McAfee.com.
For so long as we own at least 20% of McAfee.com's outstanding voting
power, we must vote our shares of McAfee.com's capital stock in favor of the
election of two independent directors. Additionally, if, as described below
under the stockholders agreement, there is a Network Associates' change of
control which is not approved by the continuing Network Associates directors, we
have agreed to vote to elect a majority of independent directors to McAfee.com's
board.
Stockholders Agreement: Under this agreement, we have agreed that if (1)
without the prior approval of the Network Associates continuing directors, as
defined below, any person acquires or agrees to acquire 15% or more of our
outstanding common stock or (2) the Network Associates continuing directors
cease to constitute a majority of serving directors, then for so long but only
for so long as that condition exists:
- our shares of McAfee.com Class B common stock are entitled to only one
vote per share instead of three votes per share; and
- we are obligated to vote our McAfee.com shares to cause, and to take such
actions reasonably within our control to cause, and to seek to cause the
McAfee.com directors appointed by us to cause, McAfee.com's 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.
EMPLOYEES
As of December 31, 1999, we employed 2,686 individuals worldwide.
Competition for qualified management and technical personnel is intense in the
software industry. Our continued success will depend in part upon our ability to
attract and retain qualified personnel. None of our employees is represented by
a labor union and we believe that our employee relations are good.
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RISK FACTORS
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.
OUR QUARTERLY FINANCIAL RESULTS WILL LIKELY FLUCTUATE
Our quarterly operating results have varied greatly in the past and will
likely vary greatly in the future depending upon a number of factors. Many of
these factors are beyond our control. Our revenues, gross margins and operating
results may fluctuate significantly from quarter to quarter due to, among other
things:
- volume, size and timing of new licenses and renewals of existing
licenses;
- our distributor inventory levels and product return rates;
- our inventory levels;
- introduction of new products, product upgrades or updates by us or our
competitors;
- the mix of products we sell;
- the size and timing of our non-cash stock-based charges;
- changes in product prices by us or our competitors;
- trends in the computer industry;
- our ability to develop, market and sell our products particularly in
light of our recent sales force reorganization;
- costs related to acquisitions of technology or businesses;
- fluctuations in McAfee.com's expenditure levels related to its efforts to
build brand awareness, and establish strategic relationships with various
Internet companies;
- fluctuations in myCIO.com's expenditure levels related to its efforts to
develop new products, adapt existing products to an application service
provider (or ASP) delivery model and build brand awareness;
- our investment experience related to our strategic minority equity
investments;
- the effectiveness of and the expenditure levels related to the recent
expansion of our European Sniffer organization;
- the effectiveness of our channel strategy and our mix of direct and
indirect revenues;
- pressure on employee wages as competition for skilled employee's
increases; and
- costs related to extraordinary events including litigation and
acquisitions.
Our business is impacted by the seasonal trends and global or regional
macroeconomic trends. For example, our net 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.
WE FACE RISKS RELATED TO THE DIVISION OF OUR BUSINESS INTO PRODUCT GROUPS
On January 1, 2000, we divided our business into four product groups:
McAfee, which markets the McAfee Active Virus Defense (AVD) product suite;
Sniffer Technologies, which markets the Sniffer Total Network Visibility (TNV)
product suite; PGP Security, which markets the PGP Total Security Defense
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(TSD) product suite; and Magic Solutions, which markets the Magic Total Support
Desk (TSD) product suite. These four individual product suites form our single
Net Tools mega suite. This reorganization, along with a related product group
sales force reorganization, is intended to allow us to react faster to
customer's needs and to focus each product group's sales force on selling their
respective product suite and the individual point products contained in those
product suites. As part of this reorganization, we also reorganized our U.S.
professional services organization around our product groups. Our customers and
potential customers, sales force and professional services organization may not
respond favorably to the change and our business and future financial
performance could suffer. This reorganization may be unsuccessful due to, among
other things:
- uncertainty and customer dissatisfaction surrounding our shift in focus
from our "Net Tools" mega-suite strategy to our product group's strategy,
including uncertainty as to our continued level of support for the Net
Tools mega suite and continued integration of our various product suites;
- customer confusion or irritation related to multiple sales calls from
different members of our reorganized sales force;
- a loss of potential cross selling opportunities and a lack of lead
sharing between the separate product group's sales representatives who
are generally only compensated for sales made by them of products within
their product groups;
- failure by our employees to embrace the changes, resulting in possible
declines in sales force productivity or employee departures;
- the possibility that our centralized general and administrative group may
be unable to meet on a timely basis or at all each product group's
individualized infrastructure and support requirements; and
- one or more of our product groups may lack sufficient qualified
professional services personnel to support its products.
WE COULD EXPERIENCE CUSTOMER AND MARKET CONFUSION DUE TO OUR MARKETING AND
ADVERTISING EFFORTS TARGETED AT THE PRODUCT GROUP OR SUBSIDIARY LEVEL, RATHER
THAN AT THE CORPORATE LEVEL, AND DUE TO SIMILARITIES IN THE NAMES USED BY OUR
PRODUCT GROUPS AND SUBSIDIARIES
Networks Associates, Inc. was formed in December 1997, by the combination
of McAfee Associates, Inc. and Network General Corporation. Over the last two
years, we have spent a significant portion of our total marketing efforts and
advertising spending building awareness of the Network Associates name. In the
future, we plan to focus our marketing efforts and advertising spending on
building brand awareness at the product group and subsidiary level, rather than
at the Network Associates corporate level. This could create confusion in the
market place and in the investor community if people are not clear about the
relationship between Network Associates, our product groups and our McAfee.com
and myCIO.com subsidiaries, many of which have potentially confusing names and
products. For example, our online consumer anti-virus products, our retail and
corporate anti-virus products (other than those hosted online) and our corporate
hosted anti-virus products are marketed and sold, respectively, by our publicly
traded McAfee.com subsidiary, our retail division which is called McAfee Retail
and our McAfee product group and our myCIO.com subsidiary.
THE TIMING AND AMOUNT OF OUR REVENUES ARE SUBJECT TO A NUMBER OF FACTORS THAT
MAKE IT DIFFICULT TO ESTIMATE OPERATING RESULTS PRIOR TO THE END OF A QUARTER
We do not expect to maintain a significant level of backlog. As a result,
product revenues in any quarter are dependent on contracts entered into or
orders' booked and shipped in that quarter. We have generally experienced a
trend toward higher order receipt, and therefore a higher percentage of revenue
shipments, toward the end of the last month of a quarter. This trend makes
predicting revenues more difficult. The timing of closing larger orders
increases the risk of quarter-to-quarter fluctuation. If orders forecasted for a
specific customer for a particular quarter are not realized or revenues are not
otherwise recognized in that quarter, our operating results for that quarter
could be materially adversely affected.
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OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE
During 1999, our stock price ranged from a per-share high of $61.25 to a
low of $11.06. 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 current and future
stock price volatility. We may not discover, or be able to confirm, revenue or
earnings shortfalls until the end of a quarter, which could result in an
immediate drop in our stock price. In addition, similar events with respect to
McAfee.com, our publicly traded subsidiary, and fluctuations in its stock price
may also contribute to the volatility of our stock price. In the past, following
periods of volatility in the market price of a company's securities, securities
class action litigation has often been instituted against companies with public
traded securities. A number of putative class actions were brought against our
officers, directors and us. See Item 3 Legal Proceedings. This litigation, and
any other litigation if instituted, could result in substantial costs and a
diversion of management's attention and resources.
COMPETITORS MAY INCLUDE PRODUCTS SIMILAR TO OURS IN THEIR HARDWARE OR SOFTWARE
AND RENDER OUR PRODUCTS OBSOLETE
Vendors of hardware and of operating system software or other software
(such as firewall or e-mail software) may enhance their products or bundle
separate products to include network security and management software similar to
our products. The widespread inclusion of products that perform the same or
similar function as our products within computer hardware or other software
could render our products obsolete and unmarketable. Furthermore, even if these
incorporated products are inferior or more limited than our products, customers
may elect to accept the incorporated products rather than purchase our products.
If we are unable to develop new network security and management products to
further enhance operating systems or other software and to successfully replace
any obsolete products, our business could suffer.
WE EXPECT SIGNIFICANT STOCK BASED COMPENSATION CHARGES RELATED TO REPRICED
OPTIONS
In light of the decline in our stock price at the time and in an effort to
retain our employee base, in April 1999, we offered to reprice options held by
all employees, other than directors and executive officers. If the employee
agreed not to exercise any of the repriced options for a period of twelve
months, the exercise price of their eligible employee options with an exercise
price in excess of $11.0625 was reduced to $11.0625, the closing market price on
the NASDAQ on April 22, 1999. Option holders electing to have their options
repriced were required to acknowledge their acceptance by April 28, 1999. As a
result of the increase in price between the date on which the options were
repriced, April 22, 1999, and the date on which the employees elected to reprice
their option grants, April 28, 1999, we have and will continue to incur a
stock-based compensation charge. The total compensation charge expensed for 1999
was approximately $8.8 million, and approximately $11.6 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 sometime in the year 2000.
Depending upon movements in the market value of our common stock, this
accounting treatment may result in significant additional compensation charges
in future periods.
EMPLOYEES MAY LEAVE AFTER THE 12-MONTH LOCK UP PERIOD ON THE EXERCISE OF
REPRICED EMPLOYEES OPTIONS
Employees whose options were repriced to $11.0625 per share, as described
above, agreed to not exercise any of the repriced options for a period of twelve
months. After April 22, 2000, the end of this 12-month lock-up period, employees
may elect to terminate their employment with us and exercise and sell some or
all of their repriced vested options. The departure of a large number of our
employees or a meaningful number of
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key non-executive employees could have a material adverse impact on many facets
of our business, including our ability to develop new products, upgrade existing
products, sell our products and provide adequate internal infrastructure.
WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE TRANSACTIONS
The software industry has experienced, and is expected to continue to
experience, a significant amount of consolidation. As part of our growth
strategy, we may buy or make investments in, complementary companies, products
and technologies. Since 1995 we have completed a large number of significant
acquisitions involving both public and private companies, including:
- CyberMedia in September 1998;
- Dr. Solomon's in August 1998;
- Secure Networks in May 1998;
- Magic Solutions and TIS in April 1998;
- Network General, PGP and Helix Software in December 1997;
- Cinco Networks in August 1997 (acquired by Network General);
- Vycor Corporation in February 1996; and
- Saber Software in August 1995.
We have also completed a number of smaller acquisitions and acquired a
number of our international distributors. Recently, we began making strategic
minority investments in complementary Internet related companies. As of December
31, 1999, these minority investments totaled $20.2 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.
In 1997 and 1998, we incurred significant nonrecurring charges associated
with our previous acquisitions. Our available cash and our securities may be
used to buy or invest in companies or products, which could result in
significant acquisition-related charges to earnings and dilution to our
stockholders. Moreover, if we buy a company, we may have to incur or assume that
company's liabilities, including liabilities that are unknown at the time of
acquisition, which may result in a material adverse effect on us.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE
NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT
In connection with our previous acquisitions accounted for under the
purchase method of accounting, in future periods we will experience significant
charges related to the amortization of purchased technology and goodwill. In
addition, if we later determine that this purchased technology and goodwill is
impaired, we will be required to take a related non-recurring charge to
earnings.
WE FACE RISKS RELATED TO OUR SNIFFER STRATEGY
We recently began investing significant resources to increase the European
Sniffer sales organization in an effort to increase brand awareness in Europe.
There is no guarantee that this investment will produce the desired results.
Certain of the Sniffer products contain critical components supplied by a
limited number of third party suppliers.
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OUR HARDWARE BASED PRODUCTS FACE MANUFACTURING, SUPPLY, INVENTORY, LICENSING AND
OBSOLESCENCE RISKS
Some of our Sniffer products and E-ppliance products include, in addition
to our software, a hardware platform as well as software licensed from other
companies. Third party manufacturers do the manufacturing of these products
under contract for us. Reliance on third party manufacturers involves a number
of risks, including the lack of control over the manufacturing process and the
potential absence or unavailability of adequate capacity. In the event that any
third party manufacturers cannot or will not continue to manufacture our
products in required volumes, on a cost effective basis, in a timely manner or
at all, we will have to secure additional manufacturing capacity. Even if such
additional capacity is available at commercially acceptable terms, the
qualification process could be lengthy and could create delay in product
shipments.
Our hardware-based products contain critical components supplied by a
single or a limited number of third parties. We have been required to purchase
certain computer platforms around which we design our network fault and
performance management products to ensure an available supply of these products
for our customers. Any significant shortage of these platforms or other
components or the failure of the third party supplier to maintain or enhance
these products could lead to cancellations of customer orders or delays in
placement of orders.
Some of our hardware based products incorporate licensed software, such as
operating system software. Our ability to successfully market these products
depends on our ability to obtain reasonably priced licenses from third party
software providers, as well as on our ability to integrate our hardware and
software with the software provided from third parties. If we are unable to
obtain software licenses from third parties or to integrate third party software
with our hardware products, our ability to market hardware based products would
suffer.
Hardware based products may face greater obsolescence risks than software
products. If our hardware products are not easily upgradable to meet future
market needs, they may become obsolete. In addition to lost future sales, we
could incur losses or other charges in disposing of obsolete inventory, both of
which could also materially adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR MYCIO.COM STRATEGY
In January 2000, we launched a new wholly owned subsidiary, myCIO.com.
myCIO.com is an infrastructure ASP which delivers to businesses hosted network
security and availability services via the Internet. This web-based model is a
relatively new concept and there is a risk that myCIO.com and its products may
fail to gain market acceptance.
The growth, market acceptance and ultimate profitability of myCIO.com's
online network security and availability services is highly uncertain and
subject to a number of factors, including:
- myCIO.com's ability to successfully adapt existing products or develop
new or enhanced products that operate in fast, secure and reliable manner
over the Internet;
- increased expenditures associated with the creation of a new business,
such as product development, marketing and technical and administrative
support;
- the introduction of new products by myCIO.com or myCIO.com's competitors;
- potential unwillingness of businesses to pay for myCIO.com's subscription
based products and services and its ability to properly price its
products and services to generate the greatest revenue opportunities;
- business reluctance to change their software purchasing behavior in favor
of services hosted on the myCIO.com servers; and
- business concerns about whether the Internet is fast, reliable and secure
enough to deliver critical network security and availability services
effectively.
There is a risk that sales of myCIO.com's products may significantly reduce
the sales of the products offered by our product groups. These sales may result
in less overall revenue and profit for us if the prices and
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profit margins of myCIO.com's products are less than the prices and profit
margins of comparable products offered by our product groups.
myCIO.com is likely to incur significant losses for the foreseeable future.
These losses will be funded by us and will impact our consolidated financial
results.
WE FACE RISKS RELATED TO OUR MCAFEE.COM STRATEGY
In December 1998, we incorporated McAfee.com as our Internet destination
dedicated to updating, upgrading and managing PCs, over the Internet for single
use retail, non-corporate, consumers. We have entered into various inter-company
arrangements including technology, licenses, shared facilities, functions,
services and tax sharing agreements with McAfee.com. On December 2, 1999,
McAfee.com completed an initial public offering. At December 31, 1999, we owned
36.0 million shares of McAfee.com's Class B common stock, which is generally
entitled to three votes per share and converts to shares of McAfee.com Class A
common stock if sold by us to a third party. McAfee.com Class A common stock is
entitled to one vote per share. At December 31, 1999, our McAfee.com holdings
represented approximately 83% of McAfee.com's outstanding capital stock and
approximately 94% of its total voting power.
Pursuant to our cross license agreement with McAfee.com, we have licensed
all our technology to McAfee.com for use in the markets specified below and
McAfee.com has licensed its technology to us for our use outside of McAfee.com's
markets. Under our license and other agreements with McAfee.com, among other
things:
- McAfee.com has the exclusive right to use the licensed technology for
providing single-user consumer licenses for our products and services
sold over the Internet or for Internet-based products and licensing the
technology to original equipment manufacturers for sale to individual
consumers;
- we are permitted to continue to sell our consumer products through
non-online channels, such as traditional retail stores, however
McAfee.com's sales of online products and services could significantly
reduce sales of these products;
- we may not offer a product incorporating third party technology if those
products are competitive with products offered by McAfee.com;
- McAfee.com is required to pay us a license fee of 20% of net revenue
derived from product sales that include the licensed technology
commencing on January 1, 1999 and declining 1.625% per quarter until the
rate is 7% in the quarter beginning January 1, 2001;
- the license agreement is perpetual and may only be terminated by us if
McAfee.com fails to cure a material breach of the license within 30 days
after we notify it of the breach, subject to mandatory dispute resolution
prior to the effectiveness of any proposed termination;
- we are required to indemnify McAfee.com with respect to existing
litigation related to the licensed technology to which we are a party,
including the litigation described in Note 15 of the Notes to the
Consolidated Financial Statements;
- McAfee.com has agreed to provide, and we are dependent on McAfee.com to
provide continuously and successfully, the infrastructure and technical
support for our web site;
- generally, we are required to cause to be elected at least two
independent directors to the McAfee.com board of directors, which term
would exclude any serving Network Associates officer or director; and
- if, without the prior approval of our continuing directors (being our
current directors and directors approved or not objected to by our
current directors), someone acquires 15% or more of our outstanding
capital stock or our continuing directors cease to constitute a majority
of our board (1) we are required to vote our shares of McAfee.com common
stock and otherwise seek to cause to the McAfee.com board of directors to
consist of at least a majority of independent directors and (2) our
shares of McAfee.com Class B common stock will be entitled to only one
vote per share instead of three.
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We expect that the McAfee.com business will incur significant losses for
the foreseeable future. These losses will impact our consolidated financial
results. The growth and market acceptance of McAfee.com's online PC security and
management products and services is highly uncertain and subject to a number of
factors, including:
- potential unwillingness of consumers to pay for McAfee.com's subscription
based products and services and its ability to properly price its
products and services to generate the greatest revenue opportunities;
- consumer reluctance to change their software purchasing behavior in favor
of services hosted on the McAfee.com's servers; and
- consumer concerns about whether the Internet is fast and reliable enough
to deliver critical PC security and management functions effectively.
McAfee.com's services are designed to protect consumer privacy by ensuring
that all PC scans are done locally at the PC, all information about the user's
PC is transmitted to it anonymously and no scanned data is stored by it.
However, consumers' misconceptions about this process could prevent McAfee.com's
ASP model from achieving market acceptance.
WE FACE RISKS RELATED TO THE ALLOCATION OF PRODUCTS, CUSTOMERS AND TERRITORIES
AMONG OUR PRODUCT GROUPS AND SUBSIDIARIES
We are continuing to focus our business around our products, our customers
and geographic territories. Our product groups are primarily product focused
selling their specific product suites. McAfee.com and myCIO.com are both product
and customer focused primarily selling their products and services over the
Internet to consumers and businesses, respectively. NAI KK is both
geographically and customer focused, selling Network Associates' products on a
generally exclusive basis in Japan and to large Japanese business customers
outside of Japan. Except as provided under our technology licensing agreements
and arrangements, we do not currently have in place a policy to govern the
pursuit or allocation of business opportunities between our subsidiaries and
product groups. These and any future internal allocation of products, customers
and territories could result in, among other things:
- sales force conflict;
- customer confusion surrounding the entity or party with whom they are
expected to deal;
- disputes over product and research and development priorities;
- disputes over allocation of corporate resources and focus; and
- loss of management focus due to efforts spent to resolve internal
conflicts.
WE MUST ADAPT TO THE RAPIDLY CHANGING BUSINESS ENVIRONMENT BROUGHT ON BY THE
WIDESPREAD USE OF THE INTERNET
We have integrated the use of the Internet in many parts of our business,
including sales, distribution and support of our products. There are still many
uncertainties regarding many facets of the Internet, including reliability,
security, access, tax, government regulation and cost. We also run the risk of
not adapting to the latest changes in the Internet, which could affect our
business operations. If growth of the Internet does not develop at the rapid
pace we expect, our operating results could be adversely affected.
WE FACE RISKS RELATED TO OUR STRATEGY OF ACQUIRING INDEPENDENT AGENTS AND
DISTRIBUTORS
We have acquired existing independent agents and distributors of our
products in certain strategic markets. We may be required to provide customers
the same level of technical support that was previously provided by the acquired
agents and distributors. We may be unable to provide technical support or
operate any acquired distributor or agent as well as previous operators or at
all. The acquisition of any distributor or agent may not result in increased
foreign revenues.
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OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISK
ASSOCIATED WITH PRODUCT DEVELOPMENT
The network security and management market is highly fragmented and
characterized by ongoing technological developments, evolving industry standards
and rapid changes in customer requirements. Our success will depend on our
ability to:
- offer a broad range of network security and management software products;
- continue to enhance existing products and expand product offerings;
- develop and introduce in a timely manner new products with technological
advances;
- respond promptly to new customer requirements;
- comply with evolving industry standards without delays in compliance;
- provide upgrades and updates to users frequently and at low cost; and
- remain compatible with popular operating systems such as Windows 98,
Windows NT and NetWare.
We may not be able to successfully develop and market, on a timely basis,
enhancements to our existing products or new products. Our product enhancements
or new products may not adequately address the changing needs of the
marketplace. New products with new technological capabilities could replace or
shorten the life cycle of our products or cause our customers to defer or cancel
purchases of our products.
We may continue to experience delays in software development as we have at
times in the past. Complex software products like ours may contain undetected
errors or version compatibility problems, particularly when first released,
which could delay or cost us our market acceptance. For example, our anti-virus
software products have in the past falsely detected viruses that did not
actually exist. Difficulties and delays associated with new product
introductions, performance or enhancements could have a material adverse effect
on our business, financial condition and results of operation.
Our product development efforts are impacted by the adoption or evolution
of industry standards. For example, no uniform industry standard has developed
in the market for encryption security products. As industry standards are
adopted or evolve, we may have to modify existing products or develop and
support new versions of existing products. In addition, if no industry standard
develops, our products and our competitors' products could be incompatible,
which could prevent or delay overall development of the market for a particular
product. If our products fail to comply with existing or evolving industry
standards in a timely fashion, our business, results of operation and financial
condition could be materially and adversely affected.
Our long-term success depends on our ability to upgrade and update existing
product offerings, modify and enhance acquired products and introduce new
products, which meet our customers' needs. Future upgrades and updates may
include additional functionality, respond to user problems or address
compatibility problems with changing operating systems and environments. We
believe that our ability to provide these upgrades and updates frequently and at
low costs is key to our success. For example, the proliferation of new and
changing viruses makes it imperative to update anti-virus products frequently to
avoid obsolescence. Failure to release upgrades and updates could have a
material adverse effect on our business, results of operations and financial
condition. We may not be successful in these efforts. In addition, future
changes in Windows 98, Windows NT, NetWare or other popular operating systems
could cause compatibility problems with our products. Further, delays in the
introduction of future versions of operating systems or lack of market
acceptance of these future versions would delay or reduce demand for our future
products which were designed to operate with these future operating systems. Our
failure to introduce in a timely manner new products that are compatible with
operating systems and environments preferred by desktop computer users would
have a material adverse effect on our business, results of operation and
financial condition.
WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenues from our
flagship McAfee anti-virus software products and Sniffer network fault and
performance management products. These products are expected to
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continue to account for a significant portion of our net revenues for the
foreseeable future. Because of this concentration of revenue, a decline in
demand for or in the prices of these products as a result of competition,
technological change, a change in our pricing model, inclusion of anti-virus or
network management and analysis software as a standard part of hardware or
operating system software or other software, or a maturation in the markets for
these products, could harm our business.
IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE
ANTICIPATE, OUR BUSINESS COULD SUFFER
The markets for our network management and network security products are
evolving, and their growth depends upon broader market acceptance of this
software, including help desk software. Although the number of PCs, attached to
large-area networks has increased dramatically, the network management and
network security markets continue to be emerging markets. These markets may not
continue to develop or may not develop rapidly enough to benefit our business
significantly. In addition, there are a number of potential approaches to
network management and network security, including the incorporation of
management and security tools into network operating systems. Therefore, even if
network management and network security tools gain broader market acceptance,
potential purchasers may not select our products. To the extent that either the
network management or network security market does continue to develop, we
expect that competition will increase.
WE ARE SUBJECT TO INTENSE COMPETITION IN THE NETWORK MANAGEMENT AND SECURITY
MARKETS AND WE EXPECT TO FACE INCREASED COMPETITION IN THE FUTURE
The markets for our products are intensely competitive we expect
competition to increase in the near-term. We believe that the principal
competitive factors affecting the markets for our products include:
- performance;
- functionality;
- quality;
- customer support;
- breadth of product line;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
- brand name recognition;
- our reputation; and
- price.
We may be unable to compete effectively against existing and potential
competitors. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources.
These factors may provide our competitors with an advantage in penetrating the
original equipment manufacturer market with their network security and
management products. As is the case in many segments of the software industry,
we have been encountering, and we expect to further encounter, increasing
competition. This increased competition could reduce average selling prices and,
therefore, profit margins. Competitive pressures could result not only in price
reductions but also in a decline in sales volume, which could cause our business
to suffer. In addition, competitive pressures may make it difficult for us to
maintain or exceed our growth rate.
Performance and quality of our anti-virus software products are measured by
number and type of viruses detected, the speed at which the products run and
ease of use. Our principal competitor in the anti-virus
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market serviced by our McAfee product groups and McAfee.com is the Peter Norton
Group of Symantec. Trend Micro remains the strongest competitor in the Asian
anti-virus market. Other competitors include numerous smaller companies and
shareware authors that may in the future develop into stronger competitors or be
consolidated into larger competitors.
Our principal competitors in the security market generally varies by
product type. For firewalls, our principal competitors include CheckPoint,
Axent, particularly for Windows NT-based firewalls, and larger companies such as
Cisco Systems and Microsoft. For intrusion detection products, we compete with
ISS, Axent and Cisco. The markets for encryption and virtual private network, or
VPN, products are highly fragmented with numerous small and large vendors.
Public key infrastructure, or PKI, encryption vendors such as Entrust
Technologies offer some products that compete with our PGP products. VPN
competitors include hardware and software vendors, including telecommunications
companies and traditional networking suppliers.
Our principal competitor in the network management market is Agilent. Other
competitors include Cisco, Computer Associates, Compuware, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies, Shomiti Systems and Wavetek Wandel & Goltermann, Inc.
Our principal competitors in the help desk market are Computer Associates,
Heat, Peregrine and Remedy.
We also face competition from large software companies such as Microsoft,
Intel, Novell and HP, which may offer network security and management products
as enhancements to their operating system.
Finally, as the network management market develops, we may face increased
competition from a number of large companies, as well as other companies seeking
to enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and support capabilities. In addition, to the extent that we
continue to develop our Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
we will likely compete with large computer systems management companies such as
Tivoli Systems and Computer Associates.
OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH COULD
ADVERSELY AFFECT OUR BUSINESS
Our products may be considered to be capital purchases by certain customers
or prospective customers. Capital purchases are often discretionary and,
therefore, are canceled or delayed if the customer experiences a downturn in its
business or prospects or as a result of economic conditions in general. Any
cancellation or delay could adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR SALES FORCE STRUCTURE AND ITS RECENT RESTRUCTURING
Our non-governmental sales force is organized by product group, with four
separately focused sales organizations selling our McAfee, Sniffer Technology,
PGP Security and Magic Solutions products and product suites. All four sales
organizations consist of field sales representatives who are located regionally
and outbound telesales representatives who actively focus on selling our
individual product suites. The telesales representatives focus on small
customers and transactions. McAfee.com has, and myCIO.com is developing, a
separate sales force, focusing on selling their ASP solution directly to
consumers and businesses, respectively. To succeed in the direct sales channel,
we must build a significant direct sales organization and must attract and
retain qualified personnel. These individuals will require training about, and
knowledge of, product attributes of the products and product suites sold by
them. We may not succeed in building the necessary sales organization or in
attracting, retaining or training these individuals.
In January 2000 we divided our U.S. direct sales force among our four
product groups, in part, to focus our sales force on selling specialized product
suites versus selling each of the various product suites that form our Net Tools
mega suite. Our customers and potential customers and sales force may not
respond favorably
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to the restructuring and our revenues, business and future financial performance
could suffer materially. In addition to customer and sales related risks
described above:
- disputes may occur between our product group sales forces;
- sales representatives may lose productivity while being retrained or
while refocusing their sales efforts; and
- sales representatives may terminate their employment with us.
Although our increased direct sales efforts may also reduce our dependence
on resellers and distributors, it may also lead to conflicts for the same
customers, further customer confusion and may result in pressure by current and
prospective customers for price reductions on products.
WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES, WHO MAY NOT VIGOROUSLY MARKET OUR
PRODUCTS, HAVE RIGHTS OF RETURN OR MAY HAVE DIFFICULTY IN TIMELY PAYING FOR
PURCHASED PRODUCTS
We market a significant portion of our products to end-users through
intermediaries, including distributors, resellers and value-added resellers. Our
distributors sell other products that are complementary to, or compete with, our
products. While we encourage our distributors to focus on our products through
market and support programs, these distributors may give greater priority to
products of other suppliers, including competitors. Our agreements with our
distributors generally permit our distributors to return our product to us in
the event of end user returns to the distributor, inaccurate estimates of end
user demand by the distributor, increased purchases by distributors in response
to sales incentives or transitions to new products. We record sales to
distributors as revenue and at the same time establish a reserve for returns.
Actual returns could exceed reserves as a result of distributors holding
excessive amounts of our product in inventory. Our current or future reserves
for returns could be inadequate which would adversely impact our operating
results.
Some of our distributors are experiencing economic difficulties worldwide,
which may adversely impact our collection of accounts receivable. For example,
one of our major European distributors, which had been experiencing significant
cash flow issues, declared bankruptcy. 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.
WE NEED TO EXPAND AND DEVELOP AN EFFECTIVE PROFESSIONAL SERVICES ORGANIZATION;
WE RELY ON THIRD-PARTY PROFESSIONAL SERVICES
As our products and computer networks in general increase in complexity,
customers require greater professional assistance to design, install, configure
and implement our products. To date, we have relied on our limited professional
services capabilities and increasingly on outside professional service
providers, including our distributors, resellers and system integrators. These
third party service providers may provide inadequate levels of professional
services. Moreover, reliance on these third parties both places a greater burden
on them and reduces our ability to control and establish standards for providing
these support services. Our reliance on these third parties could, delay our
recognition of product revenue, harm our relationships or reputation with these
third parties or the end users of our products or result in decreased future
sales of, or prices for, our products.
The failure to develop and maintain an effective professional services
organization could have a material adverse effect on our business. To more
effectively service our customer's evolving needs, we intend to significantly
expand and develop our worldwide professional service organization. We may not
succeed in 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
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existing providers of professional services and future entrants. We must also
properly price our services to attract customers, while maintaining sufficient
margins for these services. We therefore expect that we will have lower profit
margins on our service revenues. In addition, in January 2000, we reorganized
our U.S. professional services organization, in part, to enable the professional
services organization to become more specialized on individual products and
product suites. As a result, a particular product group may have insufficient
qualified personnel to perform its professional services needs as there will no
longer be a "pool" of professional service personnel from which to draw. A
product group's lack of sufficient professional services personnel could lead to
customer dissatisfaction, missed revenue opportunities and a loss of future
business.
WE RELY ON THE CONTINUED PROMINENCE OF MICROSOFT TECHNOLOGY
Although we intend to support other operating systems, our mission is to be
the leading supplier of network security and management products for Windows
NT/Intel based networks. Sales of our products would be materially and adversely
affected by market developments that are adverse to the Windows operating
environments, including the failure of users and application developers to
accept Windows NT. In addition, our ability to develop products using the
Windows operating environments is dependent on our ability to gain timely access
to, and to develop expertise in, current and future developments by Microsoft.
We may not be able to gain the necessary access from Microsoft.
WE MAY FAIL TO SUPPORT OPERATING SYSTEMS WHICH SUCCESSFULLY COMPETE WITH
MICROSOFT'S TECHNOLOGY, INCLUDING COMPETING VERSIONS OF THE UNIX OPERATING
SYSTEM
We are expanding our product support to include the Unix operating system
and the Linux operating system. Sales of our products could be materially and
adversely impacted by our failure to support those versions of the Unix
operating system or competing operating systems that receive broad market
acceptance. The Unix system encompasses many separate operating systems of which
we only support a few, including for example, Sun Microsystem's Solaris Unix
operating system.
WE MUST EFFECTIVELY MANAGE OUR GROWTH
Our business has grown rapidly, both internally and through acquisitions.
This growth has placed, and any future growth would continue to place, a
significant strain on our limited personnel, management and other resources. Our
ability to manage any future growth, particularly with the anticipated expansion
of our international business and our ASP businesses, and growth in distribution
business, will require us to:
- attract, train, retain, motivate and manage new employees successfully;
- effectively integrate new employees into our operations; and
- continue to improve our operational, financial, management and
information systems and controls.
If we continue to grow, our management systems currently in place may be
inadequate or we may not be able to effectively manage this growth. We are
currently investing in our Internet infrastructure in anticipation of expected
growth from the Internet, which may fail to materialize.
WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WHICH OFFER ONLY LIMITED
PROTECTION AGAINST POTENTIAL INFRINGERS; WE MAY FACE LITIGATION RELATED TO OUR
PROPRIETARY TECHNOLOGY AND RIGHTS.
Our success depends significantly upon our proprietary software technology.
We rely on a combination of contractual rights, trademarks, trade secrets,
patents and copyrights to establish and protect proprietary rights in our
software. However, these protections may be inadequate or competitors may
independently develop technologies or products that are substantially equivalent
or superior to our products. We do not typically obtain signed license
agreements from our corporate, government and institutional customers who
license products directly from us. Rather, we include an electronic version of a
shrink-wrap license in all of our electronically distributed software and a
printed license in the box for our products distributed through traditional
distributors in order to protect our copyrights and trade secrets in those
products. Since the licensee has not signed any of these licenses, many legal
authorities believe that such licenses may not be enforceable
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under the laws of many states and foreign jurisdictions. In addition, the laws
of some foreign countries either do not protect these rights at all or offer
only limited protection for these rights. The steps taken by us to protect our
proprietary software technology may be inadequate to deter misuse or theft of
this technology. For example, we are aware that a substantial number of users of
our anti-virus products have not paid any registration or license fees to us.
Changing legal interpretations of liability for unauthorized use of the our
software, or lessened sensitivity by corporate, government or institutional
users to avoiding infringement of intellectual property, could have a material
adverse effect on our business, results of operations and financial condition.
There has been substantial litigation regarding the intellectual property
rights of technology companies. The increased issuance of software patents in
recent years has led to and is likely to continue to lead to increased patent
and intellectual property litigation in the software industry. In the past we
have been, and we currently are, subject to litigation related to our
intellectual property, including separate patent infringement cases involving
Hilgraeve and Trend Micro. See Item 3 Legal Proceedings. 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 our products or us. Uncertainties inherent in the litigation
process involve, among other things, the complexity of the technologies
involved, potentially adverse changes in the law and discovery of facts
unfavorable to us.
In addition, as we may acquire a portion of software included in 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 1999, 1998 and 1997, net revenue from international sales represented
approximately 40%, 36%, and 36%, respectively, of our net revenue. 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 impact of foreign currency fluctuations, we use non-leveraged
forward currency contracts. However, our future results of operations may be
adversely affected by
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currency fluctuations or by costs associated with currency risk management
strategies. Other risks inherent in international revenue generally include:
- the impact of longer payment cycles;
- greater difficulty in accounts receivable collection;
- unexpected changes in regulatory requirements;
- seasonality due to the slowdown in European business activities during
the third quarter;
- tariffs and other trade barriers;
- export restrictions on our encryption and other security products;
- uncertainties relative to regional economic circumstances, including the
current economic turbulence in Asia;
- political instability in emerging markets and difficulties in staffing;
and
- managing foreign operations.
These factors may have a material adverse effect on our future
international license revenue. Further, in countries with a high incidence of
software piracy, we may experience a higher rate of piracy of our products.
In addition, a portion of our international revenue is expected to continue
to be generated through independent agents. Since these agents are not our
employees and are not required to offer our products exclusively, they may
discontinue marketing our products entirely. Also, we may have limited control
over these agents, limited access to the names of the customers to whom these
agents sell its products and limited knowledge of the information provided by,
or representations made by, these agents to its customers.
COMPUTER "HACKERS" MAY DAMAGE OUR PRODUCTS AND SERVICES
Given our high profile in the security software market, we have been a
target of computer hackers who have, among other things, created viruses to
sabotage or otherwise attack our products. While to date these efforts have been
discovered quickly and their adverse impact has been limited, similar viruses or
efforts may be created or replicated in the future. In this event, users'
computer systems could be damaged and demand for our software products may
suffer as a result. In addition, since we do not control diskette duplication by
distributors or our independent agents, diskettes containing our software may be
infected with viruses. Given our increased use of the Internet to deliver
products and services, any successful sabotage or other attack on our websites,
including the McAfee.com and myCIO.com web sites, could disrupt our ability to
provide products and services to customers. A successful sabotage of one of our
or our affiliates web based businesses could result in reduced demand for our or
our affiliates web based products and services and have a material adverse
affect on our business and our results of operation. Recently a number of
websites have been subject to denial of service attacks where a web site is
bombarded with information requests eventually causing the website to overload,
which causes a delay or disruption of service.
FALSE DETECTION OF VIRUSES AND ACTUAL OR PERCEIVED SECURITY BREACHES COULD
ADVERSELY AFFECT OUR BUSINESS
Our anti-virus software products have in the past and may at times in the
future falsely detect viruses that do not actually exist. These false alarms,
while typical in the industry, may impair the perceived reliability of our
products and may therefore adversely impact market acceptance of our products.
In addition, we have in the past been subject to litigation claiming damages
related to a false alarm, and similar claims may be made in the future. In
addition, an actual or perceived breach of network or computer security at one
of our customers, regardless of whether the breach is attributable to our
products, could adversely affect the market's perception of our security
products. This could adversely effect our business, results of operations and
financial condition.
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OUR CRYPTOGRAPHY TECHNOLOGY IS SUBJECT TO EXPORT RESTRICTIONS AND MAY BECOME
OBSOLETE
All of our products are subject to the U.S. Export Administration
Regulations, governed by the U.S. Department of Commerce. Certain of our network
security products, technology and associated technical assistance, particularly
products and technology incorporating encryption, may be subject to export
restrictions. Recent changes to U.S. laws enable Network Associates to export
more products without restrictions; however certain products still may not be
exported to foreign government customers without prior approval from the U.S.
government. The list of products and end users for which export approval is
required, and the regulatory policies with respect thereto, are subject to
revision by the U.S. Government at any time. The cost of compliance with U.S.
and international export laws and changes in existing laws could affect our
ability to sell certain products in certain markets, and could have a material
adverse effect on our international revenues.
In addition, some of our network security products are dependent on the use
of public key cryptography technology. This technology depends in part upon the
application of certain mathematical principles known as factoring and discrete
logarithms. The security afforded by public key cryptography technology is based
on our belief that the factoring of large prime numbers and solving the discrete
log problem is not computationally practical. Should an easy factoring method be
developed or the discrete log problem is solved, the security afforded by
encryption products using public key cryptography technology would be reduced or
eliminated. Furthermore, any significant advance in techniques for attacking
cryptographic systems could also render some or all of our existing products and
services obsolete or unmarketable. Moreover, the cryptographic algorithms used
in our products can theoretically be solved by computer systems significantly
faster and more powerful than those presently available. If these improved
techniques for attacking cryptographic systems were ever developed, our business
would be adversely affected.
PRODUCT LIABILITY CLAIMS ASSERTED AGAINST US IN THE FUTURE COULD ADVERSELY
AFFECT OUR BUSINESS
Our network security and management software products are used to protect
and manage computer systems and networks that may be critical to organizations.
As a result, our sale and support of these products involves the risk of
potential product liability and related claims. Our license agreements with our
customers typically contain provisions designed to limit our exposure to
potential product liability claims. It is possible, however, that the limitation
of liability provisions contained in these license agreements may not be
effective under the laws of certain jurisdictions, particularly in circumstances
involving unsigned licenses. A product liability claim brought against us could
have a material adverse effect on our business, results of operations and
financial condition.
OUR MANAGEMENT AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, THESE
INDIVIDUALS MAY NOT REMAIN WITH US IN THE FUTURE
We rely, and will continue to rely, on a number of key technical and
management employees. While employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, our employees are
generally not otherwise subject to employment agreements or to noncompetition
covenants. If any of our key employees leave, our business, results of
operations and financial condition could suffer. Furthermore, we do not maintain
life insurance policies on our key employees.
Our ability to achieve our revenue and operating performance objectives
will depend in large part on our ability to attract and retain technically
qualified and highly skilled sales, consulting, technical, marketing and
management personnel. Competition for these employees is intense and is expected
to remain so for the foreseeable future. We have seen upward pressure on wages
as a result of this intense competition for employees, which could cause an
increase in our operating expenses. We may not be successful in retaining our
existing key personnel and in attracting and retaining the personnel we require,
and our failure to retain and hire key employees could adversely affect our
business and operating results. Additions of new and departures of existing
employees, particularly in key positions, can be disruptive and can result in
departures of existing employees, which could adversely affect our business.
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WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING
We are currently engaged in several research and development contracts with
agencies of the U.S. government. We believe that the willingness of these
government agencies to enter into future contracts with us will in part be
dependent upon our continued ability to meet their expectations.
Minimum fee awards for companies entering into government contracts are
generally between 3% and 7% of the costs incurred by them in performing their
duties under the related contract. However, these fee awards may be as low as 1%
of the contract costs. Furthermore, these contracts are subject to cancellation
at the convenience of the governmental agencies. Although we have been awarded
contract fees of more than 1% of the contract costs in the past, minimum fee
awards or cancellations may occur in the future. Reductions or delays in federal
funds available for projects we are performing could also have an adverse impact
on our government business. Contracts involving the U.S. government are also
subject to the risks of disallowance of costs upon audit, changes in government
procurement policies, required competitive bidding and, with respect to
contracts involving prime contractors or government-designated subcontractors,
the inability of those parties to perform under their contracts. Any of the
foregoing events could adversely affect our results of operations or financial
conditions.
EARTHQUAKE
Our corporate headquarters is located near a major earthquake fault. The
impact of a major earthquake on our facilities, infrastructure and overall
operations is not known. Safety precautions have been implemented, however there
is no guarantee that an earthquake would not seriously disturb our entire
business process. We are largely uninsured for losses and business disruptions
caused by an earthquake.
DELAWARE LAW, OUR CERTIFICATE OF INCORPORATION AND BYLAWS, OUR ADOPTION OF A
RIGHTS PLAN AND OUR STOCKHOLDERS AGREEMENT WITH MCAFEE.COM MAY INHIBIT POTENTIAL
ACQUISITION BIDS; THIS MAY ADVERSELY AFFECT THE MARKET PRICE FOR OUR COMMON
STOCK AND PREVENT CHANGES IN OUR MANAGEMENT.
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
of action by its stockholders. The issuance of preferred stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of the outstanding voting stock.
In October 1998, our board of directors adopted a shareholders rights plan.
Each right under this plan entitles the record holder to buy 1/1000 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.
If the rights become exercisable, the holders of the rights (other than the
person acquiring 15% or more of our common stock) will be entitled to acquire in
exchange for the $200 exercise price shares of our common stock or shares of any
company in which we are merged having a value of $400. We are entitled to redeem
the rights at $0.01 per right at any time on or before the tenth day following
acquisition by a person or group of 15% or more of our common stock.
In October 1999, we entered into a stockholders agreement with McAfee.com.
Under this agreement we agreed that if (1) without the prior approval of our
continuing directors, as defined below, any person acquires or agrees to acquire
15% or more of our outstanding common stock or (2) our continuing directors
cease to constitute a majority of Network Associates serving directors, then for
so long but only for so long as that condition exists:
- our shares of McAfee.com Class B common stock will be entitled to only
one vote per share instead of three votes per share; and
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- we will be obligated to vote our McAfee.com shares to cause, and to take
such actions reasonably within our control to cause, and shall seek to
cause the McAfee.com directors appointed by us to cause, the McAfee.com
board of directors to consist of at least a majority of independent
directors.
Network Associates continuing directors consist of our current directors
and any subsequent directors approved or not objected to by a majority of our
then-continuing directors.
Certain provisions of Delaware law and our certificate of incorporation and
bylaws, such as a classified board, could delay or make a merger, tender offer
or proxy contest involving Network Associates more difficult. While these
provisions and our rights plan are intended to enable our board of directors to
maximize stockholder value, and the provisions of the McAfee.com stockholders
agreement are, among other things, intended to preserve McAfee.com's
independence, they may have the effect of discouraging takeovers, which may not
be in the best interest of certain stockholders. Our rights plan and these
provisions could have an adverse effect on the market value of our common stock.
ITEM 2. PROPERTIES
Our headquarters currently occupy 207,650 square feet in facilities located
in Santa Clara, California under leases expiring in 2013. Worldwide we lease
facilities with approximately 1.0 million total square feet, with leases that
expire at various times. Our primary international facilities are located in
Australia, Brazil, Germany, Japan, the Netherlands and the United Kingdom. Other
significant domestic sites include Maryland, Oregon and Texas. We believe that
our existing facilities are adequate for the present and that additional space
will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
Information with respect to this item is incorporated by reference to Note
15 of Notes to Condensed Consolidated Financial Statements included in this Form
10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders' during the fourth
quarter of the year ended December 31, 1999.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
Since our initial public offering on October 6, 1992, our common stock has
traded on the NASDAQ National Market. Since the combination with Network General
Corporation on December 1, 1997, our common stock has traded under the symbol
NETA. Prior thereto, our common stock traded under the symbol MCAF. The
following tables set forth, for the period indicated, the high and low closing
sales prices for our common stock for the last eight quarters, all as reported
by NASDAQ. The prices appearing in the tables below reflect over the counter
market quotations, which reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
HIGH LOW
------ ------
YEAR ENDED DECEMBER 31, 1999
First Quarter............................................. $61.25 $28.06
Second Quarter............................................ 30.75 11.06
Third Quarter............................................. 21.63 15.56
Fourth Quarter............................................ 28.00 16.56
YEAR ENDED DECEMBER 31, 1998
First Quarter............................................. $48.00 $31.33
Second Quarter............................................ 47.88 38.81
Third Quarter............................................. 55.75 32.06
Fourth Quarter............................................ 66.25 26.63
Per share amounts have been restated to give effect retroactively to a
three-for-two stock split which was effected by a stock dividend on May 29,
1998.
DIVIDEND POLICY
We have not paid any cash dividends since our reorganization into a
corporate form in October 1992. We intend to retain future earnings for use in
our business and do not anticipate paying cash dividends in the foreseeable
future.
HOLDERS OF COMMON STOCK
As of March 27, 2000, there were 1,361 record owners of our common stock.
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ITEM 6. SELECTED FINANCIAL DATA.
We have restated our financial results to incorporate the following
companies acquired through pooling of interests: Anyware, CSB, Dr. Solomon's,
Nordic, QA, Secure, Syscon, (all acquired in 1998) and Helix, Jade, Network
General, SHBV (all acquired in 1997). In addition, results for the nine months
ended September 30, 1998 and each of the years ended December 31, 1997, 1996 and
1995, have been restated from those previously reported to reflect a change in
the purchase price allocation and related amortization of intangibles for
acquisitions accounted for by the purchase method of accounting.
Dr. Solomon's had a fiscal year ended May 31. Financial statements for the
periods through December 31, 1997, reflect the combination of our operating
results for the years ended December 31, 1997, 1996, and 1995 and the operating
results of Dr. Solomon's for the years ended November 30. Restated financial
statements for the year ended December 31, 1998 reflect our operating results
for the year ended December 31, 1998 and the operating results of Dr. Solomon's
for the thirteen months ended December 31, 1998.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1999 1998 1997 1996 1995
--------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENTS OF OPERATIONS DATA:
Net revenue........................ $ 683,668 $990,045 $735,692 $514,997 $328,541
Income (loss) from operations...... (138,199) 119,966 61,947 57,568 73,941
Income (loss) before income
taxes............................ (130,658) 138,167 82,813 65,419 82,989
Net income (loss).................. (159,901) 36,438 10,639 10,711 53,752
Net income (loss) per share,
diluted.......................... $ (1.15) $ 0.26 $ 0.08 $ 0.09 $ 0.45
Shares used in per share
calculation -- diluted........... 138,695 138,609 132,729 125,502 119,243
DECEMBER 31,
------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- -------- -------- --------
BALANCE SHEET DATA:
Working capital.................. $ 285,665 $ 537,056 $247,811 $307,478 $179,049
Total assets..................... 1,479,394 1,536,721 805,350 613,867 366,280
Deferred revenue and taxes....... 163,816 205,598 129,557 91,020 68,838
Long Term Debt and other
liabilities.................... 379,267 374,132 2,353 -- --
Total equity..................... $ 660,106 $ 722,838 $492,501 $425,671 $251,810
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Fiscal Years Ended December 31, 1999, 1998 and 1997
The following table sets forth for the periods indicated the percentage of
net revenue represented by certain items in our Statements of Operations.
YEARS ENDED
DECEMBER 31,
--------------------
1999 1998 1997
---- ---- ----
Net revenue:
Product................................................... 69% 84% 86%
Services and support...................................... 31 16 14
--- --- ---
Total revenue..................................... 100 100 100
Cost of revenue:
Product................................................... 13 14 15
Services and support...................................... 5 4 4
--- --- ---
Total cost of revenue............................. 18 18 19
Operating costs and expenses:
Research and development.................................. 22 14 14
Marketing and sales....................................... 54 30 30
General and administrative................................ 18 8 11
Amortization of intangibles............................... 9 4 2
Stock compensation charge................................. 2 -- 2
Acquisition and other related costs....................... (3) 14 13
--- --- ---
Total operating costs and expenses................ 102 70 72
--- --- ---
Income (loss) from operations..................... (20) 12 8
Interest and other income................................... 4 4 3
Interest and other expense.................................. (3) (2) --
--- --- ---
Income (loss) before provision for income taxes... (19) 14 11
Provision for income taxes.................................. 4 10 10
--- --- ---
Net income (loss)................................. (23)% 4% 1%
=== === ===
Net Revenue. Net revenue decreased 31% to $683.7 million in 1999 from
$990.0 million in 1998, including an $18.2 million increase in revenue from
McAfee.com. Net revenue increased 35% from $735.7 million in 1997 to $990.0
million in 1998, including a $3.8 million increase in revenue from McAfee.com.
The decrease in net revenue from 1998 to 1999 is due 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. From 1997 to
1998, the increase in net revenue is due to the increase in product revenue and
services and support revenues described below.
Product revenue decreased 43% to $474.1 million in 1999 from $831.4 million
in 1998, and increased 31% from $634.3 million in 1997. The decrease in net
revenue from 1998 to 1999 is due 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.
Services and support revenues include revenues from software support,
maintenance contracts, education and consulting services, as well as those
revenues from customer support and maintenance contracts, which are deferred and
recognized over the related service period. Service revenues increased 32% to
$209.6 million in 1999 from $158.7 million in 1998, and 56% from $101.4 million
in 1997. The increase in services and
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support revenues resulted from growth in all categories of service revenues,
principally due to the growth of our installed customer base and the resulting
renewal of maintenance contracts.
We have historically experienced significant growth in net income (before
acquisition and related costs) and net revenue. However, our rate of growth has
slowed in recent periods due to increased price competition, a maturing
anti-virus market and an increasingly higher base from which to grow. Our growth
rate and net revenue depend significantly on renewals of existing orders as well
as expanding our customer base. If our renewal rate or our pace of new customers
slows, our net revenues and operating results would be adversely affected.
International revenue accounted for approximately 40%, 36%, and 36% of net
revenue for 1999, 1998 and 1997, respectively. The increase in international net
revenue as a percentage of net revenue from 1998 to 1999 was due primarily to
increased acceptance of our products in international markets and the continued
investment in international operations. We expect that international revenues
will increase in absolute terms. To minimize the impact of foreign currency
fluctuations, we use non-leveraged forward currency contracts. However, our
future results of operations may be adversely affected by currency fluctuations
or by costs associated with currency risk management strategies. Other risks
inherent in international revenue generally include the impact of longer payment
cycles, greater difficulty in accounts receivable collection, unexpected changes
in regulatory requirements, seasonality due to the slowdown in European business
activity during the third quarter, tariffs and other trade barriers,
uncertainties relative to regional economic circumstance, political instability
in emerging markets and difficulties staffing and managing foreign operations.
These factors may have a material adverse effect on our future international
license revenue. Further, in countries with a high incidence of software piracy,
we may experience a higher rate of piracy of our products.
Cost of Net Revenue. Cost of Net Revenue decreased 29% to $126.5 million in
1999 from $177.0 million in 1998, and increased 25% from $142.1 million in 1997.
The decrease in cost of net revenues from 1998 to 1999 was primarily due to the
decrease in net revenue. From 1997 to 1998 the increase in cost of net revenue
is due to the increase in cost of product revenue and cost of services and
support revenue described below.
Our cost of product revenue consists primarily of the cost of media,
manuals and packaging for products distributed through traditional channels,
royalties and with respect to certain Sniffer products, computer platforms and
other hardware components. Cost of product revenues decreased 35% to $88.7
million in 1999 from $137.4 million in 1998. From 1997 to 1998 cost of product
revenues increased 23% from $111.6 million. The decrease in cost of product
revenues from 1998 to 1999 was primarily due to a corresponding decrease in
product revenues. The increase in cost of product revenues from 1997 to 1998 was
due to a corresponding increase in product revenues. As a percentage of net
product revenue, cost of product revenue was 19% in 1999, 17% in 1998 and 18% in
1997.
Cost of services and support revenue consists principally of salaries and
benefits related to employees providing customer support and consulting
services. In 1999, cost of services and support revenue decreased 5% to $37.7
million from $39.7 million in 1998. Costs stayed relatively flat in 1999. From
1997 to 1998, cost of services and support revenue increased 30% from $30.5
million. The increase is due to increase in net revenue. Costs increased at a
higher rate than revenue due to the shift in the mix of support and professional
services revenue versus revenue from warranty and maintenance contracts
previously deferred. Cost of services and support revenue as a percentage of net
services and support revenue was 18% in 1999, 25% in 1998 and 30% in 1997.
To the extent that the percentage of our net revenue, which is generated
through traditional distribution channels, increases, our cost of net revenue
will increase.
Research and Development. Research and development expenses consist
primarily of salary and benefits for our development and technical support
staff. Research and development expenses increased 9% to $148.2 million in 1999
from $135.5 million in 1998. Research and development expenses increased from
1998 to 1999 due to the increase in staffing and equipment expense to support
growth in our product and service offerings. From 1997 to 1998, research and
development expenses increased 31% from $103.1 million. These increases were
primarily a result of the expansion of our product development and technical
support staff and,
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to a lesser extent, the increased use of independent contractors. As a
percentage of net revenue, research and development expenses were 22% in 1999,
14% in 1998 and 14% in 1997. We anticipate that research and development
expenses will continue to increase in absolute dollars, but may fluctuate as a
percentage of net revenue.*
We believe that our ability to maintain our competitiveness will depend in
large part upon our ability to enhance existing products, develop and acquire
new products and develop and integrate acquired products. The market for
computer software is characterized by low barriers to entry and rapid
technological change, and is highly competitive with respect to timely product
introductions. The timing and amount of research and development expenses may
vary significantly based upon the number of new products and significant
upgrades under development and products acquired during a given period.
Marketing and Sales. Marketing and sales expenses consist primarily of
salary, commissions and benefits for marketing, sales and customer support
personnel and costs associated with advertising and promotions. Marketing and
sales expenses increased 25% to $367.3 million in 1999 from $294.8 million in
1998. From 1997 to 1998, marketing and sales expenses increased 33% from $222.2
million in 1997. These increases were 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 McAfee.com. As
a percentage of net revenue, marketing and sales expense was 54% in 1999, 30% in
1998 and 1997. We anticipate that marketing and sales expenses will continue to
increase in absolute dollars, but may fluctuate as a percentage of net revenue.*
General and Administrative. General and administrative expenses consist
principally of salary and benefit costs for administrative personnel and general
operating costs. General and administrative expenses increased 49% to $124.7
million in 1999 from $83.9 million in 1998 due to a charge to cover $31.8
million in doubtful accounts, the development of our E-commerce business
systems, expansion of our IT infrastructure and the implementation of our new
SAP Human Resources module. From 1997 to 1998, general and administrative
expenses increased 1% from $83.1 million in 1997 to 83.9 million in 1998. As a
percentage of net revenues, general and administrative expenses were 18.0%, 8.0%
and 11.0% in the year ended December 31, 1999, 1998 and 1997, respectively.
Amortization of Intangibles and Stock Compensation Charges. We expensed
$74.0 million, $43.2 million and $30.5 million of amortization related to
intangibles and stock compensation charges in the years ended December 31, 1999,
1998 and 1997, 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 and employees. We do not expect to incur charges
related to these McAfee.com option grants in the future. However, we do expect
significant stock based compensation charges related to repriced employee stock
options. The increase in amortization related to intangibles is due to the
acquisitions of Magic Solutions, Inc., CyberMedia and Virex and NetOctopus
products by Dr Solomon's.
- ---------------
* 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 15 for a discussion of certain
factors that could affect future performance.
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ACQUISITION AND OTHER RELATED COSTS
Year Ended December 31, 1999
The following table is a summary of acquisitions by the Company in the
three years ended December 31, 1999:
COMMON STOCK
ISSUED IN PURCHASE PRICE OF
POOLING OF INTERESTS PURCHASE TRANSACTIONS
-------------------- ---------------------
1998
Syscon.................... 1,230 shares
Nordic.................... 30,508 shares
Magic Solutions........... $140.3 million
TIS....................... 6,755,540 shares
Secure.................... 567,000 shares
CSB....................... 9,815 shares
QA........................ 305,557 shares
Anyware................... 228,204 shares
Dr. Solomon's............. 15,813,142 shares
CyberMedia................ $174.3 million
1997
Network General........... 17,900,000 shares
Jade K.K.................. 504,107 shares
Schuijers Holdings B.V.... 95,582 shares
3DV Technology, Inc....... $20.0 million
Compusul Consultores
de Informatica, Ltda.... $2.6 million plus $1.0 million
contingently payable
Cinco Networks, Inc....... $26.0 million
Paradigm Agency Pty
Ltd..................... $2.0 million
Helix Software Company.... 825,000 shares
Pretty Good Privacy, $35 million plus warrants to
Inc..................... purchase 375,000 shares of
Common Stock at $40 per share
The following table summarizes the activity during the year ended December
31, 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, December 31, 1999........... $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
======= ======= ======= ======= ======= ========
For the year ended December 31, 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, $18,986,000, were credited to Acquisition and related charges.
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The following table summarizes the activity during the year ended December
31, 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, December 31, 1999............ $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
===== ===== ===== ====== ===== ========
For the year ended December 31, 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 an additional expense,
$254,000, was charged to Acquisition and related charges.
Year Ended December 31, 1998
In connection with the acquisitions accounted for as poolings 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 and
development. The following is a summary of these charges together with charges
for certain restructuring activities taken by us during the year ended December
31, 1998 ($000's):
LEASE COSTS
AND ASSET
DIRECT SEVERANCE WRITE IN-PROCESS
TRANSACTION COSTS & BENEFITS DOWNS R&D OTHER TOTAL
----------------- ---------- ----------- ---------- ----- --------
TIS............................. $15,023 $ 3,818 $ 4,414 $ -- $(924) $ 22,331
Dr. Solomon's................... 19,898 11,425 18,312 -- 0 49,635
Secure.......................... 500 500 1,200 -- 100 2,300
Magic........................... -- -- -- 27,014 -- 27,014
CyberMedia...................... -- -- -- 22,830 -- 22,830
Restructuring Costs -- Q2....... -- 11,318 8,644 -- 610 20,572
Restructuring Costs -- Q3....... -- 3,285 370 -- -- 3,655
Reversal of excess reserves..... (6,750) (2,276) (3,909) -- 214 (12,721)
------- ------- ------- ------- ----- --------
Total Charges................... $28,671 $28,070 $29,031 $49,844 $ -- $135,616
------- ------- ------- ------- ----- --------
Direct transaction costs included $18.0 million in investment banking fees,
$9.2 million in legal and accounting fees, and $1.5 million in filing fees,
travel and other costs. Lease costs and asset write downs include the costs of
closing approximately 33 facilities throughout the world ($12.2 million), the
disposal of excess and obsolete assets (generally computer equipment which did
not comply with our standards ($12.0 million)), and the write-off of goodwill
and intangibles associated with discontinued Dr. Solomon's products ($4.8
million). The Dr. Solomon's write-off related to two minor products which we
discontinued and which had no sales subsequent to the Dr. Solomon's acquisition.
The severance and benefits charges related to company-wide reductions in
force following our major acquisitions in the second and third quarters of 1998
of approximately 784 employees of which 107 were in research and development
functions, 302 were in sales and marketing functions and the remainder were in
administrative and other support functions. Substantially all terminated
employees left our employment in the period the related accounting charge was
recorded. We retained a limited number of employees from each acquisition for
short transition periods. The cost of these employees was charged to operating
expenses during the transition period.
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The lease costs represent an estimate of lease expense during the period
prior to re-leasing the property together with losses on subleases, if any. The
leased facilities were substantially vacated in the period in which the related
accounting charges were recorded. The costs related to any facilities, which we
used during this period, were charged to operations. However, these charges were
not material. Asset write downs, exclusive of the intangible assets of Dr.
Solomon's described above, comprised $5.6 million in losses on company owned
buildings (which were written down to estimated values) and $10.3 million in net
losses of computer and other miscellaneous assets. In general, this equipment
was discarded or sold for nominal value. Due to the immediate consolidation of
facilities, depreciation allocable to these facilities and the related assets,
during the transition period, was not material. All the facilities acquired in
our 1998 acquisitions identified for closure have been disposed of or subleased
as of December 31, 1999.
The in-process research and development costs comprise approximately $22.8
million and $27.0 million in connection with the acquisitions of CyberMedia in
the three months ended September 30, 1998 and Magic Solutions in the three
months ended June 30, 1998, respectively. The following is a summary of the
projects acquired and the assumptions used in determining the value of the
in-process research and development costs.
CyberMedia:
The ongoing projects at CyberMedia at the time of the purchase included
upgrade versions of four products (First Aid 6.0 and 7.0, UnInstaller 6.0, Guard
Dog 3.0, and Oil Change 3.0) as well as work on technologies to be used in two
of the our projects (a replacement product for PC Medic and McAfee Office).
These upgrades will include new interfaces with the Internet, enhanced use of
Active-X controls and Java and enhanced user interfaces. At the date we acquired
CyberMedia, we estimated that, on average, 42% of the development effort had
been completed and that the remaining 58% of the development effort would take
approximately 12 months to complete and would cost $2.7 million. The efforts
required to complete the development of these projects principally relate to
additional design efforts to integrate the technologies into our suite of
products, finalization of coding, and completion of prototyping, verification,
and testing activities required to establish that products associated with the
technologies can be successfully introduced. The value of the in-process
technologies was determined by estimating the projected net cash flows related
to products, including costs to complete the development of the technologies or
products, and the future net revenues that may be earned from the products,
excluding the value attributed to integration with our products or that may have
been achieved due to efficiencies resulting from the combined sales force or the
use of our more effective distribution channel. In conformity with the SEC's
revised guidelines for accounting for in-process technologies, these cash flows
were discounted back to their net present value using a discount rate of 28%
(which represents a premium of approximately 5% over our average weighted cost
of capital) and excluding the value attributable to the use of the in-process
technologies in future products. As of December 31, 1999, the projects related
to this acquisition were completed.
Magic Solutions:
The ongoing projects at Magic Solutions at the time of the purchase
comprised an upgrade version of Support Magic 4.0, Magic Solutions current
product. This upgrade, known as Merlin Enterprise, represents new technologies
with significant enhanced functionality, including increased scalability, a
32-bit browser-based technology, an enhanced user interface and integrated
management features. At the date we acquired Magic Solutions, we estimated that,
on average, 80% of the development effort had been completed and that the
remaining 20% of the development effort would take approximately 12 months to
complete and would cost $1.8 million. The efforts required to complete the
development of these projects principally relate to additional design efforts to
integrate the technologies into our suite of products, finalization of coding,
and completion of prototyping, verification, and testing activities required to
establish that products associated with the technologies can be successfully
introduced. The value of the in-process technologies was determined by
estimating the projected net cash flows related to products, including costs to
complete the development of the technologies or products, and the future net
revenues that may be earned from the products, excluding the value attributed to
integration with our products or that may have been achieved due to efficiencies
resulting from the combined sales force or the use of the our more effective
distribution channel. In conformity with the
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SEC's revised guidelines for accounting for in-process technologies, these cash
flows were discounted back to their net present value using a discount rate of
28% (which represents a premium of approximately 5% over our average weighted
cost of capital) and excluding the value attributable to the use of the
in-process technologies in future products. As of December 31, 1999, the
projects related to this acquisition were completed.
Year Ended December 31, 1997
The Acquisition and other related costs for 1997 comprise (i) the write-off
of acquired in-process research and development projects of companies acquired
in purchase accounting transactions; (ii) direct transaction costs of companies
acquired in pooling of interests transactions; (iii) accrual for severance and
benefits for terminations; and (iv) lease costs and asset write-downs in
connection with the Network General merger. The following is a summary of these
charges (in thousands):
DIRECT SEVERANCE LEASE COSTS
TRANSACTION & AND ASSET IN-PROCESS
COSTS BENEFITS WRITEDOWNS R&D OTHER TOTAL
----------- --------- ----------- ---------- ------ -------
Network General....................... $15,347 $11,083 $ 18,916 $ -- $ 603 $45,949
Helix (acquired by NAI)............... -- -- -- -- 1,874 1,874
Paradigm (acquired by NAI)............ -- -- -- 2,330 2,330
PGP (acquired by NAI)................. -- -- -- 3,937 3,937
Sybari (acquired by NAI).............. -- -- -- -- 1,100 1,100
Datawatch (acquired by Dr.
Solomon's).......................... -- -- -- 9,336 -- 9,336
Haystack (acquired by TIS)............ 3,535 -- -- -- -- 3,535
Cinco (acquired by Network General)... -- -- -- 5,234 -- 5,234
3DV (acquired by Network General)..... -- -- -- 19,504 -- 19,504
------- ------- ----------- ------- ------ -------
Total Charges............... $18,882 $11,083 $ 18,916 $38,011 $5,907 $92,799
======= ======= =========== ======= ====== =======
Direct transaction costs included $14.0 million in investment banking fees,
$3.7 million in legal and accounting fees, $709,000 in filing fees and $438,000
in other related charges.
The severance and benefits charges relate to company-wide reductions in
force following our acquisition of Network General, PGP and Helix in the fourth
quarter of approximately 186 employees across all employee groups. The
termination plan, which took place in January 1998, was finalized and approved
by management prior to December 31, 1997. The employees to be terminated and the
benefit arrangements were communicated to employees on December 31, 1997. A
limited number of employees were retained for a short period to help with the
transition. Costs associated with these transition employees were charged to
operations during the transition period.
Lease costs and asset writedowns include $3.8 million related to the costs
of closing approximately 35 facilities throughout the world and the disposal of
excess and obsolete assets (generally computer equipment which did not comply
with our standards) of $15.1 million.
The lease costs of $3.8 million represent an estimate of lease expense
during the period prior to re-leasing the property together with losses on
subleases, if any. The costs, excluding amortization of leasehold improvements
related to any facilities, which were used by us during a short transition
period, were charged to operations. However, these charges were not material.
Due to the immediate consolidation of facilities, depreciation allocable to
these facilities during the transition period was also not material. Asset
write-downs of $15.1 million comprised the write-off of leasehold improvements
($9.6 million) and the sale or abandonment of old and obsolete equipment ($5.5
million) which was discarded or sold for nominal value. To the extent that such
equipment was used during the transition, period, depreciation (which was not
material) was charged to operations. Facilities identified for closure were
available for sale or sublease as of December 31, 1997.
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The Helix charge related to direct transaction costs ($838,000), severance
costs ($495,000) and other related charges ($541,000) incurred in connection
with the Helix acquisition which was accounted for under the pooling method of
accounting.
The Paradigm charge related to the write-off of the purchase price paid in
our acquisition of an Australian distributor, Paradigm Agency Ltd., who had the
right to use the McAfee brand name in Australia. This acquisition was part of
our initiative to establish a direct presence in major foreign markets and to
recapture its brand names in these countries.
The Sybari Technology charge related to a buy-out in December 1997 of a
license agreement we entered into earlier in 1997. The buy-out was motivated in
an effort to resolve potential disputes with Sybari, and the technology was
considered obsolete at the time of the buy-out and had no alternative use in our
products.
The in-process research and development costs in 1997 comprise
approximately $5.2 million, $3.9 million, $19.5 million and $9.3 million in
connection with the acquisitions of Cinco Networks, Inc., PGP, 3DV, and
Datawatch, respectively. The following is a summary of the projects acquired in
the PGP and Cinco acquisitions and the assumptions used in determining the value
of the in-process research and development costs. The 3DV projects in process at
the date of the Network General merger, together with all other 3DV
technologies, were discontinued at that date.
PGP:
The ongoing projects at PGP at the time of the purchase included upgrade
versions of PGP Product Suite components, including PGP for Personal Privacy,
PGP for Business Security and PGP Certificate Server. These upgrades will
include features such as improved key recovery certificate management and key
splitting and enhanced user interfaces. At the date we acquired PGP, we
estimated that, on average, 20% of the development effort had been completed and
that the remaining 80% of the development effort would take approximately six
months to complete and would cost $3.6 million. The efforts required to complete
the development of these projects principally relate to additional design
efforts to integrate the technologies into our suite of products, finalization
of coding, and completion of prototyping, verification, and testing activities
required to establish that products associated with the technologies can be
successfully introduced. The value of the in-process technologies was determined
by estimating the projected net cash flows related to products, including costs
to complete the development of the technologies or products, and the future net
revenues that may be earned from the products, excluding the value attributed to
integration with our products or that may have been achieved due to efficiencies
resulting from the combined sales force or the use of our more effective
distribution channel. In conformity with the SEC's revised guidelines for
purchased in-process technologies, these cash flows were discounted back to
their net present value using a discount rate of 27% (which represents a premium
of approximately 5% over PGP's average weighted cost of capital) and excluding
the value attributable to the use of the in-process technologies in future
products. If we do not deploy commercially accepted products based on the
acquired in-process technologies, operating results could be adversely affected
in future periods. Additionally, the failure of any particular project would
impair the value of other intangibles, particularly goodwill, acquired from PGP.
As of December 31, 1998, the projects related to this acquisition were
substantially complete and actual costs were in line with our estimates.
Cinco:
The ongoing projects at Cinco at the time of the purchase comprised upgrade
versions of NetXRay, WebXRay and Distributed NetXRay, Cinco's current products.
At the date we acquired Cinco, we estimated that, on average, 80% of the
development effort had been completed and that the remaining 20% of the
development effort would take approximately 4 months to complete and would cost
$240,000. The efforts required to complete the development of these projects
principally relate to the completion of prototyping, verification, and testing
activities required to establish that products associated with the technologies
can be successfully introduced. The value of the in-process technologies was
determined by estimating the projected net cash flows related to products,
including costs to complete the development of the technologies or products, and
the future net revenues that may be earned from the products, excluding the
value attributed to
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integration with our products or that may have been achieved due to efficiencies
resulting from the combined sales force or the use of our more effective
distribution channel. In conformity with the SEC's revised guidelines for
purchased in-process technologies, these cash flows were discounted back to
their net present value using a discount rate of 37.5% and excluding the value
attributable to the use of the in-process technologies in future products. If we
do not deploy commercially accepted products based on the acquired in-process
technologies, operating results could be adversely affected in future periods.
Additionally, the failure of any particular project would impair the value of
other intangibles, particularly goodwill, acquired from Cinco Networks. As of
December 31, 1999, the projects related to this acquisition were completed.
Interest and Other Income. Interest and miscellaneous income decreased to
$24.5 million in 1999 from $33.4 million in 1998 and increased from $21.0
million in 1997. Interest and other income decreased from 1998 to 1999 due to a
decrease in interest income. Interest income decreased due to the reduced cash
balances resulting from the acquisitions of Magic and CyberMedia and cash used
to fund operating activities during the year. Interest and other income
increased from 1997 to 1998 primarily as a result of the investment of the funds
from our Zero Coupon Convertible Subordinated Debentures (the "Debentures")
issued in February 1998.
Interest and Other Expense. Interest and other expense increased to $17.3
million in 1999 from $15.2 million in 1998 and $87,000 in 1997. Interest and
other expense increased from 1998 to 1999 primarily due to the $2.5 million loss
on the liquidation of our DirectWeb investment. Interest expense increased from
1997 to 1998 primarily due to the interest expense related to the issuance of
our Zero Coupon Convertible Subordinated Debentures (the "Debentures") in
February 1998.
Provision for Income Taxes. Our provision for income taxes was $29.2
million, $101.7 million and $72.2 million in 1999, 1998, 1997, respectively. Our
effective tax rate for 1999, 1998 and 1997 was 30%, 32% and 37%, respectively,
excluding the effect of one-time non-deductible in-process research and
development, merger and other acquisition costs, amortization of intangibles,
stock compensation charges and the operating loss related to our decision to
limit distributor orders.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999, we had $316.8 million in cash and cash equivalents
and $469.6 million in marketable securities, for a combined total of $786.4
million.
Net cash provided by (used in) operating activities was $(23.3) million,
$96.0 million and $132.0 million in 1999, 1998 and 1997, respectively. Net cash
used in operating activities in 1999 consisted primarily of net loss before
depreciation and amortization, bad debt expense, stock compensation charge,
interest on the Debentures and deferred taxes. In addition, there were decreases
in accounts receivable, prepaid expenses and other assets, and an increase in
accounts payable and accrued liabilities, which was offset by a decrease in
deferred revenue. Net cash provided by operating activities in 1998 consisted
primarily of net income before acquired in-process research and development,
depreciation and amortization and interest on the Debentures as well as an
increase in deferred revenue and the tax benefit from exercise of non-qualified
stock options. Increases in accounts receivable and prepaids and other assets
and decreases in accounts payable and accrued liabilities offset these factors.
Net cash provided by operating activities in 1997 consisted primarily of net
income before acquired in-process research and development and depreciation and
amortization, plus increases in accounts payable and accrued liabilities,
deferred revenue and the tax benefit from exercise of non-qualified stock
options. Increases in accounts receivable and deferred taxes offset these
factors.
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. Additionally, our
receivable collection 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 accounts receivable balance increases, we will be subject to greater
general credit risks with respect thereto.
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Net cash used in investing activities was $168.5 million, $318.8 million
and $145.2 million in 1999, 1998 and 1997, respectively, primarily reflecting
purchases of marketable securities and additions to fixed assets.
Net cash provided by financing activities was $96.6 million in 1999
consisting primarily of the proceeds associated with the exercise of non
qualified stock options, sale of put options, and proceeds from the McAfee.com
initial public offering, which was offset by the repayment of notes payable and
repurchase of our common stock. Net cash provided by financing activities was
$489.8 million in 1998 consisting primarily of the proceeds from the issuance of
the Debentures as well as proceeds associated with the exercise of non-qualified
stock options. Net cash provided by financing activities was $5.2 million in
1997 and consisting primarily of the proceeds associated with the exercise of
non-qualified stock options partially offset by the repurchase of common stock.
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.
YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs using two digits
rather than four digits in the date code fields. Computer programs software may
recognize a two digit date code field using "00" as the year 1900 rather than
the year 2000 (the "Year 2000 Issue"). Year 2000 issues occurring in our own
infrastructure or the infrastructure of our major distributors, suppliers,
customers, vendors and financial service organizations could impact us.
We evaluated and addressed the impact of the Year 2000 Issue in the
following four program areas: Commercial Product Compliance; Internal Systems
and Technology Compliance; Supplier and Business Partner Compliance; and
Facilities and Safety Compliance. For all these areas we inventoried the
affected items, assessed the corrective action that was needed and then
corrected the indicated items. We utilized primarily internal resources in
implementing our Year 2000 program. In addition, we have worked with our key
suppliers and business partners to ensure they have proper procedures in place
to address their own Year 2000 issues.
As of December 31, 1999, we completed our Year 2000 compliance program. We
believe that all key systems are Year 2000 compliant and as of March 30, 2000 we
have incurred no significant disruption in operations. Contingency plans have
been created and are in place for our key systems and operations. We have a Year
2000 compliance team that is still monitoring any Year 2000 issues, which may
still arise.
There can be no guarantee that the systems of other companies on which we
rely are Year 2000 compliant, or that a failure to be Year 2000 compliant by
another company would not have a material adverse effect on us. 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.
Through December 31, 1999, we have incurred approximately $4.5 million in
connection with our Year 2000 compliance program.
Our management will continue to periodically report the results of our Year
2000 compliance program to the Audit Committee of our Board of Directors.
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 conversion to 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
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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. For those countries where bank accounts
were not automatically translated into dual currency bank accounts, we maintain
separate euro accounts.
FINANCIAL RISK MANAGEMENT
The following discussion about our risk management activities includes
"forward-looking statements" that involve risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements.
As a global concern, we face exposure to adverse movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could have a material adverse impact on our financial
results. Historically, our primary exposures related to nondollar-denominated
sales and operating expenses in Japan, Canada, Australia, Europe, Latin America,
and Asia. We have recently expanded our business activities in Europe. As a
result, we expect to see an increase in exposures related to nondollar-
denominated sales in several European currencies. At the present time, we hedge
only those currency exposures associated with certain assets and liabilities
denominated in nonfunctional currencies and does not generally hedge anticipated
foreign currency cash flows. Our hedging activity is intended to offset the
impact of currency fluctuations on certain nonfunctional currency assets and
liabilities. The success of this activity depends upon estimates of transaction
activity denominated in various currencies, primarily the Japanese yen, Canadian
dollar, Australian dollar, and certain European currencies. To the extent that
these estimates are over- or understated during periods of currency volatility,
we could experience unanticipated currency gains or losses.
We maintain investment portfolio holdings of various issuers, types and
maturities. These securities are generally classified as available-for-sale, and
consequently are recorded on the balance sheet at fair market value with
unrealized gains and losses reported as a separate component of shareholders'
equity. These securities are not leveraged and are held for purposes other than
trading.
The following tables present the hypothetical changes in fair values in the
securities held at December 31, 1999 that are sensitive to the changes in
interest rates. The modeling technique used measures the change in fair market
values arising from hypothetical parallel shifts in the yield curve of plus or
minus 50 basis points (BPS), 100 BPS and 150 BPS over six and twelve-month time
horizons. Beginning fair market values represent the market principal plus
accrued interest and dividends at December 31, 1999. Ending fair market values
are the market principal plus accrued interest, dividends and reinvestment
income at six and twelve month time horizons.
The following table estimates the fair value of the portfolio at a
six-month time horizon (in millions):
VALUATION OF SECURITIES VALUATION OF SECURITIES
GIVEN AN INTEREST RATE NO GIVEN AN INTEREST RATE
DECREASE OF X BASIS POINTS CHANGE INCREASE OF X BASIS POINTS
-------------------------- IN INTEREST --------------------------
ISSUER 150 BPS 100 BPS 50 BPS RATE 50 BPS 100 BPS 150 BPS
------ ------- ------- ------ ----------- ------ ------- -------
U.S. Government notes and bonds...... $197.5 $196.4 $195.3 $193.9 $192.5 $191.7 $190.6
Municipal notes and bonds............ 57.2 56.9 56.6 56.1 55.9 55.7 55.4
Corporate notes, bonds and
preferreds......................... 479.9 479.5 478.6 478.0 477.4 476.7 475.9
------ ------ ------ ------ ------ ------ ------
Total...................... $734.6 $732.8 $730.5 $728.0 $725.8 $724.1 $721.9
====== ====== ====== ====== ====== ====== ======
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The following table estimates the fair value of the portfolio at a
twelve-month time horizon (in millions):
VALUATION OF SECURITIES VALUATION OF SECURITIES
GIVEN AN INTEREST RATE NO GIVEN AN INTEREST RATE
DECREASE OF X BASIS POINTS CHANGE INCREASE OF X BASIS POINTS
-------------------------- IN INTEREST --------------------------
ISSUER 150 BPS 100 BPS 50 BPS RATE 50 BPS 100 BPS 150 BPS
------ ------- ------- ------ ----------- ------ ------- -------
U.S. Government notes and bonds...... $200.8 $199.8 $198.8 $197.8 $196.5 $196.0 $195.0
Municipal notes and bonds............ 57.6 57.3 57.2 56.9 56.8 56.6 56.4
Corporate notes, bonds and
preferreds......................... 485.6 484.9 484.4 484.0 483.5 482.9 482.2
------ ------ ------ ------ ------ ------ ------
Total...................... $744.0 $742.0 $740.4 $738.7 $736.8 $735.5 $733.6
====== ====== ====== ====== ====== ====== ======
CONVERTIBLE DEBT
On February 13, 1998, we completed a private placement of Zero Coupon
Convertible Subordinated Debentures due in 2018 (the "Debentures"). The
Debentures, with an aggregate face amount at maturity of $885.5 million,
generated net proceeds to us of approximately $337.6 million (after deducting
the fee paid to the initial purchaser of the Debentures but no other expenses of
the placement). The initial price to the public for the Debentures was $391.06
per $1,000 of face amount at maturity, which equates to a yield to maturity over
the term of the bonds of 4.75% (on a semi-annual bond equivalent basis). The
Debentures are convertible into common stock at the rate of 8.538 shares per
$1,000 of face amount at maturity, which equates to an initial conversion price
of $45.80 per share. The Debentures are subordinated in right of payment to all
existing and future Senior Indebtedness (as defined) and effectively
subordinated in right of payment to all indebtedness and other liabilities of
our subsidiaries. The Debentures may be redeemed for cash at our option
beginning on February 13, 2003. At the option of the holder, we will purchase
the Debentures as of February 13, 2003, February 13, 2008 and February 13, 2013
at purchase prices (to be paid in cash or Common Stock or any combination
thereof, our election and subject to certain conditions) equal to the initial
issue price plus accrued original issue discount to such dates. The Debentures
may also be redeemed at the option of the holder if there is a Fundamental
Change (as defined) at a price equal to the issue price plus accrued original
issue discount to the date of redemption, subject to adjustment.
QUARTERLY OPERATING RESULTS (UNAUDITED)
THREE MONTHS ENDED
----------------------------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1999 1999 1999 1999 1998 1998 1998 1998
------------ ------------- --------- --------- ------------ ------------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENTS OF OPERATIONS
AND OTHER DATA:
Net revenues.......... $218,079 $195,201 $ 25,196 $245,192 $272,191 $242,444 $249,317 $226,093
Gross Margin.......... 183,758 161,864 1,642 209,949 232,838 197,888 199,444 182,827
Income (loss) from
operations.......... 11,204 (828) (192,803) 44,228 80,970 8,167 (18,499) 49,328
Income (loss) before
provision for income
taxes............... 13,364 1,081 (190,905) 45,802 85,225 12,266 (14,348) 55,024
Net income (loss)..... 9,884 (241) (195,785) 26,241 56,685 (14,444) (38,547) 32,744
Diluted earnings
(loss) per share.... $ 0.07 $ (0.00) $ (1.41) $ 0.18 $ 0.40 $ (0.11) $ (0.29) $ 0.24
Shares used in per
share
calculation -- diluted.. 143,783 139,038 138,478 142,607 149,002 133,531 131,503 140,412
The increase in revenues and operating income in 1998 and the decrease in
revenues and operating income in 1999 are not necessarily indicative of future
results. In addition, we believe that period-to-period comparisons of our
financial results should not be relied upon as an indication of future
performance. For example, in the second quarter of 1999, our revenue decreased
89.9% from the second quarter of 1998 due to our decision to limit distributor
orders.
Our revenues and results of operations have been subject to significant
fluctuations, particularly on a quarterly basis, and our revenues and results of
operations could fluctuate significantly quarter to quarter and
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year to year. Causes of such fluctuations may include the volume and timing of
new orders and renewals, the sales cycle for our products, the introduction of
new products, distributor inventory levels and return rates, inventory levels,
product upgrades or updates by us or our competitors, changes in product mix,
changes in product prices and pricing models, seasonality, trends in the
computer industry, general economic conditions (such as the recent economic
turbulence in Asia), extraordinary events such as acquisitions or litigation and
the occurrence of unexpected events.
Significant quarterly fluctuations in revenues will cause significant
fluctuations in our cash flows and the cash and cash equivalents, accounts
receivable and deferred revenue accounts on our balance sheet. In addition, the
operating results of many software companies reflect seasonal trends, and our
business, financial condition and results of operations may be affected by such
trends in the future. These trends may include higher net revenue in the fourth
quarter as many customers complete annual budgetary cycles, and lower net
revenue in the summer months when many businesses experience lower sales,
particularly in the European market.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Quantitative and qualitative disclosure about market risk is set forth at
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" under Item 6.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Financial Statements and supplementary data of required by this item
are set forth at the pages indicated at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with our annual meeting of
stockholders to be held on May 25, 2000.
ITEM 11. EXECUTIVE COMPENSATION
The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with our annual meeting of
stockholders to be held on May 25, 2000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with our annual meeting of
stockholders to be held on May 25, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with our annual meeting of
stockholders to be held on May 25, 2000.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
PAGE
NUMBER
------
Report of Independent Accountants........................... 49
Consolidated Statements of Operations and Comprehensive
Income:
Year ending December 31, 1999, 1998, and 1997............. 50
Consolidated Balance Sheets:
December 31, 1999, and 1998............................... 51
Consolidated Statements of Stockholder's Equity:
December 31, 1999, 1998 and 1997.......................... 52
Consolidated Statements of Cash Flows:
December 31, 1999, 1998, and 1997......................... 53
Notes to Consolidated Financial Statements.................. 54
(a)(2) Financial Statement Schedules
Report of Independent Accountants
Schedule II -- Schedule of Valuation and Qualifying Accounts
Other Schedules are omitted because the conditions required for filing do
not exist or the required information is included in the financial
statements or notes thereto.
(a)(3) Exhibits: See Index to Exhibits on Page 80. The Exhibits listed on
the accompanying Index of Exhibits are filed or incorporated by reference as
part of this report.
(b) Reports on Form 8-K:
(i) On January 14, 1999, we filed a form 8-K in connection with our
receipt of a comment letter from the Securities and Exchange Commission.
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49
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders
Networks Associates, Inc.
Santa Clara, California
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and comprehensive income,
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Networks Associates, Inc. and its subsidiaries at
December 31, 1999 and December 31, 1998, and the results of their operations and
their cash flows for each of the three years in the period ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
January 24, 2000
49
50
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
-------------------------------
1999 1998 1997
--------- -------- --------
Net revenue:
Product................................................... $ 474,097 $831,363 $634,269
Services and support...................................... 209,571 158,682 101,423
--------- -------- --------
Total revenue..................................... 683,668 990,045 735,692
--------- -------- --------
Cost of net revenue:
Product................................................... 88,729 137,374 111,552
Services and support...................................... 37,726 39,674 30,547
--------- -------- --------
Total cost of net revenue......................... 126,455 177,048 142,099
--------- -------- --------
Operating costs and expenses:
Research and development.................................. 148,213 135,475 103,051
Marketing and sales....................................... 367,293 294,812 222,194
General and administrative................................ 124,669 83,946 83,083
Amortization of intangibles............................... 58,400 43,182 12,866
Stock compensation charge................................. 15,569 -- 17,653
Acquisition and other related costs....................... (18,732) 135,616 92,799
--------- -------- --------
Total operating costs and expenses................ 695,412 693,031 531,646
--------- -------- --------
Income (loss) from operations..................... (138,199) 119,966 61,947
Interest and other income................................... 24,546 33,447 20,953
Interest and other expense.................................. (17,345) (15,246) (87)
Minority interest in loss of consolidated subsidiaries...... 340 -- --
--------- -------- --------
Income (loss) before provision for income taxes... (130,658) 138,167 82,813
Provision for income taxes.................................. 29,243 101,729 72,174
--------- -------- --------
Net income (loss)................................. $(159,901) $ 36,438 $ 10,639
========= ======== ========
Other comprehensive income (loss):
Unrealized gain (loss) on investments..................... $ (1,610) $ 1,793 $ 56
Foreign currency translation loss......................... (6,813) (5,101) (791)
--------- -------- --------
Comprehensive income (loss)................................. $(168,324) $ 33,130 $ 9,904
========= ======== ========
Net income (loss) per share -- basic........................ $ (1.15) $ 0.27 $ 0.08
========= ======== ========
Shares used in per share calculation -- basic............... 138,695 133,075 126,662
========= ======== ========
Net income (loss) per share -- diluted...................... $ (1.15) $ 0.26 $ 0.08
========= ======== ========
Shares used in per share calculation -- diluted............. 138,695 138,609 132,729
========= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
50
51
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
DECEMBER 31,
------------------------
1999 1998
---------- ----------
Current assets:
Cash and cash equivalents................................. $ 316,784 $ 418,899
Short term marketable securities.......................... 72,135 98,515
Accounts receivable, net of allowance for doubtful
accounts of $16,249 in 1999 and $11,682 in 1998........ 174,646 260,784
Prepaid expenses, income taxes and other current assets..... 33,038 59,554
Deferred taxes.............................................. 79,186 65,866
---------- ----------
Total current assets.............................. 675,789 903,618
Long term marketable securities............................. 397,447 216,457
Fixed assets, net........................................... 45,392 54,489
Deferred taxes.............................................. 93,904 38,205
Intangible and other assets................................. 266,862 323,952
---------- ----------
Total assets...................................... $1,479,394 $1,536,721
========== ==========
LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 13,723 $ 20,881
Accrued liabilities....................................... 253,062 210,070
Deferred revenue.......................................... 123,236 132,409
Notes payable............................................. 103 3,202
---------- ----------
Total current liabilities......................... 390,124 366,562
Deferred taxes.............................................. 10,575 13,000
Deferred revenue, less current portion...................... 30,005 60,189
Long term debt and other liabilities........................ 379,267 374,132
---------- ----------
Total liabilities................................. 809,971 813,883
---------- ----------
Commitments and contingencies (Notes 7 and 5)
Minority Interest........................................... 9,317 --
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value:
Authorized: 5,000,000 shares; Issued and outstanding: none
in 1999 and one share in 1998
Common stock, $.01 par value:
Authorized: 300,000,000 shares; Issued: 139,419,528 shares
in 1999 and 137,123,562 shares in 1998................. 1,387 1,371
Treasury stock.............................................. (11,023) --
Additional paid-in capital.................................. 644,821 527,862
Cumulative other comprehensive income -- unrealized gain
(loss) on investments and foreign currency translation.... (9,957) (1,534)
Retained earnings........................................... 34,878 195,139
---------- ----------
Total stockholders' equity........................ 660,106 722,838
---------- ----------
Total liabilities, minority interest and
stockholders' equity............................ $1,479,394 $1,536,721
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
51
52
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
OTHER
COMMON STOCK ADDITIONAL COMPRE-
---------------- TREASURY PAID-IN DEFERRED HENSIVE RETAINED
SHARES AMOUNT STOCK CAPITAL COMP. INCOME EARNINGS TOTAL
------- ------ -------- ---------- -------- ------- --------- ---------
Balances, December 31, 1996.......... 124,628 $1,246 -- $281,610 $(944) $2,117 $ 141,642 $ 425,671
Elimination of net loss for Network
General for the quarter ended
March 31, 1997................... 1,689 17 (79,196) 83,702 -- 396 6,420 11,339
Issuance of common stock upon
exercise of stock options........ 4,999 50 -- 35,126 -- -- -- 35,176
Issuance of common stock from
Employee Stock Purchase Plan..... 549 6 -- 6,925 -- -- -- 6,931
Tax benefit from exercise of
nonqualified stock options....... -- -- -- 39,941 -- -- -- 39,941
Foreign currency translation....... -- -- -- -- -- (791) -- (791)
Unrealized gain on investments..... -- -- -- -- -- 56 -- 56
Repurchase of common stock......... (3,806) (38) 79,196 (115,895) -- -- -- (36,737)
Amortization of deferred stock
compensation..................... -- -- -- -- 276 -- -- 276
Net income......................... -- -- -- -- -- -- 10,639 10,639
------- ------ -------- -------- ----- ------- --------- ---------
Balances, December 31, 1997.......... 128,059 1,281 -- 331,409 (668) 1,778 158,701 492,501
Issuance of common stock upon
exercise of stock options........ 8,560 86 -- 144,646 -- -- -- 144,732
Issuance of common stock from
Employee Stock Purchase Plan..... 445 4 -- 6,363 -- -- -- 6,367
Tax benefit from exercise of
nonqualified stock options....... -- -- -- 43,500 -- -- -- 43,500
Foreign currency translation....... -- -- -- -- -- (5,105) -- (5,105)
Unrealized gain on investments..... -- -- -- -- -- 1,793 -- 1,793
Amortization of deferred stock
compensation..................... -- -- -- -- 668 -- -- 668
Exercise of warrants............... 59 -- -- 1,944 -- -- -- 1,944
Net income......................... -- -- -- -- -- -- 36,438 36,438
------- ------ -------- -------- ----- ------- --------- ---------
Balances, December 31, 1998.......... 137,123 1,371 -- 527,862 -- (1,534) 195,139 722,838
Issuance of common stock upon
exercise of stock options........ 1,196 12 1,414 17,471 -- -- (360) 18,537
Issuance of common stock from
Employee Stock Purchase Plan..... 578 6 -- 8,929 -- -- -- 8,935
Repurchase of common stock......... (685) (7) (12,437) -- -- -- -- (12,444)
FSA conversion of preferred stock
to common stock.................. 438 4 -- -- -- -- -- 4
Exercise of warrants............... 85 1 -- 458 -- -- -- 459
Proceeds from sale of put
options.......................... 5,250 5,250
Compensation charge due to
repricing of stock options and
McAfee.com options............... -- -- -- 15,570 -- -- -- 15,570
Capital contributed by minority
stockholders of subsidiary....... -- -- -- 69,281 -- -- -- 69,281
Foreign currency translation....... -- -- -- -- -- (6,813) -- (6,813)
Unrealized loss on investments..... -- -- -- -- -- (1,610) -- (1,610)
Net loss........................... -- -- -- -- -- -- (159,901) (159,901)
------- ------ -------- -------- ----- ------- --------- ---------
Balances, December 31, 1999.......... 138,735 $1,387 $(11,023) $644,821 $ -- $(9,957) $ 34,878 $ 660,106
======= ====== ======== ======== ===== ======= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
52
53
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31
-------------------------------------
1999 1998 1997
----------- ----------- ---------
Cash flows from operating activities:
Net income (loss)......................................... $ (159,901) $ 36,438 $ 10,639
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Acquired in-process research and development............ -- 49,843 38,011
Depreciation and amortization........................... 81,492 75,335 37,720
Write down of owned facility............................ -- 1,177 --
Stock compensation charge............................... 15,570 -- --
Minority Interest....................................... (340) -- --
Tax benefit from exercise of nonqualified stock
options............................................... -- 43,500 39,941
Deferred taxes.......................................... (71,444) (47,266) (22,220)
Interest on convertible notes........................... 17,332 14,525 --
Unrealized gain (loss) on investments................... (1,610) 1,793 56
Bad debt expense........................................ 44,809 11,253 6,575
Changes in assets and liabilities:
Accounts receivable................................... 41,329 (109,029) (58,085)
Prepaids and other assets............................. 25,150 (28,627) (26,212)
Accounts payable and accrued liabilities.............. 23,635 (2,300) 66,380
Deferred revenue...................................... (39,357) 49,324 39,180
----------- ----------- ---------
Net cash provided by (used in) operating
activities........................................ (23,335) 95,966 131,985
----------- ----------- ---------
Cash flows from investing activities:
Purchase of investment securities......................... (1,512,935) (3,284,620) (866,728)
Sale of investment securities............................. 1,358,326 3,230,412 826,294
Proceeds from sale of fixed assets........................ 6,518 -- --
Additions to fixed assets................................. (20,458) (34,940) (31,154)
Acquisition of CyberMedia................................. -- (119,958) --
Acquisition of Magic...................................... -- (109,717) --
Acquisition of Cinco, Networks, Inc....................... -- -- (25,079)
Acquisition of Compusul................................... -- -- (3,350)
Acquisition of 3DV Technology, Inc........................ -- -- (20,000)
Acquisition of Paradigm................................... -- -- (1,833)
Acquisition of Datawatch.................................. -- -- (9,336)
Acquisition of PGP........................................ -- -- (24,974)
Elimination of Network General cash flow for the quarter
Ended March 31, 1997.................................... -- -- 11,339
Purchased intangibles..................................... -- -- (374)
----------- ----------- ---------
Net cash used in investing activities............... (168,549) (318,823) (145,195)
----------- ----------- ---------
Cash flows from financing activities:
Issuance of convertible debentures, net of issuance
costs................................................... -- 337,624 --
Repayment of notes payable................................ (3,085) (837) (125)
Proceeds of McAfee.com initial public offering, net....... 78,945 -- --
Issuance of stock under stock option and stock purchase
plans................................................... 27,471 151,099 42,110
Proceeds from sale of put options......................... 5,250 -- --
Repurchase of common stock................................ (12,443) -- (36,738)
Exercise of warrants...................................... 459 1,944 --
----------- ----------- ---------
Net cash provided by financing activities........... 96,597 489,830 5,247
----------- ----------- ---------
Effect of exchange rate fluctuations on cash and cash
equivalents............................................. (6,828) (5,105) (791)
----------- ----------- ---------
Net increase (decrease) in cash and cash equivalents........ (102,115) 261,868 (8,754)
Cash and cash equivalents at beginning of year.............. 418,899 157,031 165,785
----------- ----------- ---------
Cash and cash equivalents at end of year.................... $ 316,784 $ 418,899 $ 157,031
=========== =========== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes................ $ 32,318 $ 68,446 $ 14,316
=========== =========== =========
The accompanying notes are an integral part of these consolidated financial
statements.
53
54
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Networks Associates, Inc. (the "Company"), formally McAfee Associates,
Inc., develops, markets, distributes and supports network security and network
management software products. The Company's markets are worldwide and include
corporate, governmental, and institutional users as well as resellers and
distributors throughout the world. Software products and updates are delivered
primarily through electronic distribution under two-year subscription licenses
and as boxed product sold through the retail channel. International sales and
support are provided by subsidiaries in principal European markets and
independent agents and distributors elsewhere internationally. The Company
changed its name to Networks Associates, Inc. in connection with the combination
of McAfee Associates and Network General, in December 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Presentation
The accompanying consolidated financial statements include the accounts of
the Company and its majority owned subsidiaries. All intercompany accounts and
transactions have been eliminated. Certain reclassifications have been made to
the prior year's financial statements to conform to the current year's
presentation. These reclassifications had no effect on the prior year's
stockholders' equity or net income.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period.
Specifically, significant estimates are required in the valuation of intangible
assets acquired in purchase combinations including amounts accounted for as in-
process research and development, costs accrued for restructuring merged
businesses, allowances for doubtful accounts and sales returns, and valuation
allowances for deferred tax assets. Actual results could differ from those
estimates.
Certain Risks and Concentrations
The Company's product revenues are concentrated in the computer software
industry that is highly competitive and rapidly changing. Significant
technological changes in the industry or customer requirements, or the emergence
of competitive products with new capabilities or technologies could adversely
affect operating results. Also, a majority of the Company's revenues are derived
from sales to distributors and resellers. Significant changes in operations,
buying behavior or financial stability of our channel partners could adversely
affect operating results. In addition, a significant portion of the Company's
revenue and net income is derived from international sales and distributors.
Fluctuations of the U.S. dollar against foreign currencies, changes in local
regulatory or economic conditions, piracy or significant dislocations in local
distribution channels could adversely affect operating results.
The Company maintains the majority of cash balances and all of its
short-term investments with six financial institutions. The Company invests with
high credit quality financial institutions and, by policy, limits the amount of
credit exposure to any one financial institution. The Company has significant
accounts receivable from several major distributors and from customers across a
broad demographic base. Management of the Company performs ongoing credit
evaluations of its customers and maintains allowances for doubtful accounts.
Certain of the Company's products contain critical components supplied by a
single or a limited number of third parties. The Company has been required to
purchase and inventory certain of the computer platforms around which it designs
its products so as to ensure an available supply of the product for its
customers. Any
54
55
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
significant shortage of these platforms or other components or the failure of
the third party supplier to maintain or enhance these products could materially
adversely affect the Company's results of operations.
Foreign Currency Translation
The Company considers the local currency to be the functional currency for
its international subsidiaries. Assets and liabilities denominated in foreign
currencies are translated using the exchange rate on the balance sheet date.
Translation adjustments resulting from this process are charged or credited to
equity. Revenues and expenses are translated at average exchange rates
prevailing during the year. Foreign currency transaction gains and losses, which
to date have not been material, are included in the determination of net income.
Revenue Recognition
Revenue from product licenses is generally recognized when a customer
purchase order has been received, a license agreement has been delivered, the
software or system has been shipped (or software has been electronically
delivered), remaining obligations are insignificant, and collection of the
resulting account receivable is probable. Maintenance revenue for providing
product updates and customer support is deferred and recognized ratably over the
service period. For contracts with multiple obligations (e.g. deliverable and
undeliverable products, maintenance and other services), the Company allocates
revenue to each component of the contract based on objective evidence of its
fair value, which is specific to the Company. Revenue from hardware products is
recognized upon shipment subject to a reserve for returns. Revenues on rental
units under operating leases and service agreements are recognized ratably over
the term of the rental or service period.
Revenue generated from products sold through traditional channels where the
right of return exists is reduced by reserves for estimated sales returns. Such
reserves are based on estimates developed by management. As unsold products in
these distribution channels are exposed to rapid changes in consumer preferences
or technological obsolescence due to new operating environments, product updates
or competing products, it is reasonably possible that these estimates will
change in the near term.
Government Contracts
The Company enters into research and development contracts with government
agencies under various pricing arrangements. Revenue from "cost-plus-fixed-fee"
contracts is recognized on the basis of reimbursable contract costs incurred
during the period, plus a percentage of the fixed fee. Revenue from "time and
material" contracts is recognized on the basis of hours utilized, plus other
reimbursable contract costs incurred during the period. Revenue from
"firm-fixed-price" contracts is recognized on the percentage of completion
method. Under this method, individual contract revenues are recorded based on
the percentage relationship that contract costs incurred bear to management's
estimate of work completed. Losses, if any, are accrued when their occurrence
becomes known and the amount of the loss is reasonably determined.
Under government contracts, the Company is subject to audit by the Defense
Contract Audit Agency (DCAA) which could result in the renegotiation of amounts
previously billed. The DCAA has performed audits of the Company's costs through
1996. Management believes that the results of such audits will not have a
material adverse impact on the Company's financial position or results of
operations.
Research and Development
Research and development expenditures are charged to operations as
incurred. Under the Company's development process, technological feasibility is
established on completing a working model. Subsequent costs for the Company have
not been significant and all software development costs have therefore been
expensed.
55
56
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Advertising Costs
Advertising production costs are expensed as incurred. Media (TV and print)
placement costs are expensed in the period the advertising appears. Total
advertising and promotional expenses were $58.8 million, $30.4 million, and
$22.6 million for the years ended December 31, 1999, 1998, and 1997,
respectively.
Cash and Cash Equivalents
Cash equivalents are comprised of highly liquid debt instruments with
original maturities of 90 days or less.
Marketable Securities
All marketable securities are classified as available-for-sale securities.
Available-for-sale securities are carried at fair value in accordance with
Statement of Financial Accounting Standards No. 115 ("SFAS 115"). Short-term
marketable securities are those with maturities greater than 90 days but less
than one year. Long term marketable securities have original maturities greater
than one year. Unrealized gains and losses on marketable securities are reported
net of related taxes as a separate component of stockholders' equity. Realized
gains and losses on sales of all such investments are reported in earnings and
computed using the specific identification cost method.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and include material and related manufacturing overhead.
Long Lived Assets
Fixed Assets
Fixed assets are stated at cost. Depreciation and amortization of fixed
assets is provided using the straight-line method over the estimated useful
lives of the assets (2 to 5 years). Upon disposal, the asset and related
accumulated depreciation is removed form the records and the related gain or
loss is recorded in the results of operations.
Intangible Assets
Intangible assets include the estimated fair market values of purchased
technology when the related products or products under development are
considered technologically feasible and goodwill arising from acquisitions and
other intangibles. Intangibles are amortized over their estimated useful lives
(typically three to seven years).
In accordance with FASB Statement 121, Accounting for the Impairment of
Long Lived Assets and for Long Lived Assets to be Disposed Of, the Company
assesses impairment losses on long lived assets, principally goodwill and
purchased technology when events or changes in circumstances indicate that the
carrying amount may not be recoverable. Impairment is considered to have
occurred when the undiscounted future net cash flows the assets are expected to
generate are less than the carrying value of the related asset. If such assets
are considered to be impaired, the impairment to be recognized is measured as
the amount by which the carrying amount of the asset exceeds the present value
of the future net cash flows.
56
57
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Fair Value of Financial Instruments
Carrying amounts of the Company's financial instruments including cash and
cash equivalents, investments, accounts receivable, accounts payable and accrued
liabilities approximate fair value due to their short maturities.
The fair value of the Company's convertible debentures is based on the
current market value. The carrying amount and estimated fair value of
convertible debentures at December 31, 1999 were $378.3 million and $369.40
million, respectively.
Net Income (Loss) Per Share
Net income (loss) per share has been computed in accordance with SFAS 128.
Basic net income (loss) per share is computed using the weighted average common
shares outstanding during the period. Diluted net income (loss) per share is
computed using the weighted average common shares and common equivalent shares
outstanding during the period.
3. BUSINESS COMBINATIONS AND ACQUISITIONS
The Company made no acquisitions in 1999 and the following acquisitions in
1998 and 1997:
CyberMedia, Inc.
On September 9, 1998, the Company obtained control of CyberMedia, Inc.
("CyberMedia"), a provider of desktop utility software solutions, when
CyberMedia's stockholders tendered approximately 97% of the outstanding shares
to the Company for $9.50 per share in cash. On September 10, 1998, a subsidiary
of the Company merged into CyberMedia in a transaction in which CyberMedia
shares not tendered were converted into the right to receive the same per share
cash price paid in the tender offer. Total cash paid to stockholders was $130.4
million. The transaction was accounted for as a purchase transaction. The total
purchase price including transaction costs and assumed net liabilities was
approximately $174.3 million. As the Company had assessed and formulated its
plans to terminate certain CyberMedia employees and close certain CyberMedia
facilities as of the acquisition date, the total purchase price includes related
liabilities of $13.3 million. Of the total purchase price, $22.8 million was
allocated to in-process research and development. In addition, $12.2 million was
allocated to existing technology and other intangibles and $139.3 million to
goodwill, to be amortized over 3 and 7 years, respectively. To determine the
value of the in-process research and development, the Company considered, among
other factors, the stage of development of each project at the time of
acquisition, the time and cost needed to complete each project, expected income
from the projects, and the projected incremental cash flows from the projects
when completed and any associated risks. Associated risks include the inherent
difficulties and uncertainties in completing a project and thereby achieving
technological feasibility and risks related to the impact of potential changes
in future target markets. This analysis resulted in $22.8 million being assigned
to in-process research and development projects that had not yet reached
technological feasibility and did not have alternative future use.
Dr. Solomon's Group PLC
On August 13, 1998, the Company acquired Dr. Solomon's Group PLC ("Dr.
Solomon's"), (the "Acquisition"), a European-based publicly-held provider of
anti-virus software products for approximately 15.3 million shares of the
Company's Common Stock (including 1.7 million shares held in trust pending the
exercise of certain outstanding and fully vested Dr. Solomon's options). In the
Acquisition, each outstanding ordinary share of Dr. Solomon's was exchanged for
0.27625 shares of Common Stock of the Company. The Company assumed all
outstanding options to acquire Dr. Solomon's ordinary shares.
57
58
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Acquisition was accounted for as a pooling of interests and therefore
all prior period financial statements have been restated to include the results
of Dr Solomon's for all periods presented. Financial statements for the years
ended December 31, 1997, 1996 and 1995, reflect the combination of the operating
results of the Company for the years ended December 31, 1997, 1996 and 1995 and
the operating results of Dr. Solomon's for the years ended November 30, 1997,
1996 and 1995. The results of operations for the year ended December 31, 1998
reflect the results of operations of the Company for the year ended December 31,
1998 and the results of operations of Dr. Solomon's for the thirteen months
ended December 31, 1998.
Separate and combined results of operations for the periods prior to the
merger are as follows (in thousands, except per share data):
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------- --------------------
1997 1996 1995 1998 1997
-------- -------- -------- -------- --------
Revenues:
Networks Associates............. $656,322 $470,722 $305,206 $419,512 $313,991
Dr. Solomon's................... 79,370 44,275 23,335 55,898 35,167
-------- -------- -------- -------- --------
Combined........................ $735,692 $514,997 $328,541 $475,410 $349,158
======== ======== ======== ======== ========
Net income (loss)
Networks Associates............. $ 10,635 $ 67,447 $ 52,890 $ (6,305) $ 38,503
Dr. Solomon's................... 4 (56,736) 862 502 3,678
-------- -------- -------- -------- --------
Combined........................ $ 10,639 $ 10,711 $ 53,752 $ (5,803) $ 42,181
======== ======== ======== ======== ========
Net income (loss) per
share -- diluted
Networks Associates............. $ 0.09 $ 0.58 $ 0.48 $ (0.05) $ 0.33
======== ======== ======== ======== ========
Dr. Solomon's................... $ 0.00 $ (6.34) $ 0.10 $ 0.03 $ 0.24
======== ======== ======== ======== ========
Combined........................ $ 0.08 $ 0.09 $ 0.45 $ (0.04) $ 0.32
======== ======== ======== ======== ========
Trusted Information Systems
On April 28, 1998, the Company acquired Trusted Information Systems
("TIS"), a publicly-held provider of comprehensive security systems for computer
networks. The acquisition was accounted for as a pooling of interests and
therefore all prior period financial statements have been restated to include
the results of TIS for all periods presented. In the acquisition, a wholly owned
subsidiary of the Company merged with and into TIS; TIS became a wholly owned
subsidiary of the Company; and all outstanding common stock of TIS was converted
into approximately 6.8 million shares of Common Stock of the Company, at an
exchange ratio of 0.4845. The Company also assumed all outstanding options and
other rights to acquire TIS capital stock.
Magic Solutions International, Inc.
On April 1, 1998, the Company acquired all of the outstanding capital stock
and options of Magic Solutions International, Inc. ("Magic Solutions"), a
privately held provider of internal help desk and asset management solutions,
for approximately $109.8 million in cash. The acquisition was accounted for
using the purchase method of accounting and the total purchase price was $140.3
million, including transaction costs and assumed net liabilities. As the Company
had assessed and formulated its plans to terminate certain Magic Solutions
employees and close the Magic Solutions facilities as of the acquisition date,
the total purchase price includes related liabilities of $8.7 million.
Approximately $27.0 million of the total purchase price was expensed as
purchased in-process research and development. The remaining excess of the
purchase price over the net assets acquired was $113.3 million of which, $20.3
million has been recorded as purchased technology and trademarks and $92.9
million as goodwill which are being amortized on a straight-line basis over 5
and 7 years, respectively. To determine the value of the in-process research and
development, the Company
58
59
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
considered, among other factors, the stage of development of each project at the
time of acquisition, the time and cost needed to complete each project, expected
income from the projects, and the projected incremental cash flows from the
projects when completed and any associated risks. Associated risks include the
inherent difficulties and uncertainties in completing a project and thereby
achieving technological feasibility and risks related to the impact of potential
changes in future target markets. This analysis resulted in $27.0 million being
assigned to in-process research and development projects, which had not yet
reached technological feasibility and did not have alternative future use.
The following summary, prepared on a pro forma basis, combines the results
of operations as if CyberMedia and Magic Solutions had been acquired as of the
beginning of the periods presented, after including the impact of certain
adjustments, such as amortization of intangibles, the write-off of in-process
technology and the related income tax effects (dollars in thousands, except per
share amounts):
YEARS ENDED DECEMBER 31,
------------------------
1998 1997
----------- ---------
(UNAUDITED)
Revenue.............................................. $1,003,636 $851,004
Net loss............................................. (42,556) (59,337)
Net loss per share................................... (0.32) (0.47)
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition had been in effect for the entire periods
presented. In addition, they are not intended to be a projection of future
results and do not reflect any synergies that might be achieved from combined
operations.
Other Acquisitions
On May 15, 1998, the Company acquired Secure Networks, Inc. ("Secure"). The
aggregate consideration payable in the acquisition was 567,000 shares of the
Company's Common Stock. The acquisition was accounted for as a pooling of
interests and therefore all prior period financial statements have been restated
to include the results of Secure for all periods presented. Secure is a
developer and licensor of network security auditing software based in Canada.
On August 31, 1998, the Company acquired QA Information Security Holding AB
("QA"). The consideration payable in the acquisition was 305,557 shares of the
Company's Common Stock in a transaction accounted for as a pooling of interests.
QA, based in Sweden, is a distributor of network security products. On July 30,
1998, the Company acquired Anyware Seguridad Informatica S.A. ("Anyware"). The
aggregate consideration payable in the acquisition was 228,204 shares of the
Company's Common Stock in a transaction accounted for as a pooling of interests.
Anyware, based in Madrid, Spain, is a developer and distributor of anti-virus
software products. The Company's financial statements have been restated for
these poolings, the effect of which was not material.
59
60
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table is a summary of acquisitions by the Company in the
three years ended December 31, 1999:
COMMON STOCK
ISSUED IN PURCHASE PRICE OF
POOLING OF INTERESTS PURCHASE TRANSACTIONS
-------------------- -----------------------------
1998
Syscon................................. 1,230 shares
Nordic................................. 30,508 shares
Magic Solutions........................ $140.3 million
TIS.................................... 6,755,540 shares
Secure................................. 567,000 shares
CSB.................................... 9,815 shares
QA..................................... 305,557 shares
Anyware................................ 228,204 shares
Dr. Solomon's.......................... 15,813,142 shares
CyberMedia............................. $174.3 million
1997
Network General........................ 17,900,000 shares
Jade K.K. ............................. 504,107 shares
Schuijers Holdings B.V. ............... 95,582 shares
3DV Technology, Inc. .................. $20.0 million
Compusul Consultores de Informatica,
Ltda. ............................... $2.6 million plus $1.0
million contingently payable
Cinco Networks, Inc. .................. $26.0 million
Paradigm Agency Pty Ltd. .............. $2.0 million
Helix Software Company................. 825,000 shares
Pretty Good Privacy, Inc. ............. $35 million plus warrants to
purchase 375,000 shares of
Common Stock at $40 per share
4. MARKETABLE SECURITIES:
At December 31, 1999 and 1998, marketable securities are summarized as
follows (in thousands):
AVAILABLE-FOR-SALE-SECURITIES
AMORTIZED AGGREGATE UNREALIZED
1999 COST FAIR VALUE LOSS
---- --------- ---------- ----------
(IN THOUSANDS)
U.S. Government debt securities........................ $192,730 $191,121 $(1,587)
Municipal debt securities.............................. 69,676 68,954 (723)
Corporate debt securities.............................. 475,241 474,264 (960)
-------- -------- -------
$737,647 $734,339 $(3,270)
======== ======== =======
Unrealized gains at December 31, 1999 include $3.4 million related to
unrealized gain on our investments in equity securities.
60
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1999, all marketable debt securities had scheduled
maturities of less than three years. Marketable debt securities totaling $268.1
million have maturities of less than 3 months and are classified as cash
equivalents.
AVAILABLE-FOR-SALE-SECURITIES
AMORTIZED AGGREGATE UNREALIZED
1998 COST FAIR VALUE GAIN/(LOSS)
---- --------- ---------- -----------
(IN THOUSANDS)
U.S. Government debt securities................... $148,363 $148,221 $(142)
Municipal debt securities......................... 53,463 53,677 214
Corporate debt securities......................... 275,270 275,980 710
-------- -------- -----
$477,096 $477,878 $ 782
======== ======== =====
Unrealized gains at December 31, 1998 include $1.0 million related to
unrealized gain on our investments in equity securities.
At December 31, 1998, marketable debt securities totaling $162.9 million
had maturities of less than 3 months and are classified as cash equivalents.
5. DERIVATIVES
During fiscal year 1997, the Company began using forward foreign exchange
contracts to hedge certain assets denominated in foreign currencies. For these
instruments, risk reduction is assessed on a transaction basis and the
instruments are designated as a hedge and are highly inversely correlated to the
hedged item as required by generally accepted accounting principles. Gains and
losses on these hedges are included in the carrying amount of the assets and are
ultimately recognized in income. If a hedging instrument ceases to qualify for
hedge accounting, it is accounted for on a mark to market basis and any
subsequent gains and losses are recognized currently in income. The Company does
not use any derivatives for trading or speculative purposes.
Forward Exchange Contracts
The Company conducts business globally. As a result, it is exposed to
movements in foreign currency exchange rates. The Company enters into forward
exchange contracts to hedge exposures associated with nonfunctional currency
assets and liabilities denominated in Canadian, Australian and several European
currencies.
The Company does not generally hedge anticipated foreign currency cash
flows nor does the Company enter into forward contracts for trading purposes.
Gains and losses on the contracts are reported in other income and generally
offset gains or losses from the revaluation of nonfunctional currency assets and
liabilities. The forward contracts range from one to three months in original
maturity. The forward contracts outstanding and their unrealized gains and
(losses) are presented below (in thousands):
NOTIONAL VALUE NOTIONAL VALUE UNREALIZED
PURCHASED SOLD GAIN/(LOSS)
-------------- -------------- -----------
Australian Dollar........................... $ -- $ 6,600 $(143)
Canadian Dollar............................. -- 14,980 (309)
Dutch Guilder............................... -- -- --
Euro........................................ 37,571 -- (6)
Other European Currencies................... 43,626 -- 258
------- ------- -----
$81,197 $21,580 $(200)
======= ======= =====
61
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. BALANCE SHEET DETAIL (IN THOUSANDS):
DECEMBER 31,
---------------------
1999 1998
--------- --------
Fixed assets:
Furniture and fixtures.............................. $ 15,918 $ 16,520
Computers, demonstration and rental equipment....... 105,203 97,665
Leasehold improvements.............................. 13,191 13,464
--------- --------
134,312 127,649
Less accumulated depreciation....................... (88,920) (73,160)
--------- --------
$ 45,392 $ 54,489
========= ========
Intangibles assets (see Note 2):
Purchased technology................................ $ 68,490 $ 68,905
Other............................................... 1,261 1,261
Goodwill............................................ 327,024 327,760
--------- --------
396,775 397,926
Less accumulated amortization....................... (143,535) (86,350)
--------- --------
253,240 311,576
Other assets.......................................... 13,622 12,376
--------- --------
$ 266,862 $323,952
========= ========
Accrued liabilities:
Accrued compensation................................ $ 38,150 $ 26,954
Accrued acquisition and merger costs................ 41 28,234
Accrued compensation -- Cinco acquisition........... -- 10,837
Accrued legal and accounting........................ 9,669 12,482
Accrued inventory................................... 10,193 10,068
Accrued taxes....................................... 147,472 64,744
Other accrued expenses.............................. 47,537 56,751
--------- --------
$ 253,062 $210,070
========= ========
Depreciation and amortization expense for the years ended December 31, 1999,
1998 and 1997 were $81.5 million, $75.3 million and $37.7 million respectively.
62
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. COMMITMENTS:
Leases
The Company leases its operating facilities under non-cancelable operating
leases, which expire at various times ranging from the year 2000 through 2013.
In addition, the Company has leased certain equipment with various lease
expiration dates.
At December 31, 1999, future minimum payments under non-cancelable
operating leases are as follows (in thousands):
YEAR ENDING DECEMBER 31,
------------------------
2000...................................................... $ 23,874
2001...................................................... 19,336
2002...................................................... 16,589
2003...................................................... 11,931
2004 and thereafter....................................... 88,158
--------
$159,888
========
Rent expense for the years ended December 31, 1999, 1998 and 1997 amounted
to $15.1 million, $10.8 million, and $12.4 million, respectively.
8. CONVERTIBLE DEBENTURES
On February 13, 1998, the Company completed a private placement of zero
coupon convertible subordinated debentures due in 2018 (the "Debentures"). The
debentures, with an aggregate face amount at maturity of $885.5 million,
generated net proceeds to the Company of approximately $337.6 million. The
initial price to the public for the debentures was $391.06 per $1,000 of face
amount at maturity, which equates to a yield to maturity over the term of the
bonds of 4.75% (on a semi-annual bond equivalent basis). The debentures are
convertible into Common Stock at the rate of 8.538 shares per $1,000 of face
amount at maturity, which equates to an initial conversion price of $45.80 per
share. The Debentures are subordinated in right of payment to all existing and
future Senior Indebtedness (as defined) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the Company's subsidiaries.
The Debentures may be redeemed for cash at the option of the Company beginning
on February 13, 2003. At the option of the holder, the Company will purchase the
Debentures on February 13, 2003, February 13, 2008 and February 13, 2013 at
purchase prices (to be paid in cash or Common Stock or any combination thereof,
at the election of the Company and subject to certain conditions) equal to the
initial issue price plus accrued original issue discount to such dates. The
Debentures may also be redeemed at the option of the holder if there is a
Fundamental Change (as defined) at a price equal to the issue price plus accrued
original issue discount to the date of redemption, subject to adjustment.
9. EMPLOYEE BENEFIT PLANS
401(k) and Profit Sharing Plan
Under the Company's 401(k) and Profit Sharing Plans, the Board of
Directors, at its discretion, can match employee contributions in an amount not
to exceed 20% of total compensation. Annual amounts provided by the Company
under the plan to date have not been material.
Employee Stock Purchase Plan
Under the 1994 Employee Qualified Stock Purchase Plan, the Company can
grant stock purchase rights to all eligible employees during one year offering
periods with exercise dates approximately every six months
63
64
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(beginning each August and February). The Company has reserved 3.8 million
shares of common stock for issuance under the plan. Shares are purchased through
employees' payroll deductions at exercise prices equal to 85% of the lesser of
the fair market value of the Company's common stock at either the first day of
an offering period or the last day of such offering period. No participant may
purchase more than $21,250 worth of common stock in any one calendar year.
10. 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 December 1999, McAfee.com
completed its initial public offering and began publicly trading under the
symbol of "MCAF." The Company received net proceeds of $78.9 million. The
Company owns all of the outstanding Class B common stock, representing
approximately 83% of McAfee.com's outstanding common stock at December 31, 1999.
In January 1999, executives of Network Associates were granted options to
purchase 1,710,000 shares (after restatement for the effects of a 2 for 1 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. In
September and October 1999, certain Network Associates employees were also
granted options to purchase 379,000 shares of McAfee.com common stock. As of
December 31, 1999, all these options were fully vested. In connection with these
options, the Company recorded total compensation expense for the year ended
December 31, 1999 of approximately $6.7 million.
11. STOCKHOLDERS' EQUITY
Preferred Stock
The Company has authorized 5,000,000 shares of preferred stock, par value
$.01 per share. The Company's Board of Directors has authority to provide for
the issuance of the shares of preferred stock in series, to establish from time
to time the number of shares to be included in each such series and to fix the
designation, powers, preferences and rights of the shares of each such series
and the qualifications, limitations or restrictions thereof, without any further
vote or action by the shareholders.
At December 31, 1998 there was one share of Series A preferred stock
outstanding, which was issued in connection with the acquisition of FSA. The
share of Series A preferred stock had no preferential rights other than the
right to cast a number of votes equal to the number of common shares issuable in
exchange for certain exchangeable non-voting shares of FSA. During 1999, that
single preferred share was converted into 437,589 of the Company's common stock.
At December 31, 1999, there was no preferred stock outstanding.
Stock Option Plans
In June 1997, the Board of Directors approved the 1997 Stock Incentive Plan
(the "1997 Plan") to replace the 1995 Stock Incentive Plan. Under the amended
1997 Plan, the Company has reserved 16,475,000 shares for issuance to employees,
officers, directors, third-party contractors and consultants. The plan provides
for an option price no less than 100% of the fair market value of the Company's
common stock on the date of grant for incentive stock options granted to
employees and officers (including directors who are also employees) or 85% of
the fair market value on the date of grant for all others. The options may be
exercisable immediately, or over time, generally vest 25% one year after
commencing employment or from date of grant and vest thereafter in monthly
increments over three years. All options under the option plan expire ten years
after grant.
64
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Under the amended Stock Option Plan for Outside Directors, the Company has
reserved 1,132,813 shares for issuance to certain members of its Board who are
not employees of the Company or any affiliated corporation. The plan provides
for an option price at fair market value of the Company's common stock on the
date of grant. The initial grant to each outside director generally vests
ratably over a three-year period. Subsequent option grants will vest after three
years from the date of grant. All options under the option plan expire ten years
after grant.
In December 1999, the Board of Directors approved the 2000 Nonstatutory
Stock Option Plan. The Company has reserved 3,000,000 shares for issuance to
employees, officers, directors, third-party contracts and consultants. The plan
provides for an option price at fair market value of the Company's common stock
on the date of grant. The options vest over a period of four years: 25% vest one
year from the date of grant and the remaining vest ratably in monthly increments
over three years. All options under the option plan expire ten years after
grant. As of December 31, 1999, no options had been granted from this plan.
Aggregate activity under stock option plans is as follows:
OUTSTANDING OPTIONS
SHARES --------------------------------------------------------------
AVAILABLE NUMBER OF PRICE PER AGGREGATE WEIGHTED AVG.
FOR GRANT SHARES SHARE PRICE EX. PRICE
----------- ----------- ---------------- ------------- -------------
Balances, December 31,
1996................... 3,656,831 19,424,310 $ 0.48 - $ 74.23 232,579,079 $11.98
Additional shares
authorized............. 8,775,000
Eliminate NGC duplicate
period................. 83,016 223,466 $ 0.53 - $ 43.79 1,106,862 $ 4.95
Shares granted........... (9,669,921) 9,669,921 $ 0.23 - $ 79.21 282,196,266 $29.18
Shares exercised......... -- (4,998,801) $ 0.53 - $ 40.20 (35,126,226) $ 7.03
Shares canceled.......... 4,247,884 (4,247,884) $ 0.65 - $ 44.42 (79,717,708) $18.77
----------- ----------- -------------
Balances, December 31,
1997................... 7,092,810 20,071,012 $ 0.23 - $ 44.42 401,038,273 $19.98
Additional shares
authorized............. 3,000,000 --
Shares granted........... (11,397,414) 11,397,414 $21.41 - $121.80 419,774,937 $36.83
Shares exercised......... -- (8,560,824) $ 0.06 - $ 44.42 (144,646,193) $16.90
Shares canceled.......... 3,587,906 (3,587,906) $ 0.65 - $ 48.38 (92,013,391) $25.65
----------- ----------- -------------
Balances, December 31,
1998................... 2,283,302 19,319,696 $ 0.06 - $121.80 584,153,626 $30.24
Additional shares
authorized............. 9,200,000 --
Shares granted........... (16,881,939) 16,881,939 $11.06 - $ 56.00 242,970,168 $14.39
Shares exercised......... -- (1,196,165) $ 0.06 - $ 44.42 (18,537,384) $15.50
Shares canceled.......... 14,921,896 (14,921,896) $ 0.48 - $121.80 (482,328,792) $33.08
----------- ----------- -------------
Balances, December 31,
1999................... 9,523,259 20,083,574 $ 0.06 - $ 56.00 $ 326,257,618 $16.24
=========== =========== =============
At December 31, 1999, a total of 8,133,388 options to purchase common stock
were exercisable at an average exercise price of $16.98. During 1999, the
Company used 431,552 shares of treasury stock to fulfill employee option
exercises.
At December 31, 1998 and December 31, 1997, approximately 3.7 million and
5.5 million outstanding options, respectively, were exercisable. The weighted
average exercise prices for exercisable options were $21.59 and $14.17 at
December 31, 1998 and December 31, 1997, respectively.
65
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following information regarding the stock option program and employee
stock purchase programs is provided in compliance with SFAS 123, "Accounting for
Stock Based Compensation". The Company has elected to continue accounting for
such plans in accordance with APB No. 25.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- ------------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
RANGE OF EXERCISE OUTSTANDING REMAINING EXERCISABLE EXERCISABLE EXERCISE
PRICES AT 12/31/99 CONTRACTUAL LIFE (YRS) PRICE AT 12/31/99 PRICE
- ----------------- ----------- ---------------------- ---------------- ----------- ----------------
$ 0.00 - $12.18.. 10,649,094 7.5 $10.49 4,706,161 $ 9.77
$12.18 - $24.36.. 5,068,101 8.2 $16.73 648,886 $17.23
$24.36 - $36.54.. 4,107,517 6.7 $28.84 2,696,756 $28.68
$36.54 - $48.72.. 256,362 8.3 $43.30 81,585 $43.47
$48.72 - $60.90.. 2,500 2.1 $56.00 0 0
---------- --- ------ --------- ------
$ 0.00 - $60.90.. 20,083,574 7.5 $16.24 8,133,388 $16.98
The fair market value of options granted has been calculated using the
Black-Scholes option pricing model using the multiple option approach. A typical
option grant vests over a four-year period. Parameters for the option analysis
are listed below.
1997 1998 1999
---- ---- ----
Risk free interest rate..................................... 5.39% 5.04% 5.47%
Expected life (years)....................................... 4 4 4
Volatility.................................................. 0.66 0.63 0.97
Dividend yield.............................................. 0 0 0
The weighted average expected life of the option grants was estimated based
on examination of previously exercised options over the life of the program.
Volatility was estimated on a monthly basis since the company became public in
October of 1992. The average volatility for the 36-month period from January
1997 through December 1999 was 75%. The Company has not paid a dividend, and has
no plans to do so.
The weighted average fair value of options granted in 1999, 1998 and 1997
was $14.39, $19.08 and $18.29, respectively.
The company has also estimated the fair value of purchase rights issued
under the Employee Stock Purchase Program. Rights under this plan were also
evaluated using the Black-Scholes option-pricing model. The company's plan is
described in Note 10. Purchase periods occur twice yearly and each effectively
contains a 6 and 12 month option.
FEBRUARY AUGUST FEBRUARY AUGUST FEBRUARY AUGUST
1997 1997 1998 1998 1999 1999
--------- --------- --------- --------- --------- ---------
Risk Free Interest Rate........ 5.40% 5.44% 5.36% 5.28% 4.52% 5.01%
Expected Life.................. 6,12 mos 6,12 mos 6,12 mos 6,12 mos 6,12 mos 6,12 mos
Volatility..................... 0.66 0.66 0.63 0.63 0.66 0.66
Dividend Yield................. -- -- -- -- -- --
The weighted average fair value of options granted pursuant to the Employee
Stock Purchase Program in 1999, 1998 and 1997 was $21.43, $14.81 and $10.77,
respectively.
The following pro forma income information has been prepared following the
provisions of SFAS 123.
1999 1998 1997
--------- -------- --------
Net loss -- pro forma (thousands)................. $(209,890) $(35,002) $(46,671)
Net loss per share -- diluted -- pro forma........ $ (1.51) $ (0.26) $ (0.37)
66
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The impact on pro forma earnings per share and net income in the table
above may not be indicative of the effect in future years as options vest over
several years and the company continues to grant stock options to new employees.
This policy may or may not continue.
Warrants
Pursuant to the acquisition of PGP, the Company issued warrants to purchase
375,000 shares of common stock at a price of $40 per share, which expire,
subject to certain extensions, on June 5, 2000. As of December 31, 1999 warrants
for 315,816 shares were outstanding. The warrants issued pursuant to the
acquisition of PGP were valued using the Black Scholes model, using the
following parameters: Stock price $50.44 (prior to a 3:2 stock split in May
1998); Exercise Price $60.00 (prior to the 3:2 stock split); Term 1 year;
Volatility 66%; Annual dividend 0%; Discount rate 5.5%. The resulting valuation
of the 375,000 warrants was $2,722,500, the total amount of which was included
in the purchase price allocation. In addition, warrants for the purchase of
6,340 shares of Common Stock issued in connection with the Company's 1995
acquisition of Assurdata were exercised during the year ended December 31, 1998.
Preferred Shares Rights Agreement
On October 19, 1998, pursuant to a Preferred Shares Rights Agreement
between the Company and BankBoston, N.A. as Rights Agent, the Board of Directors
of the Company announced that it had declared a dividend distribution of one
preferred share purchase right (a "Right") on each outstanding share of the
Company's Common Stock. Each Right will entitle stockholders to buy one-one
thousandth of a share of the Company's Series B Participating Preferred Stock at
an exercise price of $200.00. The Rights will become exercisable following the
tenth day after a person or group announces the acquisition of 15% or more of
the Company's Common Stock or announces commencement of a tender or exchange
offer, the consummation of which would result in ownership by the person or
group of 15% or more of the Common Stock of the Company. The Company will be
entitled to redeem the Rights at $0.01 per Right at any time on or before the
tenth day following acquisition by a person or group of 15% or more of the
Company's Common Stock. The dividend distribution was made on November 3, 1998,
payable to the stockholders of record on November 3, 1998. The Rights will
expire on October 20, 2008.
12. PROVISION FOR INCOME TAXES
Income taxes have been provided using the liability method in accordance
with FASB No. 109 Accounting For Income Taxes.
Pre-tax book income (loss) from continuing operations for the years ended
December 31, was earned in the following jurisdictions (in thousands):
1999 1998 1997
--------- -------- -------
Domestic........................................... $(219,456) $123,535 $55,222
Foreign............................................ 88,798 14,632 27,591
--------- -------- -------
$(130,658) $138,167 $82,813
========= ======== =======
67
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Significant components of the provision (benefit) for income taxes
attributable to continuing operations are as follows (in thousands):
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
FEDERAL:
Current.............................................. $ 52,902 $113,575 $ 63,826
Deferred............................................. (58,256) (41,311) (18,515)
-------- -------- --------
Total federal................................ (5,354) 72,264 45,311
STATE:
Current.............................................. 216 21,224 11,950
Deferred............................................. (5,160) (5,633) (3,203)
-------- -------- --------
Total state.................................. (4,944) 15,591 8,747
-------- -------- --------
Foreign................................................ 39,541 13,874 18,116
-------- -------- --------
Provision for income taxes............................. $ 29,243 $101,729 $ 72,174
======== ======== ========
Significant components of net deferred tax assets at December 31 are as
follows (in thousands):
YEARS ENDED DECEMBER 31,
-------------------------------
1999 1998 1997
-------- -------- -------
Deferred revenue.................................... $ 10,786 $ 10,390 $ 1,387
State taxes......................................... 546 2,082 1,740
Accrued liabilities and reserves.................... 54,354 53,394 28,349
Depreciation and amortization....................... 43,581 30,533 11,917
Tax credits......................................... 56,211 -- --
Net operating loss carryover........................ 71,168 30,130 10,597
-------- -------- -------
236,646 126,529 53,990
Valuation allowance................................. (63,556) (22,458) (7,728)
-------- -------- -------
173,090 104,071 46,262
Deferred liability.................................. 10,575 13,000 2,100
-------- -------- -------
Net deferred tax asset.............................. $162,515 $ 91,071 $44,162
======== ======== =======
Current portion..................................... $ 93,904 $ 65,866 $30,089
Non-current portion................................. 68,611 25,205 14,073
-------- -------- -------
$162,515 $ 91,071 $44,162
======== ======== =======
Realization of net deferred tax assets of $162.5 million as of December 31,
1999 is dependent on generating sufficient future taxable income, which is not
assured. The amount of the deferred tax asset realizable, however, could be
reduced in the near term if estimates of future taxable income are reduced. The
net deferred tax asset at December 31, 1999 includes recognition of
approximately $8 million of foreign deferred tax assets.
At December 31, 1999, the Company has available net operating loss
carryforwards for U.S. federal income tax return purposes of $201.4 million,
which expire from 2009 to 2020. A valuation allowance of $20.8 million is
recorded primarily for operating losses attributed to certain subsidiaries.
Valuation allowances recorded for 1998 and 1997 include net operating losses
acquired in connection with certain acquisitions. The operating losses are
subject to annual limitations and may expire before utilization by the Company.
At December 31, 1999, the Company has available foreign tax credit
carryforwards of $42.7 million, which expire in 2020. In addition, the Company
has federal R&D credit carryforwards of $9.0 million which
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
expire in 2005 and California R&D credit carryforwards of $4.5 million with no
expiration. A valuation allowance of $42.7 million is recorded for foreign tax
credits due to uncertainty of future utilization.
U.S. income taxes were not provided for on a cumulative total of
approximately $13.8 million of undistributed earnings for certain non-U.S.
subsidiaries. The Company intends to reinvest these earnings indefinitely in
operations outside the United States.
The Company's effective tax rate on income before income taxes differs from
the U.S. Federal statutory regular tax rate as follows:
YEARS ENDED DECEMBER 31,
------------------------
1999 1998 1997
------ ----- -----
U.S. Federal income tax provision (benefit) statutory
rate...................................................... (35.0)% 35.0% 35.0%
State taxes (benefit)....................................... (4.1) 4.4 4.7
Non deductible acquisition and other costs.................. 17.8 29.6 48.9
Tax exempt interest income.................................. -- (1.1) (3.4)
Foreign earnings taxed at rates different than the U.S.
rate...................................................... 6.5 (6.3) (7.1)
Goodwill and other permanent differences.................... 16.1 16.3 10.6
Change in valuation allowance............................... 31.5 -- --
Tax credits................................................. (10.3) (4.3) (1.5)
----- ---- ----
22.5% 73.6% 87.2%
13. NET INCOME (LOSS) PER SHARE
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted net income
(loss) per share is provided as follows (in thousands, except per share
amounts):
YEARS ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
--------- -------- --------
Numerator -- Basic
Net income (loss)................................. $(159,901) $ 36,438 $ 10,639
Numerator -- Diluted
Net income (loss)................................. $(159,901) $ 36,438 $ 10,639
Interest on convertible debentures(1)............. -- -- --
--------- -------- --------
$(159,901) $ 36,438 $ 10,639
========= ======== ========
Denominator -- Basic
Basic weighted average common shares
outstanding..................................... 138,695 133,075 126,662
========= ======== ========
Denominator -- Diluted
Basic weighted average common shares
outstanding..................................... 138,695 133,075 126,662
Effective of dilutive securities:
Common stock options.............................. -- 5,534 6,067
--------- -------- --------
Diluted weighted average shares................... 138,695 138,609 132,729
========= ======== ========
Net income (loss) per share -- Basic.............. $ (1.15) $ 0.27 $ 0.08
========= ======== ========
Net income (loss) per share -- Diluted............ $ (1.15) $ 0.26 $ 0.08
========= ======== ========
- ---------------
(1) Convertible debt interest and related as-if converted shares are excluded
from the 1998 calculation as they are anti-dilutive.
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. BUSINESS SEGMENT AND MAJOR CUSTOMER INFORMATION
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
December 31, 1999, the Company evaluated its product segments in accordance with
SFAS 131 and concluded that its reportable segments are computer security and
management software ("Infrastructure"), and consumer PC security and management
software on the Internet ("McAfee.com").
The Infrastructure segment consists of anti-virus, network management,
security and help desk software. These products 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 in the years ended December 31, 1999 and 1998 is provided as
follows (in thousands):
YEARS ENDED DECEMBER 31,
-------------------------
1999 1998
----------- ----------
Infrastructure:
Net revenues........................................ $ 659,170 $983,753
Segment profit (loss)............................... (131,976) 38,431
McAfee.com:
Net revenues........................................ 24,497 6,292
Segment loss........................................ (27,925) (1,993)
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
Infrastructure:
Total Assets............................. $1,384,107 $1,534,283
McAfee.com:
Total Assets............................. 95,287 2,438
The table below presents information about the revenues and long-lived
assets by geographical area as of and for the years ended December 31:
1999 1998 1997
-------- -------- --------
(IN THOUSANDS)
Revenue
United States................................ $406,805 $629,450 $479,224
Netherlands.................................. 208,583 217,177 64,449
Other International.......................... 68,280 143,418 192,019
-------- -------- --------
Total................................ $683,668 $990,045 $735,692
======== ======== ========
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1999 1998 1997
------- ------- -------
(IN THOUSANDS)
Long-Lived Assets
United States................................... $33,569 $39,429 $30,434
United Kingdom.................................. -- 6,713 11,420
Other Foreign................................... 11,823 8,347 6,474
------- ------- -------
Total................................... $45,392 $54,489 $48,328
======= ======= =======
At December 31,1999, one customer had an accounts receivable balance
representing 12% of our total accounts receivable balance. No other customer had
an accounts receivable balance greater than 10% of the total December 31, 1999
accounts receivable balance. During 1999, one customer accounted for 30% of the
total revenue for the year. No other customer accounted for more than 10% of the
total revenue in 1999.
15. LITIGATION
Securities Cases
Knisley v. Network Associates. On April 7, 1999, a putative securities
class action, captioned Knisley v. Network Associates, Inc., et al., Civil
Action No. C-99-1729-SBA, was filed against Network Associates and several of
its officers in the United States District Court for the Northern District of
California. The complaint alleges violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, and seeks unspecified damages on behalf of a
purported class of purchasers of common stock between January 20, 1998 and April
6, 1999. Twenty-five similar actions asserting virtually identical allegations
have been filed by other plaintiffs. The Court has consolidated these cases and
has appointed Lead Plaintiff. Other lead plaintiff candidates have appealed the
District Court's appointment of Lead Plaintiff to the Ninth Circuit. The Ninth
Circuit has stayed proceedings in the District Court, pending its review. Once
an amended consolidated complaint is filed, defendants intend to move to
dismiss.
Dow Jones Investment Club v. Network Associates. On May 12, 1999, a
purported derivative action, captioned Dow Jones Investment Club v. Network
Associates, Inc. et al., Civil Action No. CV-781854, was filed against nominal
defendant Network Associates, 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., et al., Civil
Action No. CV-782194. The court ordered these three actions consolidated for
pretrial and trial proceedings and deemed the complaint filed in the Leighton
action the operative complaint. Defendants' demurrer to the operative complaint
was sustained with leave to amend. Discovery is ongoing.
Gage v. Network Associates. A similar case, captioned Gage v. Network
Associates, Inc., et al., Civil Action No. B C211552, has been filed in the
Superior Court of California, County of Los Angeles. Plaintiffs allege
violations of Sections 25400 et seq. of the California Corporations Code,
Section 17200 of the California Business and Professions Code, and breach of
fiduciary duty. The parties stipulated to transfer the action to Santa Clara
County Superior Court where it is now pending under Civil Action No. CV-785715.
The complaint was dismissed with prejudice. Gage has until March 18, 2000 to
file an amended complaint asserting individual claims. Discovery is ongoing.
Ong, et al. v. CyberMedia, et al. On September 14, 1998, CyberMedia and
certain of its former officers and directors were named as defendants in a
consolidated amended securities class action complaint filed in the United
States District Court for the Central District of California. The consolidated
amended complaint consolidated the following previously filed cases: Ong v.
CyberMedia, Inc., et al., No. 98-1811 CBM (Ex),
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
filed on March 12, 1998, St. John v. CyberMedia, Inc., et al., No. 98-2085 MRP
(SHx), filed on March 24, 1998, Zier v. CyberMedia, Inc., et al., No. 98-2210 CM
(MCx), filed on March 26, 1998, Liu v. CyberMedia, Inc., et al., No. 98-2617,
filed on April 8, 1998, Kerr, et al. v. CyberMedia, Inc., et al., No. 98-3104
RJK (Anx), filed on April 23, 1998, and Barker v. CyberMedia, Inc., et al., No.
SA CV98-401 AHS (ANx), filed on May 6, 1998. Plaintiffs filed a second
consolidated amended complaint on March 8, 1999. It alleges that the defendants
violated federal securities laws by artificially inflating the price of
CyberMedia stock to the detriment of a purported class of investors who
purchased or otherwise acquired CyberMedia stock between March 31, 1997 and
March 12, 1998. CyberMedia and certain of its former officers and directors were
also named as defendants in three securities class action lawsuits filed in the
Superior Court of Los Angeles County. Such complaints have been ordered
consolidated, although a consolidated amended complaint has not yet been filed.
The consolidated complaints include: Brown v. CyberMedia, Inc., et al., No. B
C187898, filed on March 19, 1998, Smith v. CyberMedia, Inc., et al. No. B
C188527, filed on March 31, 1998, and Stockwell v. CyberMedia, Inc., et al., No.
B C189020, filed on April 8, 1998. The complaints allege that defendants
violated California state securities laws and common law by artificially
inflating the price of CyberMedia stock to the detriment of a purported class of
investors who purchased or otherwise acquired CyberMedia stock between March 31,
1997 and March 13, 1998. Network Associates has reached an agreement with
plaintiffs to settle the state and federal securities class actions. The
settlement provides for a payment of $11.5 million plus interest from
approximately May 6, 1999, $1.5 million (and interest on that amount) of which
is to be paid by Network Associates and the remainder of which is to be paid by
the Company's insurers. The parties memorialized the agreement in a Stipulation
of Settlement lodged with the District Court on November 12, 1999. The Court
preliminarily approved the settlement on December 15, 1999, and a hearing is
currently set for March 27, 2000 to determine whether final approval will be
granted. Consummation of the settlement is contingent upon final judicial
approval.
Other Litigation
Trend Micro, Inc. v. Network Associates. On May 13, 1997, Trend Micro, Inc.
("Trend") filed suit in United States District Court for the Northern District
of California against both Network Associates and Symantec. Trend currently
alleges that Network Associates' "WebShield" and "GroupShield" products infringe
a Trend patent which was issued on April 22, 1997. Trend's complaint seeks
injunctive relief and unspecified money damages. On June 6, 1997, 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.
The Court held a patent claim interpretation hearing on September 1, 1998.
The Court issued a ruling on claim interpretation on or about December 29, 1998.
In addition, Trend filed a supplemental complaint on October 5, 1998, adding the
Gauntlet product to the products accused of infringing Trend's patent. At a case
management conference held on October 2, 1998, the Court set a new trial date of
November 8, 1999. The trial has since been postponed and is now scheduled for
May 1, 2000. The parties are engaged in completing expert discovery and
preparing for trial.
Hilgraeve v. Network Associates. On September 15, 1997, Network Associates
was named as a defendant in a patent infringement action filed by Hilgraeve
Corporation ("Hilgraeve") in the United States District Court, Eastern District
of Michigan. Hilgraeve alleges that Network Associates' VirusScan product
infringes a Hilgraeve patent which was issued on June 7, 1994. Hilgraeve's
action seeks injunctive relief and unspecified money damages. All discovery has
been completed. The Court heard Network Associates' motions for summary judgment
of non-infringement on May 20, 1999 and granted the motion in a written opinion
dated June 10, 1999. The Court entered judgment in favor of Network Associates
on July 7, 1999. Hilgraeve has filed an appeal from the judgment to the United
States Court of Appeals for the Federal Circuit. That appeal is pending.
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Foremost Systems v. Network Associates, No. CV 777301 (Santa Clara County).
A former agent of Network Associates in India, Foremost Systems Pvt. Ltd, filed
this action on October 14, 1998, in California State court and filed a Second
Amended Complaint on February 18, 2000. Network Associates removed the action to
the United States District Court, Northern District of California, San Jose
Division. The Second Amended Complaint alleges that Network Associates wrongly
terminated Foremost Systems in breach of their agency agreement and, in
addition, contains counts for breach of oral contract, promissory estoppel,
intentional and negligent misrepresentation, breach of fiduciary duty, tortious
interference with contractual relations, unfair competition, and racketeering in
violation of 18 U.S.C 1962 et seq.
Homenexus Inc. f/k/a HomeRun Network, Inc. v. DirectWeb, Inc., et al, No.
99-CV-2316 (CRW) (E.D. Pa.). In this action, filed in federal court in the
Eastern District of Pennsylvania on May 5, 1999, plaintiff Homenexus alleges
that DirectWeb successfully conspired with all defendants, including Network
Associates and William Larson, to wrongly misappropriate plaintiff's purported
proprietary business plan and to deliberately infringe plaintiff's purported
trade dress in its alleged web-site. The complaint further alleges that all
defendants conspired to commit, and did commit, the torts of conversion and
unfair competition. Plaintiff has indicated that it will intends to amend the
complaint to add a new defendant. Network Associates and William Larson deny the
charges against them. To date, the parties have taken limited discovery.
SYMANTEC LITIGATION
On December 20, 1999, Network Associates entered into a settlement
agreement resolving the Symantec I, Symantec II, and CyberMedia/Symantec cases
as well as the Symantec State Action (such terms are defined below). Dismissals
of each of these actions has or is in the process of being filed. The CyberMedia
v. Symantec litigation, as described below, remains on file as to defendant
ZebraSoft.
Symantec v. Network Associates (USDC). 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
I"). 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 CrashGuard or an approximately 100-line
routine found in 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.
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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).
Symantec v. Network Associates (USDC). 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 II"). 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.
CyberMedia v. Symantec. On February 4, 1998, CyberMedia filed a lawsuit
against Symantec in United States District Court for the Northern District of
California ("CyberMedia"). 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 the 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.
Symantec v. Network Associates (Superior Court). On April 27, 1999, Network
Associates was served by Symantec with a suit filed in the Superior Court of
California, County of Santa Clara ("Symantec State Action"). 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.
16. 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
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
hedges must be adjusted to fair value through net income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of the
derivative are either offset against the change in fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. SFAS 133, as amended, is effective for quarters
beginning after June 15, 2000.
In February 1998, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position No. 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed of Obtained for Internal Use." SOP 98-1 establishes
the accounting for costs of software products developed or purchased for
internal use, including when such costs should be capitalized. Adoption of this
pronouncement, which is effective for fiscal 1999, did not materially impact the
Company's results of operations.
In July 1999, the FASB issued Statement of Financial Accounting Standards
No. 137, or SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities -- Deferral of the Effective Date of FASB No. 133. SFAS 137 deferred
the effective date of SFAS 133 until the first fiscal quarter beginning after
June 15, 2000.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under certain
circumstances. The Company is currently evaluating the impact of SAB 101 on its
financial statements and related disclosures, but does not expect that such
impact, if any, will be material. The accounting and disclosures prescribed by
101 will be effective for our fiscal year ended December 31, 2000.
17. RELATED PARTY TRANSACTIONS
The Company purchased 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 in 1999. 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. Prior to
the transactions described below, 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 this balance, approximately 35.2% was owned by William L.
Larson, a DirectWeb founder and the Company's Chief Executive Officer; 35.4% was
owned by Dennis Cline, a DirectWeb founder and the Company's former Vice
President of Worldwide Sales; and 17.1% was owned by unrelated third party
investors who, along with the Company, invested in DirectWeb's Series A and
Series B Preferred Stock.
In November 1999, the Company sold its 12.3% ownership to Dennis Cline,
resulting in a net loss of $2.5 million to the Company. At the time, the Company
also agreed to exchange its warrant to acquire 3,175,000 shares of DirectWeb
common stock for a warrant to acquire $2 million worth of DirectWeb Series C
preferred stock at the same price per share as paid by the Series C preferred
stock investors. William L. Larson sold approximately 83.0% of his stake in
DirectWeb to Dennis Cline in November 1999. He retains an approximately 5.9%
ownership interest in DirectWeb.
18. 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 3.3 million shares at
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NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
$11.063 were vested at December 31, 1999, however the new options cannot be
exercised for a period of twelve months from the date the options were repriced,
regardless of vesting status.
In accordance with Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees," the Company incurred an initial stock based
compensation charge in connection with this repricing. This charge was
calculated based on the difference between the exercise price of the new options
and their market value on the date of acceptance by employees. Approximately
$0.7 million and $8.8 million were expensed in the three months and year ended
December 31, 1999, respectively, and approximately $11.6 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 second 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 year ended
December 31, 1999, the Company repurchased 685,000 shares of its common stock
for a total cash outlay of approximately $12.4 million. The timing and size of
any future stock repurchases are subject to market conditions, stock prices, the
Company's cash position and other cash requirements.
On 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.
19. FIXED ASSETS SALE-LEASEBACK
On September 20, 1999, the Company sold approximately $6.6 million of fixed
assets, consisting mostly of computer equipment, 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.
20. SUBSEQUENT EVENTS (UNAUDITED)
On February 4, 2000, several companies acquired a less than 4% minority
equity interest in NAI KK, our Japanese subsidiary, for a combined total of
approximately $11.9 million.
On February 16, 2000, Network Associates sold "European style" put options
for 1,000,000 shares of the Company's common stock as part of its stock
repurchase plan. European style put options can only be exercised on the expiry
date, which is February 16, 2001. The strike price for these put options is
$30.00, and the Company received total proceeds of $7,890,000 from the sale.
On March 10, 1999, the Company acquired 597,062 shares of Tesserae
Information Systems, Inc. for approximately $10 million. Shortly thereafter,
Tesserae was acquired by Cadabra, Inc. and, in January 2000, Cadabra Inc. was
acquired by Goto.com. The Company's Cadabra shares were converted into 554,093
shares of Goto.com, and the Company received $1.2 million in cash. In February
2000, the Company sold the majority of its Goto.com shares for a net realized
gain of approximately $28.4 million.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Santa
Clara, State of California, on the 30th day of March, 2000.
NETWORKS ASSOCIATES, INC.
/s/ WILLIAM L. LARSON
--------------------------------------
William L. Larson
Chief Executive Officer and
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 30, 2000 by the following persons on
behalf of the Registrant and in the capacities indicated.
SIGNATURE TITLE
--------- -----
/s/ WILLIAM L. LARSON Chief Executive Officer and Chairman of the
- ----------------------------------------------------- Board (Principal Executive Officer)
(William L. Larson)
/s/ PRABHAT K. GOYAL Vice President of Administration, Chief
- ----------------------------------------------------- Financial Officer, Treasurer and Secretary
(Prabhat K. Goyal) (Principal Financial Officer and Principal
Accounting Officer)
/s/ LESLIE G. DENEND Director
- -----------------------------------------------------
(Leslie G. Denend)
/s/ VIRGINIA GEMMELL Director
- -----------------------------------------------------
(Virginia Gemmell)
/s/ EDWIN L. HARPER Director
- -----------------------------------------------------
(Edwin L. Harper)
/s/ ENZO TORRESI Director
- -----------------------------------------------------
(Enzo Toressi)
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders
Network Associates, Inc.
Santa Clara, California
Our audits of the consolidated financial statements referred to in our
report dated January 24, 2000 appearing on page 44 of this Annual Report on Form
10-K also included an audit of the financial statement schedules listed in Item
14(a)(2) of this Form 10-K. In our opinion, these financial statement schedules
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
San Jose, California
January 24, 2000
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SCHEDULE II
NETWORKS ASSOCIATES, INC.
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS AT DECEMBER 31, 1999
(DOLLARS IN THOUSANDS)
BALANCE AT ADDITIONS CHARGED
BEGINNING OF TO EXPENSE BALANCE AT END
PERIOD OR REVENUE DEDUCTIONS OF PERIOD
------------ ----------------- ---------- --------------
YEAR ENDED DECEMBER 31, 1999
Allowance for Doubtful Accounts.... $11,682 $ 44,809 $ (40,242) $16,249
Allowance for Sales Returns........ 85,631 249,138 (262,471) 72,298
YEAR ENDED DECEMBER 31, 1998
Allowance for Doubtful Accounts.... 5,107 11,283 (4,708) 11,682
Allowance for Sales Returns........ 21,294 170,714 (106,377) 85,631
YEAR ENDED DECEMBER 31, 1997(1)
Allowance for Doubtful Accounts.... 4,205 3,575 (2,673) 5,107
Allowance for Sales Returns........ $ 2,523 $ 47,032 $ (28,261) $21,294
- ---------------
(1) Includes Network General balance sheet data at December 31, 1997.
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EXHIBIT INDEX
EXHIBIT NO. EXHIBIT TITLE PAGE NO.
----------- ------------- --------
2.1 Agreement and Plan of Reorganization, dated October 13,
1997, among McAfee Associates, Inc., Mystery Acquisition
Corp. and Network General Corporation, as amended by the
First Amendment dated as of October 22, 1997.(1)............
2.2 Combination Agreement dated August 16, 1996 among the
Registrant, FSA Combination Corp., FSA Corporation and
Daniel Freedman.(2).........................................
2.3 Stock Exchange Agreement dated January 13, 1996 among the
Registrant, FSA Combination Corp., Kabushiki Kaisha Jade and
the shareholders of Jade.(3)................................
2.4 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, Helix Software Company an DNA
Acquisition Corp.(4)........................................
2.5 Agreement and Plan of Reorganization dated December 1, 1997
between the Registrant, PGP and PG Acquisition Corp.(5).....
2.6 Agreement and Plan of Reorganization dated February 22,
1998, between the Registrant, TIS and Thor Acquisition
Corp.(6)....................................................
2.7 Agreement and Plan of Reorganization by and among the
Registrant, Magic Solutions International, Inc., Merlin
Acquisition Corp. and Igal Lichtman, Amendment Agreement by
and among the Registrant, Magic Solutions International,
Inc., Merlin Acquisition Corp., and Igal Lichtman dated
March 24, 1998. Second Amendment Agreement by and among the
Registrant, Magic Solutions International, Inc., Merlin
Acquisition Corp., and Igal Lichtman dated April 1,
1998.(7)....................................................
2.8 Stock Purchase Agreement, dated as of February 26, 1998, by
and between FSA Combination Corp., and Brenda Joyce
Cook.(8)....................................................
2.9 Share Purchase Agreement, dated as of March 30, 1998, among
FSA Combination Corp., and Irina Karlsson and Jarmo
Rouvinen.(8)................................................
2.10 Stock Purchase Agreement, dated as of May 8, 1998, among FSA
Combination Corp., and Secure Networks, Inc.(8).............
2.11 Transaction Agreement, dated June 9, 1998, by and between
the Registrant and Dr. Solomon's Group Plc.(21).............
2.12 Agreement and Plan of Merger, dated July 28, 1998, by and
between the Registrant and CyberMedia, Inc.(22).............
3.1 Second Restated Certificate of Incorporation of Networks
Associates, Inc., as amended on December 1, 1997.(6)........
3.2 Restated Bylaws of Networks Associates, Inc.(6).............
3.3 Certificate of Designation of Series A Preferred Stock of
Networks Associates, Inc.(9)................................
3.4 Certificate of Designation of Series B Participating
Preferred Stock of the Registrant.(23)......................
4.2 Registration Rights Agreement dated August 30, 1996 between
the Registrant and Daniel Freedman.(1)......................
4.5 Registration Rights Agreement dated December 9, 1997 between
the Registrant and certain shareholders of PGP.(4)..........
4.6 Registration Rights Agreement, dated as of February 13,
1998, by and between the Registrant and Morgan Stanley & Co.
Incorporated.(10)...........................................
4.7 Indenture dated as of February 13, 1998 between the
Registrant and State Street Bank and Trust Company of
California, N.A., as Trustee.(10)...........................
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EXHIBIT NO. EXHIBIT TITLE PAGE NO.
----------- ------------- --------
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 NO. EXHIBIT TITLE PAGE NO.
----------- ------------- --------
10.17 Quota Purchase Agreement, dated as of April 14, 1997 by and
among McAfee Associates, Inc. and McAfee Do Brasil Ltda.,
Compusul-Consultoria E Comercio De Informatica Ltda., and
the stockholders of Compusul-Consultoria E Comercio De
Informatica Ltda.(17).......................................
10.18* 1997 Stock Incentive Plan.(17)..............................
10.19* Stock Option Plan for Outside Directors(18).................
10.20* 2000 Nonstatutory Stock Option Plan.........................
10.21* Change in control agreement between the Company and Peter
Watkins dated May 11, 1999(25)..............................
10.22* Change in control agreement between the Company and William
L. Larson dated May 11, 1999(25)............................
10.23* Change in control agreement between the Company and Prabhat
K. Goyal dated May 11, 1999(25).............................
10.24* Change in control agreement between the Company and Zachary
Nelson, dated May 11, 1999(25)..............................
10.25 Corporate Management Services Agreement between the
Registrant and McAfee.com Corporation, dated as of January
1, 1999(26).................................................
10.26 Technology Cross License Agreement between the Registrant
and McAfee.com Corporation dated as of January 1,
1999(26)....................................................
10.27 Registration Rights Agreement between the Registrant and
McAfee.com Corporation, dated as of January 1, 1999(26).....
10.28 Asset Contribution and Receivables Settlement Agreement
between the Registrant and McAfee.com Corporation, dated as
of January 1, 1999(26)......................................
10.29 Intercompany Revolving Loan Agreement between the Registrant
and McAfee.com Corporation, dated as of January 1,
1999(26)....................................................
10.30 Tax Sharing Agreement between the Registrant and McAfee.com
dated as of January 1, 1999(26).............................
10.31 Indemnification and Voting Agreement between the Registrant
and McAfee.com Corporation, dated as of January 1,
1999(26)....................................................
10.32 Joint Cooperation and Master Services Agreement between the
Registrant and McAfee.com Corporation, dated as of January
1, 1999(26).................................................
21.1 Subsidiaries of Network Associates, Inc. ...................
23.1 Consent of PricewaterhouseCoopers LLP.......................
27.1 Financial Data Schedule.....................................
- ---------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on October 31, 1997.
(2) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on September 24, 1996.
(3) Incorporated by reference from the Registrants Current Report on Form 8-K
filed with the Commission on March 14, 1997.
(4) Incorporated by reference from the Registrant's Registration Statement on
Form S-3, filed with the Commission on February 12, 1998.
(5) Incorporated by reference from the Registrant's Report on Form 8-K filed
with the Commission on December 11, 1997.
(6) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 filed with the Commission on March 25, 1998.
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83
(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.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
83