NETWORKS ASSOCIATES INC/ - 10-Q Quarterly Report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

147,724,216 shares of the registrant’s common stock, $0.01 par value, were outstanding as of June 30, 2002.

The accompanying notes are an integral part of these condensed consolidated financial statements.


(1)	Includes stock-based compensation charges (credits) of ($1,233) and $107 for the three months ended June 30, 2002 and 2001, respectively, and ($1,115) and $198 for the six months ended June 30, 2002 and 2001, respectively.

(2)	Includes stock-based compensation charges (credits) of ($1,312) and $169 for the three months ended June 30, 2002 and 2001, respectively, and ($1,137) and $313 for the six months ended June 30, 2002 and 2001, respectively.

(3)	Includes stock-based compensation charges (credits) of ($1,316) and $931 for the three months ended June 30, 2002 and 2001, respectively, and ($895) and $2,352 for the six months ended June 30, 2002 and 2001, respectively.

The accompanying notes are an integral part of these condensed consolidated financial statements.

These condensed consolidated financial statements have been prepared by Networks Associates, Inc. (the “Company”) without audit in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X. The unaudited, condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of management, all adjustments, consisting only of normal recurring adjustments considered necessary for a fair presentation, have been included. The results of operations for the three and six months ended June 30, 2002 are not necessarily indicative of the results to be expected for the full year or for any future periods. The accompanying unaudited, condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K/ A filed with the Securities and Exchange Commission on June 28, 2002. The balance sheet at December 31, 2001 has been derived from the audited financial statements as of and for the year ended December 31, 2001, but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements.

Certain reclassifications have been made to the 2001 unaudited condensed financial statements and related notes to conform to the 2002 presentation.

The Company restated its balance sheet as of December 31, 2001. The restatement is further discussed in Note 3 of the Notes to the Consolidated Financial Statements on Form 10-K/ A for the year ended December 31, 2001, filed with the Securities and Exchange Commission on June 28, 2002.

The Company has concluded that it has two businesses, consisting of the Infrastructure business (“Infrastructure”) and McAfee.com. The Infrastructure business markets and sells computer security, management and availability software and hardware for corporate and government users. McAfee.com markets and sells PC security and management software on the Internet to consumers and small to medium-sized businesses. Management measures profitability based on these two businesses; however, within the Infrastructure business the Company’s operating segments are defined by six geographic regions. The segments are evidence of the operating structure of the Company’s internal organization. The Company operates in one industry: computer security, management and availability software, hardware and related services for, primarily, corporate and government users.

The Infrastructure business markets and sells, through its geographic segments, anti-virus and security software, hardware and services; network management software, hardware and services; and help desk software and services. These products and services are marketed and sold worldwide through a direct sales force to corporate and government users, as well as through resellers, distributors, systems integrators and retailers. In addition, the Infrastructure business includes managed security and availability applications to corporations and governments on the Internet.

McAfee.com is an application service provider targeted at consumers and small to medium-sized businesses. The McAfee.com web site provides a suite of online products and services personalized for the user based on the user’s PC configuration, attached peripherals and resident software.

Following is the summary of the Company’s revenue and income (loss) from operations by business and by geographic segment. To reconcile to the consolidated financial statements, where applicable, “Corporate” represents costs and expenses associated with corporate activities. Corporate activities include general and administrative expenses; corporate marketing expenses of $8.5 million and $6.5 million for the three months ended June 30, 2002 and 2001 respectively, and $19.1 million and $22.6 million for the six months ended June 30, 2002 and 2001, respectively; amortization of intangibles; stock-based compensation charges; and restructuring costs. These corporate expenses are not considered attributable to any specific geographic

Net revenue information on a product and service basis is as follows (in thousands):

On October 9, 2001, the Board of Directors of the Company approved a plan to integrate the activities of the Company’s PGP product group into its McAfee Security and Sniffer Technologies product groups. In addition to the integration plan, the Company began to look for a buyer for the PGP desktop encryption and

In March 2002, the Company purchased a one-year collar consisting of 300,354 purchased puts options with a strike price of $17.31 and the same number of written calls options with a strike price of $22.04. Underlying both the put and call options are the Secure Computing shares. The Company designated the purchased collar as a fair value hedge of the Secure Computing available-for-sale securities in accordance with Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities.” At the inception of the hedge, the Company assessed that the collar is highly effective based upon expected changes in the collar’s intrinsic value. On an ongoing basis, changes in the fair value of Secure Computing shares within the collar’s range of $17.31 and $22.04 are recorded as part of accumulated other comprehensive income within stockholders’ equity. Changes in the fair value of Secure Computing’s shares outside of the collar range of $17.31 and $22.04 are recorded immediately in earnings. Changes in the fair value of the collar are measured using an option pricing model and are also recorded immediately in earnings. As of June 30, 2002, the fair value of Secure Computing’s shares were outside of the collar range. During the three and six months ended June 30, 2002, the Company recognized a loss of $15,000 and $179,000, respectively, in the earnings relating to the change in fair value of the collar, net of changes of fair value of the Secure Computing shares outside of the collar range.

As part of the plan to integrate certain activities of the Company’s PGP product group into its McAfee Security and Sniffer Technologies product group and to dispose of other product lines, the Company sold its Gauntlet business and discontinued other product lines during the first quarter of 2002. In connection with this process, a restructuring charge of approximately $1.1 million was recorded during the first quarter of 2002. The restructuring charge consists of costs of severance packages for 44 employees as well as related legal and outplacement services.

The following table sets forth the Company’s restructuring accrual established in February 2002 and the activity against the accrual during the six months ended June 30, 2002 (in thousands):

In May 2000, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 00-14, “Accounting for Certain Sales Incentives.” EITF Issue No. 00-14 addresses the recognition, measurement, and income statement classification for sales incentives that a vendor voluntarily offers to customers (without charge), which the customer can use in, or exercise as a result of, a single exchange transaction. Sales incentives that fall within the scope of EITF Issue No. 00-14 include offers that a customer can use to receive a reduction in the price of a product or service at the point of sale. The EITF changed the transition date for Issue 00-14, concluding that a company should apply this consensus no later than the company’s annual or interim financial statements for the periods beginning after December 15, 2001. In June 2001, the EITF issued EITF Issue No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products,” effective for periods beginning after December 15, 2001. EITF Issue No. 00-25 addresses whether consideration from a vendor to a reseller is (a) an adjustment of the selling prices of the vendor’s products and, therefore, should be deducted from revenue when recognized in the vendor’s statement of operations or (b) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be

included as a cost or expense when recognized in the vendor’s statement of operations. Upon application of these EITFs, financial statements for prior periods presented for comparative purposes should be reclassified to comply with the income statement display requirements under these Issues. In September of 2001, the EITF issued EITF Issue No. 01-09, “Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor’s Products”, which is a codification of EITF Issues No. 00-14, No. 00-25 and No. 00-22 “Accounting for ‘Points’ and Certain Other Time-or Volume-Based Sales Incentive Offers and Offers for Free Products or Services to be Delivered in the Future.” During the three months ended March 31, 2002, the Company adopted EITF 01-09. As a result, the Company reclassed $3.4 million and $18.1 million from marketing and sales expense to revenue for the three and six months ended June 30, 2001, respectively.

In November 2001, the Financial Accounting Standards Board (“FASB”) discussed Topic D-103, recharacterized as EITF Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred.” This issue deals with classification in the income statement of incidental expenses, that in practice are commonly referred to as “out-of-pocket” expenses, incurred by entities that provide services as part of their central ongoing operations. The Task Force reached a consensus that reimbursements received for out-of-pocket expenses incurred should be characterized as revenue in the income statement. This issue is effective for fiscal years beginning after December 15, 2001. During the quarter ended March 31, 2002, the Company adopted EITF 01-14. As a result, the Company reclassed a total amount of $0.3 million and $0.6 million from cost of revenue to revenue for the three and six months ended June 30, 2001, respectively.

In October 2001, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 establishes a single accounting model, based on the framework established in Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (“SFAS 121”), for long-lived assets to be disposed of by sale, and resolves implementation issues related to SFAS 121. The Company is currently assessing the impact of SFAS 144 on its operating results and financial condition. The Company is required to adopt SFAS 144 no later than the first quarter of fiscal 2003.

In May 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections” (“SFAS 145”). Among other things, SFAS 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” are met. SFAS 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. The Company is currently assessing the impact of SFAS 145 on its financial statements.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company is currently assessing the impact of SFAS 146 on its financial statements.

In April of 2001, the EITF issued EITF Issue No. 01-03 “Accounting in a Purchase Business Combination for Deferred Revenue of an Acquiree.” EITF Issue No. 01-03 addresses whether an acquiring entity should recognize a liability for deferred revenue recorded by the acquiree when the business combination is initially recorded and, if so, how the amount assigned to that liability should be measured and presented in the acquiring entity’s financial statements. In March 2002, the Task Force reached a consensus that the acquiring entity should recognize a liability related to a revenue arrangement of an acquired entity only if it has assumed a legal obligation to provide goods, services, or other consideration to the customer(s) (a legal performance obligation) and the amount assigned to the liability should be based on its fair value at

In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 142, “Goodwill and Other Intangible Assets,” which is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. During the three months ended March 31, 2002, the Company adopted SFAS 142 and has ceased to amortize approximately $156.9 million of goodwill. In lieu of amortization, the Company performed an impairment review of its goodwill balance upon the initial adoption of SFAS No. 142. The impairment review performed by the Company involves a two-step process as follows:


	•	*Step 1* — The Company compares the fair value of its reporting units to the carrying value, including goodwill of each of those units. For each reporting unit where the carrying value, including goodwill, exceeds the unit’s fair value, the Company moves on to step 2. If a unit’s fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary.

	•	*Step 2* — The Company performs an allocation of the fair value of the reporting unit to its identifiable tangible and non-goodwill intangible assets and liabilities. This derives an implied fair value for the reporting unit’s goodwill. The Company then compares the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess.

The Company performed Step 1 of the goodwill impairment analysis required by SFAS 142 as of January 1, 2002 and concluded that goodwill was not impaired, as the fair value of each reporting unit exceeded its carrying value, including goodwill. Accordingly, Step 2 was not performed. The fair value of the reporting units was estimated using the average of the expected present value of future cash flows and of the market multiple value. The Company will continue to test for impairment on an annual basis and on an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of the Company’s reporting units below their carrying amounts.

The following table presents comparative information showing the effects that non-amortization of goodwill would have had on the income statement for the three and six months ended June 30, 2001 (in thousands, except per share amounts):

The components of intangible assets, excluding goodwill, are as follows (in thousands):

The aggregate amortization expenses for the intangible assets listed above totaled $2.5 million and $4.1 million for the three months ended June 30, 2002 and 2001, respectively, and $5.4 million and $7.3 million for the six months ended June 30, 2002 and 2001, respectively.

Expected future intangible asset amortization expense is as follows (in thousands):

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 Debentures 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 in the related indenture) 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 must 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 the accretion of the discount on the Debentures to such dates. The Debentures may also be redeemed at the option of the holder if there is a Fundamental Change (as defined in the related indenture) at a price equal to the issue price plus the accretion of the discount on the debenture to the date of redemption, subject to adjustment. The accretion of the discount on the Debentures is calculated using the effective interest method.

During the six months ended June 30, 2002, the Company repurchased Debentures, which had an aggregate face amount at maturity of $40.0 million, at a net price of $18.8 million, which was financed from the Company’s investment portfolio. In connection with the repurchase, the Company recognized an extraordinary loss of approximately $31,000, net of taxes.

As of June 30, 2002, the Company’s aggregate cash, cash equivalents and marketable securities were approximately $1,102.8 million, including $117.4 million held by McAfee.com. Assuming that as of February 13, 2003 all Debentures outstanding as of June 30, 2002 are redeemed, the aggregate redemption price would equal approximately $226.7 million (see Note 12 to these Notes to the Condensed Consolidated Financial Statements).

On August 17, 2001, the Company issued 5.25% convertible subordinated notes due 2006 (the “Notes”) with an aggregate principal amount of $345.0 million. The issuance generated net proceeds (after deducting fees and expenses) of approximately $335.1 million. The amortization of the issuance costs related to the

Notes is calculated using the effective interest method. The Notes mature on August 15, 2006, unless earlier redeemed by the Company at its option or converted at the holder’s option. Interest is payable in cash semi-annually in arrears on February 15 and August 15 of each year, commencing February 15, 2002. At the option of the holder, Notes may be converted into the Company’s common stock at any time, unless previously redeemed, at a conversion price of $18.07 per share. The Notes may also be redeemed at the option of the holder in the event of a Change of Control (as defined in the related indenture). The Company may redeem all or a portion of the Notes for cash at any time on or after August 20, 2004 at a redemption price of 101.3125% of the principal amount, between August 20, 2004 and August 14, 2005 and 100.0% of the principal amount after August 14, 2005. The Notes are unsecured and are subordinated to all existing and future Senior Indebtedness (as defined in the related indenture), and are pari passu with respect to the Debentures.

Aggregate maturities of the value of the long-term debt outstanding at June 30, 2002 are as follows (in thousands):


(1)	In February 2003, the Company may be required to use a significant portion of its cash balance to redeem its outstanding Debentures. The redemption value corresponds to the aggregate face value outstanding of $458.5 million less the related unamortized discount of $231.8 million on February 13, 2003.

(2)	In 2002, 2003, 2004, 2005 and 2006, the Company must make interest payments of $18.1 million.

A reconciliation of the numerator and denominator of basic and diluted net loss per share is provided as follows (in thousands, except per share amounts):


(1)	Diluted net income (loss) per share excludes the effects of shares which will be issued in the event of conversion of the Company’s outstanding convertible debt. The total number of shares excluded from the calculation related to as-if converted shares was 23.0 million for the three and six months ended June 30, 2002 and 7.6 million for the three and six months ended June 30, 2001.

(2)	For the three and six months ended June 30, 2002 and 2001, 10.2 million and 32.7 million options to purchase common stock, respectively, and 8.1 million and 32.7 million options to purchase common stock, respectively, were excluded from the calculation since the effect was anti-dilutive.

(3)	Warrants to purchase 0.2 million shares of the Company’s common stock were excluded from the determination of diluted net loss per share for the three and six months ended June 30, 2001 as the effect of such warrants was anti-dilutive.

From time to time, the Company has been subject to litigation including the pending litigation described below. The Company’s current estimated range of liability related to some of the pending litigation below is based on claims for which management can estimate the amount and range of loss. The Company has recorded the minimum estimated liability related to those claims, where there is a range of loss. Because of the uncertainties related to both the amount and range of loss on the remaining pending litigation, management is unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, the Company will assess its potential liability and revise its estimates. Pending or future litigation could be costly, could cause the diversion of management’s attention and could upon resolution, have a material adverse effect on the business, results of operations, financial condition and cash flow.

In addition, the Company is engaged in certain legal and administrative proceedings incidental to our normal business activities and believes that these matters will not have a material adverse effect on our financial position, results of operations or cash flow.

Between December 29, 2000 and February 7, 2001, the Company and certain of its current and former officers and directors were named in securities class action lawsuits filed in the United States District Court for the Northern District of California. On September 24, 2001, a consolidated class action complaint was filed which asserts claims against the Company, William Larson, Prabhat Goyal and Peter Watkins on behalf of a putative class of persons who purchased the Company’s stock between July 19 and December 26, 2000. The complaint asserts causes of action (and seeks unspecified damages) for alleged violations of Exchange Act Section 10(b)/ SEC Rule 10b-5 and Exchange Act Section 20(a). In particular, the complaint alleges that defendants engaged in improper practices designed to increase the Company’s revenues and earnings and that, as a result of those practices, the Company’s class period financial statements were false and misleading and failed to comply with Generally Accepted Accounting Principles (GAAP). Defendants’ filed a motion to dismiss plaintiff’s consolidated complaint on October 29, 2001. Plaintiff filed an opposition to the motion to dismiss on December 21, 2001 and defendants filed a reply to plaintiff’s opposition on February 1, 2002. The hearing on the motion to dismiss was held on April 16, 2002. On April 26, 2002, the parties stipulated to the withdrawal of defendants’ motion to dismiss. On April 29, 2002, the Court entered an order approving the withdrawal of defendants’ motion to dismiss. On June 24, 2002, the Court entered an order approving the parties stipulation setting forth a schedule for the filing of a first amended consolidated complaint and the briefing of defendants’ motion to dismiss that complaint.

On February 5, 2001, the Company was nominally sued in a derivative lawsuit filed in the Superior Court in Santa Clara County. The lawsuit, encaptioned Mean Ann Krim v. William L. Larson, et al., Case No. CV795734, asserts claims against William Larson, Peter Watkins, Prabhat Goyal, Leslie Denend, Virginia Gemmell, Edwin Harper, Enzo Torresi, and others for breach of fiduciary duty, unjust enrichment and professional negligence against the accountants. In particular, the complaints allege that the defendants engaged in a course of conduct by which they improperly accounted for revenue from software license sales, and that, as a result of their actions, certain of the Company’s financial statements were false and misleading and not in compliance with GAAP. The complaint seeks an unspecified amount of damages. Nominal defendant the Company filed a demurrer to the complaint on May 21, 2001. A hearing on the demurrer was held on June 29, 2001. On July 24, 2001, the Court sustained the demurrer with leave to amend. By order dated August 21, 2001, the Court granted plaintiff limited discovery for purposes of amending the complaint to meet the demand futility test imposed by Delaware law. Plaintiff filed an amended complaint on December 26, 2001. Nominal defendant Network Associates, Inc. filed a demurrer, which was joined by the individual defendants, to the amended complaint on January 30, 2002. A hearing on the demurrer was held on March 8, 2002. The Court entered an order on March 28, 2002 sustaining the demurrer without leave to

In March 2002, several putative securities class action lawsuits were filed in the Court of Chancery in the State of Delaware, County of New Castle, and the Superior Court of the State of California, County of Santa Clara, arising out of the Company’s proposed acquisition of McAfee.com Corporation (“McAfee.com”). The lawsuits name as defendants the Company and certain of McAfee.com’s officers and directors, and with respect to the Delaware Court of Chancery actions, McAfee.com. The lawsuits filed in the Delaware Court of Chancery, which were encaptioned Bank v. McAfee.com Corp., et al., Civil Action No. 19481; Birnbaum v. Sampath, et al., Civil Action No. 19482 NC; Brown v. Sampath, et al., Civil Action No. 19483 NC; Chin v. McAfee.com Corp., et al., Civil Action No. 19484 NC; Monastero v. Sampath, et al., Civil Action No. 19485; and Ebner v. Sampath, et al., Civil Action No. 19487, were consolidated into a single case (the “Consolidated Action”) by Court order dated April 9, 2002. Plaintiffs amended the complaint in the Consolidated Action on July 8, 2002. The second amended complaint asserts claims against defendants for breach of fiduciary duty on the grounds that (i) the price at which the Company proposes to consummate the current exchange offer purportedly is unfair and inadequate, and (ii) defendants purportedly have failed to disclose information material to assessing the propriety of the exchange offer. The plaintiffs seek, among other things, to recover unspecified damages and costs and to enjoin or rescind the transaction contemplated by the offer. On July 9, 2002, the Delaware Court of Chancery granted plaintiffs’ request for expedited discovery and set a hearing on plaintiffs’ application for a preliminary injunction for July 23, 2002. On July 19, 2002, after conducting additional due diligence and discovery, plaintiffs withdrew their motion for a preliminary injunction. The lawsuit filed in Santa Clara County is encaptioned Peyton v. Richards, et al., No. CV 806199. Another class action lawsuit was filed on April 9, 2002 in the United States District Court for the Northern District of California, encaptioned Getty v. Sampath, et. al., Case No. C 02 1692. On April 2, 2002, defendants removed the California state action encaptioned Peyton v. Richards, et al., No. CV 806199 to the United States District Court for the Northern District of California. On April 4, 2002, plaintiff moved for an order shortening time on his motion to remand the case to state court and for expedited discovery. On April 8, 2002, defendants filed a motion to dismiss the California case under the Securities Litigation Uniform Standards Act of 1998. By order dated June 10, 2002, the California case encaptioned Peyton v. Richards, et al., No. C 02 1572 SBA was dismissed with prejudice. Subsequently, by stipulation filed June 20, 2002, the parties in Peyton agreed for the action to be remanded to California Superior Court for the County of Santa Clara solely for the purpose of allowing plaintiff Justin Peyton to dismiss the action, and the district court vacated the prior dismissal order as nunc pro tunc. On July 1, 2002, a putative class action lawsuit encaptioned Peyton v. Richards, et al., Case No. CV 809111 was filed in the California Superior Court for the County of Santa Clara against Network Associates and various officers and directors of McAfee.com. The complaint generally alleges that (i) the defendant directors of McAfee.com are liable for breach of fiduciary duty because they failed to maximize the price of the Company’s exchange offer, and (ii) defendant the Company aided and abetted these breaches of fiduciary duty by structuring the exchange offer in terms preferential to the Company. The plaintiff seeks, among other things, to enjoin or rescind the transaction contemplated by the offer, to recover costs, and to impose a constructive trust upon any benefits improperly received by defendants. On July 5, 2002, the plaintiff applied to the Court for expedited discovery and an expedited hearing on its anticipated application for a temporary restraining order. The defendants opposed plaintiff’s application, and on July 9, 2002, the Court denied plaintiff’s application.

Foremost Systems v. Network Associates, No. CV 777301 (Santa Clara County). A former agent of the Company 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. The Company removed the action to the United States District Court, Northern District of California, San Jose Division. The Second Amended Complaint alleges that the Company 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. The parties held a preliminary mediation

On March 22, 2002, the Securities and Exchange Commission notified the Company that it has commenced a “Formal Order of Private Investigation” into the Company’s accounting practices. The SEC investigation is continuing, and the Company continues to provide documents and information to the SEC on a voluntary basis.

The Company has recorded stock-based compensation charges (credits) of $(3.9) million and $1.2 million in the three months ended June 30, 2002 and 2001, respectively, and $(3.1) million and $2.9 million in the six months ended June 30, 2002 and 2001, respectively. These charges (credits) are made up of the following (in thousands):

Repriced options. During the three and six months ended June 30, 2002, the Company recorded credits of approximately $4.6 million and $6.5 million, respectively, related to options subject to variable plan accounting. During the three and six months ended June 30, 2001, the Company did not incur a charge related to options subject to variable plan accounting. For the three months ended June 30, 2002 and 2001, the Company’s stock compensation charges related to options subject to variable plan accounting were based on quarter end per share prices of the Company’s stock of $19.27 and $12.45, respectively, and per share prices of McAfee.com stock of $14.64 and $12.28, respectively. As of June 30, 2002 the Company and McAfee.com had options to purchase approximately 1.1 million shares and 0.2 million shares, respectively, which were outstanding and subject to variable plan accounting.

The Company also incurred a stock-based compensation charge in connection with the initial issuance of the repriced options. 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 $0.2 million and $0.4 million was expensed during the three months ended June 30, 2002 and 2001, respectively, and approximately $1.0 million and $0.7 million was expensed during the six months ended June 30, 2002, respectively.

Options issued below fair market value. During the three months ended March 31, 2002, the Company recorded a one-time stock compensation charge of $1.2 million for stock options granted below fair market value. This charge relates to options granted in prior periods, which were identified in the first quarter of 2002 as having been granted below market value. The amount was determined to be immaterial for the periods when the grants were made and for the current period.

New and existing executives. On January 3, 2001, the Company entered into an employment agreement with George Samenuk to become the Company’s president and chief executive officer. In accordance with the terms of the agreement, the Company issued 400,000 shares of restricted stock to Mr. Samenuk. The price of the underlying shares is $0.01 per share. The Company recorded approximately $247,000 and $209,000 during

On January 15, 2002, the Company’s board of directors approved a grant of 50,000 shares of restricted stock to Mr. Samenuk. The price of the underlying shares is $0.01 per share. The shares will vest and the Company’s right to repurchase such shares will lapse as follows: 3,000 vested as of the grant date and 47,000 are restricted until January 15, 2005. The fair value of the restricted stock was determined to be approximately $1.4 million and was estimated based on the difference between the exercise price of the restricted stock and the fair market value of the Company’s common stock on January 15, 2002. During the three and six months ended June 30, 2002, the Company recorded approximately $102,000 and $286,000, respectively, related to stock compensation associated with Mr. Samenuk’s restricted stock.

On April 3, 2001, the Company entered into an employment agreement with Stephen C. Richards to become the Company’s executive vice president and chief financial officer. In accordance with the terms of the agreement, the Company issued 50,000 shares of stock to Mr. Richards for $0.01 per share. In the three months ended June 30, 2001, the Company recognized approximately $350,000 related to stock compensation associated with the stock issued to Mr. Richards.

Shares purchased outside Employee Stock Purchase Plan. On January 31, 2002, the Company experienced a shortfall in the number of shares available under the 1994 Employee Qualified Stock Purchase Plan to meet the requirements of the open purchase period. Although the Company reduced the number of shares plan participants could purchase by a pro rata amount, additional shares were required to be purchased outside of the plan in order to meet this shortfall. As a result, the Company recorded a one-time stock compensation charge of approximately $60,000 in the three months ending March 31, 2002. The charge was based on the difference between the fair value of the shares purchased outside of the plan and the price the shares were sold to plan participants.

Extended vesting term of options. During the three months ended June 30, 2002, the Company recorded a one-time stock compensation charge of $0.2 million as a result of the modification of the terms of the options previously granted to employees.

Warrants to outside consultants. In January 2001, upon completion of the search for the Company’s current chief executive officer, the Company issued warrants to a retained executive search firm for services performed. The warrants, if exercised, can be exchanged for 166,667 shares of the Company’s common stock. The weighted-average exercise price of the underlying shares is $2.97 per share. The warrants are immediately exercisable and expire in January 2004. The combined fair value of the warrants was determined to be approximately $530,000 and was estimated using the Black-Scholes model with the following assumptions: risk free interest rate of 4.82%; contractual life of 3 years; dividend yield of 0%; and expected volatility of 91%. The fair market value of the warrants was included as stock compensation during the three months ended March 31, 2001 and included in general and administrative expenses in the accompanying statement of operations.

In April 2001, upon completion of the search for the Company’s chief financial officer, the Company issued warrants to a retained executive search firm for services performed. The warrants, if exercised, can be exchanged for 66,667 shares of the Company’s common stock. The weighted-average exercise price of the underlying shares is $4.50 per share. The warrants are immediately exercisable and expire in April 2004. The combined fair value of the warrants was determined to be approximately $280,000 and was estimated using the Black-Scholes model with the following assumptions: risk free interest rate of 4.27%; expected life of 3 years; dividend yield of 0%; and expected volatility of 91%. The fair value of the warrants was included as stock compensation during the three months ended June 30, 2001 and included in general and administrative expenses in the accompanying statement of operations.

Former executives. In January 2001, the Company’s board of directors appointed the Company’s current chief executive officer. Effective January 2001, the Company’s former chief executive officer, former chief financial officer, and former president and chief operating officer, became special advisors. Options held by

In July 2002, the Company commenced an exchange offer to acquire approximately 12 million publicly traded shares of McAfee.com common stock.

In July 2002, the Company entered into interest rate swap agreements with two investment banks. The interest swaps allow the Company to pay a floating interest rate based upon the London InterBank Offer Rate plus 1.66%. These interest rate swaps were designated as fair value hedges under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.”

In July 2002, the Company sold its shares in Secure Computing previously received in exchange for the Gauntlet assets and closed its collar, financial derivative consisting of puts and call options in Secure Computing shares. (See Note 4).

In August 2002, the Company repurchased outstanding zero coupon convertible subordinated debentures due 2018 with an aggregate face amount of $100.0 million for approximately $47.4 million.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report. The results shown herein are not necessarily indicative of the results to be expected for the full year or any future periods.

Some of the statements contained in this Report on Form 10-Q are forward-looking statements, including but not limited to those specifically identified as such, that involve risks and uncertainties. The statements contained in the Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this Report on Form 10-Q are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. 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. In some instances, we have also indicated forward-looking statements with an asterisk (*). 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 assume responsibility for the accuracy and completeness of such statements. Important factors that may cause actual results to differ from expectations include, but not limited to, those discussed in “Risk Factors” and elsewhere in this Report on Form 10-Q.

We are a leading supplier of network security and network management solutions. We operate through two businesses, consisting of our infrastructure business and McAfee.com, our publicly traded subsidiary. Our infrastructure business is operated in six geographic regions: the United States, Europe, Japan, Canada, Asia-Pacific and Latin America. McAfee.com is an application service provider, or ASP, targeted at consumers and small to medium-sized businesses.

The majority of our net revenue has historically been derived from our McAfee Security anti-virus products and our Sniffer Technologies network fault and performance products. In addition to these two flagship products, 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 detection, encryption, and virtual private networking categories. On the network management side, we built upon our Sniffer Technologies line by adding products in the help desk, asset management, network monitoring, and network reporting categories. We continuously seek to expand our product lines.

To more effectively market our infrastructure products in our various geographic regions, we have combined complementary products into separate product groups, as follows:


	•	McAfee Security, which delivers world-class anti-virus and security products and services;

	•	Sniffer Technologies, which is a leader in network availability and system security products; and

	•	Magic Solutions, which is a leading provider of web-based service desk solutions.

In the three and six months ended June 30, 2002, our infrastructure business accounted for approximately $212.3 million and $414.2 million in net revenue, respectively, and a net operating income of $20.3 million and $28.0 million, respectively. In the three and six months ended June 30, 2002, McAfee.com accounted for approximately $20.7 million and $39.5 million in net revenue, respectively, and a net operating income of approximately $6.2 million and $11.4 million, respectively.

McAfee Security’s products and services provide solutions designed to enforce anti-virus policies and measure the performance of anti-virus activities and deliver network security. The McAfee Security product group includes products and services that provide multi-layer anti-virus protection, management and reporting for desktops, servers, GroupWare, Internet technologies, and wireless technologies. The McAfee Security product group also includes distributed firewalls and virtual private network products for corporate users. McAfee Security’s services are provided by McAfee Security’s Anti-Virus Emergency Response Team (AVERT). AVERT augments McAfee Security’s product offerings by identifying new viruses and deploying anti-virus solutions to our customers. McAfee Security customers are primarily corporate customers, including customers in the managed service market (such as ASPs, and managed service providers, or MSPs).

Sniffer Technologies’ products and services provide customers with network and application management solutions designed to maximize network availability and performance and system security. Sniffer Technologies’ products capture data, monitor network traffic and collect key network statistics. Sniffer Technologies’ products are also designed to optimize network and application performance and increase network reliability by uncovering and analyzing network problems and system vulnerabilities and recommending solutions to such problems, automatically and in real-time for mid-level and high-speed networks. Sniffer Technologies’ products also proactively monitor and diagnose network and application-level problems on complex, multi-segment networks from centralized locations as well as troubleshooting high-speed telecommunications and Internet service provider networks. Sniffer Technologies’ customers are primarily corporate customers, including customers in the managed service market.

Magic Solutions’ products provide customers with a web-based set of tools to manage their customer support and problem management needs. Magic Solutions’ product group consists of products that promote information sharing, facilitate workflow, and improve service delivery. Magic Solutions’ products include the Magic Total Service Desk Suite, a 100% browser-based service desk and problem management solution. In addition, Magic Solutions’ stand-alone products include Magic HelpDesk, Self Service Desk, Remote Desktop and Event Management. Magic Solutions’ customers are primarily corporations.

McAfee.com is a security ASP delivering security applications software and related services through an Internet browser. The McAfee.com applications allow users to detect and eliminate viruses on their PCs, repair their PCs from damage caused by viruses, optimize their hard drives and update their PCs’ virus protection system with current software patches and upgrades. McAfee.com also offers customers access to McAfee.com Personal Firewall, McAfee.com Wireless Security Center and McAfee.com Internet Privacy Service.

Under the terms of our licensing agreement with McAfee.com, McAfee.com’s business has historically been targeted exclusively at consumers. In March 2001, we entered into a reseller agreement with McAfee.com allowing it to expand its product offerings with McAfee.com for Business. McAfee.com for Business is a website serving the security needs for small and medium-sized businesses, delivering managed applications services that allow businesses to provide anti-virus and firewall security for their desktop PCs.

As of June 30, 2002, we owned 36.0 million shares of McAfee.com Class B common stock, entitled to three votes per share and representing approximately 75% of McAfee.com’s outstanding common stock and 90% of its total voting power. In July 2002, we commenced an exchange offer to acquire the publicly traded shares of McAfee.com. If the exchange offer and related merger are completed, we would own 100% of McAfee.com’s common stock.

From time to time, we enter into strategic alliances with third parties in order to expand the marketing of our products and meet our customers’ additional needs.

In May 2002, we announced a strategic alliance with Internet Systems Security (ISS). ISS has entered into a license agreement for the resale of our McAfee ASaP service. In addition, the parties have entered into a mutual license agreement under which, we will offer our customers certain ISS intrusion detection products bundled with our product, and ISS will offer its customers our anti-virus products bundled with their products. We have also agreed to share research regarding intrusion detection, computer viruses and computer vulnerability risks to protect and defend customer networks worldwide.

There have been no material changes to our critical accounting policies and estimates as disclosed in our report on Form 10-K/A for the year ended December 31, 2001 except as follows:

On January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets”. The standard requires, among other things, the discontinuance of goodwill amortization and the testing for impairment of existing goodwill and other intangibles. In accordance with the provisions of the standard, we ceased to amortize approximately $156.9 million of goodwill and performed an initial impairment test of our goodwill and other intangibles.

In accordance with the provision of SFAS No. 142, the impairment review involves a two-step process as follows:


	•	*Step 1* — We compare the fair value of our reporting units to the carrying value, including goodwill of each of those units. For each reporting unit where the carrying value, including goodwill, exceeds the unit’s fair value, we move on to step 2. If a unit’s fair value exceeds the carrying value, no further work was performed and no impairment charge is necessary.

	•	*Step 2* — We perform an allocation of the fair value of the reporting unit to our identifiable tangible and non-goodwill intangible assets and liabilities. This derives an implied fair value for the reporting unit’s goodwill. We then compare the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess.

We performed Step 1 of the goodwill impairment analysis required by SFAS 142 as of January 1, 2002 and concluded that goodwill was not impaired, as the fair value of each reporting unit substantially exceeded its carrying value, including goodwill. Accordingly, Step 2 was not performed. The fair value of the reporting units was estimated using the average of the expected present value of future cash flows and of the market multiple value. The use of the discounted cash flow approach requires that we make estimates of the future cash flows of each of our reporting units. The projection of cash flows involves several estimates and assumptions such as projected revenue growth, projected level of expenses, amount of future investments and projected tax rates. We are also required to estimate an appropriate rate at which to discount these cash flows. The use of the market multiple approach requires us to identify comparable companies in order to estimate the fair value of our reporting units.

The fair value of each of the reporting units is related to market conditions and our overall market capitalization. As a result, a substantial decline in our stock price for a sustained period could indicate a decrease in the fair value of our reporting units and lead to impairment.

In accordance with the provision of SFAS 142, we will continue to test for impairment our goodwill and other intangibles on an annual basis and on an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting units below their carrying amounts. In

addition to a significant decline in our stock price for a sustained period and our market capitalization relative to our net book value, factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business and significant negative industry or economic trends.

The following table sets forth, for the periods indicated, the percentage of net revenue represented by certain items in our Condensed Consolidated Statements of Operations.

Net Revenue. Net revenue increased 21% to $233.0 million from $192.8 million in the three months ended June 30, 2002 and 2001, respectively, including a $6.3 million increase in revenue from McAfee.com. Net revenue increased 30% to $453.7 million from $348.7 million in the six months ended June 30, 2002 and 2001, respectively, including a $12.2 million increase in revenue from McAfee.com.

The following table sets forth for the periods indicated our product revenue and services and support revenue as a percent of net revenue.

The following table sets forth for the periods indicated each major category of our product revenue as a percent of product revenue.

Product revenue includes revenue from software licenses, hardware, our retail products and royalties. Product revenue increased 13% to $149.6 million from $132.4 million in the three months ended June 30, 2002 and 2001, respectively. The increase in product revenue is attributable to the increase in new customer purchases of our anti-virus suite of products, specifically perpetual and subscription licenses. The product revenue for the six months ended June 30, 2001 was adversely affected by our completion in the first quarter of 2001 of our move to the sell-through business model.

Our customers license our software on a perpetual or subscription basis depending on their preference. Recently, we have seen an increased customer preference for perpetual licenses. This preference may result in higher overall revenue in the near-term.* Sales of perpetual licenses typically result in significantly higher up-front revenue and lower recurring and future revenues as the sales price for related upgrades and updates tends to be significantly lower than those of the initial perpetual license. We believe it is important to maintain a proper mix of perpetual and subscription based licenses, and we continue to monitor the product mix.

The following table sets forth, for the periods indicated each major category of our services and support as a percent of services and support revenue.

Services and support revenues include revenues from software support and maintenance contracts, consulting, training and hosting arrangements. Service revenues increased 38% to $83.4 million from $60.4 million in the three months ended June 30, 2002 and 2001, respectively. The increase in service revenue is attributable to the growth of our installed customer base and the resulting renewal of support and maintenance contracts over the past periods. In addition, we experienced growth in our Managed Service Provider (MSP) and Application Service Provider (ASP) service offerings, including those offered by McAfee.com, for the three months ended June 30, 2002.

Our future profitability and rate of growth, if any, will be directly affected by increased price competition and an increasingly higher revenue base from which to grow. Our growth rate and net revenue depend significantly on renewals of existing orders, as well as our ability to respond successfully to the pace of technological change and expand our customer base. If our renewal rate or our pace of new customer acquisition slows, our net revenues and operating results would be adversely affected.

International revenue accounted for approximately 38% and 37% of net revenue for the three months ended June 30, 2002 and 2001, respectively and approximately 41% and 36% of net revenue for the six months ended June 30, 2002 and 2001, respectively. The increase in international revenue as a percentage of net revenue was attributable to the focus on sales execution in regions around the world.

We have announced our intentions to increase our international revenues both in absolute terms and as a percentage of our overall revenues.* Risks inherent in international revenue 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, risks associated with currency fluctuations and hedging, tariffs and other trade barriers, and difficulties staffing and managing international operations. Poor economic conditions in Asia, particularly Japan and Latin America have hurt our business and may impact our ability to expand international revenue. These factors may have a material adverse effect on our future international revenue.

Cost of Net Revenue. Cost of net revenue remained relatively constant at $39.8 million and $39.9 million in the three months ended June 30, 2002 and 2001, respectively, including an increase of $0.8 million from McAfee.com. As a percentage of net revenue, cost of net revenue decreased to 17% from 20% for the three months ended June 30, 2002 and 2001, respectively. The decrease is primarily due to a decrease in the cost of product revenue as a percentage of revenue. Cost of net revenue increased 5% to $80.4 million from $76.9 million in the six months ended June 30, 2002 and 2001, respectively, including a decrease of $0.2 million from McAfee.com. As a percentage of net revenue, cost of net revenue decreased to 18% from 22% for the six months ended June 30, 2002 and 2001, respectively.

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 hardware-based anti-virus products and network fault and performance products, computer platforms and other hardware components. Cost of product revenue decreased 2% to $24.9 million from $25.4 million for the three months ended June 30, 2002 and 2001, respectively. As a percentage of net product revenue, cost of product revenue decreased to 17% from 19% in the three months ended June 30, 2002 and 2001, respectively. The decrease in the cost of product revenue and percentage of net product revenue is due to the change in product mix of hardware and software product revenue. In the three months ended June 30, 2002, we sold more software licenses, which carry a lower cost of revenue. Cost of product revenue increased 3% to $50.2 million from $48.9 million for the six months ended June 30, 2002 and 2001, respectively. The increase in the cost of net product revenue relates to the increase in product revenue to $288.9 million from $224.9 million for the six months ended June 30, 2002 and 2001, respectively. As a percentage of net product revenue, cost of product revenue decreased to 17% from 22% in the six months ended June 30, 2001 and 2002, respectively. The decrease in the cost of product revenue percentage is due to the change in product mix of hardware and software product revenue.

Due to new hardware-based anti-virus product introductions during the second half of 2001 and anticipated growth in our hardware-based network fault and performance products, we expect that the cost of product revenue will increase both in absolute terms and as a percentage of product revenue in future periods.*

Cost of services and support revenue consists principally of salaries and benefits related to employees providing customer support and consulting services. The cost of services and support revenue increased 3% to $14.9 million from $14.5 million in the three months ended June 30, 2002 and 2001, respectively. The increase in the cost of services and support revenue was due to additional technical support and customer service personnel hired to meet our customers’ technical support needs. Cost of services and support revenue as a percentage of net services and support revenue was 18% and 24% in the three months ended June 30, 2002 and 2001, respectively. The cost of services and support revenue increased 8% to $30.2 million from $28.0 million in the six months ended June 30, 2002 and 2001, respectively. Cost of services and support revenue as a percentage of net services and support revenue was 18% and 23% in the six months ended June 30, 2002 and 2001, respectively. The percentage of cost of services and support revenue decreased due to the cost of services and support revenue remaining relatively flat while services and support revenue increased 34% for the six months ended June 30, 2002.

Due to new service introductions during 2001, including anti-virus hosted services, anticipated growth in hosted services by McAfee.com, increased maintenance and support orders and an increase in consulting and training services, we expect that the cost of service revenue will increase both in absolute terms and as a percentage of net revenue in future periods.*

We have excluded the effects of stock-based compensation in our discussion of operating costs and expenses below. The size and amount of our stock-based charges will vary from period to period based on movements in our stock price, making period to period comparisons difficult and, in some cases, not meaningful. See “Stock-Based Compensation” below.

The following sets forth for the periods indicated, our operating expenses, excluding the effects of stock-based compensation (in thousands):


(1)	Excludes stock-based compensation charge of $(1,233) and $107 for the three months ended June 30, 2002 and 2001, respectively, and $(1,115) and $198 for the six months ended June 30, 2002 and 2001, respectively.

(2)	Excludes stock-based compensation charge of $(1,312) and $169 for the three months ended June 30, 2002 and 2001, respectively, and $(1,137) and $313 for the six months ended June 30, 2002 and 2001, respectively.

(3)	Excludes stock-based compensation charge of $(1,316) and $931 for the three months ended June 30, 2002 and 2001, respectively, and $(895) and $2,352 for the six months ended June 30, 2002 and 2001, respectively.

Research and Development. Research and development expenses consist primarily of salary, benefits, and contractors fees for our development and technical support staff, and other costs associated with the enhancements of existing products and services and development of new products and services. Excluding the effects of stock-based compensation of approximately $(1.2) million and $0.1 million for the three months ended June 30, 2002 and 2001, respectively, research and development expenses decreased 1% to $34.7 million from $34.8 million for the three months ended June 30, 2002 and 2001, respectively. Excluding the effects of stock-based compensation of approximately $(1.1) million and $0.2 million for the six months ended June 30, 2002 and 2001, respectively, research and development expenses decreased 7% to $69.2 million from $74.7 million for the three months ended June 30, 2002 and 2001, respectively. Research and development expenses decreased due to focused product development, discontinuance of certain development efforts, and more efficient operations in our research and development groups.

As a percentage of net revenue, research and development expenses were 14% and 18% for the three months ended June 30, 2002 and 2001, respectively. Excluding stock-based compensation charges, as a percentage of net revenue, research and development expenses were 15% and 18% for the three months ended June 30, 2002 and 2001, respectively. As a percentage of net revenue, research and development expenses were 15% and 22% for the six months ended June 30, 2002 and 2001, respectively. Excluding stock-based compensation charges, as a percentage of net revenue, research and development expenses were 15% and 21% for the six months ended June 30, 2002 and 2001, respectively. We believe that continued investment in product and development is critical to attaining our strategic objectives and, as a result, expect product development expenses to increase in future periods. We anticipate research and development expenses to increase in absolute dollars, but will continue to fluctuate as a percent of net revenue.*

Marketing and sales. Marketing and sales expenses consist primarily of salary, commissions and benefits for marketing and sales personnel and costs associated with advertising and promotions. Excluding the effects of stock-based compensation of $(1.3) million and $0.2 million for the three months ended June, 2002 and 2001, respectively, marketing and sales expenses increased 6% to $108.0 million from $102.3 million for the three months ended June 30, 2002 and 2001, respectively. The increase is primarily due to additional hiring in our sales force. Excluding the effects of stock-based compensation of $(1.1) million and $0.3 million for the six months ended June 30, 2002 and 2001, respectively, marketing and sales expenses increased 4% to $210.3 million from $202.9 million for the six months ended June 30, 2002 and 2001, respectively.

As a percentage of net revenue, marketing and sales expenses were 46% and 53% for the three months ended June 30, 2002 and 2001, respectively. Excluding stock-based compensation charges, as a percentage of net revenue, marketing and sales expenses were 46% and 53% for the three months ended June 30, 2002 and 2001, respectively. As a percentage of net revenue, marketing and sales expenses were 46% and 58% for the six months ended June 30, 2002 and 2001, respectively. Excluding stock-based compensation charges, as a percentage of net revenue, marketing and sales expenses were 46% and 58% for the six months ended June 30, 2002 and 2001, respectively. We anticipate marketing and sales expenses to increase in absolute dollars, but will continue to fluctuate as a percent of net revenue.*

General and administrative. General and administrative expenses consist primarily of salary and benefit costs for executive and administrative personnel, professional services and other general corporate activities. Excluding the effects of stock-based compensation of $(1.3) million and $0.9 million for the three months ended June 30, 2002 and 2001, respectively, general and administrative expenses increased 12% to $26.4 million from $23.5 million for the three months ended June 30, 2002 and 2001, respectively. Of the total increase, approximately $0.5 million was attributable to the expenses incurred by McAfee.com related to our exchange offer for all outstanding publicly held shares of McAfee.com Class A common. The remaining increase is due to recruiting and hiring additional personnel, and continued expansion of the information technology infrastructure to support business information systems. Excluding the effects of stock-based compensation of $(0.9) million and $2.4 million for the six months ended June 30, 2002 and 2001, respectively, general and administrative expenses decreased 4% to $51.4 million from $53.5 million for the six months ended June 30, 2002 and 2001, respectively. The decrease was primarily attributable to a decrease in legal fees.

As a percentage of net revenue, general and administrative expenses were 11% and 13% for the three months ended June 30, 2002 and 2001, respectively. Excluding stock-based compensation charges, as a percentage of net revenue, general and administrative expenses were 11% and 12% for the three months ended June 30, 2002 and 2001, respectively. As a percentage of net revenue, general and administrative expenses were 11% and 16% for the six months ended June 30, 2002 and 2001, respectively. Excluding stock-based compensation charges, as a percentage of net revenue, general and administrative expenses were 11% and 15% for the six months ended June 30, 2002 and 2001, respectively. We anticipate general and administrative expenses to increase in absolute dollars as we continue to expand our staff and incur additional infrastructure and other costs to support the anticipated growth of our business.*

Provision for (Recovery from) Doubtful Accounts. Provision for doubtful accounts consists of our estimates for the uncollectability of receivables, net of recoveries of amounts previously written off. For the three months ended June 30, 2002, the changes in our doubtful accounts resulted in a net credit of $1.1 million compared to a provision for doubtful accounts of $2.4 million for the three months ended June 30, 2001. For the six months ended June 2002, we had a credit of $0.4 million compared to a credit resulting from recoveries of $6.8 million for the six months ended June 30, 2001. For the six months ended June 30, 2001, the recovery related to previously reserved receivables from two distributors who were undergoing restructurings of their business operations and experiencing cash flow difficulties at the end of 2000.

Amortization of Intangibles. We expensed $2.5 million and $16.7 million of amortization related to intangibles for the three months ended June 30, 2002 and 2001, respectively and $5.4 million and $32.5 million for the six months ended June 30, 2002, respectively. For the three and six months ended June 30, 2002, amortization of intangibles relates to amortization of purchased technology and other identifiable intangible assets. For the three and six months ended June 30, 2001, amortization of intangibles relates to amortization of purchased goodwill as well as purchased technology and other identifiable intangible assets. The decrease in amortization for the three and six months ending March 31, 2002 was the result of adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 requires, among other things, the discontinuance of goodwill amortization.

Restructuring Charge. As part of the plan to integrate certain activities of our PGP product group into our McAfee Security and Sniffer Technologies product groups and to dispose of other product lines, we sold our Gauntlet business and discontinued other product lines during the first quarter of 2002. In connection with this process, a restructuring charge of approximately $1.1 million was recorded during the first quarter of 2002. The restructuring charge consists of costs of severance packages for 44 employees as well as related legal and outplacement services.

The following table sets forth our restructuring accrual established in February 2002 and the activity against the accrual during the six months ended June 30, 2002 (in thousands):

Interest and Other Income. Interest and other income decreased to $7.6 million from $7.9 million for the three months ended June 30, 2002 and 2001, respectively, and decreased to $14.3 million from $18.9 million for the six months ended June 30, 2002 and 2001, respectively. The decrease was primarily due to lower interest yields on cash and investments.

Interest Expense. Interest expense increased to $7.9 million from $4.7 million for the three months ended June 30, 2002 and 2001, respectively, and increased to $15.6 million from $9.4 million for the six months ended June 30, 2002 and 2001, respectively. Interest expense increased primarily due to the issuance in August 2001 of our 5.25% convertible subordinated notes due 2006.

Gain on Sale of Assets and Technology. In the six months ending June 30, 2002, we recognized a $6.7 million gain on the sale of PGP Gauntlet assets and technology.

Write Down of Strategic and Other Investments. For the three and six months ended June 30, 2001, we recorded an impairment charge of $13.1 million and $18.1 million, respectively, related to an other than temporary decline in the value of some of our venture and strategic investments. As of June 30, 2002, the minority venture investments we continue to hold totaled $2.7 million in estimated fair value, consisting of investments in public and private companies, amounting to $2.5 million and $0.2 million, respectively.

Provision for Income Taxes. Our consolidated provision for income taxes for the three months and six months ended June 30, 2002 was $3.2 million and $4.6 million, reflecting an effective tax rate of rate of 12% and 10%. The effective tax rate differs from the statutory rate primarily due to the impact of research and experimentation tax credits, utilization of foreign tax credit carryovers, lower effective rates in some overseas jurisdictions and utilization of subsidiary losses not previously benefited. Our future effective tax rates could be adversely affected if earnings are lower than anticipated in countries where we have lower statutory rates or by unfavorable changes in tax laws and regulations.

Our income tax benefit was $0.7 million and $11.2 million for the three months and six months ended June 30, 2001, which was primarily due to the net benefit of operating losses generated in various taxing jurisdictions.

We recorded stock-based compensation charges (credits) of $(3.9) million and $1.2 million in the three months ended June 30, 2002 and 2001, respectively, and $(3.1) million and $2.9 million in the six months ended June 30, 2002 and 2001, respectively. These charges (credits) are made up of the following (in thousands):

Repriced options. During the three and six months ended June 30, 2002, the Company recorded credits of approximately $4.6 million and $6.5 million, respectively, related to options subject to variable plan accounting. During the three and six months ended June 30, 2001, we did not incur a charge related to options subject to variable plan accounting. For the three months ended June 30, 2002 and 2001, our stock compensation charges related to options subject to variable plan accounting were based on quarter end per share prices of our stock of $19.27 and $12.45, respectively, and per share prices of McAfee.com stock of $14.64 and $12.28, respectively. As of June 30, 2002 we and McAfee.com had options to purchase approximately 1.1 million shares and 0.2 million shares, respectively, which were outstanding and subject to variable plan accounting.

We also incurred a stock-based compensation charge in connection with the initial issuance of the repriced options. 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 $0.2 million and $0.4 million was expensed during the three months ended June 30, 2002 and 2001, respectively, and approximately $1.0 million and $0.7 million was expensed during the six months ended June 30, 2002, respectively.

Options issued below fair market value. During the three months ended March 31, 2002, we recorded a one-time stock compensation charge of $1.2 million for stock options granted below fair market value. This charge relates to options granted in prior periods, which were identified in the first quarter of 2002 as having been granted below market value. The amount was determined to be immaterial for the periods when the grants were made and for the current period. The related charge has been recorded in the first quarter of 2002.

New and existing executives. On January 3, 2001, we entered into an employment agreement with George Samenuk to become our president and chief executive officer. In accordance with the terms of the agreement, we issued 400,000 shares of restricted stock to Mr. Samenuk. The price of the underlying shares is $0.01 per share. We recorded approximately $247,000 and $209,000 during the three months ended June 30, 2002 and 2001, respectively, and approximately $643,000 and $418,000 during the six months ended June 30, 2002 and 2001, respectively, related to stock compensation associated with Mr. Samenuk’s restricted stock.

On January 15, 2002, our board of directors approved a grant of 50,000 shares of restricted stock to Mr. Samenuk. The price of the underlying shares is $0.01 per share. The shares will vest and our right to repurchase such shares will lapse as follows: 3,000 vested as of the grant date and 47,000 are restricted until January 15, 2005. The fair value of the restricted stock was determined to be approximately $1.4 million and was estimated based on the difference between the exercise price of the restricted stock and the fair market

On April 3, 2001, we entered into an employment agreement with Stephen C. Richards to become our executive vice president and chief financial officer. In accordance with the terms of the agreement, we issued 50,000 shares of stock to Mr. Richards for $0.01 per share. In the three months ended June 30, 2001, we recognized approximately $350,000 related to stock compensation associated with the stock issued to Mr. Richards.

Shares purchased outside Employee Stock Purchase Plan. On January 31, 2002, we experienced a shortfall in the number of shares available under the 1994 Employee Qualified Stock Purchase Plan to meet the requirements of the open purchase period. Although we reduced the number of shares plan participants could purchase by a pro rata amount, additional shares were required to be purchased outside of the plan in order to meet this shortfall. As a result, we recorded a one-time stock compensation charge of approximately $60,000 in the three months ending March 31, 2002. The charge was based on the difference between the fair value of the shares purchased outside of the plan and the price the shares were sold to plan participants.

Extended vesting term of options. During the three months ended June 30, 2002, we recorded a one-time stock compensation charge of $0.2 million as a result of the modification of the terms of the options previously granted to employees.

Warrants to outside consultants. In January 2001, upon completion of the search for our current chief executive officer, we issued warrants to a retained executive search firm for services performed. The warrants, if exercised, can be exchanged for 166,667 shares of our common stock. The weighted-average exercise price of the underlying shares is $2.97 per share. The warrants are immediately exercisable and expire in January 2004. The combined fair value of the warrants was determined to be approximately $530,000 and was estimated using the Black-Scholes model with the following assumptions: risk free interest rate of 4.82%; contractual life of 3 years; dividend yield of 0%; and expected volatility of 91%. The fair market value of the warrants was included as stock compensation during the three months ended March 31, 2001 and included in general and administrative expenses in the accompanying statement of operations.

In April 2001, upon completion of the search for our chief financial officer, we issued warrants to a retained executive search firm for services performed. The warrants, if exercised, can be exchanged for 66,667 shares of our common stock. The weighted-average exercise price of the underlying shares is $4.50 per share. The warrants are immediately exercisable and expire in April 2004. The combined fair value of the warrants was determined to be approximately $280,000 and was estimated using the Black-Scholes model with the following assumptions: risk free interest rate of 4.27%; expected life of 3 years; dividend yield of 0%; and expected volatility of 91%. The fair value of the warrants was included as stock compensation during the three months ended June 30, 2001 and included in general and administrative expenses in the accompanying financial statements.

Former executives. In January 2001, our board of directors appointed our current chief executive officer. Effective January 2001, our former chief executive officer, former chief financial officer, and former president and chief operating officer, became special advisors. Options held by these individuals continued to vest during 2001 while they each served their one-year terms as special advisors. As a result, we recorded a one-time stock compensation charge of approximately $603,000 during the three months ended March 31, 2001.

concluding that a company should apply this consensus no later than the company’s annual or interim financial statements for the periods beginning after December 15, 2001. In June 2001, the EITF issued EITF Issue No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products,” effective for periods beginning after December 15, 2001. EITF Issue No. 00-25 addresses whether consideration from a vendor to a reseller is (a) an adjustment of the selling prices of the vendor’s products and, therefore, should be deducted from revenue when recognized in the vendor’s statement of operations or (b) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be included as a cost or expense when recognized in the vendor’s statement of operations. Upon application of these EITFs, financial statements for prior periods presented for comparative purposes should be reclassified to comply with the income statement display requirements under these Issues. In September of 2001, the EITF issued EITF Issue No. 01-09, “Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor’s Products”, which is a codification of EITF Issues No. 00-14, No. 00-25 and No. 00-22 “Accounting for “Points’ and Certain Other Time-or Volume-Based Sales Incentive Offers and Offers for Free Products or Services to be Delivered in the Future.” During the quarter ended March 31, 2002, we adopted EITF 01-09. As a result, we reclassed $3.4 million and $18.1 million from marketing and sales expense to revenue for the three and six months ended June 30, 2001, respectively.

In November 2001, the FASB discussed Topic D-103, recharacterized as EITF Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for “Out-of-Pocket’ Expenses Incurred.” This issue deals with classification in the income statement of incidental expenses, that in practice are commonly referred to as “out-of-pocket” expenses, incurred by entities that provide services as part of their central ongoing operations. The Task Force reached a consensus that reimbursements received for out-of-pocket expenses incurred should be characterized as revenue in the income statement. This issue is effective for fiscal years beginning after December 15, 2001. During the quarter ended March 31, 2002, we adopted EITF 01-14. As a result, we reclassed a total amount of $0.3 million and $0.6 million from cost of revenue to revenue for the three and six months ended June 30, 2001, respectively.

In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 establishes a single accounting model, based on the framework established in Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (“SFAS 121”), for long-lived assets to be disposed of by sale, and resolves implementation issues related to SFAS 121. We are currently assessing the impact of SFAS 144 on its operating results and financial condition. We are required to adopt SFAS 144 no later than the first quarter of fiscal 2003.

In May 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections” (“SFAS 145”). Among other things, SFAS 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” are met. SFAS 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. We are currently assessing the impact of SFAS 145 on our financial statements.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. We are currently assessing the impact of SFAS 146 on our financial statements.

In April of 2001, the EITF issued EITF Issue No. 01-03 “Accounting in a Purchase Business Combination for Deferred Revenue of an Acquiree.” EITF Issue No. 01-03 addresses whether an acquiring

entity should recognize a liability for deferred revenue recorded by the acquiree when the business combination is initially recorded and, if so, how the amount assigned to that liability should be measured and presented in the acquiring entity’s financial statements. In March 2002, the Task Force reached a consensus that the acquiring entity should recognize a liability related to a revenue arrangement of an acquired entity only if it has assumed a legal obligation to provide goods, services, or other consideration to the customer(s) (a legal performance obligation) and the amount assigned to the liability should be based on its fair value at the date of the acquisition. We are currently assessing the impact of EITF 01-03 on our financial statements.

At June 30, 2002, we had $733.4 million in cash and cash equivalents and $369.4 million in marketable securities, for a combined total of $1,102.8 million.

Net cash provided by operating activities was $92.6 million and $31.0 million in the six months ended June 30, 2002 and 2001, respectively.

Net cash provided by operating activities in the six months ended June 30, 2002 resulted primarily from net income before non-cash charges and minority interest. Non-cash charges primarily include depreciation, amortization and interest expense on convertible notes, offset by the gain on sale of assets and technology and negative stock compensation charges. After excluding the effects of non-cash charges and minority interest, our net income was approximately $61.1 million for the six months ended June 30, 2002. Additional cash was generated from a decrease of $37.5 million in our accounts receivable balance and a decrease of $2.5 million in our deferred taxes and decrease of $3.0 million in prepaid expenses and other assets. This cash increase was offset by a decrease in our accounts payable and accrued liabilities of $9.4 million and deferred revenue of $2.0 million during the six months ended June 30, 2002.

Net cash provided by operating activities in the six months ended June 30, 2001 resulted primarily from collections of accounts receivable and an increase in our deferred revenue. These cash inflows were partially offset by a net loss before non-cash charges and payments made on accounts payable and other accrued liabilities and increases in our deferred taxes.

Net cash provided by (used in) investing activities was $(52.9) million and $97.6 million in the six months ended June 30, 2002 and 2001, respectively. In the six months ended June 30, 2002, the activity in the portfolio of our investment in marketable securities had a net cash usage of $30.8 million. Additional cash was used by our purchases of fixed assets of $21.3 million and purchase of technology of $0.8 million. In the six months ended June 30, 2001, the activity in the portfolio of our investment in marketable securities generated net cash proceeds of $121.6 million. These proceeds were offset by our purchase of shares of Network Associates Japan of $10.7 million and purchase of fixed assets of $13.4 million.

Net cash provided by financing activities in the six months ended June 30, 2002 amounted to $77.8 million, consisting of cash generated from the issuance of common stock under our stock option plan and employee stock purchase plan of $96.6 million offset by cash used in the repurchase of a portion of our zero coupon debentures of $18.8 million. In the six months ended June 30, 2001, we used approximately $53.8 million to settle all outstanding put options requiring us to repurchase our common stock at the election of the holders of these put options. The settlement costs were slightly offset by proceeds associated with the exercise of our stock options and employee stock purchase plan.

During the six months ended June 30, 2002, a significant portion of our cash inflows was generated by our operations. Because our operating results may fluctuate significantly, as a result of decrease in customer demand or decrease in the acceptance of our future products, our ability to generate positive cash flow from operations may be jeopardized.

As described below, in February 2003, we may be required to use a significant portion of our cash balances to redeem outstanding zero coupon convertible subordinated debentures.*

We believe that our available cash and anticipated cash flows from operations will be sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months.*

On February 13, 1998, we issued zero coupon convertible subordinated debentures due 2018, which have an aggregate face amount at maturity of $885.5 million and generated net proceeds to us of approximately $337.6 million (after deducting fees and expenses). The initial price for the debentures was $391.06 per $1,000 of principal amount at maturity. At the option of the holder, we are required to redeem the debentures as of February 13, 2003, February 13, 2008 and February 13, 2013 at purchase prices equal to the initial issue price plus the accretion of the discount on the debentures to such dates (or $494.52, $625.35 and $790.79 per $1,000 of principal amount at maturity, respectively). In the case of such a required redemption, at our option, we may pay the aggregate redemption price in cash, shares of our common stock or a combination of cash and common stock. The number of shares of common stock so issued by us would be based on the fair value of our common stock at the time of any required redemption. On the same dates and at the same redemption prices, we may at our option redeem the outstanding debentures for cash. The debentures may also be redeemed at the option of the holder if there is a Fundamental Change (as defined in the related indenture) at a price equal to the issue price plus the accretion of the discount on the debenture to the date of redemption, subject to adjustment. The accretion of the discount on the debentures is calculated using the effective interest method.

Through a limited number of privately negotiated purchases, the most recent of which occurred in August 2002, we have repurchased zero coupon convertible subordinated debentures with an aggregate face amount of approximately $527.0 million, leaving an outstanding balance of approximately $358.5 million face amount. During the six months ended June 30, 2002, we repurchased zero coupon convertible subordinated debentures, which had an aggregate face amount at maturity of $40.0 million, at a price of $18.8 million, which was financed from our investment portfolio. In connection with the repurchase, we recognized an extraordinary loss of approximately $31,000, net of taxes. In August 2002, we repurchased outstanding zero coupon convertible subordinated debentures with an aggregate face amount of $100.0 million for approximately $47.4 million. If and when appropriate opportunities present themselves, we may continue to use a portion of our cash balances to buy back additional amounts of these debentures.*

As of June 30, 2002, our aggregate cash, cash equivalents and marketable securities were approximately $1,102.8 million, including $117.4 million held by McAfee.com. Assuming that as of February 13, 2003 all zero coupon convertible subordinated debentures currently outstanding as of the filing of this report on Form 10-Q are redeemed, the aggregate redemption price would equal approximately $177.2 million.

On August 17, 2001, we issued 5.25% convertible subordinated notes due 2006 with an aggregate principal amount of $345.0 million. The issuance generated net proceeds to us of approximately $335.1 million (after deducting fees and expenses). The notes mature on August 15, 2006, unless earlier redeemed by us at our option or converted at the holder’s option. Interest is payable semi-annually, in cash, in arrears on February 15 and August 15 of each year, commencing February 15, 2002. At the option of the holder, the notes may be converted into our common stock at any time, unless previously redeemed, at a conversion price of $18.07 per share. We may redeem all or a portion of the notes for cash at any time on or after August 20, 2004 at a redemption price of 101.3125% of the principal amount between August 20, 2004 and August 14, 2005 and 100.0% of the principal amount after August 14, 2005. The notes are unsecured and are subordinated to all of our existing and future Senior Indebtedness (as defined in the related Indenture) and are pari passu with respect to the zero coupon subordinated debentures due 2018.

Our market risks at June 30, 2002 have not changed significantly from those discussed in Item 7A of our Form 10-K/ A for the year ended December 31, 2001 filed with the Securities and Exchange Commission on June 28, 2002, except for the collar financial derivative used as a hedge of Secure Computing available-for-sale securities under SFAS No. 133. See also Note 4, “Gain on Sale of Assets and Technology,” in the Notes to Condensed Consolidated Financial Statements of Part I and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of Item 2 of this Form 10-Q for additional discussions of our market risks.

Investing in our common stock involves a high degree of risk. The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we deem immaterial may also impair our business operations. 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.

We were not profitable in 2001, 2000 and 1999. In 2001, we had a net loss of $100.7 million compared to a net loss of $123.9 million in 2000 and a net loss of $156.9 million in 1999. For the three months ended June 30, 2002 and 2001, we had net income of $21.2 million on net revenue of $233.0 million and net loss of $37.2 million on net revenue of $192.6 million, respectively. For the six months ended June 30, 2002 and 2001, we had net income of $37.0 million on net revenue of $453.7 million and net loss of $85.5 million on net revenue of $348.7 million, respectively.

Our revenues and operating results have varied significantly in the past. We expect fluctuations in our operating results to continue. As a result, we believe that period-to-period comparisons of our financial results should not be relied on as an indicator of our future results. Our expense levels are based in part on our expectations regarding future revenues and in the short term are relatively fixed. We may be unable to adjust our expenses in time to compensate for any unexpected revenue shortfall.

Operational factors that may cause our revenues, gross margins and operating results to fluctuate significantly from quarter to quarter include:


	•	volume, size and timing of new licenses and renewals of existing licenses;

	•	introduction of new products, product upgrades or updates by us or our competitors;

	•	the mix of products we sell and whether those products are sold directly by us or indirectly through distributors and whether, in the case of software licenses, the licenses are time-based subscription licenses or perpetual licenses;

	•	costs or charges related to our acquisition or dispositions, including our recent disposition of the Gauntlet firewall product line;

	•	the components of our revenue that are deferred, particularly that portion attributable to our ASP/ MSP subscription model; and

	•	stock-based compensation charges and costs related to extraordinary events, including litigation and any reductions in force.

Our net revenue is typically higher in the fourth quarter, as many customers complete annual budgetary cycles, and lower in the summer months when many businesses experience lower sales, particularly in the European market. In recent periods, poor economic conditions in Asia, particularly Japan, and Latin America

We Face Risks Related To The Pending Formal SEC Investigation And Our Recent Accounting Restatement.

On March 22, 2002, the Securities and Exchange Commission notified us that it has commenced a “Formal Order of Private Investigation” into our accounting practices. The SEC inquiry may result in a diversion of management’s attention and resources and may contribute to current and future stock price volatility.

On April 26, 2002, we announced that we had discovered accounting inaccuracies in certain prior period financial statements, requiring restatement of the financial statements for these periods. We conducted an internal investigation under the direction of the audit committee of our board of directors to determine the scope and magnitude of these inaccuracies. On May 17, 2002, we announced that the audit committee had completed its internal accounting investigation and as a result we were required to restate certain of our financial statements. On June 28, 2002, we filed the required restated financial statements. The filing of these restated financial statements may lead to new litigation, may expand the claims and the class period in pending litigation, and may increase the cost of defending or resolving current litigation. We are aware that the plaintiffs in the securities class action pending against us and our former officers have announced that they intend to file an amended complaint for federal securities claims related to the accounting inaccuracies.

The filing of restated financial statements to correct the discovered accounting inaccuracies does not resolve the pending SEC inquiry into our accounting practices. The resolution of the SEC inquiry into our prior accounting practices could require the filing of additional restatements of our prior financial statements or require that we take other actions not presently contemplated.

We May Incur Integration And Restructuring Costs Associated With The Proposed Acquisition of McAfee.com.

If our acquisition of the publicly traded shares of McAfee.com is completed, we may incur significant costs and other charges resulting from related restructuring and integrating operations. In addition, based on our stock price as of July 15, 2002, we would also expect to incur an immediate one-time, non-cash charge of approximately $4.9 million relating to the assumption of vested McAfee.com options and an aggregate non-cash charge of approximately $12.9 million related to the assumption of unvested McAfee.com options. The charge related to the unvested McAfee.com options would be recognized as these options vest. The actual charges will be calculated at the time the acquisition is completed and may be materially different to our estimate.

It Is Difficult For Us To Estimate Operating Results Prior To The End Of A Quarter.

Because we do not maintain a significant level of backlog, product revenues in any quarter are dependent on contracts entered into or orders booked and shipped in that quarter. Historically, we have experienced a trend toward more product orders, and therefore, a higher percentage of revenue shipments, in the last month of a quarter. Some customers believe they can enhance their bargaining power by waiting until the end of a quarter to place their order.

Net revenue from international sales represented approximately 38% and 37% of our net revenue for the three months ended June 30, 2002 and 2001, respectively, and 41% and 36% for the six months ended June 30,


	•	longer payment cycles and greater difficulty in collecting accounts receivable;

	•	increased costs and management difficulties related to the building of our international sales and support organization;

	•	the acceptance of the reorganization of our international sales forces by regions;

	•	the need to train and integrate recently hired senior personnel in Europe, Asia-Pacific and Latin America;

	•	uncertainties relative to regional economic circumstances, including the continued economic weakness in Asia and economic weakness in Latin America and pricing pressures associated with weak economic conditions in these regions;

	•	our ability to adapt to sales practices and customer requirements in different cultures;

	•	currency fluctuations and risks related to hedging strategies;

	•	political instability in emerging markets;

	•	tariffs, trade barriers and export restrictions; and

	•	a high incidence of software piracy in some countries.

We Have Recently Experienced Significant Changes In Senior Management And Plan To Add New Members Of Senior Management.

Many members of our senior management have only been added in the last year, and we intend to continue to add new members to senior management. Changes in management may be disruptive to our business and may result in the departure of existing employees and/or customers. It may take significant time to locate, retain and integrate qualified management personnel.

Our success depends in large part on our ability to attract and retain technically qualified and highly skilled sales, consulting, technical, marketing and management employees. Competition for qualified employees is intense, resulting in upward pressure on wages. In addition to our recent management additions, we hired a significant number of new employees in 2000 and 2001. We may continue to add new employees to fill positions vacated by departing employees and to expand our business. There may be reduced levels of productivity as recent hires are trained and otherwise assimilate and adapt to our organization.

Other than executive management who have “at will” employment agreements, our employees are not typically subject to an employment agreement or non-competition agreement. We may be unsuccessful in retaining key personnel. For example, after April 22, 2000, the end of the 12-month lock-up period for options repriced in April 1999, we experienced a larger than normal level of employee departures as many of these employees elected to terminate their employment with us. We may also have difficulties in retaining employees because many of our employees hold options to purchase our stock at prices significantly above the current market price for our stock.

We Depend On Revenue From Our Flagship Anti-Virus And Sniffer Technologies Products.

We have historically derived a majority of our net revenues from our flagship McAfee Security anti-virus software products and Sniffer Technologies network fault and performance management products. These products are expected to continue to account for a significant portion of our net revenues for the foreseeable future. Because of this revenue concentration, our business could be harmed by a decline in demand for, or in the prices of, these products as a result of, among other factors, any change in our pricing model, a maturation in the markets for these products or other risks described in this document.

Weakening economic conditions, new product introductions and expansions of our business may increase the time necessary to sell our products and require us to spend more on our sales efforts. Our products may be considered to be capital purchases by our current or prospective customers. Capital purchases are often discretionary and, therefore, are canceled or delayed if the customer experiences a downturn in its business prospects or as a result of economic conditions in general.

We Face A Number Of Risks Related To Our Product Sales Through Distributors.

We sell a significant amount of our products through intermediaries such as distributors. Our top ten distributors typically represent approximately 38% to 43% of our net revenue in any quarter. Our largest distributor, Ingram Micro, accounted for approximately 25% and 27% of net revenue during the three months ended June 30, 2002 and 2001, respectively, and 26% of net revenue during the six months ended June 30, 2002 and 2001.

Our distributor agreements may be terminated by either party without cause. If one of our significant distributors terminates its distribution agreement, we could experience a significant interruption in the distribution of our products.

We recognize revenue on products sold by our distributors when distributors sell our products to their customers. To determine our business performance at any point in time or for any given period, we must timely and accurately gather sales information from our distributors’ information systems, at an increased cost to us. Our distributors’ information systems may be less accurate or reliable than our internal systems.

Our distributors may sell other vendors’ 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.

Some of our distributors may experience financial difficulties, which could adversely impact our collection of accounts receivable. Our allowance for doubtful accounts was approximately $10.7 million at June 30, 2002; $8.4 million at December 31, 2001; and $15.3 million at December 31, 2000. In 1999, one of our large European distributors, CHS, entered bankruptcy requiring us to record a related accounts receivable write-off of approximately $28.7 million. Also in 1999, Pinacor, a U.S. distributor, entered bankruptcy requiring us to record a related accounts receivable write-off of approximately $6.0 million. We regularly review the collectibility and credit-worthiness of our distributors and other customers to determine an appropriate allowance for doubtful accounts. Our uncollectable accounts could exceed our current or future allowances.

We May Incur Significant Stock-Based Compensation Charges Related to Repriced Options.

We may incur stock-based compensation charges related to employee options repriced in April 1999. The size of these charges could be significant depending on the movements in the market value of our common stock and in some cases, the market value of McAfee.com common stock. As a result of Financial Accounting Standards Board Interpretation No. 44, effective July 1, 2000, options we repriced in April 1999 are subject to variable accounting treatment. The stock-based compensation charge or credit is determined by the excess (or deficiency) of our closing stock price at the end of a reporting period over the fair value of our common stock on July 1, 2000, which was $20.375. Remeasurement of the charge continues until the earlier of the date of

exercise, forfeiture or cancellation without replacement. The resulting compensation charge (or credit) to earnings will be recorded over the remaining vesting period of the options subject to variable accounting treatment. Certain options issued to McAfee.com employees as replacements for our options are also subject to variable accounting treatment and may cause us to incur additional stock based compensation charges.

We Face The Risk Of Future Non-Recurring Charges In The Event Of Impairment And Will Experience Significant Amortization Charges Related To Purchased Technology.

We adopted SFAS 142 beginning in 2002 and, as a result, we no longer amortize goodwill. However, we will continue to have significant amortization related to purchased technology, trademarks, patents and other intangibles, and we must evaluate our intangible assets, including goodwill and purchased technology, at least annually for impairment. We completed the initial impairment review during the second quarter of 2002. As a result, the intangible assets were determined not to be impaired. For the three months ended June 30, 2002 and 2001, our amortization charge for purchased technology and other intangibles was $2.5 million and $4.1 million, respectively. For the six months ended June 30, 2002 and 2001, our amortization charge for purchased technology and other intangibles was $5.4 million and $7.3 million, respectively. If we determine that these items are impaired, we will be required to take a related non-recurring charge to earnings.

We May Need To Use A Large Portion Of Our Cash Balances, Issue A Significant Amount Of Our Common Stock Or Incur Additional Indebtedness To Redeem Our Outstanding Debentures.

On February 13, 1998, we issued zero coupon debentures having an aggregate face amount at maturity of $885.5 million and generating net proceeds (after deducting fees and expenses) to us of approximately $337.6 million. The initial price for the debentures was $391.06 per $1,000 of principal amount at maturity. At the option of the holder, we must redeem the debentures as of February 13, 2003 at a repurchase price equal to the initial issue price plus the accretion of original issue discount on the debentures to such date (or $494.52 per $1,000 of principal amount at maturity). In the case of such a required redemption, at our option, we may pay the aggregate redemption price in cash, shares of our common stock or a combination of cash and common stock. The number of shares of common stock so issued by us would be based on the fair value of our common stock at the time of any required repurchase. On the same date and at the same repurchase price, we may at our option redeem the outstanding debentures for cash.

As of August 6, 2002, we had outstanding zero coupon debentures with an aggregate face amount of approximately $358.5 million. Assuming that as of February 13, 2003, these outstanding debentures are redeemed, the aggregate redemption price would equal approximately $177.2 million.

In anticipation of any repurchase or optional redemption of the debentures, we may issue additional indebtedness to pay all or a portion of the repurchase or redemption price. This indebtedness may be issued in a greater amount than, or on terms less favorable than, the outstanding debentures or notes.

We Face Risks Related To The Organization Of Our U.S. Professional Services Organization And Sales Efforts By Product Groups.

Our U.S. sales force and related professional service organization are organized by product group: McAfee Security, Sniffer Technologies and Magic Solutions. Risks related to this structure include:


	•	customer confusion or irritation related to multiple sales calls from different members of our sales forces;

	•	potential losses of cross-selling opportunities and lead sharing between the separate product groups’ sales representatives;

	•	possible failures by our centralized general and administrative group to meet each product group’s individualized infrastructure and support requirements; and

	•	one or more of our product groups lacking sufficient qualified professional services personnel to support its products.

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 the acquisition of CyberMedia and Dr. Solomon’s in 1998 and Network General in 1997. We have also completed a number of smaller acquisitions and we have acquired a number of our international distributors.

Integration of an acquired company or technology involves a complex, time consuming and expensive process. The successful integration of an acquisition requires, among other things, that we:


	•	integrate and retain key management, sales and other personnel;

	•	integrate the acquired products into our product offerings both from an engineering and sales and marketing perspective;

	•	integrate and support preexisting supplier, distribution and customer relationships;

	•	coordinate research and development efforts; and

	•	consolidate duplicate facilities and functions.

The geographic distance between the companies, the complexity of the technologies and operations being integrated, and the disparate corporate cultures being combined may increase the difficulties of integrating an acquired company or technology. Management’s focus on the integration of operations may distract attention from our day-to-day business and may disrupt key research and development, marketing or sales efforts. In addition, it is common in the technology industry for aggressive competitors to attract customers and recruit key employees away from companies during the integration phase of an acquisition.

Our available cash and securities may be used to buy or invest in companies or products, possibly resulting 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.

We have made a number of venture and minority investments in private and publicly-traded companies with complementary products, services and technologies. As of June 30, 2002, the minority venture investments we continue to hold totaled approximately $2.7 million consisting of investments in public and private companies, amounting to approximately $2.5 million and $0.2 million, respectively. During 2001, we recorded a $20.6 million impairment charge in connection with these investments. We may make additional strategic investments.

We Could Experience Customer And Market Confusion Due To Similarities In The Names Used By Our Different Product Groups And Subsidiaries.

Network Associates, our product groups and our subsidiaries, often have similar and potentially confusing names, products and Web addresses. For example, our online consumer anti-virus products are sold by our publicly-traded McAfee.com subsidiary, our retail and large corporate anti-virus products are sold by our retail division, which is called McAfee Retail, and our hosted anti-virus products are marketed and sold by our McAfee Security product group. Customers of our McAfee Security product group are frequently confused by the need to access information regarding our products and services at www.mcafeeb2b.com. The web address www.mcafee.com is utilized by our publicly traded subsidiary McAfee.com.

Customers of our ASP or hosted products and services essentially “rent” the use of our software. For example, McAfee Security ASaP offers hosted services to corporate customers and McAfee.com is dedicated to updating, upgrading and managing PCs over the Internet for consumers and small to medium-sized businesses. This web-based model is a relatively new concept, and our ASP products and services may fail to maintain or increase market acceptance. The growth, market acceptance and ultimate profitability of our ASP services is highly uncertain and subject to a number of factors, including:


	•	our ability to successfully adapt existing products or develop new or enhanced products that operate in a fast, secure and reliable manner over the Internet;

	•	increased expenditures associated with the creation of a new business or delivery platform, such as product development, marketing and technical and administrative support;

	•	the introduction of new products by third-party competitors; and

	•	our ability to properly price our products and services to generate the greatest revenue opportunities.

Our Managed Service Provider Strategy Exposes Us To Risks In Addition To Those Generally Experienced As An ASP.

We also make our hosted products and services available over the Internet in what we refer to as a managed environment. Unlike our ASP solutions, these managed service provider, or MSP, solutions are customized, monitored and updated by networking professionals for a specific customer. To successfully offer MSP services we must:


	•	effectively monitor and customize each customer’s managed services;

	•	attract and retain qualified networking professionals to manage customer accounts; and

	•	effectively price our products and services to account for the higher costs associated with selling managed services.

We also allow intermediaries, such as Internet Service Providers, to sell and host our products and services in a managed environment. This MSP reseller strategy exposes us to additional risks:


	•	we must select, train and maintain qualified and financially stable MSP resellers;

	•	it is more difficult for us to ensure customer satisfaction as we do not have direct customer contact and we rely on our resellers to timely and properly customize and administer our products and services;

	•	we must develop and maintain mutually satisfactory revenue sharing arrangements with our MSP resellers; and

	•	our MSP resellers may compete with our own MSP efforts.

We have entered into various inter-company arrangements with McAfee.com, our publicly traded subsidiary. 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. Our license and other agreements with McAfee.com expose us to risks, including:


	•	subject to the reseller agreement described below, 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 may not offer a product incorporating third-party technology if those products are competitive with products offered by McAfee.com;

	•	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; and

	•	we are required to indemnify McAfee.com with respect to litigation related to our licensed technology.

These risk manifest themselves, among other ways, in terms of customer confusion, sales force confusion over market boundaries and possible conflicts between the companies.

In March 2001, we entered into reseller agreements with McAfee.com. Under these agreements, McAfee.com may resell our products to business customers, except in Japan, and, in certain countries, we may sell McAfee.com products to OEMs and end-users directly or through ASPs.

We Face Risks Related to Our Strategic Alliances, including Our Recently Announced Alliance With ISS.

We may not realize the desired benefits from our strategic alliances on a timely basis or at all. We face a number of risk relating to our strategic alliances including:


	•	Our strategic alliances are generally terminable by either party with no or minimal notice or penalties. We may expend significant time, money and resources to further strategic alliances that are terminated.

	•	Business interests may diverge over time, which might result in conflict or termination.

	•	Strategic alliances require significant coordination between the parties involved. To be successful, our alliances may require the integration of other companies’ products with our products, which may involve significant time and expenditure by our technical staff and the technical staff of our strategic allies.

	•	Our sales and marketing force may require additional training to market products that result from our strategic alliances. The marketing of these products may require additional sales force efforts and may be more complex than the marketing of our own products.

	•	The integration of products from different companies may be more difficult than we anticipate, the risk of integration difficulties, incompatible products and undetected programming errors or bugs may be higher than that normally associated with new products.

	•	Due to the complex nature of our products and of those parties with whom we have strategic alliances, it may take longer then we anticipate to successfully integrate and market our respective products and we may not realize the anticipated benefits from our strategic alliances.

We Are Subject To Intense Competition In The Network Management And Security Markets And We Expect To Face Increased Competition In The Future.

The markets for our products are intensely competitive and we expect competition to increase in the near-term. 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.

Our principal competitor in the anti-virus market is the Norton Product Group of Symantec. Trend Micro remains the strongest competitor in the Asian anti-virus market, with Dr. Ahn’s making recent inroads, particularly in Japan and Korea. Other anti-virus competitors include numerous smaller companies and

Our principal competitors in the security market vary by product type. For firewalls, our principal competitors include CheckPoint, Symantec, and larger companies such as Cisco Systems and Microsoft. For intrusion detection products, we compete with Cisco Systems, Internet Security Systems and Symantec. The markets for encryption and virtual private network, or VPN, products are highly fragmented with numerous small and large vendors. 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 Acterna Corporation, Cisco Systems, Computer Associates, Compuware, Concord Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom Technologies, Shomiti Systems and WildPackets.

Our principal competitors in the help desk market are Computer Associates, FrontRange Solutions and Peregrine Systems.

We also face competition from large software companies such as HP, Intel, Microsoft and Novell, which may offer network security and management products as enhancements to their operating system.

We Face Product Development Risks Associated With Rapid Technological Changes In Our Market.

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 depends on our ability to timely and effectively:


	•	offer a broad range of network security and management software products;

	•	enhance existing products and expand product offerings;

	•	respond promptly to new customer requirements and industry standards; and

	•	remain compatible with popular operating systems such as Linux, NetWare, Windows XP, Windows 2000, Windows 98 and Windows NT, and develop products that are compatible with new or otherwise emerging operating systems.

We may 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 harm market acceptance.

Our long-term success depends on our ability to keep our products current. For example, the proliferation of new and changing viruses makes it imperative to update anti-virus products frequently to avoid obsolescence. Accordingly, we must upgrade and update existing product offerings, modify and enhance acquired products and introduce new products which meet our customers’ needs. We believe that our ability to provide these upgrades and updates frequently and at low costs is key to our anti-virus success.

Competitors May Include Products Similar To Ours In Their Hardware Or Software And Render Our Products Obsolete, And If There Are Fewer Weaknesses In Third-Party Software, The Perceived Need For Our Software May Decline.

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. From time to time, Microsoft has indicated that it would incorporate its own anti-virus software or functionality into its products. The widespread inclusion of products that perform the same or similar functions 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.

Many current viruses exploit known weaknesses in third-party software. If these weaknesses are corrected or, if there are fewer third-party software weaknesses, the perceived need for our products may decline.

Our Hardware Based Products Face Manufacturing, Supply, Inventory, Licensing And Obsolescence Risks.

We rely on a small number of third parties to manufacture some of our hardware-based Sniffer Technologies and E-ppliance products. We expect the number of our hardware-based products and our reliance on third-party manufacturers to increase as software-only network security and management solutions become less viable. 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. If any of our third party manufacturers cannot or will not 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 this additional capacity is available at commercially acceptable terms, the qualification process could be lengthy and could cause interruptions in product shipments. The unexpected loss of any of our manufacturers would be disruptive to our business.

Our hardware-based products contain critical components supplied by a single or a limited number of third parties. Any significant shortage of 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. We must be able to obtain reasonably priced licenses and successfully integrate this software with our hardware.

Hardware based products may face greater obsolescence risks than software products. We could incur losses or other charges in disposing of obsolete inventory.

Although we intend to support other operating systems, we seek to be the leading supplier of network security and management products for Windows/ 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. In addition, our ability to develop products using the Windows operating environments is dependent on our ability to gain

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 operating systems 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 Microsystems’ Solaris Unix operating system.

We Rely Heavily On Our Intellectual Property Rights Which Offer Only Limited Protection Against Potential Infringers.

We rely on a combination of contractual rights, trademarks, trade secrets, patents and copyrights to establish and protect proprietary rights in our software. However, the steps taken by us to protect our proprietary software may not deter its misuse or theft. We are aware that a substantial number of users of our anti-virus products have not paid any registration or license fees to us. Competitors may also independently develop technologies or products that are substantially equivalent or superior to our products. 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 also harm our business.

Intellectual Property Litigation In The Network Security And Management Market Is Common and Can Be Expensive.

Litigation may be necessary to enforce and protect trade secrets and other intellectual property rights that we own. Similarly, we may be required to defend against claimed infringement by others.

In addition to the expense and distractions associated with litigation, adverse determinations could:


	•	result in the loss of our proprietary rights;

	•	subject us to significant liabilities, including monetary 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. 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.

If we acquire a portion of software included in our products from third parties, our exposure to infringement actions may increase because we must rely upon these third parties as to the origin and ownership of any software being acquired. Similarly, exposure to infringement claims increases if we employ or hire software engineers previously employed by competitors, notwithstanding measures taken by us or our competitors to protect our competitors’ intellectual property.

Pending Or Future Litigation Could Have A Material Adverse Impact On Our Results Of Operation And Financial Condition.

In addition to intellectual property litigation, from time to time, we have been subject to litigation. Where we can make a reasonable estimate of the liability relating to pending litigation, we record a related liability. As additional information becomes available, we assess the potential liability and revise estimates as appropriate. However, because of uncertainties relating to litigation, the amount of our estimates could be wrong. In addition to the related cost and use of cash, pending or future litigation could cause the diversion of

management’s attention and resources. A putative securities class action is currently pending against us, our directors and our former officers. The plaintiffs allege that we and the other defendants improperly engaged in a course of conduct by which we improperly accounted for revenue from our software license sales and that, as a result, certain of our financial statements were false and misleading and not in compliance with generally accepted accounting principles. The plaintiffs in this action have announced that they intend to file an amended complaint for federal securities claims related to accounting inaccuracies we announced.

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 may not be effective under the laws of certain jurisdictions, particularly in circumstances involving unsigned licenses.

Due to 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 and services, including our various websites. For example, we have recently seen the spread of viruses, or worms, that intentionally delete antivirus and firewall software. Similarly, hackers may attempt to penetrate our network security and misappropriate proprietary information or cause interruptions of our internal systems and services. Also, a number of websites have been subject to denial of service attacks, where a website is bombarded with information requests eventually causing the website to overload, which causes a delay or disruption of service. If successful, any of these events could damage users’ or our computer systems. In addition, since we do not control diskette duplication by distributors or our independent agents, diskettes containing our software may be infected with viruses.

False Detection Of Viruses And Actual Or Perceived Security Breaches Could Adversely Affect Our Business.

Our anti-virus software products have in the past and may at times in the future falsely detect viruses that do not actually exist. These false alarms, while typical in the industry, may impair the perceived reliability of our products and may therefore adversely impact market acceptance of our products. In addition, we have in the past been subject to litigation claiming damages related to a false alarm, and similar claims may be made in the future. 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.

Business Interruptions May Impede Our Operations And Adversely Affect Our Business.

We face a number of potential business interruption risks that are beyond our control. The State of California has experienced intermittent power shortages, sharp increases in the cost of energy and even interruptions of service to some business customers.

Additionally, we may experience natural disasters that could interrupt our business. Our corporate headquarters is located near a major earthquake fault. The potential impact of a major earthquake on our facilities, infrastructure and overall operations is not known. Despite safety precautions that have been implemented, 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 and other natural disasters.

We are currently engaged in several research and development contracts with agencies of the U.S. government. The willingness of these government agencies to enter into future contracts with us depends in part on 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 government 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.

Some of our network security products, particularly those incorporating encryption, may be subject to export restrictions. As a result, some products may not be exported to international customers without prior U.S. government approval. 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.

During the three months ended June 30, 2002, our stock price was highly volatile ranging from a per-share high of $25.81 to a low of $16.293 and during the year ended December 31, 2001 our stock price ranged from a per-share high of $27.27 to a low of $4.19. On August 8, 2002, our stock closed a per share price of $11.17. Announcements, business developments, such as our proposed acquisition of McAfee.com, litigation developments, and our ability to meet the expectations of 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. Securities class action litigation has been instituted following previous periods of volatility. A number of putative class actions were brought against our former officers, directors and us. This litigation, and any other litigation, could result in substantial costs and a diversion of management’s attention and resources.

Future Sales Of Our Common Stock In The Public Market Or Option Exercises And Sales Could Lower Our Stock Price.

A substantial number of the shares of our common stock are subject to stock options and our outstanding convertible debentures and notes may be converted into shares of common stock. We cannot predict the effect, if any, that future sales of shares of common stock, or the availability of shares of common stock for future sale, will have on the market price of our common stock. Sales of substantial amounts of common stock, including shares issued upon the exercise of stock options or the conversion of our outstanding convertible notes or debentures, or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock.

Our Charter Documents, Delaware Law, Our Rights Plan And Our Stockholder Agreement with McAfee.com May Impede Or Discourage A Takeover, Which Could Lower Our Stock Price.

Pursuant to our charter, 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 or action by our stockholders. The issuance of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock.

Our classified board and other provisions of Delaware law and our certificate of incorporation and bylaws, could also delay or make a merger, tender offer or proxy contest involving us more difficult.

Our board of directors has adopted a shareholders rights plan. The rights will become exercisable 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 rights’ exercise price, shares of our common stock or shares of any company in which we are merged, with a value equal to twice the rights’ exercise price.

Under our McAfee.com stockholders 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 our serving directors, then for so long but only for so long as that condition exists:


	•	our shares of McAfee.com Class B common stock will be entitled to only one vote per share instead of three votes per share; and

	•	we will be obligated to vote our McAfee.com shares to cause, and to take such actions reasonably within our control to cause, and shall seek to cause the McAfee.com directors appointed by us to cause, the McAfee.com board of directors to consist of at least a majority of independent directors.

Our continuing directors consist of our current directors and any subsequent directors approved or not objected to by a majority of our then-continuing directors.

Information with respect to this item is incorporated by reference to Note 10 of the Notes to the Condensed Consolidated Financial Statements included herein on page 14 of this Report on Form 10-Q.

2. The approval of an amendment to the Company’s 1997 Stock Incentive Plan, to increase the number of shares of the Company’s Common Stock reserved for issuance thereunder by 5,000,000 shares:

3. The approval of the adoption of the Company’s 2002 Employee Stock Purchase Plan:

4. The ratification of the appointment of PricewaterhouseCoopers LLP as the independent accountants of the Company for the fiscal year ending December 31, 2002:

The Company has revised its Insider Trading Policy to allow directors, officers and other employees covered under the policy to establish, under limited circumstances contemplated by Rule 10b5-1 under the Securities Exchange Act of 1934, written programs that permit automatic trading of the Company’s stock or trading of the Company’s stock by an independent person (such as an investment bank) who is not aware of material inside information at the time of the trade. As of June 30, 2002, George Samenuk, the Company’s Chairman and Chief Executive Officer, Stephen C. Richards, the Company’s Chief Operating Officer and Chief Financial Officer, Vernon Gene Hodges, the Company’s President, Kent H. Roberts, the Company’s Executive Vice President and General Counsel, and Bakulesh Mehta, the President of the Company’s Sniffer Technologies product group adopted Rule 10b5-1 trading plans. The Company believes that additional directors, officers and employees may establish such programs. In the quarter ended June 30, 2002, all trades

(a) Exhibits. The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Report.

Form 8-K. On April 25, 2002, the Company filed a report on Form 8-K announcing that the audit committee of its board of directors was conducting an investigation of accounting inaccuracies and that it plans to restate certain financial statements. The Company also announced that it planned to withdraw its exchange offer commenced on March 29, 2002 relating to the outstanding shares of Class A common stock of McAfee.com. On May 17, 2002, the Company filed a report on Form 8-K announcing that the audit committee of its board of directors completed its internal accounting investigation. As a result of the investigation, the Company announced that it would restate certain prior financial statements.

Pursuant to the requirements of the Securities Exchange Act of 1934, and the results and regulations promulgated thereunder, the registrant has duly caused this amended report to be signed on its behalf by the undersigned thereunto duly authorized.


	NETWORKS ASSOCIATES, INC.

	/s/ STEPHEN C. RICHARDS

	Name: Stephen C. Richards


	Title:	Chief Operating Officer and


	Chief Financial Officer


(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 Registrant’s 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 11, 1998.

(5)	Incorporated by reference from the Registrant’s Report on Form 8-K filed with the Commission on December 11, 1997.


(6)	Incorporated by reference from the Registrant’s Registration Statement on Form S-4 filed with the Commission on March 25, 1998.

(7)	Incorporated by reference from the Registrant’s Report on Form 8-K filed with the Commission on April 2, 1998.

(8)	Incorporated by reference from the Registrant’s Registration Statement on Form S-3 filed with the Commission on May 26, 1998.

(9)	Incorporated by reference from the Registrant’s Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Commission on November 4, 1996.


(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-8 filed with the Commission on July 21, 2000.

(12)	Incorporated by reference from the Registrant’s Report on Form 10-Q for the quarter ended March 31, 1997 filed with the Commission on May 15, 1997.

(13)	Incorporated by reference from the Registrant’s Registration Statement filed on Form S-8 filed with the Commission on December 2, 1997.

(14)	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.

(15)	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.

(16)	Incorporated by reference from the Registrant’s Report on Form 8-K filed with the Commission on June 16, 1998.

(17)	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.

(18)	Incorporated by reference from the Registrant’s Report on Form 8-A filed with the Commission on October 22, 1998.

(19)	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.

(20)	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.

(21)	Incorporated by reference from the Registrant’s report on Form 10-K for the year ended December 31, 2000, filed with the Commission on April 2, 2001.

(22)	Incorporated by reference from the Registrant’s report on Form 10-Q for the quarter ended March 31, 2001, filed with the Commission on May 15, 2001.

(23)	Incorporated by reference from the Registrant’s report on Form 10-Q for the quarter ended June 30, 2001 filed with the Commission on August 6, 2001.

(24)	Incorporated by reference from the Registrant’s Registration Statement on Form S-3 filed with the Commission on November 9, 2001.

(25)	Incorporated by reference from the Registrant’s report on Form 10-Q for the quarter ended September 30, 2001, filed with the Commission on November 13, 2001.

(26)	Incorporated by reference from the Registrant’s report on Form 10-K for the year ended December 31, 2001, filed with the Commission on February 8, 2002.


*	Management contracts or compensatory plans or arrangements covering executive officers or directors of Networks Associates, Inc.


Delaware		77-0316593
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
3965 Freedom Circle		95054
Santa Clara, California		(Zip Code)
(Address of principal executive offices)


CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosure about Market Risk
PART II: OTHER INFORMATION
	Item 1. Legal Proceedings:
	Item 2. Changes in Securities:
	Item 3. Defaults in Securities:
	Item 4. Submission of Matters to a Vote of Security Holders:
	Item 5. Other Information:
	Item 6. Exhibits and Reports on Form 8-K:
SIGNATURES
EXHIBIT INDEX
EXHIBIT 12.1
EXHIBIT 99.1


Item Number		Page

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets: June 30, 2002 and December 31, 2001 (As restated)	2
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss):
	Three and six months ended June 30, 2002 and 2001	3
	Condensed Consolidated Statements of Cash Flows: Six months ended June 30, 2002 and 2001	4
	Notes to Condensed Consolidated Financial Statements	5

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19

Item 3. Quantitative and Qualitative Disclosures about Market Risk		34

PART II: OTHER INFORMATION

Item 1. Legal Proceedings		48

Item 2. Changes in Securities		48

Item 3. Defaults in Securities		48

Item 4. Submission of Matters to a Vote of Security Holders		48

Item 5. Other Information		48

Item 6. Exhibits and Reports on Form 8-K		49

SIGNATURES		50
EXHIBIT INDEX		51


			June 30,			December 31,
			2002			2001

						(As Restated
						See Note 2)

			(In thousands, except share
			and per share data)
			(Unadited)
ASSETS
Current assets:
	Cash and cash equivalents		$	733,409		$	612,832
	Short-term marketable securities			194,970			135,761
	Accounts receivable, net			101,521			136,366
	Prepaid expenses, income taxes and other current assets			53,796			54,959
	Deferred taxes			120,280			142,869

		Total current assets		1,203,976			1,082,787
Long-term marketable securities				174,424			194,357
Fixed assets, net				65,961			64,040
Land				4,414			4,414
Deferred taxes				101,743			84,399
Intangible assets, excluding goodwill, net				23,551			28,124
Goodwill, net				157,398			156,930
Other assets				18,291			18,853

		Total assets	$	1,749,758		$	1,633,904

LIABILITIES
Current liabilities:
	Accounts payable		$	18,797		$	26,368
	Accrued liabilities			292,756			293,583
	Deferred revenue			244,554			250,048
	Current portion of convertible debt			___220,273			—

		Total current liabilities		776,380			569,999
Deferred taxes				16,933			20,445
Deferred revenue, less current portion				32,089			24,312
Convertible debt, less current portion				345,000			578,850
Other long term debt and liabilities				420			393

		Total liabilities		1,170,822			1,193,999

Contingencies (Note 10)
Minority interest				21,424			17,311
STOCKHOLDERS’ EQUITY
Preferred stock, $0.01 par value:
	Authorized: 5,000,000 shares; Issued and outstanding: none at June 30, 2002 and December 31, 2001.			—			—
Common stock, $0.01 par value:
	Authorized: 300,000,000 shares; Issued and Outstanding: 147,724,216 shares at June 30, 2002 and 140,699,222 shares at December 31, 2001.			1,477			1,406
Additional paid-in capital				834,786			742,315
Accumulated other comprehensive loss				(24,922	)		(30,345	)
Accumulated deficit				(253,829	)		(290,782	)

		Total stockholders’ equity		557,512			422,594

		Total liabilities, minority interest and stockholders’ equity	$	1,749,758		$	1,633,904



			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2002			2001			2002			2001


			(in thousands, except per share data)
			(Unaudited)
Net revenue:
	Product		$	149,601		$	132,368		$	288,851		$	224,869
	Services and support			83,358			60,449			164,820			123,840

		Total net revenue		232,959			192,817			453,671			348,709

Cost of net revenue:
	Product			24,934			25,421			50,223			48,881
	Services and support			14,851			14,488			30,198			28,011

		Total cost of net revenue		39,785			39,909			80,421			76,892

Operating costs and expenses:
	Research and development(1)			33,452			34,886			68,057			74,859
	Marketing and sales(2)			106,726			102,427			209,200			203,244
	General and administrative(3)			25,053			24,446			50,469			55,854
	Provision for (recovery from) doubtful accounts			(1,087	)		2,437			(357	)		(6,832	)
	Amortization of intangibles			2,515			16,672			5,367			32,517
	Restructuring charge			—			—			1,116			—

		Total operating costs and expenses		166,659			180,868			333,852			359,642

		Income (loss) from operations		26,515			(27,960	)		39,398			(87,825	)
Interest and other income				7,637			7,903			14,299			18,945
Interest expense				(7,899	)		(4,735	)		(15,589	)		(9,415	)
Gain on sale of assets and technology				—			—			6,717			—
Write-down of strategic and other investments				—			(13,138	)		—			(18,138	)

	Income (loss) before provision for income tax, minority interest and extraordinary item			26,253			(37,930	)		44,825			(96,433	)
Provision for (benefit from) income taxes				3,242			(732	)		4,645			(11,172	)

	Income (loss) before minority interest and extraordinary item			23,011			(37,198	)		40,180			(85,261	)
Minority interest in loss (income) of consolidated subsidiaries				(1,779	)		19			(3,196	)		721

	Income (loss) before extraordinary item			21,232			(37,179	)		36,984			(84,540	)
Extraordinary item — loss on repurchase of debt, net of taxes				(31	)		—			(31	)		—

	Net income (loss)		$	21,201		$	(37,179	)	$	36,953		$	(84,540	)

Other comprehensive income (loss):
	Unrealized gain (loss) on investments, net			175			8,308			(2,352	)		295
	Foreign currency translation gain			8,947			397			7,775			81

Comprehensive income (loss)			$	30,323		$	(28,474	)	$	42,376		$	(84,164	)

Basic net income (loss) per share:
Income (loss) before extraordinary item			$	0.14		$	(0.27	)	$	0.25		$	(0.62	)
Extraordinary item — loss on repurchase of debt, net of taxes				—			—			—			—

Net income (loss)			$	0.14		$	(0.27	)	$	0.25		$	(0.62	)

Shares used in per share calculation — basic				147,222			136,879			145,829			137,010

Diluted net income (loss) per share:
Income (loss) before extraordinary item			$	0.14		$	(0.27	)	$	0.24		$	(0.62	)
Extraordinary item — loss on repurchase of debt, net of taxes				—			—			—			—

Net income (loss)			$	0.14		$	(0.27	)	$	0.24		$	(0.62	)

Shares used in per share calculation — diluted				154,747			136,879			154,791			137,010


				Severance
	Other Costs			and Benefits			Total

Balance, February 2002	$	190		$	926		$	1,116
Paid out		(190	)		(926	)		(1,116	)

Balance, June 30, 2002	$	—		$	—		$	—


			Goodwill				Effects of Foreign
	January 1, 2002		Acquired		Adjustments		Currency Exchange		June 30, 2002

United States	$	73,549	$	—	$	—	$	—	$	73,549
Europe	$	36,320	$	—	$	—	$	127	$	36,447
Japan	$	13,640	$	—	$	—	$	—	$	13,640
Canada	$	5,287	$	—	$	—	$	—	$	5,287
Asia-Pacific (excluding Japan)	$	3,439	$	—	$	—	$	—	$	3,439
Latin America	$	3,005	$	—	$	—	$	—	$	3,005

Infrastructure	$	135,240	$	—	$	—	$	127	$	135,367
McAfee.com	$	21,690	$	—	$	—	$	341	$	22,031

Total	$	156,930	$	—	$	—	$	468	$	157,398


				June 30, 2002
				Accumulated							December 31, 2001
				Amortization							Accumulated
				(Including effects							Amortization
		Gross		of foreign			Net		Gross		(Including effects			Net
		Carrying		currency			Carrying		Carrying		of foreign			Carrying
		Amount		exchange)			Amount		Amount		currency exchange)			Amount

Other Intangible assets:
	Purchased technologies	$	45,917	$	(42,432	)	$	3,485	$	43,954	$	(40,050	)	$	3,904
	Trademarks, patents and other intangibles		48,351		(28,285	)		20,066		48,351		(24,131	)		24,220

		$	94,268	$	(70,717	)	$	23,551	$	92,305	$	(64,181	)	$	28,124


Fiscal Years:
Remainder of 2002	$	5,213
2003		7,272
2004		5,303
2005		3,812
2006		1,745
Thereafter		206

	$	23,551


			June 30, 2002			December 31, 2001

Zero Coupon Convertible Subordinated Debentures due 2018
	Face Value		$	458,500		$	498,500
	Unamortized Discount			(238,227	)		(264,650	)

	Carrying Value			220,273			233,850

5.25% Convertible Subordinated Notes due 2006
	Face Value			345,000			345,000
	Unamortized Discount			—			—

	Carrying Value			345,000			345,000

		Total convertible debt	$	565,273		$	578,850


			5.25%
	Zero Coupon		Convertible
	Convertible		Subordinated
	Debentures		Notes due
	due 2018(1)		2006(2)		Total

2002	$	—	$	—	$	—
2003		226,689		—		226,689
2004		—		—		—
2005		—		—		—
2006		—		345,000		345,000
2007 and thereafter		—		—		—

	$	226,689	$	345,000	$	571,689



			Three Months						Six Months
			Ended						Ended
			June 30,						June 30,

			2002			2001			2002			2001

Net revenue:
	Product			64	%		69	%		64	%		64	%
	Services and support			36			31			36			36

		Total net revenue		100			100			100			100
Cost of net revenue:
	Product			11			13			11			14
	Services and support			7			7			7			8

		Total cost of net revenue		17			20			18			22
Operating costs and expenses:
	Research and development			14			18			15			22
	Marketing and sales			46			53			46			58
	General and administrative			11			13			11			16
	Provision for (recovery from) doubtful accounts			—			1			—			(2	)
	Amortization of intangibles			1			9			1			9
	Restructuring charge			—			—			—			—

		Total operating costs and expenses		72			94			73			103

		Income (loss) from operations		11			(14	)		9			(25	)
Interest and other income				3			4			3			6
Interest expense				(3	)		(2	)		(3	)		(3	)
Gain on sale of assets and technology				—			—			1			—
Write down of strategic and other investments				—			(7	)		—			(5	)

		Income (loss) before provision for income taxes, minority interest and extraordinary item		11			(19	)		10			(27	)

Provision for (benefit from) income taxes				1			—			1			(3	)

		Income (loss) before minority interest and extraordinary item		10			(19	)		9			(24	)

Minority interest in loss (income) of consolidated subsidiaries				(1	)		—			(1	)		—

		Income (loss) before extraordinary item		9			(19	)		8			(24	)

Extraordinary item — loss on repurchase of debt, net of taxes				—			—			—			—

		Net income (loss)		9	%		(19	)%		8	%		(24	)%


*	This statement and other statements similarly marked are forward-looking statements reflecting current expectations. There can be no assurance that our actual performance will meet current expectations. See “Risk Factors” discussion beginning on page 34 of this document.


Shares in Favor			70,729,716
Shares Against			56,350,374
Shares Abstained			204,496


Shares in Favor			123,592,657
Shares Against			3,548,617
Shares Abstained			143,312


þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)


o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)



				Three Months Ended						Six Months Ended
				June 30,						June 30,

				2002			2001			2002			2001

Net revenue by segment:
	United States			$	124,957		$	107,062		$	226,918		$	196,247
	Europe				60,441			53,055			127,902			86,560
	Japan				9,053			1,179			20,765			6,314
	Canada				5,544			6,024			16,415			12,206
	Asia-Pacific (excluding Japan)				7,147			6,744			13,722			11,315
	Latin America				5,120			4,344			8,488			8,842

		Infrastructure net revenue			212,262			178,408			414,210			321,484
		McAfee.com net revenue			20,697			14,409			39,461			27,225

			Net revenue	$	232,959		$	192,817		$	453,671		$	348,709

Income (loss) from operations by segment:
	United States			$	26,787		$	3,306		$	37,225		$	(522	)
	Europe				20,212			18,650			47,786			18,978
	Japan				1,410			(6,393	)		4,683			(10,308	)
	Canada				1,221			1,936			6,671			2,746
	Asia-Pacific (excluding Japan)				(817	)		1,125			(979	)		557
	Latin America				857			766			717			1,856
	Corporate				(29,355	)		(46,711	)		(68,133	)		(97,775	)

		Infrastructure operating income (loss)			20,315			(27,321	)		27,970			(84,468	)
		McAfee.com operating income (loss)			6,200			(639	)		11,428			(3,357	)

			Income (loss) from operations	$	26,515		$	(27,960	)	$	39,398		$	(87,825	)



		Three Months Ended				Six Months Ended
		June 30,				June 30,

		2002		2001		2002		2001

Software licenses		$	114,751	$	86,004	$	225,889	$	132,246
Maintenance			57,505		35,733		114,423		77,846
Hardware			21,618		21,344		38,637		53,106
Retail			8,179		22,977		16,966		35,731
Consulting			9,872		9,820		18,944		18,176
Training			3,221		4,386		6,929		8,958
Hosting arrangements			12,760		10,510		24,524		18,860
Other			5,053		2,043		7,359		3,786

	Total	$	232,959	$	192,817	$	453,671	$	348,709


Shares in Favor			122,442,057
Shares Against			4,758,446
Shares Abstained			84,083


Exhibit
Number		Description

	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, 1997 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 and 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 dated March 2, 1998. 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 10, 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.(16)
	2.12	Agreement and Plan of Merger, dated July 28, 1998, by and between the Registrant and CyberMedia, Inc.(17)
	3.1	Second Restated Certificate of Incorporation of the Registrant, as amended on December 1, 1997.(6)
	3.2	Restated Bylaws of the Registrant.(23)
	3.3	Certificate of Designation of Series A Preferred Stock of the Registrant.(9)
	3.4	Certificate of Designation of Series B Participating Preferred Stock of the Registrant.(18)
	4.1	Indenture dated as of February 13, 1998 between the Registrant and State Street Bank and Trust Company of California, N.A., as Trustee.(10)
	4.2	Resale Registration Rights Agreement, dated as of August 17, 2001, by and between the Registrant and Lehman Brothers, Inc.(24)
	4.3	Indenture dated as of August 17, 2001 between the Registrant and State Street Bank and Trust Company of California.(24)
	10.1	Lease Assignment dated November 17, 1997 for facility at 3965 Freedom Circle, Santa Clara, California by and between Informix Corporation and McAfee Associates, Inc.(4)
	10.2	Consent to Assignment Agreement dated December 19, 1997 by and among Birk S. McCandless, LLC, Guaranty Federal Bank, F.S.B., Informix Corporation and the Registrant.(4)
	10.3	Subordination, Nondisturbance and Attornment Agreement dated December 18, 1997, between Guaranty Federal Bank, F.S.B., the Registrant and Birk S. McCandless, LLC.(4)