Back to GetFilings.com
1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
------------------------
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED 31 DECEMBER 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
--------------- TO
---------------
COMMISSION FILE NUMBER 0-20558
NETWORKS ASSOCIATES, INC.
(FORMERLY MCAFEE ASSOCIATES, INC.)
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0316593
(STATE OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
2805 BOWERS AVENUE
SANTA CLARA, CALIFORNIA 95051-0963
(408) 988-3832
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.01
par value
Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the issuer as of December 31, 1997 was approximately $3.6 billion. The number of
shares outstanding of the issuer's common stock as of December 31, 1997 was
69,920,883.
Documents incorporated by reference: Items 10, 11, 12, and 13 of Part III
are incorporated by reference from the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held May 13, 1998.
This report contains 61 pages. The Exhibit Index is on page 58.
================================================================================
2
PART I
ITEM 1. BUSINESS
GENERAL
This Annual Report on Form 10-K contains forward-looking statements that
involve risks and uncertainties. The statements contained herein that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act, including without
limitation statements regarding the Company's expectations, beliefs, intentions
or strategies regarding the future. All forward-looking statements included in
this document or incorporated by reference herein are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. The Company's actual
results could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including those set forth in "-- Risk
Factors" and elsewhere herein.
Networks Associates, Inc. (the "Company") was formed in December 1997 as a
result of the strategic business combination of McAfee Associates, Inc.
("McAfee") and Network General Corporation ("Network General"). Pursuant to this
strategic combination, Network General merged with a wholly owned subsidiary of
McAfee, and McAfee changed its legal name. In mid-December 1997, the Company
acquired Pretty Good Privacy, Inc. ("PGP"), a provider of applied cryptographic
solutions for securing corporate digital assets and protecting privacy.
OVERVIEW
The Company is a leading developer and provider of network security and
management software products. The Company has historically derived a significant
majority of its revenues from the licensing of its flagship McAfee anti-virus
products and Sniffer network fault and performance management products. The
Company is currently focusing its efforts on broadening its revenue base by
providing network security and management solutions to enterprise customers,
targeting in particular the Windows NT/Intel platform. In furtherance of this
strategy, the Company recently organized its products into four product
suites -- McAfee Total Virus Defense and PGP Total Network Security (together
comprising "Net Tools Secure") and Sniffer Total Network Visibility and McAfee
Total Service Desk (together comprising "Net Tools Manager"). These four product
suites together form an integrated solution called "Net Tools".
Many of the Company's network security and management products, including
its industry-leading network security products for anti-virus protection and
Sniffer software-based fault and performance solutions for managing computer
networks, are also available as stand-alone products or as part of smaller
product suites. The Company is also a leader in electronic software
distribution, which is the principal means by which it markets its products and
one of the principal ways it distributes its software products to its customers.
The Company generally utilizes a two-year subscription model for licensing its
non-Sniffer products to corporate clients and is in the process of developing a
two-year subscription model for licensing its Sniffer products as well.
The following table depicts the Company's product suites:
- --------------------------------------------------------------------------------
NET TOOLS
- ------------------------------------------------------------------------------------------------------------
NET TOOLS SECURE NET TOOLS MANAGER
- ------------------------------------------------------------------------------------------------------------
McAfee Total Virus PGP Total Network Sniffer Total Network McAfee Total Service
Defense Security Visibility Desk
- ------------------------------------------------------------------------------------------------------------
- Virus Scan Security - PGP Desktop Suite - Sniffer Portable Analysis - McAfee Help Desk Suite
Suite - PGP Server Suite Suite - Zero Administration
- Net Shield Security - CyberCop - Sniffer Distributed Client Suite
Suite Analysis Suite - Self Service Desk Suite
- Internet Security Suite - Sniffer Service Desk
Suite
- --------------------------------------------------------------------------------
1
3
NET TOOLS
Net Tools is being designed as an integrated solution to protect the
enterprise from network security threats and to reduce the cost of managing an
enterprise network. While supporting other operating systems, Net Tools is being
optimized for Microsoft Windows NT technology ("NT"), employing an Explorer
Interface, Distributed OLE, ActiveX and the DCOM object model. Net Tools is
being designed to leverage NT to bridge the gap between the disparate network
management universes of NetWare and Unix servers. In addition, Net Tools is
being engineered to employ a common graphical user interface ("GUI"), together
with common reporting, alerting and scripting functionalities. The Company is
currently developing its pricing model for the licensing of its Net Tools suite
of products. Among other things, the Company is currently developing a
centralized console for its Net Tools product suite; developing its pricing
model for the Net Tools product suite; and integrating various recently acquired
products (including certain PGP encryption products) into smaller suites sold
under the Net Tools umbrella.
NET TOOLS SECURE: MCAFEE TOTAL VIRUS DEFENSE AND PGP TOTAL NETWORK SECURITY
The Net Tools Secure product suite is comprised of McAfee Total Virus
Defense and PGP Total Network Security. The current U.S. list price for a 1,000
node Net Tools Secure license is $79 per node. A number of the products
incorporated in the Net Tools Secure product suite may be purchased as
stand-alone products or as part of smaller product suites.
McAfee Total Virus Defense. McAfee Total Virus Defense ("McAfee TVD") is
designed to provide a single integrated defense against computer viruses at the
desktop, server and Internet gateway. McAfee TVD is comprised of three security
product suites: VirusScan Security Suite (providing multi-platform protection
for desktop clients); NetShield Security Suite (protects file, application and
groupware servers); and Internet Security Suite (locks out viruses and hostile
applets at the Internet gateway). The current U.S. list price for a 1,000 node
McAfee Total Virus Defense license is $34 per node.
VirusScan Security Suite. VirusScan, one of the Company's flagship
products, is a virus protection program for Windows 3.X, Windows 95, Windows NT,
Macintosh, DOS and OS/2 personal computers ("PCs"). VirusScan scans for known
viruses upon installation. When installation is completed, VirusScan becomes
memory resident and protects systems from further infection. VirusScan is
designed to detect and remove even the most sophisticated categories of known PC
viruses. Corporate users now purchase VirusScan almost exclusively as part of
the VirusScan Security Suite ("VSS"). VSS also includes: (i) WebScanX which
protects against virus infected Internet downloads and e-mails, as well as
emerging hostile Java and Active-X applets; (ii) PCMedic which automatically
diagnoses and corrects PC system problems, as well as prevents errors and
crashes which damage data; and (iii) QuickBackUp which provides fast and easy
retrieval of automatically backed up data files. The NetTools Distribution
Console and Enterprise SecureCast are also included to provide automated remote
installation, updating, and management of the VSS components. The current list
price for a 1,000 user VSS site license is $25 per node. The single user retail
version of VirusScan sells at an average retail price of approximately $29.95.
NetShield Security Suite. NetShield Security Suite ("NSS") provides virus
protection for network file servers running NT, NetWare or Solaris operating
systems. NetShield Security Suite blocks viruses from being transferred over
networks by scanning files which are accessed from the server. It can also
perform regularly scheduled scanning of the server. NSS also includes: (i)
VirusScan Unix which provides virus protection for network file servers running
Solaris, HP-UX, NCR and AIX; (ii) GroupShield for Notes which is a native Lotus
Notes application that is designed to protect the Notes server from viruses as
well as other known security threats; and (iii) GroupShield for Microsoft
Exchange which is a native NT service that prevents virus infected attachments
from being stored or transported by Microsoft Exchange. The NetTools
Distribution Console and Enterprise SecureCast are also included to provide
automated remote installation, updating, and management of the NSS components.
The current list price for a 1,000 node NetShield Security Suite site license is
$16 per node.
Internet Security Suite. Internet Security Suite ("ISS") provides
comprehensive virus protection at the Internet gateway for all likely virus
entry points. The ISS products are designed to capture both known and
2
4
new viruses before they infect multiple users on the network. Servers are
scanned in real-time as messages pass through and downloads occur. Viruses
discovered are automatically cleaned, quarantined, or deleted as configured. In
addition to viruses, ISS products also scan for hostile Java and Active-X
applets. Java and Active-X applets offer a powerful way to make web sites more
interactive for visitors, but can also be used to execute destructive commands.
ISS includes: (i) WebShield SMTP which is designed to scan all inbound and
outbound e-mail passing through the SMTP gateway; (ii) WebShieldX Proxy which
provides protection for HTTP and FTP traffic and scans for hostile Java and
Active-X applets; and (iii) WebScanX which protects against virus infected
Internet downloads and e-mails, as well as emerging hostile Java and Active-X
applets, by filtering them out before they can cause damage to users on desktop
or mobile PC's. The NetTools Distribution Console and Enterprise SecureCast are
also included to provide automated remote installation, updating, and management
of the ISS components. The current list price for a 1,000 node Internet Security
Suite site license is $16 per node.
PGP Total Network Security. PGP Total Network Security ("PGP TNS") is being
designed as an integrated suite of desktop and server solutions designed to
protect the digital assets of an enterprise through encryption and
authentication. All encryption algorithms used in PGP TNS provide "strong"
encryption with a minimum 128 bit key length for symmetric encryption, plus the
use of a public/private key scheme with larger keys. To the Company's knowledge,
no techniques currently exist that can "crack" these strong encryption
algorithms so they are usable even in demanding commercial and military
applications. PGP TNS is being designed as a comprehensive, scalable security
solution with central manageability and policy-based administration. PGP TNS
will comprise two network security product suites: the PGP Desktop Suite
(protects e-mails, files, disks and network communication); and the PGP Server
Suite (which is being developed to manage certificates, control encryption
policies and replicate certificate servers). Both PGP Desktop and Server suites
also include the PGPsdk which allows corporate or application developers to
create custom encryption using PGP's strong encryption algorithms. Complementing
PGP TNS is intrusion protection through the CyberCop product (described below)
which is sold separately and not as part of a suite. The current U.S. list price
for a 1,000 node PGP Total Network Security site license utilizing the Diffie-
Hellman strong encryption algorithm is $65 per node. The current list price for
CyberCop is $35,700 per unit.
PGP Desktop Suite. The PGP Desktop Suite ("PGP DS") provides multi-platform
encryption protection for a wide range of desktop computers. The PGP DS includes
the PGP for emails and files ("PGPEF") product. PGPEF uses compression,
encryption and digital signatures to ensure privacy at the desktop and during
transmission over both internal and public networks. PGP provides these
capabilities by allowing end users to encrypt mail messages, files or mail
attachments easily and then mail them to other PGP users who decrypt them using
a public/private key encryption scheme. PGPEF is currently available on more
than 15 different platforms, including Windows 3.1/95/NT, Macintosh and multiple
versions of UNIX. In addition, PGPEF is designed to offer seamless integration
with most commonly used e-mail applications. PGP DS also includes: (i) PGPdisk
(currently available for the Macintosh platform only) which provides hard disk
protection, even if the machine is compromised, by allowing only the correct
private key to unlock encrypted data on the hard disk; and (ii) PGPsdk
(described above). The PGPsdk can also be purchased by OEMs so that they may use
it to develop applications using encryption for sale in the commercial market.
The current U.S. list price for a 1,000 node PGP Desktop Suite site license
utilizing the Diffie-Hellman strong encryption algorithm is $55 per node.
PGP Server Suite. The PGP Server Suite ("PGP SS") is being designed to
provide management of public keys, authentication and policy-based
administration and management of security policies on an enterprise-wide basis.
The PGP SS is comprised of (i) the PGP Certificate Server, (ii) the Policy
Management Agent; and (iii) the Policy Server. The PGP Certificate Server is
designed to enable corporations to deploy, certify, revoke and store digital
certificates allowing hundreds of thousands of users to exchange and
authenticate digital information in a public/private key encryption system.
Certificate directories, also known as key rings at the single-user level, are
the equivalent of electronic address books for information security. Although
users can maintain their own key rings, large corporate customers have requested
the capability to centrally manage thousands of geographically dispersed keys
and the associated encryption processes and policies for their employees. The
PGP Certificate Server is designed to allow
3
5
corporate users to easily locate their electronic correspondents' keys in order
to encrypt, decrypt, verify and/or sign digital information. In addition, the
PGP Certificate Server is designed to allow administrators to manage keys
seamlessly and centrally. Designed to handle all certificate types, the PGP
Certificate Server allows for an integrated policy management system when
coupled with other products included in PGP SS, such as the Policy Management
Agent and Policy Server (a future component of the suite), facilitating the
establishment and enforcement of corporate information security regulations. The
Policy Management Agent allows corporations to integrate security policy
enforcement as part of their networking infrastructure. The Policy Server will
enable companies to consolidate control, coordination and enforcement of
business security policies through the centralized management of geographically
dispersed clients, servers and associated policy agents. The Policy Server is
being designed to verify, enforce and distribute policy configurations for
clients, certificate servers and their associated policy agents. PGP SS further
includes PGPsdk. The current U.S. list price for a 1,000 node PGP Server Suite
site license utilizing the Diffie-Hellman strong encryption algorithm is $31 per
node.
CyberCop. The CyberCop intrusion detection system is designed to safeguard
networks from external and internal attacks by performing real-time surveillance
of network traffic and sending out an alarm when intrusion is detected. The
CyberCop product's sensors are placed at key locations throughout a network,
from LAN segments and dial-up modem servers to connection to the internet or
other wide area networks. CyberCop is not sold as part of a suite. The current
list price for the CyberCop product is $35,700 per unit.
NET TOOLS MANAGER: SNIFFER TOTAL NETWORK VISIBILITY AND MCAFEE TOTAL SERVICE
DESK
Net Tools Manager is a network management and service desk solution
designed to make networks more efficient and network users more productive. The
Net Tools Manager product suite is comprised of Sniffer Total Network
Visibility, a comprehensive set of products and services for network fault and
performance management; and McAfee Total Service Desk, which integrates help
desk applications with desktop management software. McAfee Total Service Desk is
licensed on a two-year subscription basis. Pricing for 10 HelpDesk Users
supporting 1000 nodes is $45.95 per node. A number of the products incorporated
in the Net Tools Manager product suite may be purchased as stand-alone products
or as part of smaller product suites.
Sniffer Total Network Visibility. Sniffer Total Network Visibility
("Sniffer TNV") offers comprehensive network fault and performance solutions to
provide optimum network performance. Sniffer TNV is comprised of three product
suites: Sniffer Portable Analysis Suites which consist of portable tools which
analyze network traffic to pinpoint and help resolve performance problems on a
variety of multi-topology, multi-protocol networks; Sniffer Distributed Analysis
Suites which perform automatic network monitoring, protocol decodes and problem
analysis for identifying and resolving network problems from a central single-
fault and performance-management console; and Sniffer Service Desk Suite which
offers proactive management, reporting and service desk tools for better
supporting business objectives and delivering a higher quality of service to end
users. The U.S. list price for Sniffer Total Network Visibility Suite starts at
$100 per network node for a two year license on a network with a minimum 5,000
nodes.
Sniffer Portable Analysis Suite. The Sniffer Portable Analysis Suite
("Sniffer PAS") consists of portable tools designed to automatically pinpoint
and analyze network problems and to recommend solutions. To address the growing
complexity of multi-vendor, multi-protocol, multi-topology network environments,
Sniffer PAS is designed and tested to run on a variety of computer platforms.
The product is intended to be used as a portable tool, either on a portable or
notebook size computer platform, but it can also be installed on a desktop
computer platform. The Sniffer PAS addresses a variety of network needs ranging
from less-critical segment coverage to high-speed, mission-critical or backbone
networks. Products sold under the Sniffer PAS range from products which capture
data, monitor network traffic and collect key network statistics for small
networks, to products which optimize network performance and increase network
reliability by uncovering and analyzing network problems and recommending
solutions to such problems, automatically and in real-time for mid-level and
high-speed networks. The U.S. list price for the Sniffer Portable Analysis Suite
is $23,050 per copy.
4
6
Sniffer Distributed Analysis Suite. The Sniffer Distributed Analysis Suite
("Sniffer DAS") is designed to allow customers to monitor and diagnose problems
on complex, multi-segment networks from centralized locations. With the addition
of expert analysis capabilities, the Sniffer DAS provides automatic problem
diagnosis and recommends solutions which are displayed on a central console. The
Sniffer DAS addresses a variety of network needs ranging from less critical
segment coverage to high-speed, mission-critical or backbone products. Products
sold under the Sniffer DAS range from easy-to-use products which feature decode
and analysis capabilities and network health and availability summaries for
small or department networks, to products which provide service level management
and proactive device analysis for enterprises employing high-speed networks. The
U.S. list price for the Sniffer Distributed Analysis Suite for 2,001 - 5,000
desktops starts at $45 per desktop.
Sniffer Service Desk Suite. The Sniffer Service Desk Suite ("Sniffer SDS")
is a web browser-based network management suite that is designed to automate and
manage the process of resolving network problems proactively by identifying,
analyzing, tracking and resolving network problems and assessing trends. The
Sniffer SDS includes features such as trouble ticketing to problem resolution,
exception reporting and final close of ticket. The Sniffer SDS is comprised of
products designed to automatically collect data on instrumented network
components and to provide real-time and historic health and availability
summaries; to monitor and analyze the long-term performance of routers,
switches, hubs, and frame relay devices; and to provide immediate access to
service desk trouble tickets from any browser. The U.S. list price for the
Sniffer Service Desk Suite starts at $500 per network device.
McAfee Total Service Desk. McAfee Total Service Desk ("McAfee TSD")
provides proactive network management and help desk technology in one integrated
service desk solution. McAfee TSD comprises three suites: McAfee HelpDesk Suite;
Zero Administration Suite; and Self ServiceDesk Suite. The current U.S. list
price for a ten concurrent user license for McAfee TSD is $4,595. This price
also includes support of 1000 desktops.
McAfee HelpDesk Suite. The McAfee HelpDesk Suite is designed to provide
complete call management, problem resolution, crisis management, change
management and reporting for mid-range and departmental help desks. The McAfee
HelpDesk Suite automates the process of entering caller information and
automatically displays information about a caller allowing faster service and
minimizing duplication of efforts. In addition, the McAfee HelpDesk Suite is
designed to provide automated crisis management, by posting notices of known
problems on a centralized "white board." Related calls can be linked,
automatically generating or resolving (and subsequently closing) all linked
trouble tickets. Finally, the McAfee HelpDesk Suite is designed to automate
change management throughout the enterprise, allowing work orders for a selected
task to be automatically sent to all appropriate parties. Detailed reports
generated by the McAfee HelpDesk Suite help measure the impact of each problem
and the use of enterprise resources to solve each problem. The current U.S. list
price for a ten concurrent user license for McAfee HelpDesk Suite is $2,428.
Zero Administration Client Suite. The Zero Administration Client ("ZAC")
Suite is designed to provide enterprise wide control of network software with
integrated software distribution, software and hardware inventory, desktop
management/menuing, license metering and remote control features. The ZAC Suite
can automatically distribute, install and track new software and updates
throughout an enterprise and can perform an enterprise-wide hardware, software
and system file inventory without having to visit each station. The ZAC Suite
also includes management/menuing capabilities which enable central configuration
of application access and desktop layout. In addition, the ZAC Suite provides
software metering capabilities, allowing the efficient management of license
sharing, and transfers and reducing the number of licenses that need to be
purchased based on actual usage. Furthermore, the ZAC Suite allows compliance
with license
5
7
limitations by restricting concurrent usage of a software product to only the
total of number of licenses purchased. Finally, the ZAC Suite allows remote
access to critical information on multiple platforms. The Zero Administrator
Client Suite console controls DOS, Windows, Windows 95 and Windows NT-based PC
assets connected to NT and NetWare file servers, and its open database structure
is designed to ensure accessibility. The current U.S. list price for a 1,000
node ZAC Suite site license is $39 per node.
Self ServiceDesk Suite. The Self ServiceDesk Suite provides information
services organizations with self service oriented applications designed to make
all supported PCs help desk ready. The Self ServiceDesk Suite integrates PC
diagnostic software with remote control and web-based access, allowing cost
savings for help desk and network administrators. The Self ServiceDesk Suite
allows employees to solve their own PC application problems over the web using
Knowledge Wizard, a searchable information database that gives employees instant
answers to thousands of common hardware and software application questions. The
Self ServiceDesk Suite also includes PCMedic. PCMedic automatically diagnoses
and corrects PC system problems, as well as prevents errors and crashes which
damage data. The current U.S. list price for a 1,000 node Self Service Desk
Suite site license is $39 per node.
TOTAL SERVICE SOLUTIONS
As the Company's products and computer networks become more complex,
customers increasingly require greater professional assistance in the design,
installation, configuration and implementation of their networks and acquired
products. To meet these evolving customer needs, the Company has established
Total Service Solutions. Total Service Solutions is focused on three services
segments: Consulting Services, Total Education Service and Product Support to
complete the customer's product license relationship with the Company. The
Company intends to expand and develop significantly its worldwide professional
services organization.
Consulting Services supports product integrations, customization and
deployment with an array of standardized and custom offerings. Consulting
Services also offers other services ranging from proactive and emergency
troubleshooting to network design, planning and simulation.
Total Education Service offers an extensive curriculum of computer network
technology courses, from product training to advanced network troubleshooting
and performance management. Total Education Service is delivered from nine
training centers and 50 roadshow locations nationally, and 18 international
locations. Total Education Service emphasizes customized on-site training at
customer locations, and has trained over 35,000 individuals in Fortune 500 and
other companies.
Product Support technical representatives respond to customer calls and
electronic messages, resolve product issues and answer detailed questions. Three
levels of phone support are available, so that customers can choose the
availability and response times that meet their business needs. Product Support
is available to all Company customers on a worldwide basis. Additionally,
Product Support delivers advanced technology solutions on the Internet, allowing
customers to resolve issues expeditiously at any time of day or night.
SUBSCRIPTION LICENSING MODEL
The Company typically licenses its non-Sniffer products (together with the
related maintenance) to corporate and government customers for a period of two
years during which time the licensees receive all upgrades, updates and
technical support. Upon expiration of the two-year period, customers are
contacted by the Company for renewal. The Company is currently developing a
two-year subscription model for licensing its Sniffer products, which accounted
for a significant portion of its revenues in 1997 and historically have been
licensed on a perpetual basis with annual maintenance and support contracts. The
Company believes that the two-year subscription licensing and related
maintenance offers several benefits to its customers. For one initial fee, the
customer receives the software and all upgrades, updates and support for two
years. In addition, the customer only has to make a decision on its investment
in the software every two years. Since the Company is able to distribute its
products and upgrades at a lower cost than do companies using traditional
distribution methods, the Company also has the ability to offer upgrades and
updates and address user feature requirements on a more regular basis. In
addition, by offering a two-year license, as opposed to a traditional
6
8
perpetual term license, the Company is able to meet a lower initial cost
threshold for customers with annual budgeting constraints.
The Company's two-year subscription licensing model creates the opportunity
for recurring revenue for the Company through the renewal of existing licenses.
Since the Company typically licenses its products on a per user basis, at the
time of renewal the Company has the potential to increase the number of
computers licensed at existing sites and to expand its licenses to new sites in
an organization. The renewal process also provides an opportunity to cross-sell
new products and product suites to existing customers. There can be no assurance
that the Company will be able to sustain current renewal rates in the future.
With the expansion of the Company's distribution channels to include
resellers and distributors, the Company also provides single user licenses for
its products under traditional, unlimited term licenses with product updates,
upgrades and support available to customers under separate maintenance
contracts.
ELECTRONIC SOFTWARE DISTRIBUTION
The Company was the first company to successfully utilize electronic
software distribution to reach corporate and government customers. Through the
World Wide Web and various online services such as CompuServe, America Online
and the Microsoft Network, the Company is able to electronically communicate and
interact with its customers from pre-sales evaluation through product delivery
and post-sales support. The Company believes that the electronic channel is an
important source of information and support for IT professionals. By making
fully-functioning, unencrypted versions of many of its products widely available
for evaluation, the Company seeks to encourage product sampling among these
sophisticated users. Unlike traditional software evaluation programs, where
potential customers often are required to identify themselves (typically
resulting in their inclusion in a sales database), go through a qualification
process and then wait for the evaluation copy to be shipped, potential customers
desiring to evaluate Company products for a 30-day period can anonymously
download Company products from the Company's World Wide Web site. In 1996, the
Company opened the McAfee Store on the World Wide Web to distribute its own and
third party products.
The Company uses electronic software distribution as a principal means of
delivering licensed software, as well as upgrades and updates to its customers.
Electronic software distribution offers a number of advantages to the Company
over traditional software distribution methods including the ability to
distribute its products and upgrades more rapidly and at a lower cost than
traditional distribution methods. Since all of the software and documentation
can be distributed electronically, the cost of internal distribution by the
customer is also lower than with traditional software and printed documentation.
The Company also seeks to increase awareness of its products, to provide
customer and technical support and to encourage dialogue regarding its products
by maintaining a World Wide Web site and forums on CompuServe, America Online
and The Microsoft Network. The Company also provides support through the World
Wide Web. By providing support electronically, the Company believes that it is
often able to identify and solve customer problems more rapidly.
SALES AND MARKETING
To augment and capitalize upon the awareness of the Company's products
resulting from its electronic distribution model, the Company's sales and
marketing efforts are directed primarily at large corporate and government
customers as well as to resellers, distributors and system integrators worldwide
through the following channels:
North American Direct Sales. The Company has recently reorganized its
combined direct sales force into three tiers. The first tier focuses on the sale
of the full product suite under the Net Tools umbrella to enterprise and
national account customers. The second tier consists of four separate sales
groups focused on the sale of the individual product suites (i.e., McAfee Total
Virus Defense; PGP Total Network Security; Sniffer Total Network Visibility; or
McAfee Total Service Desk) to the departmental level. The third tier consists of
four separate outbound corporate telesales forces who actively market the
Company's individual
7
9
product suites to customers with less than 1,000 nodes. The Company's corporate
telesales representatives also respond to prospective customers who contact the
Company as a result of a particular marketing program or after electronically
evaluating a Company product. Another significant focus of the Company's
corporate telesales force is to contact existing customers to cross-sell
additional products and product suites. To augment its sales organization, the
Company's executives are involved with sales to many major accounts. The Company
historically has not had a large enterprise or national accounts sales force and
only recently developed a direct sales group focused on these larger accounts.
In addition, the Company has not historically had a separate sales force focused
on the sale of its suite of security products (many of which were only recently
acquired and are currently being engineered into a common suite). Accordingly,
the Company is currently expanding these direct sales organizations in North
America.
The Company devotes a portion of its corporate telesales force to the
renewal of its existing licenses. Prior to expiration of a license, a corporate
telesales representative contacts the customer and encourages renewal of the
expiring license while determining if increasing the number of computers
licensed is appropriate and, additionally, marketing new products and product
suites to this existing customer.
International Sales. The Company has sales and support operations in
Europe, Asia, South America and Australia. In 1997, international revenues
accounted for approximately 28% of the Company's net revenues. Historically, the
Company has relied primarily upon independent agents and distributors to market
its products internationally. The Company expects that international revenues
will continue to account for a significant percentage of net revenues. In 1997,
the Company acquired, among others, its distributors in Japan and in The
Netherlands. The Company expects to continue using independent agents primarily
in smaller markets where a direct sales presence is not currently warranted.
While the Company's agents and distributors include some large systems
integrators, most are small companies that market the Company's software along
with products of other companies that they represent. The Company typically
enters into agreements with its agents which, among other things, obligate its
agents to provide technical support and the most current versions of the
Company's products to its customers and to provide the Company with information
about its licensees. Such agreements permit either the Company or the agent to
terminate the agreement upon proper prior written notice. International agents
invoice their own orders and collect payment, remitting the license fee, net of
commissions, to the Company in United States dollars.
Channel Sales. To complement its direct sales, the Company markets many of
its products through corporate resellers and distributors, and indirectly
through retailers. While historical sales through these distribution channels
have generated a relatively small portion of the Company's net revenue, over the
past two years the Company's presence in these channels has expanded
significantly. The Company currently utilizes corporate resellers, including
STREAM, Software Spectrum, Softmart and ASAP, which focus primarily on selling
site licenses for the Company's software to corporate customers. The Company is
currently expanding the indirect sales channel for its Sniffer products and its
PGP security products.
Independent software distributors who market the Company's products include
Ingram Micro, Merisel America and Tech Data. These distributors stock the
Company's products in inventory for redistribution primarily to large retailers,
VARs and mail order companies. Through its authorized distributors, the Company
sells its retail packaged products to several of the large computer and software
retailers in the United States, including Staples, CompUSA, Computer City,
Software Etc. and Best Buy. Several members of the Company's channel sales force
work closely with the Company's major reseller and distributor accounts on the
management of orders and inventory level, as well as on promotion and selling
activities.
The Company's distributors generally are permitted stock balancing and
stock rotation rights but are typically required to place offsetting orders of
equal value. The Company often relies on resellers and distributors, including
retail outlets, to market and support its products. The Company's agreements
with its distributors are not exclusive and may be terminated by either party
without cause. There can be no assurance that any distributors will continue to
represent the Company's products.
Original Equipment Manufacturers ("OEMs"). OEMs license the Company's
products (mainly anti-virus products) and bundle them with personal computer
hardware or software. OEMs typically sublicense a
8
10
single version of the Company's products to end users who must contact the
Company in order to license updates. The Company typically receives a per copy
royalty from its OEMs.
Other Marketing Activities. The Company's principal means of marketing its
products is through the World Wide Web. Not only does the Company's Website
contain various marketing materials and information about its products, but from
the Website customers may download and purchase products and potential customers
may download Company products for a 30-day free trial. The Company also promotes
its products through advertising activities in trade publications and direct
mail campaigns. The Company is currently conducting a national television
advertising campaign in the U.S. during certain major sporting events. The
Company also attends trade shows, sponsors conferences and publishes a quarterly
newsletter which is mailed to existing and prospective customers. In addition,
the Company also maintains forums on CompuServe, America Online and The
Microsoft Network which provide electronic forums for subscribers of these
services to discuss issues related to computer viruses and make inquiries
regarding the Company's products.
CUSTOMERS
The Company primarily markets its products directly to large corporate and
government customers as well as to resellers and distributors. No customer
accounted for more than 10% of the Company's net revenue during 1997, 1996 or
1995.
PRODUCT DEVELOPMENT AND ACQUISITION
The software industry has experienced and is expected to continue to
experience a significant amount of consolidation. In addition, it is expected
that the Company will grow internally and through strategic acquisitions in
order, among other things, to expand the breadth and depth of its product suites
and to build its professional services organization. The Company continually
evaluates potential acquisitions of complementary businesses, products and
technologies. In addition to the Network General merger in December 1997, the
Company has consummated a series of significant acquisitions since 1994,
including the acquisitions of PGP and Helix in December 1997, Cinco Networks,
Inc. in August 1997, 3DV Technology, Inc. in March 1997, a controlling interest
in FSA Corporation of Canada in August 1996, Vycor Corporation in February 1996,
Saber Software Corporation, Inc. in August 1995 and ProTools, Inc. in January
1994. In addition, since 1995 the Company has acquired a number of its
international agents and distributors, including agents or distributors in
Australia, Brazil, Japan and The Netherlands and is currently investigating
acquisitions of additional foreign agents and distributors. Past acquisitions
have consisted of, and future acquisitions will likely include, acquisitions of
businesses, interests in businesses and assets of businesses.
The Company believes that its ability to maintain its competitiveness will
depend in large part upon its ability to enhance existing products, develop and
acquire new products and develop and integrate acquired products. The market for
computer software is characterized by low barriers to entry and rapid
technological change, and is highly competitive with respect to timely product
introductions. There can be no assurance that product enhancements or new
products will be developed or acquired on a timely basis or at all.
In addition to developing new products, the Company's internal development
staff is also focused on developing updates to existing products and modifying
and enhancing any acquired products. For example, the Company is designing a
centralized console from which the various Net Tools component suites can be
operated, administered and maintained utilizing a common look and feel and is
integrating its various security products (such as its recently acquired PGP
encryption products and Network General CyberCop product) into a marketable
suite of products. Future updates may, among other things, include additional
functionality, respond to user problems or address issues of compatibility with
changing operating systems and environments. The Company believes that the
ability to provide these updates to users frequently and at a low cost is a key
to its success. Failure to release such updates on a timely basis could have a
material adverse impact on the Company. There can be no assurance that the
Company will be successful in these efforts. In addition, there can be no
assurance that future changes in Windows 95, Windows NT, NetWare or other
popular operating systems would not result in incompatibility with the Company's
products. The Company's failure to
9
11
introduce on a timely basis new products that are compatible with operating
systems and environments preferred by desktop computer users would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company expended $85.0 million, $52.2 million and $36.8 million in the
years ended December 31, 1997, 1996 and 1995, respectively, on research and
development.
MANUFACTURING AND SUPPLIERS
The Company's manufacturing operations consist primarily of final assembly,
testing and quality control of materials, components, subassemblies and systems
for its Sniffer based products. The Company believes its quality control
procedures have been instrumental in achieving the high performance and
reliability of these products. To date, the Company has experienced minimal
return of its products by users. The Company's manufacturing operations do not
require any capital expenditures for environmental control facilities or any
special activities for protection of the environment. The Company intends to
outsource the manufacturing operations related to its Sniffer based products in
1998. There can be no assurance that, among other things, the Company will be
able to outsource these manufacturing operations on a timely basis or at all.
The Company's Sniffer products are designed to work with a variety of
network topologies and computer platforms available from multiple manufacturers.
The Company relies on a limited number of suppliers for certain critical
components of its products. Some of the Sniffer products are designed around a
specific computer platform available only from certain manufacturers. In the
case of Sniffer Analyzer products, customers purchase the required platform
either from the Company or from suppliers. As a result of product transitions by
its computer platform vendors, the Company has found it necessary to purchase
and inventory computer platforms for resale to customers. Any significant
shortage of computer platforms or other critical components for Sniffer products
could lead to cancellations or delays of purchases of these products, which
could materially and adversely affect the Company's results of operations. If
purchases of computer platforms or other components exceed demand, the Company
could incur expenses for disposing of excess inventory, which would also
adversely affect its results of operations.
The Company is in the process of developing software only versionS of its
Sniffer products. Purchasers of these Sniffer software products would be
required to already own or purchase directly from the manufacturer or other
vendors the necessary hardware products (such as computer platforms and
components). There can be no assurance that the Company can produce a software
only Sniffer product on a timely basis or at all or that customers will not
require that the Company continue to provide the necessary hardware products.
COMPETITION
The markets for the Company's products are intensely competitive and the
Company expects competition to increase in the near-term. The Company believes
that the principal competitive factors affecting the markets for its products
include performance, functionality, quality, customer support, breadth of
product line, frequency of upgrades and updates, integration of products,
manageability of products, brand name recognition, company reputation and price.
Certain of the criteria upon which the performance and quality of the Company's
anti-virus software products compete include the number and types of viruses
detected, the speed at which the products run and ease of use. Certain of the
Company's competitors have been in the network management market longer than the
Company, and other competitors, such as Symantec Corporation ("Symantec"), Intel
Corporation ("Intel"), Seagate Technology, Inc. ("Seagate"), and Hewlett-Packard
Company ("HP"), are larger and have greater name recognition than the Company.
The Company will also need to develop name recognition for the name "Network
Associates." In addition, certain larger competitors such as Intel, Microsoft
Corporation ("Microsoft") and Novell, Inc. ("Novell") have established
relationships with hardware vendors related to their other product lines. These
relationships may provide them with a competitive advantage in penetrating the
OEM market with their network security and management products. As is the case
in many segments of the software industry, the Company has been encountering,
and expects to further encounter, increasing competition. This increased
competition could reduce average selling prices and, therefore, profit margins.
Competitive pressures could result not only in sustained price reductions but
also in a
10
12
decline in sales volume, which events would materially adversely affect the
Company's business, financial condition and results of operations. In addition,
competitive pressures may make it difficult for the Company to maintain or
exceed its growth rate.
Although there is a trend toward consolidation in the network security and
management market, the market is currently highly fragmented with products
offered by many vendors. The Company's principal competitor is the Peter Norton
Group of Symantec in the network security market and Intel's LanDesk in the
network management market. The Company's other competitors include Computer
Associates/Cheyenne Software, IBM, Seagate, the Dr. Solomon Group and Trend
Micro, Inc., as well as numerous smaller companies and shareware authors that
may in the future develop into stronger competitors or be consolidated into
larger competitors. In the encryption portion of the security market, the
Company's principal competitors are Security Dynamics Technologies, Inc., Cylink
Corporation, Entrust Technologies and VeriSign, Inc. The Company's principal
competitors in the help desk market are Remedy Corporation, Software Artistry
(recently acquired by Tivoli Systems/IBM) and Magic Solutions, Inc. The
Company's principal competitor in the software-based network fault and
performance management market is HP, with other competitors including Azure
Technologies Incorporated, Concord Communications, DeskTalk Systems, Kaspia
Systems, Shomiti Systems, Inc. and Wandel & Goltermann, Inc. The Company also
faces competition in the security market from Cisco Systems, Inc., Security
Dynamics Technologies, Inc., Checkpoint Software and other vendors in the
encryption/firewall market. In addition, the Company faces competition from
large and established software companies such as Microsoft, Intel, Novell and HP
which offer network management products as enhancements to their network
operating systems. As the network management market develops, the Company may
face increased competition from these large companies, as well as other
companies seeking to enter the market. The trend toward enterprise-wide network
management and security solutions may result in a consolidation of the network
management and security market around a smaller number of vendors who are able
to provide the necessary software and support capabilities. In addition, to the
extent that the Company is successful in developing its Net Tools suite of
products designed around a centralized management and administration console for
the Windows NT platform, the Company will likely compete with large computer
systems management companies such as Tivoli Systems (TME) and Computer
Associates (Unicenter).
PROPRIETARY TECHNOLOGY
The Company's success is heavily dependent upon proprietary software
technology. The Company relies on a combination of contractual rights,
trademarks, trade secrets and copyrights to establish and protect proprietary
rights in its software. There can be no assurance these protections will be
adequate or that competitors will not independently develop technologies or
products that are substantially equivalent or superior to the Company's
products.
The Company recently changed its legal name to "Networks Associates, Inc."
and has recently begun conducting business as "Network Associates." The Company
believes that there are a number of other companies with similar names and,
although the Company has not been served in any suit, three companies (including
Network Associates Corporation in California and Network Associates, Inc. in
Oregon) have made claims (including various trademark claims) or demands with
respect to the Company's use of the name Network Associates. There can be no
assurance that the Company will be able to enforce rights in that name, that it
will be free to use the name in all jurisdictions, that there will be no
additional challenges to the use of that name or that it will not be required to
expend significant resources in securing the use of that name.
The Company does not typically obtain signed license agreements from its
corporate, government and institutional customers who license products directly
from it. The Company includes an electronic version of a "shrink-wrap" license
in all of its electronically distributed software and a printed license in the
box for its products distributed through traditional distribution channels in
order to protect its copyrights and trade secrets in those products. Since none
of these licenses are signed by the licensee, many authorities believe that such
licenses may not be enforceable under the laws of many states and foreign
jurisdictions. In addition, the laws of some foreign countries either do not
protect proprietary rights or offer only limited protection for those rights.
There can be no assurance that the steps taken by the Company to protect its
proprietary software
11
13
technology will be adequate to deter misappropriation of this technology. For
example, the Company is aware that a substantial number of users of its
anti-virus products have not paid any registration or license fees to the
Company. Changing legal interpretations of liability for unauthorized use of the
Company's software, or lessened sensitivity by corporate, government or
institutional users to avoiding copyright infringement, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
EMPLOYEES
As of December 31, 1997, the Company employed over 1,600 individuals
worldwide. Competition for qualified management and technical personnel is
intense in the software industry. The Company's continued success will depend in
part upon its ability to attract and retain qualified personnel. None of the
Company's employees is represented by a labor union and the Company believes
that its employee relations are good.
RISK FACTORS
Variability of Quarterly Operating Results. The Company's results of
operations have been subject to significant fluctuations, particularly on a
quarterly basis, and the Company's future results of operations could fluctuate
significantly from quarter to quarter and from year to year. Causes of such
fluctuations may include the volume and timing of new orders and renewals,
distributor inventory levels and return rates, Company inventory levels, the
introduction of new products, product upgrades or updates by the Company or its
competitors, changes in product mix, changes in product prices and pricing
models, seasonality, trends in the computer industry, general economic
conditions (such as the recent economic turbulence in Asia), extraordinary
events such as acquisitions or litigation and the occurrence of unexpected
events. The operating results of many software companies reflect seasonal
trends, and the Company's business, financial condition and results of
operations may be affected by such trends in the future. Such trends may include
higher net revenue in the fourth quarter as many customers complete annual
budgetary cycles, and lower net revenue in the summer months when many
businesses experience lower sales, particularly in the European market.
Although the Company has experienced significant growth in net revenue and
net income (before acquisition and other related costs) in absolute terms, the
Company's growth rate has slowed in recent periods. The Company has experienced
increased price competition for its products and the Company expects competition
to increase in the near-term, which may result in reduced average selling prices
for the Company's products in the future. Due to these and other factors (such
as a maturing anti-virus market and an increasingly higher base from which to
grow), the Company's historic revenue growth rate will be difficult to sustain
or increase. To the extent these trends continue, the Company's results of
operations could be materially adversely affected. Renewals have historically
accounted for a significant portion of the Company's net revenue; however, there
can be no assurance that the Company will be able to sustain historic renewal
rates for its products in the future. Risks related to the Company's recent
change in business strategies could also cause fluctuations in operating results
and could make comparisons with historic operating results and balances
difficult or not meaningful. See "-- Risks Related to Certain Business
Strategies."
The timing and amount of the Company's revenues are subject to a number of
factors that make estimating operating results prior to the end of a quarter
uncertain. The Company does not expect to maintain a significant level of
backlog and, as a result, product revenues in any quarter will be dependent on
contracts entered into or orders booked and shipped in that quarter. During
1997, the Company generally experienced a trend toward higher order receipts
toward the end of the last month of a quarter, resulting in a higher percentage
of revenue shipments during the last month of a quarter than in 1996, which
makes predicting revenues more difficult. The timing of closing larger orders
increases the risks of quarter-to-quarter fluctuation. To the extent that the
Company is successful in licensing larger product suites under the Net Tools
umbrella (particularly to large enterprise and national accounts), the size of
its orders and the length of its sales cycle are likely to increase. If orders
forecasted for a specific customer for a particular quarter are not realized or
revenues are not otherwise recognized in that quarter, the Company's operating
results for that quarter could be materially adversely affected. See
"Potentially Longer Sales and Implementation Cycles for Certain Products."
12
14
The trading price of the Company's Common Stock has historically been
subject to wide fluctuations, with factors such as earnings announcements and
litigation developments contributing to this volatility. Failure to achieve
periodic revenue, earnings and other operating and financial results as
forecasted or anticipated by brokerage firms, industry analysts or investors
could result in an immediate and adverse effect on the market price of the
Company's Common Stock. The Company may not discover, or be able to confirm,
revenue or earnings shortfalls until the end of a quarter, which could result in
an immediate and adverse effect on the price of the Company's Common Stock.
Risk of Inclusion of Network Management and Security Functionality in
Hardware and Other Software. In the future, vendors of hardware and of operating
system software or other software (such as firewall or electronic mail software)
may continue to enhance their products or bundle separate products to include
functionality that currently is provided primarily by network security and
management software. Such enhancements may be achieved through the addition of
functionality to operating system software or other software or the bundling of
network security and management software with operating system software or other
products. For example, Cisco Systems, Inc. ("Cisco") recently incorporated a
firewall in certain of its hardware products and Microsoft introduced limited
anti-virus functionality into its MS-DOS versions in 1993. The widespread
inclusion of the functionality of the Company's products as standard features of
computer hardware or of operating system software or other software could render
the Company's products obsolete and unmarketable, particularly if the quality of
such functionality were comparable to that of the Company's products.
Furthermore, even if the network security and/or management functionality
provided as standard features by hardware providers or operating systems or
other software is more limited than that of the Company's products, there can be
no assurance that a significant number of customers would not elect to accept
such functionality in lieu of purchasing additional software. If the Company
were unable to develop new network security and management products to further
enhance operating systems or other software and to replace successfully any
obsolete products, the Company's business, financial condition and results of
operations would be materially adversely affected.
Risks Associated with Recent Acquisitions. In addition to risks described
under "-- Risks Associated with Acquisitions Generally," the Company faces
significant risks associated with its recent combination with Network General
and other recent acquisitions (including the acquisitions of PGP and Helix
Software Company ("Helix"). There can be no assurance that the Company will
realize the desired benefits of these transactions. In order to successfully
integrate these companies, the Company must, among other things, continue to
attract and retain key management and other personnel; integrate, both from an
engineering and a sales and marketing perspective, the acquired products
(including Network General's Sniffer and CyberCop products, PGP's encryption
products and Helix's utilities products) into its suite of product offerings;
integrate and develop a cohesive focused direct and indirect sales force for its
product offerings; consolidate duplicate facilities; and develop name
recognition for its new name. The diversion of the attention of management from
the day-to-day operations of the Company, or difficulties encountered in the
integration process, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "-- Need to Develop
Enterprise and National Accounts Sales Force and Security Products Sales Force;
Risks Related to Direct Sales Force" and "-- Use of Indirect Sales Channels;
Need to Develop Indirect Sales Channel for Sniffer and PGP Security Products."
During 1997, the Company incurred significant non-recurring charges
associated with the Network General combination and the acquisitions of PGP and
Helix. There can be no assurance that the Company will not incur additional
material charges in subsequent quarters to reflect additional costs associated
with these transactions and with respect to its name change and the marketing of
its products under the "Network Associates" name.
Risks Related to Certain Business Strategies. The Company has historically
derived a significant majority of its revenues from the licensing of its
flagship anti-virus products and Sniffer products. See "-- Dependence on Revenue
from Flagship Anti-Virus and Sniffer Products." The Company is currently
focusing its efforts on broadening its revenue base by providing network
security and management solutions to enterprise customers, targeting in
particular the Windows NT/Intel platform. In furtherance of this strategy, the
Company recently organized its products into four product suites -- McAfee Total
Virus Defense, PGP
13
15
Total Network Security, and Sniffer Total Network Visibility and McAfee Total
Virus Defense. These four product suites together form an integrated solution
called "Net Tools" which utilizes a new pricing model. See "Business -- Net
Tools." There can be no assurance that potential customers will respond
favorably to the modified pricing structure and the lack of a favorable response
could materially adversely affect the Company's operating results. Although the
Company will continue to offer perpetual licenses with annual support and
maintenance contracts for its Sniffer products, it is currently developing a
subscription licensing model for those products. In addition, in an effort to
increase total Sniffer unit sales the Company intends to develop software only
versions of its Sniffer products -- meaning that the Company would no longer
sell the hardware components contained in the current Sniffer products. There
can be no assurance that the Company can produce a software only Sniffer product
on a timely basis or at all, that customers will not continue to require that
the Company provide the associated hardware platform and components, that total
unit licenses of Sniffer products will increase over previous levels or that
customers will react favorably to the subscription pricing model for Sniffer
products. To the extent that customers do license Sniffer products on a two-year
subscription basis or license significant amounts of software only Sniffer
products, the Company's operating results and financial condition would likely
be affected. In the case of subscription licenses, the Company would, among
other things, expect an increase in deferred revenues related to the service
portion of the two-year Sniffer license that would be capitalized on the
Company's balance sheet. In the initial year of the license, the corresponding
revenue would be lower than if the license were perpetual. In the case of the
software only Sniffer product, for any individual license, the Company would
expect lower total revenues and a higher overall gross margin related to the
transaction, as the Company would not be selling the corresponding hardware
component. Currently, the hardware component has a lower gross margin than the
total product gross margin.
The Company has been acquiring (and is continuing to investigate the
acquisition of) existing independent agents and distributors of its products in
certain strategic markets or has been converting these independent agents into
resellers who must purchase Company products from Company approved distributors.
These actions may require, among other things, that the Company provide the
technical support to customers that was previously provided by such agents and
distributors. There can be no assurance that the Company can provide such
support as effectively or on a timely basis or at all, that the Company will
operate any acquired distributor or agent as successfully as the previous
operators, that the acquisition of any distributor or agent or the conversion of
any agent into a reseller will result in the desired increased foreign revenues
or that the Company will be able to identify and retain suitable distributors in
any market in which it converts an independent agent. See " -- Risks Associated
with Acquisitions Generally" and " -- Risks Related to International Revenue and
Activities."
As part of the Net Tools concept, the Company is in the process of
designing a centralized console from which the various component suites can be
operated, administered and maintained utilizing a common look and feel. The
Company faces significant engineering challenges related to these efforts. In
addition, the Company faces significant engineering and other challenges related
to the integration of its various security products (such as its recently
acquired PGP encryption products and Network General CyberCop product) into a
marketable suite of products and the development of a software only Sniffer
product. Success of the Company's Net Tools suite strategy will also depend, in
part, upon successful development and coordination of the Company's sales force;
on successful development of a national accounts sales force and an effective
indirect sales channel for the Company's Sniffer and PGP security products; and
on the development and expansion of an effective professional services
organization. See " -- Risks Associated with Recent Transactions," " -- Risks
Associated with Acquisitions Generally," " -- Need to Develop Enterprise and
National Accounts Sales Force and Security Products Sales Force; Risks Related
to Direct Sales Force," " -- Use of Indirect Sales Channels; Need to Develop
Indirect Sales Channel for Sniffer and PGP Security Products" and " -- Need to
Expand and Develop An Effective Professional Services Organization."
The foregoing factors, individually or in the aggregate, could materially
adversely affect the Company's operating results and could make comparison of
historic operating results and balances difficult or not meaningful.
14
16
Risks Associated with Acquisitions Generally. The software industry has
experienced and is expected to continue to experience a significant amount of
consolidation. In addition, it is expected that the Company will grow internally
and through strategic acquisitions in order, among other things, to expand the
breadth and depth of its product suites and to build its professional services
organization. The Company continually evaluates potential acquisitions of
complementary businesses, products and technologies. In addition to the
combination with Network General in December 1997, the Company has consummated a
series of significant acquisitions since 1994, including the acquisitions of PGP
and Helix in December 1997, Cinco Networks, Inc. in August 1997, 3DV Technology,
Inc. in March 1997, FSA Corporation of Canada in August 1996, Vycor Corporation
in February 1996, Saber Software Corporation, Inc. in August 1995 and ProTools,
Inc. in January 1994. In addition, since 1995 the Company has acquired a number
of its international distributors, including distributors in Australia, Brazil,
Japan and The Netherlands and is currently investigating acquisitions of
additional foreign distributors. Past acquisitions have consisted of, and future
acquisitions will likely include, acquisitions of businesses, interests in
businesses and assets of businesses. Any acquisition, depending on its size,
could result in the use of a significant portion of the Company's available cash
or, if such acquisition is made utilizing the Company's securities, could result
in significant dilution to the Company's stockholders, and could result in the
incurrence of significant acquisition related charges to earnings. Acquisitions
by the Company may result in the incurrence or the assumption of liabilities,
including liabilities that are unknown or not fully known at the time of
acquisition, which could have a material adverse effect on the Company.
Furthermore, there can be no assurance that any products acquired in connection
with any such acquisition will gain acceptance in the Company's markets or that
the Company will obtain the anticipated or desired benefits of such
transactions.
Achieving the anticipated benefits of an acquisition will depend, in part,
upon whether the integration of the acquired business, products or technology is
accomplished in an efficient and effective manner, and there can be no assurance
that this will occur. Moreover, successful acquisitions in the high technology
industry may be more difficult to accomplish than in other industries. Combining
a merged or acquired company requires, among other things, integration of
product offerings and coordination of sales and marketing and research and
development efforts. There can be no assurance that such an integration can be
accomplished smoothly or successfully. The difficulties of such integration may
be increased by the necessity of coordinating geographically separated
organizations, the complexity of the technologies being integrated, and the
necessity of integrating personnel with disparate business backgrounds and
combining two different corporate cultures. The integration of operations
following an acquisition requires the dedication of management resources that
may distract attention from the day-to-day business, and may disrupt key
research and development, marketing or sales efforts. The inability of
management to successfully integrate any acquisition could have a material
adverse effect on the business, operating results and financial condition of the
Company. In addition, as commonly occurs, during the pre-acquisition and
integration phases of technology company acquisitions, aggressive competitors
may undertake initiatives to attract customers and to recruit key employees
through various incentives.
Rapid Technological Change; Risks Associated with Product Development. The
network security and management market is highly fragmented and is characterized
by ongoing technological developments, evolving industry standards and rapid
changes in customer requirements. The Company's success depends upon its ability
to offer a broad range of network security and management software products, to
continue to enhance existing products, to develop and introduce in a timely
manner new products that take advantage of technological advances, and to
respond promptly to new customer requirements. While the Company believes that
it offers one of the broadest product lines in the network management and
security market, this market is continuing to evolve and customer requirements
are continuing to change. As the market evolves and competitive pressures
increase, the Company believes that it will need to further expand its product
offerings. There can be no assurance that the Company will be successful in
developing and marketing, on a timely basis, enhancements to its existing
products or new products, or that such enhancements or new products will
adequately address the changing needs of the marketplace.
In addition, from time to time, the Company or its competitors may announce
new products with new or additional capabilities or technologies. Such
announcements of new products could have the potential to
15
17
replace, or shorten the life cycles of, the Company's existing products and to
cause customers to defer or cancel purchases of the Company's existing products.
The Company has in the past experienced delays in software development, and
there can be no assurance that the Company will not experience delays in
connection with its current or future product development activities. Complex
software products such as those offered by the Company may contain undetected
errors or version compatibility issues, particularly when first introduced or
when new versions are released, resulting in loss of or delay in market
acceptance. For example, the Company experienced compatibility issues in
connection with its recent NetShield upgrade, and the Company's anti-virus
software products have in the past falsely detected viruses that did not
actually exist. See " -- Risk of False Detection of Viruses." Delays and
difficulties associated with new product introductions, performance or
enhancements could have a material adverse effect on the Company's business,
financial condition and results of operation.
The Company's development efforts are impacted by the adoption or evolution
of industry standards related to its products and the environments in which they
operate. For example, no uniform industry standard has developed in the market
for encryption security products. As industry standards are adopted or evolve,
the Company may be required to modify existing products or develop and support
new versions of existing products. In addition, to the extent that no industry
standard develops, the Company's products and those of its competitors may be
incompatible if they use competing standards, which could prevent or
significantly delay overall development of the market for a particular product
or products. The failure of the Company's products to comply, or delays in
compliance, with existing or evolving industry standards could have a material
adverse effect on the Company's business, financial condition and results of
operation.
The Company's long-term success will depend on its ability on a timely and
cost-effective basis to develop upgrades and updates to its existing product
offerings, to modify and enhance acquired products, and to introduce new
products which meet the needs of current and potential customers. Future
upgrades and updates may, among other things, include additional functionality,
respond to user problems or address issues of compatibility with changing
operating systems and environments. The Company believes that the ability to
provide these upgrades and updates to users frequently and at a low cost is a
key to success. For example, the proliferation of new and changing viruses makes
it imperative to update anti-virus products frequently in order for the products
to avoid obsolescence. Failure to release such upgrades and updates on a timely
basis could have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that the Company
will be successful in these efforts. In addition, future changes in Windows 95,
Windows NT, NetWare or other popular operating systems may result in
compatibility problems with the Company's products. Further, delays in the
introduction of future versions of operating systems or lack of market
acceptance of future versions of operating systems would result in a delay or a
reduction in the demand for the Company's future products and product versions
which are designed to operate with such future versions of operating systems.
The Company's failure to introduce in a timely manner new products that are
compatible with operating systems and environments preferred by desktop computer
users would have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on Revenue from Flagship Anti-Virus and Sniffer Products. In
recent years, the Company has derived a substantial majority of its net revenue
from its flagship McAfee anti-virus software products and Sniffer network fault
and performance management products. These products are expected to continue to
account for a significant portion of the Company's net revenue for the
foreseeable future. Because of this concentration of revenue, a decline in
demand for, or in the prices of, these anti-virus and network management
products as a result of competition, technological change, a change in the
Company's pricing model for such products, the inclusion of anti-virus or
network management and analysis functionality in system hardware or operating
system software or other software or otherwise, or a maturation in the
respective markets for these products could have a material adverse effect on
the Company's business, financial condition and results of operations.
Dependence on Emergence of Network Management and Network Security
Markets. The markets for the Company's network management and network security
products are evolving, and their growth depends upon broader market acceptance
of network management and network security software, including help desk
16
18
software. Although the number of LAN-attached personal computers has increased
dramatically, the network management and network security markets continue to be
emerging markets and there can be no assurance that such markets will continue
to develop or that further market development will be rapid enough to benefit
the Company significantly. In addition, there are a number of potential
approaches to network management and network security, including the
incorporation of management and security tools into network operating systems.
Therefore, even if network management and network security tools gain broader
market acceptance, there can be no assurance that the Company's products will be
chosen by organizations which acquire network management and network security
tools. Furthermore, to the extent that either the network management or network
security market does continue to develop, the Company expects that competition
will increase. See "-- Competition" and "-- Risk of Inclusion of Network
Security and Management Functionality in Hardware and Other Software."
Competition. The markets for the Company's products are intensely
competitive and the Company expects competition to increase in the near-term.
The Company believes that the principal competitive factors affecting the
markets for its products include performance, functionality, quality, customer
support, breadth of product line, frequency of upgrades and updates, integration
of products, manageability of products, brand name recognition, company
reputation and price. Certain of the criteria upon which the performance and
quality of the Company's anti-virus software products compete include the number
and types of viruses detected, the speed at which the products run and ease of
use. Certain of the Company's competitors have been in the network management
market longer than the Company, and other competitors, such as Symantec, Intel,
Seagate and HP, are larger and have greater name recognition than the Company.
The Company will also need to develop name recognition for its new name,
"Network Associates." In addition, certain larger competitors such as Intel,
Microsoft and Novell have established relationships with hardware vendors
related to their other product lines. These relationships may provide them with
a competitive advantage in penetrating the OEM market with their network
security and management products. As is the case in many segments of the
software industry, the Company has been encountering, and expects to further
encounter, increasing competition. This increased competition could reduce
average selling prices and, therefore, profit margins. Competitive pressures
could result not only in sustained price reductions but also in a decline in
sales volume, which events would materially adversely affect the Company's
business, financial condition and results of operations. In addition,
competitive pressures may make it difficult for the Company to maintain or
exceed its growth rate.
Although there is a trend toward consolidation in the network security and
management market, the market is currently highly fragmented with products
offered by many vendors. The Company's principal competitor is the Peter Norton
Group of Symantec in the network security market and Intel's LanDesk in the
network management market. The Company's other competitors include Computer
Associates/Cheyenne Software, IBM, Seagate, the Dr. Solomon Group and Trend
Micro, Inc., as well as numerous smaller companies and shareware authors that
may in the future develop into stronger competitors or be consolidated into
larger competitors. In the encryption portion of the security market, the
Company's principal competitors are Security Dynamics Technologies, Inc., Cylink
Corporation, Entrust Technologies and VeriSign, Inc. The Company's principal
competitors in the help desk market are Remedy Corporation, Software Artistry
(recently acquired by Tivoli Systems/IBM) and Magic Solutions, Inc. The
Company's principal competitor in the software-based network fault and
performance management market is HP, with other competitors including Azure
Technologies Incorporated, Concord Communications, DeskTalk Systems, Kaspia
Systems, Shomiti Systems, Inc. and Wandel & Goltermann, Inc. The Company also
faces competition in the security market from Cisco, Security Dynamics
Technologies, Inc., Checkpoint Software and other vendors in the
encryption/firewall market. In addition, the Company faces competition from
large and established software companies such as Microsoft, Intel, Novell and HP
which offer network management products as enhancements to their network
operating systems. As the network management market develops, the Company may
face increased competition from these large companies, as well as other
companies seeking to enter the market. The trend toward enterprise-wide network
management and security solutions may result in a consolidation of the network
management and security market around a smaller number of vendors who are able
to provide the necessary software and support capabilities. In addition, to the
extent that the Company is successful in developing its Net Tools suite of
products designed around a centralized management and
17
19
administration console for the Windows NT platform, the Company will likely
compete with large computer systems management companies such as Tivoli Systems
(TME) and Computer Associates (Unicenter). There can be no assurance that the
Company will continue to compete effectively against existing and potential
competitors, many of whom have substantially greater financial, technical,
marketing and support resources and name recognition than the Company. In
addition, there can be no assurance that software vendors who currently use
traditional distribution methods will not in the future decide to compete more
directly with the Company by utilizing electronic software distribution.
The competitive environment for anti-virus software internationally is
similar to that in North America, although local competitors in specific foreign
markets often present stronger competition and shareware authors control a more
significant portion of the European market. The international market for network
management software has developed more slowly than the North American market,
although larger competitors such as Intel and Symantec have begun to penetrate
European markets. Asian markets have lagged significantly behind North America
and Europe in their adoption of networking technology. There can be no assurance
that the Company will be able to compete successfully in international markets.
Need to Develop Enterprise and National Accounts Sales Force and Security
Products Sales Force; Risks Related to Direct Sales Force. In connection with
its recent acquisitions and as part of its evolving strategy of offering product
suites under the Net Tools umbrella, the Company has recently reorganized its
direct sales force into three tiers. The first tier focuses on the sale of the
full product suite under the Net Tools umbrella to enterprise and national
account customers. The second tier consists of four separate sales groups
focused on the sale of the individual product suites (i.e., McAfee Total Virus
Defense; PGP Total Network Security; Sniffer Total Network Visibility; or McAfee
Total Service Desk) to the departmental level. The third tier consists of four
separate outbound corporate telesales forces who actively market the Company's
individual product suites to customers with less than 1,000 nodes. The Company
historically has not had a large enterprise or national accounts sales force and
only recently developed a direct sales group focused on these larger accounts.
In addition, the Company has not historically had a separate sales force focused
on the sale of its suite of security products (many of which were only recently
acquired and are currently being engineered into a common suite). To succeed in
the direct sales channel for the enterprise and national accounts market and for
the sale of the separate security product suite, the Company will be required to
build a significant direct sales organization and will be required to attract
and retain qualified personnel, which personnel will require training about, and
knowledge of, product attributes for the Company's suite of products. There can
be no assurance that the Company will be successful in building the necessary
sales organization or in attracting, retaining or training these individuals.
Historically, the Company has sold its products at the departmental level. To
succeed in the enterprise and national accounts market will require, among other
things, establishing relationships and contacts with senior technology officers
at these accounts. There can be no assurance that the Company or its sales force
will be successful in these efforts.
The Company's sales organization structure may result in multiple customer
contacts by different Company sales representatives (particularly in
circumstances where the customer has multiple facilities and offices), a lack of
coordination between the Company's various sales organizations and a lack of
focus by the individual sales representatives on their designated customers or
products. The occurrence of these events could lead to customer confusion,
disputes in the sales force and lost revenue opportunities which could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, while the development of a direct sales
channel reduces the Company's dependence on resellers and distributors, it may
lead to conflicts for the same customers and further customer confusion,
pressure by current and prospective customers for price reductions on products
and, consequently, in reductions in the Company's gross margin and operating
profit.
Use of Indirect Sales Channels; Need to Develop Indirect Sales Channel for
Sniffer and PGP Security Products. The Company markets a significant portion of
its products to end-users through distributors, resellers and VARs. The
Company's distributors sell other products that are complementary to, or compete
with, those of the Company. While the Company encourages its distributors to
focus on its products through market and support programs, there can be no
assurance that these distributors will not give greater priority to products of
other suppliers, including competitors.
18
20
The Company does not have an extensive indirect sales channel for its
Network Sniffer products or its PGP security products. To succeed in the
indirect sales channel, the Company will be required to build a more extensive
network of distributors, resellers and VARs who will support and market these
products. These indirect channel participants will require significant training
about, and knowledge of, product attributes for these products and the related
product suites. There can be no assurance that the Company can successfully
establish such an indirect channel on a timely basis or at all or that such a
channel, once established, can be maintained.
The Company's agreements with its distributors provide for a right of
return. This right of return may be triggered by a number of events, including
returns to distributors by end users, inaccurate estimates of end user demand by
distributors, increased purchases by distributors in response to sales
incentives or transitions to new products or versions of products. As a result
of this right of return, revenue recognized by the Company upon sales to
distributors is subject to a reserve for returns. Returns could exceed reserves
as a result of distributors holding excessive Company product inventory. There
can be no assurance that current or future reserves established by the Company
will be adequate.
Need to Expand and Develop An Effective Professional Services Organization;
Risks Related to Third-Party Professional Services. As the Company's products
and computer networks become more complex, customers will increasingly require
greater professional assistance in the design, installation, configuration and
implementation of their networks and acquired products. To date, the Company has
relied on its limited professional services capabilities and increasingly on
outside professional service providers (including its distributors, resellers
and system integrators). There can be no assurance that third party service
providers can or will continue to be willing to provide adequate levels (both in
terms of time and quality) of professional services. Moreover, reliance on these
third parties reduces the Company's control over the provision of support
services for its products and places a greater burden on these third parties,
which, in turn, could delay the Company's recognition of product revenue, could
harm the Company's relationships or reputation with such third parties or the
end users of its products and could result in decreased future sales of, or
prices for, its products.
To more effectively service its customer's evolving needs, the Company
intends to significantly expand and develop its worldwide professional service
organization. There can be no assurance that the Company will be successful in
its efforts to expand and develop an effective professional services
organization. This will require that the Company hire and train additional
service professional who must be continually trained and educated to ensure that
they possess sufficient technical skills and product knowledge. In particular,
the market for qualified professionals is intensely competitive, making hiring
and retention difficult. The Company expects significant competition in this
market from existing providers of professional services and future entrants. The
Company must also properly price its services to attract customers, while
maintaining sufficient margins for its services. The Company expects that it
will have lower profit margins on its service revenues. The failure to develop
an effective professional services organization could have a material adverse
effect on the Company's business, financial condition and results of operations.
Reliance on Microsoft Technology. Although the Company intends to support
other operating systems, the Company's mission is to be the leading supplier of
network security and management products for Windows NT/Intel based networks.
Sales of the Company's products would be materially and adversely affected by
market developments which are adverse to the Windows operating environments,
including the failure of users and application developers to accept Windows NT.
In addition, the Company's ability to develop products using the Windows
operating environments is substantially dependent on its ability to gain timely
access to, and to develop expertise in, current and future developments by
Microsoft, of which there can be no assurance.
Risks Associated with Failure to Manage Growth. The Company's growth
internally and through its numerous acquisitions has placed, and any further
expansion would continue to place, a significant strain on its limited
personnel, management and other resources. In the future, the Company's ability
to manage any growth, particularly with the anticipated expansion of the
Company's international business and growth in indirect channel business, will
require it to attract, train, motivate and manage new employees successfully, to
19
21
effectively integrate new employees into its operations and to continue to
improve its operational, financial, management and information systems and
controls. The failure to effectively manage any further growth could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Proprietary Technology and Rights; Litigation. The Company's success is
heavily dependent upon proprietary software technology. The Company relies on a
combination of contractual rights, trademarks, trade secrets and copyrights to
establish and protect proprietary rights in its software. There can be no
assurance these protections will be adequate or that competitors will not
independently develop technologies or products that are substantially equivalent
or superior to the Company's products.
The Company recently changed its legal name to "Networks Associates, Inc."
and has recently begun conducting business as "Network Associates." The Company
believes that there are a number of other companies with similar names and,
although the Company has not been served in any suit, three companies (including
Network Associates Corporation in California and Network Associates, Inc. in
Oregon) have made claims (including various trademark claims) or demands with
respect to the Company's use of the name Network Associates. There can be no
assurance that the Company will be able to enforce rights in that name, that it
will be free to use the name in all jurisdictions, that there will be no
additional challenges to the use of that name or that it will not be required to
expend significant resources in securing the use of that name.
The Company does not typically obtain signed license agreements from its
corporate, government and institutional customers who license products directly
from it. The Company includes an electronic version of a "shrink-wrap" license
in all of its electronically distributed software and a printed license in the
box for its products distributed through traditional distribution channels in
order to protect its copyrights and trade secrets in those products. Since none
of these licenses are signed by the licensee, many authorities believe that such
licenses may not be enforceable under the laws of many states and foreign
jurisdictions. In addition, the laws of some foreign countries either do not
protect proprietary rights or offer only limited protection for those rights.
There can be no assurance that the steps taken by the Company to protect its
proprietary software technology will be adequate to deter misappropriation of
this technology. For example, the Company is aware that a substantial number of
users of its anti-virus products have not paid any registration or license fees
to the Company. Changing legal interpretations of liability for unauthorized use
of the Company's software, or lessened sensitivity by corporate, government or
institutional users to avoiding copyright infringement, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's principal assets are its intellectual property, and the
Company competes in an increasingly competitive market. There has been
substantial litigation regarding intellectual property rights of technology
companies. The Company has in the past been, and currently is, subject to
litigation related to its intellectual property (including a pending unfair
trade practice case and a patent infringement case involving Symantec and Trend
Micro Inc., respectively). There can be no assurance that there will be no
developments arising out of such pending litigation or any other litigation to
which the Company is or may become party which could have a material adverse
effect on the Company's business, financial condition and results of operation.
See "Item 3, Legal Proceedings."
In addition, as the Company may acquire a portion of software included in
its products from third parties, its exposure to infringement actions may
increase because it must rely upon such third parties as to the origin and
ownership of any software being acquired. Similarly, exposure to infringement
claims exists and will increase to the extent that the Company employs or hires
additional software engineers previously employed by competitors,
notwithstanding measures taken by them to prevent usage by such software
engineers of intellectual property used or developed by them while employed by a
competitor. In the future, litigation may be necessary to enforce and protect
trade secrets and other intellectual property rights owned by the Company. The
Company may also be subject to litigation to defend it against claimed
infringement of the rights of others or to determine the scope and validity of
the proprietary rights of others. Any such litigation could be costly and cause
diversion of management's attention, either of which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Adverse determinations in such litigation could result in the loss
of the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or prevent
the Company from manufacturing or
20
22
selling its products, any one of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
Furthermore, there can be no assurance that any necessary licenses will be
available on reasonable terms, or at all.
Risks Related to International Revenue and Activities. In 1997, 1996 and
1995, net revenue from international licenses represented approximately 28%, 24%
and 25%, respectively, of the Company's net revenue. Historically, the Company
has relied primarily upon independent agents and distributors to market its
products internationally. The Company expects that international revenues will
continue to account for a significant percentage of net revenue. The Company
also expects that a significant portion of such international revenue will be
denominated in local currencies. To reduce the impact of foreign currency
fluctuations, the Company uses non-leveraged forward currency contracts.
However, there can be no assurance that the Company's future results of
operations will not be adversely affected by such fluctuations or by costs
associated with currency risk management strategies. Other risks inherent in
international revenue generally include the impact of longer payment cycles,
greater difficulty in accounts receivable collection, unexpected changes in
regulatory requirements, seasonality due to the slowdown in European business
activity during the third quarter, tariffs and other trade barriers,
uncertainties relative to regional economic circumstances (such as the current
economic turbulence in Asia), political instability in emerging markets and
difficulties in staffing and managing foreign operations. There can be no
assurance that these factors will not have a material adverse effect on the
Company's future international license revenue. Further, in countries with a
high incidence of software piracy, the Company may experience a higher rate of
piracy of its products.
There are a number of additional risks related to the export of the Company's
PGP security products. See "-- Risks Relating to Cryptography Technology."
In addition, a portion of the Company's international revenue is expected
to continue to be generated through independent agents. Since these agents will
not be employees of the Company and will not be required to offer the Company's
products exclusively, there can be no assurance that they will continue to
market the Company's products. Also, the Company is likely to have limited
control over its agents, limited access to the names of the customers to whom
the agents sell its products and limited knowledge of the information provided
by, or representations made by, these agents to its customers.
Risk of Sabotage. Given the Company's high profile in the anti-virus
software market, the Company has been a target of computer "hackers" who have
created viruses to sabotage its products. While to date these viruses have been
discovered quickly and their dissemination has been limited, there can be no
assurance that similar viruses will not be created in the future, that they will
not cause damage to users' computer systems and that demand for the Company's
software products will not suffer as a result. In addition, since the Company
does not control diskette duplication by distributors or its independent agents,
there can be no assurance that diskettes containing the Company's software will
not be infected.
Risk of False Detection of Viruses. The Company's anti-virus software
products have in the past and may at times in the future falsely detect viruses
that do not actually exist. Such "false alarms," while typical in the industry,
may impair the perceived reliability of the Company's products and may therefore
adversely impact market acceptance of the Company's products. In addition, the
Company has in the past been subject to litigation claiming damages related to a
false alarm, and there can be no assurance that similar claims will not be made
in the future.
Risks Relating to Cryptography Technology. Certain of the Company's PGP
network security products, technology and associated assistance are subject to
export restrictions administered by the U.S. Department of State and the U.S.
Department of Commerce, which permit the export of encryption products only with
the required level of export license. In addition, these U.S. export laws
prohibit the export of encryption products to a number of countries deemed
hostile by the U.S. government. U.S. export regulations regarding the export of
encryption technology require either a transactional export license or the
granting of Department of Commerce Commodity jurisdiction. As result of this
regulatory regime, foreign competitors facing less stringent controls on their
products may be able to compete more effectively than the Company in the global
market. While the Company has obtained approval from the Department of Commerce
to export to certain end users, there can be no assurance that the U.S.
government will approve pending or future export license
21
23
requests. Further, there can be no assurance that the list of products and
countries for which export approval is required, and the regulatory policies
with respect thereto, will not be revised from time to time. Failure to obtain
the required licenses or the costs of compliance could have a material adverse
effect on the Company's international revenues.
The Company's PGP network security products are dependent on the use of
public key cryptography technology, which depends in part on the application of
certain mathematical principles known as "factoring." The security afforded by
public key cryptography technology is predicated on the assumption that the
factoring of the composite of large prime numbers is difficult. Should an easy
factoring method be developed, then the security afforded by encryption products
utilizing public key cryptography technology would be reduced or eliminated.
Furthermore, any significant advance in techniques for attacking cryptographic
systems could also render some or all of the Company's existing products and
services obsolete or unmarketable. There can be no assurance that such
developments will not occur. Moreover, even if no breakthroughs in factoring or
other methods of attacking cryptographic systems are made, factoring problems
can theoretically be solved by computer systems significantly faster and more
powerful than those presently available. If such improved techniques for
attacking cryptographic systems are ever developed, it could have a material
adverse effect on the Company's business, operating results and financial
condition.
Product Liability. The Company's anti-virus and network management software
products are used to protect and manage computer systems and networks that may
be critical to organizations and, as a result, the sale and support of these
products by the Company may entail the risk of product liability and related
claims. The Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims. It is possible, however, that the limitation of liability
provisions contained in these license agreements may not be effective under the
laws of certain jurisdictions, particularly in circumstances involving unsigned
licenses. A product liability claim brought against the Company could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Dependence upon Key Personnel. The success of the Company will depend to a
significant extent upon a number of key technical and management employees.
While employees are required to sign standard agreements concerning
confidentiality and ownership of inventions, Company employees are generally not
otherwise subject to employment agreements or to noncompetition covenants. The
loss of the services of any key employees could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company does not maintain life insurance policies on its key employees. The
ability of the Company to achieve its revenue and operating performance
objectives will depend in large part on its ability to attract and retain
technically qualified and highly skilled sales, consulting, technical, marketing
and management personnel. Competition for such personnel is intense and is
expected to remain so for the foreseeable future. There can be no assurance the
Company will be successful in retaining its existing key personnel and in
attracting and retaining the personnel it requires, and failure of the Company
to retain and grow its key employee population could adversely affect the
Company's business and operating results. Further, additions of new and
departures of existing personnel, particularly in key positions, can be
disruptive and can result in departures of existing personnel, which could have
a material adverse effect upon the Company's business, operating results and
financial condition.
Customer Purchase Decisions; Potentially Longer Sales and Implementation
Cycles for Certain Products Suites. The products offered by the Company may be
considered to be capital purchases by certain customers or prospective
customers. Capital purchases are often considered discretionary and, therefore,
are canceled or delayed if the customer experiences a downturn in its business
or prospects or as a result of economic conditions in general. Any such
cancellation or delay could adversely affect the Company's results of
operations. In addition, as the Company proceeds with its strategy of selling
product suites under the Net Tools umbrella (particularly to larger enterprise
and national accounts), its sales cycle is likely to lengthen. Such sales may
involve a lengthy education process and a significant technical evaluation and
commitment of capital and other resources and may be subject to the risk of
delays associated with customers' internal budget and other procedures for
approving large capital expenditures, deploying new technologies within their
networks and testing and accepting new technologies that affect key operations.
Because of the potentially
22
24
lengthy sales cycle and the potentially large size of such orders, if orders
forecasted for a specific customer for a particular quarter are not realized or
revenues are not otherwise recognized in that quarter, the Company's operating
results for that quarter could be materially adversely affected. See
"-- Variability of Quarterly Operating Results" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. Although the Company
believes that its products and systems are Year 2000 compliant, the Company
utilizes third-party equipment and software that may not be Year 2000 compliant.
Failure of such third-party equipment or software to operate properly with
regard to the Year 2000 and thereafter could require the Company to incur
unanticipated expenses to remedy any problems, which could have a material
adverse effect on the Company's business, operating results and financial
condition. The business, operating results and financial condition of the
Company's customers could be adversely affected to the extent that they utilize
third-party software products which are not Year 2000 compliant. Furthermore,
the purchasing patterns of customers or potential customers may be affected by
Year 2000 issues as companies expend significant resources to correct their
current systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase products and services such as those offered
by the Company, which could have a material adverse effect on the Company's
business, operating results and financial condition.
Supplier Dependence; Third Party Manufacturing. Certain of the Company's
products contain critical components supplied by a single or a limited number of
third parties. The Company has been required to purchase and inventory certain
of the computer platforms around which it designs its network fault and
performance management products to ensure an available supply of the product for
its customers. Any significant shortage of these platforms or other components
or the failure of the third party supplier to maintain or enhance these products
could lead to cancellations of customer orders or delays in placement of orders
which could materially adversely affect the Company's results of operations. If
the Company's purchase of such components or platforms exceeds demand, the
Company could incur losses or other charges in disposing of excess inventory,
which could also materially adversely affect the Company's results of
operations.
The Company's manufacturing operations consist primarily of final assembly,
testing and quality control of materials, components, subassemblies and systems
for its Sniffer based products. The Company intends to outsource these
manufacturing operations in 1998. There can be no assurance that the Company
will be able to qualify and secure on commercially acceptable terms satisfactory
third party manufacturers on a timely basis or at all. In addition, reliance on
third party manufacturers will involve a number of risks, including the lack of
direct control over the manufacturing process, the absence or unavailability of
adequate capacity and reduced control over delivery schedules, quality control
and costs. In the event that, once initially secured, the Company's third party
manufacturers are unable or unwilling to continue to manufacture the Sniffer
based products in required volumes, on a cost effective basis, in a timely
manner or at all, the Company will have to secure additional manufacturing
capacity. Even if such additional capacity is available at commercially
acceptable terms, the qualification process could be lengthy and could create
delay in product shipments.
Possible Price Volatility of Common Stock. The trading price of the
Company's Common Stock has historically been, and is expected to be, subject to
wide fluctuations. The market price of the Common Stock may be significantly
impacted by quarterly variations in financial performance, shortfalls in revenue
or earnings from levels forecast by securities analysts, changes in estimates by
such analysts, market conditions in the computer software or hardware
industries, product introductions by the Company or its competitors,
announcements of extraordinary events such as acquisitions or litigation or
general economic conditions. Statements or changes in opinions, ratings, or
earnings estimates made by brokerage firms or industry analysts relating to the
market in which the Company does business or relating to the Company
specifically could result in an immediate and adverse effect on the market price
of the Common Stock. In addition, in recent years the stock market has
experienced extreme price and volume fluctuations. These fluctuations have had a
substantial effect on the market prices for many high technology and emerging
growth companies, often
23
25
unrelated to the operating performance of the specific companies. There can be
no assurances that the market price of the Common Stock will not decline below
the levels prevailing at the time of this offering. Securities class action
lawsuits are often brought against companies following periods of volatility in
the market price of their securities. Any such litigation against the Company
could result in substantial costs and a diversion of resources and management
attention.
Effect of Certain Provisional Anti-Takeover Effects of Certificate of
Incorporation, Bylaws and Delaware Law. The board of directors of the Company
has the authority to issue up to 5,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, privileges and restrictions, including
voting rights, of those shares without any further vote or action by its
stockholders. The rights of the holders of Company Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of the outstanding voting stock. Further,
certain provisions of Delaware law and the Company's Certificate of
Incorporation and Bylaws, such as a classified board, could delay or make more
difficult a merger, tender offer or proxy contest involving the Company. While
such provisions are intended to enable the Company's Board to maximize
stockholder value, they may have the effect of discouraging takeovers which
could be in the best interest of certain stockholders. There is no assurance
that such provisions will not have an adverse effect on the market value of the
Company's Common Stock.
ITEM 2. PROPERTIES
The Company's headquarters currently occupy approximately 62,000 square
feet in facilities located in Santa Clara, California under leases expiring in
2000. As a result of the merger with Network General, the Company now also
maintains administrative marketing, manufacturing and product development
facilities consisting of some 170,000 square feet in Menlo Park, California. The
Company occupies this space under lease agreements that expire no later than
June 2002. The Company also maintains regional offices in New Jersey, Virginia
and Texas as well as development facilities in Illinois and Oregon. The Company
also leases space to maintain several domestic and foreign sales offices.
The Company presently intends to relocate its headquarters to larger
facilities in Santa Clara, California. To that end, the Company has agreed, as
the assignee of certain rights of the existing tenant, to rent a facility of
approximately 200,000 square feet commencing on or about April 1, 1988. The
underlying lease is set to expire in 2013. The Company believes that these
facilities, together with its existing facilities, are adequate for the present
and that additional space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
The Company's principal assets are its intellectual property, and the
Company competes in an increasingly competitive market. There has been
substantial litigation regarding intellectual property rights of technology
companies. The Company has in the past been, and currently is, subject to
litigation related to its intellectual property. There can be no assurance that
there will be no developments arising out of such pending litigation or any
other litigation to which the Company is or may become party which could have a
material adverse effect on the Company's business, financial condition and
results of operation.
On April 24, 1997, the Company was served by Symantec with a suit filed in
the United States District Court, Northern District of California, San Jose
Division, alleging copyright infringement and unfair competition by the Company.
Symantec alleges that the Company's computer software program called "PC Medic"
copied portions of Symantec's computer software program entitled "CrashGuard."
Symantec's complaint sought injunctive relief and unspecified money damages. On
July 20, 1997, Symantec sought leave to amend its complaint to include
additional allegations of copyright infringement and trade secret
misappropriation pertaining to the Company's "VirusScan" product. Symantec
sought injunctive relief and unspecified money damages. On October 6, 1997, the
Court issued an order granting Symantec's motion to amend its complaint and
enjoining the Company from shipping any product containing either an approxi-
24
26
mately 30-line routine found in Crash Guard or an approximately 100-line routine
found in a Symantec DLL. The Court's order expressly stated that "the court is
not enjoining the sale or distribution of [McAfee's] current product." On
December 19, 1997, the Court denied Symantec's motion to enjoin sale or
distribution of the Company's current PC Medic product. On February 11, 1998,
Symantec filed another motion seeking leave to again amend its complaint to
include additional allegations of trade secret misappropriation, interference
with economic advantage and business relations and violations of the Racketeer
Influenced and Corrupt Organization Act ("RICO"), in connection with the alleged
use at the Company by a former Symantec employee of allegedly proprietary
Symantec customer information. Symantec also filed a motion for a preliminary
injunction relating to these new allegations, and has scheduled both motions for
hearing on May 15, 1998. Trial is currently set for September 1998.
On May 13, 1997, Trend Micro, Inc. ("Trend") filed suit in United States
District Court for the Northern District of California against both the Company
and Symantec. Trend alleges that the Company's "WebShield" and "GroupShield"
products infringe a Trend patent which issued on April 22, 1997. Trend's
complaint seeks injunctive relief and unspecified money damages. On June 6,
1997, the Company filed its answer denying any infringement. The Company also
filed a counterclaim against Trend alleging unfair competition, false
advertising, trade libel, and interference with prospective economic advantage.
On September 19, 1997, Symantec filed a motion to sever Trend's action against
the Company from its action against Symantec. The Company did not oppose
Symantec's motion to sever, other than to recommend a joint hearing on patent
claim interpretation. On December 19, 1997, the Court granted Symantec's motion
to sever and adopted the Company's recommendation regarding a joint hearing on
patent claim interpretation. As a result of the Court's decision, Trend's
actions against the Company and Symantec will proceed separately. The exact
terms of the severance order have not yet been approved by the Court, and the
Court has yet to reset key dates for discovery and trial in the two cases. The
Company anticipates that the Court will shortly reset the date for the joint
patent claim interpretation hearing for late June or July, 1998. Thirty days
after the joint patent claim interpretation hearing, the Court has indicated it
will set further dates for discovery and trial.
On May 6, 1997, RSA Data Security, Inc. ("RSA") filed a lawsuit against
PGP, a wholly owned subsidiary of the Company since December 9, 1997, in San
Mateo County Superior Court. RSA seeks a declaration from the court that certain
paragraphs of a license agreement between PGP and Public Key Partners (the
"License Agreement") have been terminated and certain other paragraphs have
survived RSA's purported termination of the License Agreement. RSA, which
purports to act on behalf of Public Key Partners, also seeks an accounting of
PGP's sales of products subject to the License Agreement. PGP denies that RSA
has the authority to act on behalf of Public Key Partners, and denies that the
License Agreement has been breached or terminated in whole or in part. On May
22, 1997, PGP filed a motion to compel arbitration of the action pursuant to an
arbitration clause in the License Agreement. PGP's motion was granted on October
9, 1997. The Court stayed the state court proceedings and ordered the action to
arbitration. The arbitration proceedings are in the preliminary stages.
On October 14, 1997, RSA filed a patent infringement lawsuit against PGP in
the United States District Court for the Northern District of California. RSA
alleges PGP has infringed one of the patents which was licensed to PGP under the
License Agreement. On November 4, 1997, PGP moved to stay the federal action,
or, in the alternative, compel it to arbitration. On December 23, 1997, RSA
filed a motion to amend its complaint to include the Company as defendant. PGP's
motion to stay and RSA's motion to amend its complaint are scheduled to be heard
by the federal court in February 1998.
On September 15, 1997, the Company was named as a defendant in a patent
infringement action filed by Hilgraeve Corporation ("Hilgraeve") in the United
States District Court, Eastern District of Michigan. Hilgraeve alleges that the
Company's VirusScan product infringes a Hilgraeve patent which was issued on
June 7, 1994. Hilgraeve's action seeks injunctive relief and unspecified money
damages. The case is in discovery.
Although the Company has not been served in any suit, three companies
(including Network Associates Corporation in California and Network Associates,
Inc. in Oregon) have made claims (including various trademark claims) or demands
with respect to the Company's use of the name Network Associates.
25
27
Although the Company intends to defend itself vigorously against the claims
asserted against it in the foregoing actions or matters, there can be no
assurance that such pending litigation will not have a material adverse effect
on the Company's business, financial condition or operating results. The
litigation process is subject to inherent uncertainties and no assurance can be
given that the Company will prevail in any such matters, or will be able to
obtain licenses, on commercially reasonable terms, or at all, under any patents
or other intellectual property rights that may be held valid or infringed by the
Company or its products. Uncertainties inherent in the litigation process
involve, among other things, the complexity of the technologies involved,
potentially adverse changes in the law and discovery of facts unfavorable to the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At a Special Meeting of Stockholders of the Company on December 1, 1997,
the following matters were acted upon by the stockholders of the Company:
1. The approval of the issuance of Company Common Stock to the
stockholders of Network General Corporation ("Network General") pursuant to
the Agreement and Plan of Reorganization, dated as of October 13, 1997, as
amended by the First Amendment thereto dated as of October 22, 1997, among
the Company, Network General and Mystery Acquisition Corp., a wholly-owned
subsidiary of the Company, providing for the merger of Mystery Acquisition
Corp. with and into Network General (the "Network General Merger");
2. The approval of an amendment to the Company's Second Restated
Certificate of Incorporation (the "Certificate") to change the corporate
name of the Company to "Network Associates, Inc.," or, if that name was
unavailable, to "Networks Associates, Inc." (and not to "Network
Associates, Inc.");
3. The approval of an amendment to the Company's Certificate
increasing the number of authorized shares of the Company's Common Stock by
200,000,000 shares to 300,000,000 shares; and
4. The approval of an amendment to the Company's 1997 Stock Incentive
Plan to (a) increase the number of shares of Company Common Stock
authorized thereunder by 3.4 million shares to 5.85 million shares and (b)
eliminate the ability of the Company's Board of Directors (the "Board") to
grant options thereunder with an exercise price less than the fair market
value of the Company's Common Stock on the date of grant.
The number of shares of Common Stock outstanding and entitled to vote at
the Special Meeting was 51,403,965, and 46,895,610 shares were represented in
person or by proxy. The results of the voting on each of the matters presented
to stockholders at the Special Meeting are set forth below:
VOTES BROKER
VOTES FOR AGAINST ABSTENTIONS NON-VOTES
---------- ---------- ----------- ---------
1. Share Issuance in connection with Network
General Merger................................. 38,448,089 383,477 83,600 7,980,444
2. Amendment to Company Certificate -- Name
Change......................................... 41,220,333 435,766 86,221 5,153,290
3. Amendment to Company Certificate -- Authorized
Capital Increase............................... 32,785,856 14,023,191 86,563 --
4. Amendment to Company's 1997 Stock Incentive
Plan........................................... 24,126,526 14,926,148 102,841 7,740,095
26
28
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
Since the Company's Common initial public offering on October 6, 1992, the
Company's Common Stock has traded on the NASDAQ National Market. Since the
combination with Network General Corporation on December 1, 1997, the Company's
Common Stock has traded under the symbol NETA. Prior thereto, the Company's
Common Stock traded under the symbol MCAF. The following tables set forth, for
the period indicated, the high and low closing sales prices for the Common Stock
for the last eight quarters, all as reported by NASDAQ. The prices appearing in
the tables below reflect over the counter market quotations which reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
necessarily represent actual transactions.
HIGH LOW
------ ------
YEAR ENDED DECEMBER 31, 1997
First Quarter.......................................... $64.50 $38.50
Second Quarter......................................... 68.50 42.25
Third Quarter.......................................... 77.75 49.50
Fourth Quarter......................................... 66.38 44.56
YEAR ENDED DECEMBER 31, 1996
First Quarter.......................................... $28.50 $14.33
Second Quarter......................................... 35.00 23.78
Third Quarter.......................................... 46.92 30.83
Fourth Quarter......................................... 52.50 41.75
Per share amounts have been restated to give effect retroactively to three
separate stock dividends, which each effected a three-for-two stock split, in
October 1995, April 1996 and October 1996.
On December 1, 1997, the Company acquired all the outstanding stock in
Helix through a merger in which the Company issued an aggregate of 550,000
shares of Company Common Stock to the shareholders of Helix. The transaction was
exempt from the registration requirements of Section 5 of the Securities Act
pursuant to Section 4(2).
On December 9, 1997, the Company acquired PGP through a merger in which the
Company paid an aggregate consideration of approximately $35 million in cash
(including the assumption of certain liabilities) and issued warrants to acquire
250,000 shares of Company Common Stock to the Series B Preferred shareholders of
PGP. The warrants to purchase up to an aggregate of 250,000 shares are
exercisable for a purchase price of $60.00 per share and expire, subject to
certain extensions, on June 5, 1999. The transaction was exempt from the
registration requirements of Section 5 of the Securities Act pursuant to Section
4(2).
DIVIDEND POLICY
The Company has not paid any cash dividends since its reorganization into a
corporate form in October 1992. The Company intends to retain future earnings
for use in its business and does not anticipate paying cash dividends in the
foreseeable future.
27
29
ITEM 6. SELECTED FINANCIAL DATA
On December 1, 1997, the Company acquired Network General Corporation in a
transaction accounted for as a pooling of interests. Accordingly the financial
statements have been restated for all periods presented.
Network General had a fiscal year ended March 31. Restated financial
statements combine the Network General results for the fiscal years ended March
31, 1997 and 1996 with the Company's results for the years ended December 31,
1996 and 1995, respectively. In order to conform Network General's fiscal year
end to the Company's fiscal year end, the consolidated statement of operations
for the year ended December 31, 1997 includes the three months ended March 31,
1997 for Network General which is also included in the consolidated statement of
income for the year ended December 31, 1996. Revenue and net loss of Network
General for such period were $68.0 million and $6.4 million, respectively.
YEARS ENDED DECEMBER 31,
----------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
STATEMENTS OF OPERATIONS DATA:
Net revenue............................... $612,193 $421,794 $278,910 $192,692 $145,939
Income from operations.................... 18,221 105,846 59,696 35,053 27,265
Income before provision for income
taxes................................... 32,964 115,394 68,495 41,254 31,397
Net income (loss)......................... $(28,356) $ 64,110 $ 42,341 $ 28,016 $ 19,782
Net income (loss) per share -- diluted.... $ (0.41) $ 0.89 $ 0.62 $ 0.43 $ 0.32
Shares used in per share
calculation -- diluted.................. 68,748 72,221 68,693 64,771 61,768
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
BALANCE SHEET DATA:
Working capital........................... $201,286 $246,671 $180,673 $133,130 $ 88,451
Total Assets.............................. 601,931 457,756 327,350 269,947 204,941
Deferred revenue and taxes................ 82,650 58,921 53,584 48,149 34,256
Total equity.............................. 359,759 328,923 243,659 202,498 150,272
28
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
Fiscal Years Ended December 31, 1997, 1996 and 1995
The following table sets forth for the periods indicated the percentage of
net revenue represented by certain items in the Company's Statements of
Operations.
YEARS ENDED DECEMBER
31,
---------------------
1997 1996 1995
--- --- ---
Net revenue:
Product.............................................................. 83% 82% 90%
Services and support................................................. 17 18 10
Total revenue.......................................................... 100 100 100
Cost of revenue:
Product.............................................................. 13 14 14
Services and support................................................. 5 5 4
Total cost of revenue.................................................. 18 19 18
Operating costs and expenses:
Research and development............................................. 14 12 13
Marketing and sales.................................................. 29 29 33
General and administrative........................................... 7 7 7
Amortization of intangibles.......................................... -- 1 1
Acquisition and other related costs.................................. 29 7 7
--- --- ---
Total operating costs and expenses........................... 79 56 61
Income from operations....................................... 3 25 21
Interest and other income, net......................................... 2 2 3
--- --- ---
Income before provision for income taxes..................... 5 27 24
Provision for income taxes............................................. 10 12 9
--- --- ---
Net income (loss)............................................ (5)% 15% 15%
=== === ===
Net Revenue. Net revenue increased 45% to $612.2 million in 1997 from
$421.8 million in 1996, and 51% from $278.9 million in 1995. The increases in
net revenue are due to the increases in product revenue and services and support
revenues described below.
Product revenue increased 49% to $510.8 million from $343.9 million in
1996, and 36% from $252.2 million in 1995. The increase in the growth rate in
product revenues was primarily due to increases in the licensing of anti-virus
software products to new customers, renewing expiring anti-virus licenses,
continued acceptance of the Company's Sniffer products and continued acceptance
of the Company's consulting and support services. The increase is also
attributable to a lessor extent to the licensing of products (other than
anti-virus and Sniffer products) to new and existing customers as well as
expansion into indirect product distribution channels and international markets.
Finally, changes in 1995 in the Company's anti-virus revenue recognition
described below contributed to the increase in product revenue in both 1996 and
1995.
Prior to July 1, 1995 revenue from subscription licenses for anti-virus
software was recognized ratably over a two year period as the Company did not
separately sell the product license and maintenance. Effective July 1, 1995, the
Company began to sell these components separately and currently recognizes, upon
the initial sale, 80% of the total fee as product license revenue and defers 20%
of the fee as maintenance. The maintenance fee is recognized over the service
period, generally two years.
As a result of the change in revenue recognition for anti-virus licenses in
July 1995, period-to-period results are not directly comparable and should not
be relied upon as indicative of future performance. As a decreasing percentage
of the Company's net revenue is attributable to the recognition of previously
deferred anti-virus revenue, the Company's net revenue in future periods may be
subject to greater fluctuations. In
29
31
addition to generating net revenue through licenses, the Company sells certain
of its network security and management products with shrink-wrap licenses
through traditional distribution channels. The Company recognizes revenue from
sales to distributors upon shipment, subject to a reserve for returns.
Services and support revenues include revenues from software support,
maintenance contracts, education and consulting services, as well as those
revenues from warranty, customer support and maintenance contracts which are
deferred and recognized over the related service period. Service revenues
increased 30% to $101.4 million in 1997 from $77.9 million in 1996 and 192% from
$26.7 million in 1995. The increase in services and support revenues resulted
from growth in all categories of service revenues, principally due to the growth
of the installed customer base and the resulting renewal of maintenance
contracts. The high growth from 1995 to 1996 was due primarily to the Company
initiating consulting and support services relating to the anti-virus and
network security software products.
Although the Company has had significant growth in net revenue and net
income (before acquisition and other related charges), the Company's growth rate
has slowed in recent periods. The Company has experienced increased price
competition for its products and the Company expects competition to increase in
the near-term, which may result in reduced average selling prices for the
Company's products. Due to these and factors such as a maturing anti-virus
market and an increasingly higher base from which to grow, the historic revenue
growth rate will be difficult to sustain or increase. To the extent these trends
continue, the Company's results of operations could be materially adversely
affected. Renewals have historically accounted for a significant portion of the
Company's net revenue; however, there can be no assurance that the Company will
be able to sustain historic renewal rates for its products in the future. Risks
related to the Company's change in business strategies, including its newly
introduced suite pricing model and its development of a two-year subscription
licensing model for the Company's Sniffer products and a software only version
of the Company's Sniffer products, could also cause fluctuations in the
Company's operating results and could make comparisons with historic operating
results and balances difficult. To more effectively service its customer's
evolving needs, the Company also intends to significantly expand and develop its
worldwide professional service organization. The Company expects that it will
have lower profit margins on its service revenues relative to licensing
revenues. See "Risk Factors -- Variability of Quarterly Operating Results,"
"-- Risks Related to Certain Business Strategies" and "-- Need to Expand and
Develop An Effective Professional Services Organization; Risks Related to
Third-Party Professional Services".
Although the Company believes that its products and systems are Year 2000
compliant, the Company's revenues and results of operations and financial
condition may be adversely impacted by, among other things, failure of third
party equipment and software utilized by the Company to be Year 2000 compliant
and the potential adverse impact of Year 2000 compliance on its customers
purchasing patterns and availability of resources to acquire Company products.
See "Risk Factors -- Year 2000 Compliance."
International revenue accounted for approximately 28%, 24% and 25% of net
revenue for 1997, 1996 and 1995, respectively. The increase in international net
revenue as a percentage of net revenue from 1996 to 1997 was due primarily to
increased acceptance of the Company's products in international markets and the
continued investment in international operations. The decrease from 1995 to 1996
was due primarily to domestic revenue growing at a faster rate than
international revenue. The Company also expects that a significant portion of
such international revenue will be denominated in local currencies. To reduce
the impact of foreign currency fluctuations, the Company uses non-leveraged
forward currency contracts. However, there can be no assurance that the
Company's future results of operations will not be adversely affected by such
fluctuations or by costs associated with currency risk management strategies.
Other risks inherent in international revenue generally include the impact of
longer payment cycles, greater difficulty in accounts receivable collection,
unexpected changes in regulatory requirements, seasonality due to the slowdown
in European business activity during the third quarter, tariffs and other trade
barriers, uncertainties relative to regional economic circumstances (such as the
current economic turbulence in Asia), political instability in emerging markets
and difficulties in staffing and managing foreign operations. There can be no
assurance that these factors will not have a material adverse affect on the
Company's future international license revenue. Further, in countries with a
high incidence of software piracy, the Company may experience a higher rate of
30
32
piracy of its products. There are a number of additional risks related to the
export of the Company's PGP security products.
Cost of Revenue. Cost of revenue increased 41% to $108.2 million in 1997
from $76.9 million in 1996, and 58% from $48.7 million in 1995. The increases in
net revenue are due to the increases in cost of product revenue and cost of
services and support revenue described below.
The Company's cost of product revenue consists primarily of the cost of
media, manuals and packaging for products distributed through traditional
channels, royalties and, with respect to certain Sniffer products, computer
platforms and other hardware components. Cost of product revenues increased 35%
to $77.7 million in 1997 from $57.6 million in 1996. From 1995 to 1996 cost of
product revenues increased 52% from $37.9 million. The increase in cost of
product revenues from 1996 to 1997 was primarily due to a corresponding increase
in product revenues. The increase in cost of product revenues from 1995 to 1996
was due to an increase in product revenues as well as the increase in sales of
third party computer platforms and other hardware components as part of certain
Sniffer products, which have a lower gross margin than the Company's other
products. As a percentage of net product revenue, cost of product revenue was
15% in 1997 and 17% in 1996 and 15% in 1995.
Cost of services and support revenue consists principally of salaries and
benefits related to employees providing customer support and consulting
services. In 1997, cost of services and support revenue increased 58% to $30.5
million from $19.4 million in 1996. From 1995 to 1996, cost of services and
support revenues increased 78% from $10.8 million. These increases are due to
increases in net revenue as well as the initial investment in the anti-virus
professional services organization. Costs increased at a higher rate than
revenue due to the shift in the mix of support and professional services revenue
versus revenue from warranty and maintenance contracts previously deferred. Cost
of services and support revenue as a percentage of net services and support
revenue was 30% in 1997, 25% in 1996 and 41% in 1995.
The Company intends to expand its professional services organization which
is expected to cause the cost of services and support revenue to increase in
absolute dollars and may cause such expenses as a percentage of net revenue to
increase. To the extent that the percentage of the Company's net revenue which
is generated through traditional distribution channels increases, the Company's
cost of net revenue will increase and, accordingly, gross margins will decrease.
In addition, to the extent that the Company increases its reliance on retail
distribution, it may encounter problems related to product returns and limited
shelf space availability.
Research and Development. Research and development expenses consist
primarily of salary and benefits for the Company's development and technical
support staff. Research and development expenses increased 63% to $85.0 million
in 1997 from $52.2 million in 1996. From 1995 to 1996, research and development
expenses increased 42% from $36.8 million. These increases were primarily a
result of the expansion of the Company's product development and technical
support staff and, to a lesser extent, the increased use of independent
contractors. As a percentage of net revenue, research and development expenses
increased to 14% in 1997 from 12% in 1996. Research and development spending
decreased as a percentage of net revenue in 1996 from 13% in 1995. Although in
absolute dollars, research and development spending increased, as a percentage
of net revenue research and development expenses decreased due to a higher rate
of increase in net revenue. The Company anticipates that research and
development expenses will continue to increase in absolute dollars, but may
fluctuate as a percentage of net revenue.
The Company believes that its ability to maintain its competitiveness will
depend in large part upon its ability to enhance existing products, develop and
acquire new products and develop and integrate acquired products. The market for
computer software is characterized by low barriers to entry and rapid
technological change, and is highly competitive with respect to timely product
introductions. The timing and amount of research and development expenses may
vary significantly based upon the number of new products and significant
upgrades under development and products acquired during a given period.
Marketing and Sales. Marketing and sales expenses consist primarily of
salary, commissions and benefits for marketing, sales and customer support
personnel and costs associated with advertising and promotions. Marketing and
sales expenses increased 48% to $181.0 million in 1997 from $122.6 million in
31
33
1996. From 1995 to 1996, marketing and sales expenses increased 33% from $92.3
million in 1995. These increases were primarily the result of an increase in
marketing and sales personnel and, to a lesser extent, increased advertising and
promotional activities required to support increased sales volumes and expanding
product lines. As a percentage of net revenue, marketing and sales expense was
29% in 1997 and 1996 a decrease from 33% in 1995. Although in absolute dollars,
marketing and sales spending increased from 1995 to 1996, as a percentage of net
revenue these expenses decreased due to a higher rate of growth in net revenue.
The Company is seeking to expand the breadth and depth of its product suites.
Such expansion, together with the Company's efforts to build brand identity
under its new corporate name are expected to contribute to a further increase in
marketing and sales expenses in absolute dollars, which expenses may fluctuate
as a percentage of net revenue.
General and Administrative. General and administrative expenses consist
principally of salary and benefit costs for administrative personnel and general
operating costs. General and administrative costs increased 42% to $43.1 million
in 1997 from $30.3 million in 1996. From 1995 to 1996, general and
administrative expenses increased 51% from $20.1 million. The increase in 1997
is largely a result of a increased staffing to support operations both
domestically and internationally and to accommodate the growth in revenue. As a
percentage of net revenue, general and administrative expenses were 7% in 1997,
1996 and 1995. The Company intends to continue to make investments in its
finance and administrative infrastructure, and, as a result, expects general and
administrative expenses will increase in absolute dollars, but may fluctuate as
a percentage of net revenue.
Acquisition and Other Related Costs. In connection with the Network General
merger, the Company incurred direct transaction costs of approximately $15
million consisting of fees for investment bankers, attorneys, accountants,
financial printing and other related charges. These costs have been charged to
operations in December 1997. The Company has also incurred restructuring charges
of approximately $69.2 million in connection with the merger and the
acquisitions of Helix, Paradigm Agency Pty Ltd. and PGP. These restructuring
costs relate to the closure and elimination of duplicate leased facilities, the
write-off of inventory associated with duplicate and discontinued product,
repackaging of product, the write-off of impaired assets and severance costs
related to terminated employees. In addition, $18 million of restructuring costs
relate to the write-off of contingent payments associated with the acquisition
of Cinco Networks, Inc. ("Cinco") by Network General. The Company also wrote off
$73.6 million of acquired in-process research and development in 1997 in
connection with the acquisitions of PGP, Cinco and 3DV Technology, Inc. ("3DV").
In 1996, the Company wrote off $19.5 million of acquired in-process
technology in connection with the acquisition of 3DV and also expensed $9.0
million and $2.1 million in connection with the acquisitions of Vycor and
Interactive Distributed Systems Software GmbH, respectively.
In 1995, the Company wrote off $7.1 million of acquired in-process
technology in connection with the acquisition of AIM Technology and expensed
$6.8 million, $1.6 million and $2.5 million in connection with the acquisitions
of Saber, Assurdata and IPE, respectively. Also in 1995, the Company expensed
$1.9 million in connection with the acquisition of distribution rights from
three German distribution entities.
The software industry has experienced and is expected to continue to
experience a significant amount of consolidation. In addition, it is expected
that the Company will grow internally and through strategic acquisitions in
order, among other things, to expand the breadth and depth of its product suites
and to build its professional services organization. The Company continually
evaluates potential acquisitions of complementary businesses, products and
technologies. Any acquisition, depending on its size, could result in the use of
a significant portion of the Company's available cash or, if such acquisition is
made utilizing the Company's securities, could result in significant dilution to
the Company's stockholders, and could result in the incurrence of significant
acquisition related charges to earnings. Acquisitions by the Company may result
in the incurrence or the assumption of liabilities, including liabilities that
are unknown or not fully known at the time of acquisition, which could have a
material adverse effect on the Company. Furthermore, there can be no assurance
that any products acquired in connection with any such acquisition will gain
acceptance in the Company's markets or that the Company will obtain the
anticipated or desired benefits of such transactions.
32
34
See "Risk Factors -- Risks Associated with Recent Acquisitions" and "-- Risks
Associated with Acquisitions Generally."
Interest and Miscellaneous Income. Interest and miscellaneous income
increased to $14.7 million in 1997 from $9.5 million in 1996 and $8.8 million in
1995. Interest and miscellaneous income increased from 1996 to 1997 and from
1995 to 1996 due to the investment of cash generated from operating activities.
Provision for Income Taxes. The Company's effective tax rate for 1997, 1996
and 1995 was 186%, 44% and 38% respectively. The Company's effective tax rate
for 1997 and 1996 was 38% and 36% respectively, excluding the effect of one-time
non-deductible in-process research and development, merger and other acquisition
costs.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had $123.5 million in cash and cash
equivalents and $233.1 million in marketable securities, for a combined total of
$356.6 million.
Net cash provided by operating activities was $90.7 million, $99.3 million
and $50.4 million in 1997, 1996 and 1995, respectively. Net cash provided by
operating activities in 1997 consisted primarily of net income before
acquisition costs, plus increases in accounts payable and accrued liabilities
and deferred revenue which were offset primarily by an increase in accounts
receivable and deferred taxes. In 1996, net cash provided by operating
activities consisted primarily of net income plus accounts payable and accrued
liabilities which was offset primarily by increases in accounts receivable and
deferred taxes. In 1995, net cash provided by operating activities consisted
primarily of net income, accounts payable and accrued liabilities and deferred
revenue offset primarily by increases in accounts receivable and a decrease in
refundable income taxes.
The Company expects its accounts receivable balance as a percentage of
sales to increase due to the Company's increased emphasis on international sales
(typically having longer payment terms) and the Company's emphasis on licensing
its network security and management product suites to enterprise customers
(which complex products may require longer installation and implementation
cycles, in turn resulting in potentially longer payment cycles). Increased
licensing through the indirect channel may also impact the Company's receivable
collection experience due to the longer payment cycle for VARs and system
integrators. To address this increase in accounts receivable and to improve cash
flow, the Company may, among other things, take actions to encourage earlier
payment of receivables or sell receivables. To the extent d that the Company's
receivable balance increases, the Company will be subject to greater general
credit risks with respect thereto.
Net cash used in investing activities was $134.7 million, $58.9 million and
$24.2 million in 1997, 1996 and 1995, respectively, primarily reflecting
investments in acquisitions and mergers, purchases of marketable securities and
additions to fixed assets and intangible assets.
Net cash provided by financing activities was $43.4 million and $20.2
million in 1997 and 1996 consisting primarily of the proceeds and tax benefits
associated with the exercise of non-qualified stock options. Net cash used in
financing activities in 1995 was $1.2 million consisting primarily of the
repurchase of common stock offset by the tax benefits associated with the
exercise of non-qualified stock options.
The Company believes that its available cash and anticipated cash flow from
operations will be sufficient to fund the Company's working capital and capital
expenditure requirements for at least the next twelve months.
FINANCIAL RISK MANAGEMENT
The following discussion about the Company's risk management activities
includes "forward-looking statements" that involve risks and uncertainties.
Actual results could differ materially from those projected in the
forward-looking statements.
As a global concern, the Company faces exposure to adverse movements in
foreign currency exchange rates. These exposures may change over time as
business practices evolve and could have a material adverse impact on the
Company's financial results. Historically, the Company's primary exposures
related to
33
35
nondollar-denominated sales and operating expenses in Japan, Canada, Australia,
Europe, Latin America, and Asia. The Company has recently expanded its business
activities in Europe. As a result, the Company expects to see an increase in
exposures related to nondollar-denominated sales in several European currencies.
At the present time, the Company hedges only those currency exposures associated
with certain assets and liabilities denominated in nonfunctional currencies and
does not generally hedge anticipated foreign currency cash flows. The hedging
activity undertaken by the Company is intended to offset the impact of currency
fluctuations on certain nonfunctional currency assets and liabilities. The
success of this activity depends upon estimates of transaction activity
denominated in various currencies, primarily the Japanese yen, Canadian dollar,
Australian dollar, and certain European currencies. To the extent that these
estimates are over- or understated during periods of currency volatility, the
Company could experience unanticipated currency gains or losses.
The Company maintains investment portfolio holdings of various issuers,
types and maturities. These securities are generally classified as
available-for-sale, and consequently are recorded on the balance sheet at fair
market value with unrealized gains and losses reported as a separate component
of shareholders' equity. These securities are not leveraged and are held for
purposes other than trading.
The following tables present the hypothetical changes in fair values in the
securities held by the Company at December 31, 1997 that are sensitive to the
changes in interest rates. The modeling technique used measures the change in
fair market values arising from hypothetical parallel shifts in the yield curve
of plus or minus 50 basis points "BPS", 100 BPS and 150 BPS over six and
twelve-month time horizons. Beginning fair market values represent the market
principal plus accrued interest and dividends at December 31, 1997. Ending fair
market values are the market principal plus accrued interest, dividends and
reinvestment income at six and twelve month time horizons.
The following table estimates the fair value of the portfolio at a
six-month time horizon (in millions):
VALUATION OF SECURITIES VALUATION OF SECURITIES
GIVEN AN INTEREST RATE NO CHANGE GIVEN AN INTEREST RATE
DECREASE OF X BASIS POINTS IN INCREASE OF X BASIS POINTS
-------------------------- INTEREST --------------------------
ISSUER 150 BPS 100 BPS 50 BPS RATE 50 BPS 100 BPS 150 BPS
- ------------------------------------- ------- ------- ------ --------- ------ ------- -------
U.S. Government notes and bonds...... $ 4.1 $ 4.1 $ 4.1 $ 4.1 $ 4.1 $ 4.1 $ 4.1
Municipal notes and bonds............ 204.4 203.8 203.1 202.6 201.9 201.2 200.7
Corporate notes, bonds and
preferreds......................... 89.2 89.1 89.1 89.0 89.0 88.9 88.9
----- ----- ----- ----- ----- ----- -----
Total...................... $297.7 $297.0 $296.3 $ 295.7 $294.9 $294.2 $293.6
===== ===== ===== ===== ===== ===== =====
The following table estimates the fair value of the portfolio at a
twelve-month time horizon (in millions):
VALUATION OF SECURITIES VALUATION OF SECURITIES
GIVEN AN INTEREST RATE NO CHANGE GIVEN AN INTEREST RATE
DECREASE OF X BASIS POINTS IN INCREASE OF X BASIS POINTS
-------------------------- INTEREST --------------------------
ISSUER 150 BPS 100 BPS 50 BPS RATE 50 BPS 100 BPS 150 BPS
- ------------------------------------- ------- ------- ------ --------- ------ ------- -------
U.S. Government notes and bonds...... $ 4.2 $ 4.1 $ 4.1 $ 4.1 4.1 $ 4.1 $ 4.0
Municipal notes and bonds............ 205.0 204.6 204.2 203.8 203.2 202.7 202.4
Corporate notes, bonds and
preferreds......................... 89.4 89.4 89.3 89.3 89.2 89.2 89.2
----- ----- ----- ----- ----- ----- -----
Total...................... $298.6 $298.1 $297.6 $ 297.1 296.6 $296.0 $295.6
===== ===== ===== ===== ===== ===== =====
CONVERTIBLE DEBT
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 (after
deducting the fee paid to the initial purchaser of the Debentures but no other
expenses of the placement). The initial price to the public for the Debentures
was $391.06 per $1,000 of face amount at maturity, which equates to a yield to
maturity over the term of the bonds of 4.75% (on a semi-annual bond equivalent
basis). The Debentures are convertible into Common Stock at the rate of 5.692
shares per $1,000 of face amount at
34
36
maturity, which equates to an initial conversion price of $68.70 per share. The
Debentures are subordinated in right of payment to all existing and future
Senior Indebtedness (as defined) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the Company's subsidiaries.
The Debentures may be redeemed for cash at the option of the Company beginning
on February 13, 2003. At the option of the holder, the Company will purchase the
Debentures as of February 13, 2003, February 13, 2008 and February 13, 2013 at
purchase prices (to be paid in cash or Common Stock or any combination thereof,
at the election of the Company and subject to certain conditions) equal to the
initial issue price plus accrued original issue discount to such dates. The
Debentures may also be redeemed at the option of the holder if there is a
Fundamental Change (as defined) at a price equal to the issue price plus accrued
original issue discount to the date of redemption, subject to adjustment.
QUARTERLY OPERATING RESULTS (UNAUDITED)
THREE MONTHS ENDED
---------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
1997 1997 1997 1997 1996 1996 1996 1996
-------- --------- -------- -------- -------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenue............................ $173,305 $152,932 $144,594 $141,362 $124,662 $102,835 $92,447 $87,631
Income (loss) from operations.......... (78,007) 23,968 44,075 28,185 41,988 33,137 25,846 19,955
Income (loss) before provision for
income taxes......................... (74,358) 27,569 48,671 31,082 44,811 35,664 28,182 22,313
Net income (loss)...................... (80,896) 8,621 30,648 13,271 28,643 22,724 18,085 11,433
Net income (loss) per
share -- diluted..................... (1.16) 0.12 0.42 0.18 0.39 0.31 0.25 0.16
Shares used in per share
calculation -- diluted............... 69,714 72,407 72,270 72,599 73,480 72,595 71,697 71,113
In view of certain acquisitions in 1997 and 1996, the growth in net revenue
and income from operations experienced by the Company in 1997 and 1996 are not
necessarily indicative of future results. In addition, the Company believes that
period-to-period comparisons of its financial results should not be relied upon
as an indication of future performance.
The Company's revenues and results of operations have been subject to
significant fluctuations, particularly on a quarterly basis, and the Company's
future revenues and results of operations could fluctuate significantly from
quarter to quarter and from year to year. Causes of such fluctuations may
include the volume and timing of new orders and renewals, the introduction of
new products, distributor inventory levels and return rates, Company inventory
levels, the introduction of new products, product upgrades or updates by the
Company or its competitors, changes in product mix, changes in product prices
and pricing models, seasonality, trends in the computer industry, general
economic conditions (such as the recent economic turbulence in Asia),
extraordinary events such as acquisitions or litigation and the occurrence of
unexpected events.
Significant quarterly fluctuations in revenues will cause significant
fluctuations in the Company's cash flows and the cash and cash equivalents,
accounts receivable and deferred revenue accounts on the Company's balance
sheet. In addition, the operating results of many software companies reflect
seasonal trends, and the Company's business, financial condition and results of
operations may be affected by such trends in the future. Such trends may include
higher net revenue in the fourth quarter as many customers complete annual
budgetary cycles, and lower net revenue in the summer months when many
businesses experience lower sales, particularly in the European market. See
"Risk Factors -- Variability of Quarterly Opening Results."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and supplementary data of the Company required by
this item are set forth at the pages indicated at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
35
37
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The information required hereunder is incorporated by reference from the
Company's Proxy Statement to be filed in connection with Company's annual
meeting of Stockholders to be held on May 13, 1998.
ITEM 11. EXECUTIVE COMPENSATION
The information required hereunder is incorporated by reference from the
Company's Proxy Statement to be filed in connection with Company's annual
meeting of Stockholders to be held on May 13, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required hereunder is incorporated by reference from the
Company's Proxy Statement to be filed in connection with Company's annual
meeting of Stockholders to be held on May 13, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required hereunder is incorporated by reference from the
Company's Proxy Statement to be filed in connection with Company's annual
meeting of Stockholders to be held on May 13, 1998.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
PAGE
NUMBER
------
Report of Independent Accountants........................................... 37
Consolidated Balance Sheets:
December 31, 1997 and 1996................................................ 38
Consolidated Statements of Operations:
Years ended December 31, 1997, 1996 and 1995.............................. 39
Consolidated Statements of Stockholder's Equity:
Years ended December 31, 1997, 1996 and 1995.............................. 40
Consolidated Statements of Cash Flows:
Years ended December 31, 1997, 1996, and 1995............................. 41
Notes to Consolidated Financial Statements.................................. 42
(a)(2) Financial Statement Schedules
Report of Independent Accountants
Schedule II -- Schedule of Valuation and Qualifying Accounts
Other Schedules are omitted because the conditions required for
filing do not exist or the required information is included in the
financial statements or notes thereto.
(a)(3) Exhibits: See Index to Exhibits on Page 58. The Exhibits listed on the
accompanying Index of Exhibits are filed or incorporated by reference as
part of this report.
(b) Reports on Form 8-K:
(i) On November 24, 1997, the Company filed a Form 8-K reporting a
modification to a proposal presented at its Special Stockholders
Meeting on December 1, 1997.
(ii) On December 11, 1997, the Company filed a Form 8-K reporting the
closing of the merger of a wholly owned subsidiary of the Company
with Network General Corporation.
(iii) On December 11, 1997, the Company filed a Form 8-K reporting the
closing of the Company's acquisition of Pretty Good Privacy, Inc.
36
38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders
Networks Associates, Inc.
Santa Clara, California
We have audited the accompanying consolidated balance sheets of Networks
Associates, Inc., (formerly McAfee Associates, Inc.) and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Networks
Associates, Inc. and subsidiaries as of December 31, 1997 and 1996 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 20, 1998, except for
the matters discussed in Notes 14 and 16 as to which the date is February 13,
1998
37
39
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------
1997 1996
-------- --------
(IN THOUSANDS, EXCEPT
SHARE DATA)
---------------------
ASSETS
Current assets:
Cash and cash equivalents.......................................... $123,494 $125,141
Marketable securities.............................................. 123,882 134,029
Accounts receivable, net of allowance for doubtful accounts and
returns of $3,662 in 1997, $4,077 in 1996...................... 125,284 77,391
Prepaid expenses, taxes and other.................................. 57,612 31,420
-------- --------
Total current assets....................................... 430,272 367,981
Marketable securities................................................ 109,184 46,483
Fixed assets, net.................................................... 28,570 28,363
Deferred taxes....................................................... 16,173 12,088
Intangible and other assets.......................................... 17,732 2,841
-------- --------
Total assets............................................... $601,931 $457,756
======== ========
LIABILITIES
Current liabilities:
Accounts payable................................................... $ 18,439 $ 33,552
Accrued liabilities................................................ 141,083 36,360
Deferred revenue................................................... 69,464 51,398
-------- --------
Total current liabilities.................................. 228,986 121,310
Deferred revenue and taxes, less current portion..................... 13,186 7,523
-------- --------
Total liabilities.......................................... 242,172 128,833
-------- --------
Commitments and contingencies (Notes 7 and 14).
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; authorized; 5,000,000 shares; issued
and outstanding; one share.........................................
Common stock, $.01 par value; authorized; 300,000,000 shares; issued
and outstanding; 69,920,883 shares in 1997 and 66,684,176 shares in
1996............................................................... 699 666
Additional paid-in capital........................................... 191,047 139,263
Other................................................................ (54) 514
Retained earnings.................................................... 168,067 188,480
-------- --------
Total stockholders' equity................................. 359,759 328,923
-------- --------
Total liabilities and stockholders' equity................. $601,931 $457,756
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
38
40
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
Net revenue:
Product.................................................. $510,770 $343,940 $252,231
Services and support..................................... 101,423 77,854 26,679
-------- -------- --------
Total revenue.................................... 612,193 421,794 278,910
-------- -------- --------
Cost of revenue:
Product.................................................. 77,669 57,550 37,873
Services and support..................................... 30,547 19,363 10,849
-------- -------- --------
Total cost of revenue............................ 108,216 76,913 48,722
-------- -------- --------
Operating costs and expenses:
Research and development................................. 85,021 52,244 36,771
Marketing and sales...................................... 181,017 122,638 92,295
General and administrative............................... 43,060 30,315 20,134
Amortization of intangibles.............................. 858 3,169 1,356
Acquisition and other related costs...................... 175,800 30,669 19,936
-------- -------- --------
Total operating costs and expenses............... 485,756 239,035 170,492
-------- -------- --------
Income from operations........................... 18,221 105,846 59,696
Interest and other income, net............................. 14,743 9,548 8,799
-------- -------- --------
Income before provision for income taxes......... 32,964 115,394 68,495
Provision for income taxes................................. 61,320 51,284 26,154
-------- -------- --------
Net income (loss)................................ $(28,356) $ 64,110 $ 42,341
======== ======== ========
Net income (loss) per share -- basic....................... $ (0.41) $ 0.97 $ 0.67
======== ======== ========
Shares used in per share calculation -- basic.............. 68,748 65,835 63,651
======== ======== ========
Net income (loss) per share -- diluted..................... $ (0.41) $ 0.89 $ 0.62
======== ======== ========
Shares used in per share calculation -- diluted............ 68,748 72,221 68,693
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
39
41
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
COMMON STOCK ADDITIONAL
--------------- PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL OTHER EARNINGS STOCK TOTAL
------ ------ ---------- ------- -------- -------- --------
Balances, December 31, 1994........................ 62,566 $625 $128,896 $ 90 $81,642 $ (8,755) $202,498
Issuance of common stock upon exercise of stock
options........................................ 2,587 26 13,035 -- -- -- 13,061
Issuance of common stock from Employee Stock
Purchase Plan.................................. 174 2 2,386 -- -- -- 2,388
Tax benefit from exercise of nonqualified stock
options........................................ -- -- 14,731 -- -- -- 14,731
Secondary offering costs......................... -- -- (445) -- -- -- (445)
Repurchase of common stock....................... -- -- -- -- -- (30,870) (30,870)
Foreign currency translation..................... -- -- -- (45) -- -- (45)
Net income....................................... -- -- -- -- 42,341 --
------ ---- -------- ------- -------- -------- --------
Balances, December 31, 1995........................ 65,327 653 158,603 45 123,983 (39,625) 243,659
Net book value of assets of FSA acquired in
issuance of common stock upon pooling
transaction.................................... -- -- -- -- 387 -- 387
------ ---- -------- ------- -------- -------- --------
Restated balances, December 31, 1995............... 65,327 653 158,603 45 124,370 (39,625) 244,046
Issuance of common stock upon exercise of stock
options........................................ 3,329 33 28,534 -- -- -- 28,567
Issuance of common stock from Employee Stock
Purchase Plan.................................. 157 2 3,697 -- -- -- 3,699
Fractional shares returned upon stock split...... (175) (2) 2 -- -- -- --
Tax benefit from exercise of nonqualified stock
options........................................ -- -- 40,981 -- -- -- 40,981
Foreign currency translation..................... -- -- -- (113) -- -- (113)
Unrealized gain on marketable securities......... -- -- -- 582 -- -- 582
Repurchase of common stock....................... -- -- -- -- -- (52,949) (52,949)
Retirement of treasury stock..................... (1,954) (20) (92,554) -- -- 92,574 --
Net income....................................... -- -- -- -- 64,110 -- 64,110
------ ---- -------- ------- -------- -------- --------
Balances, December 31, 1996........................ 66,684 666 139,263 514 188,480 -- 328,923
Net book value of liabilities of Jade K.K.
acquired in issuance of common stock upon
pooling transaction............................ 336 3 -- -- (1,126) -- (1,123)
Net book value of assets of SHBV acquired in
issuance of common stock upon pooling
transaction.................................... 64 1 -- -- 924 -- 925
Net book value of assets of Helix acquired in
issuance of common stock upon pooling
transaction.................................... 550 6 883 -- 1,720 -- 2,609
------ ---- -------- ------- -------- -------- --------
Restated balances, December 31, 1996............... 67,634 676 140,146 514 189,998 -- 331,334
Elimination of net loss for Network General for
the quarter ended March 31,1997................ 1,705 18 83,711 396 6,425 79,196 14,354
Issuance of common stock upon exercise of stock
options........................................ 2,753 28 36,232 -- -- -- 36,260
Issuance of common stock from Employee Stock
Purchase Plan.................................. 366 3 6,925 -- -- -- 6,928
Tax benefit from exercise of nonqualified stock
options........................................ -- -- 39,941 -- -- -- 39,941
Foreign currency translation....................... -- -- -- (1,020) -- -- (1,020)
Unrealized gain on marketable securities......... -- -- -- 56 -- -- 56
Repurchase of common stock....................... (2,537) (26) (115,908) -- -- (79,196) (39,738)
Net loss......................................... -- -- -- -- (28,356) -- (28,356)
------ ---- -------- ------- -------- -------- --------
Balances, December 31, 1997........................ 69,921 $699 $191,047 $ (54) $168,067 -- $359,759
====== ==== ======== ======= ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
40
42
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31
-------------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Cash flows from operating activities:
Net income (loss)........................................................... $ (28,356) $ 64,110 $ 42,341
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Acquired in-process research and development............................... 75,717 19,504 7,153
Depreciation and amortization............................................. 25,436 17,484 12,199
Deferred taxes............................................................ (23,593) (4,806) (1,455)
Unrealized gain on investments............................................ 56 184 --
Changes in assets and liabilities:
Accounts receivable...................................................... (46,355) (22,031) (19,230)
Refundable income taxes.................................................. 1,593 4,195 (5,228)
Prepaids and other assets................................................ (9,017) (2,847) (368)
Accounts payable and accrued liabilities................................. 71,815 18,277 9,676
Deferred revenue......................................................... 23,390 5,254 5,347
-------- -------- -------
Net cash provided by operating activities.............................. 90,686 99,324 50,435
-------- -------- -------
Cash flows from investing activities:
Elimination of Network General cash flow for the quarter ended March 31,
1997....................................................................... 14,354 -- --
Purchases of available-for-sale investments................................. (785,060) (199,854) (30,800)
Sales of available-for-sale investments..................................... 768,867 162,332 20,784
Purchases of held-to-maturity investments................................... (81,668) (112,062) (204,626)
Sales of held-to-maturity investments....................................... 45,307 112,977 213,262
Additions to fixed assets................................................... (23,305) (22,657) (16,294)
Net liabilities of Jade K.K. and net assets of SHBV acquired in pooling
transactions............................................................... (198) -- --
Net assets of Helix Software acquired in pooling transaction, net of
transaction costs.......................................................... 2,609 -- --
Acquisition of AIM Technology............................................... -- -- (6,501)
Acquisition of Cinco Networks, Inc.......................................... (25,079) -- --
Acquisition of Compusul..................................................... (3,350) -- --
Acquisition of 3DV Technology, Inc.......................................... (20,000) -- --
Acquisition of PGP.......................................................... (24,974) -- --
Acquisition of Paradigm..................................................... (1,833) -- --
Purchased intangibles....................................................... (374) -- --
Net assets of FSA acquired under pooling transaction........................ -- 387 --
-------- -------- -------
Net cash used in investing activities.................................. (134,704) (58,877) (24,175)
-------- -------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of offering costs............... -- -- 232
Proceeds from exercise of stock options..................................... 43,188 41,057 21,509
Tax benefit from exercise of nonqualified stock options..................... 39,941 32,107 8,386
Cost of secondary security offering......................................... -- -- (445)
Repurchase of common stock.................................................. (39,738) (52,949) (30,870)
-------- -------- -------
Net cash provided (used) by financing activities....................... 43,391 20,215 (1,188)
-------- -------- -------
Effect of exchange rate fluctuations on cash and cash equivalents........... (1,020) -- 8
-------- -------- -------
Net increase (decrease) in cash and cash equivalents......................... (1,647) 60,662 25,080
Cash and cash equivalents at beginning of year............................... 125,141 64,479 39,399
-------- -------- -------
Cash and cash equivalents at end of year..................................... $ 123,494 $ 125,141 $ 64,479
======== ======== =======
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes.................................. $ 14,316 $ 12,610 $ 18,075
======== ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
41
43
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Networks Associates, Inc. (the "Company"), formerly McAfee Associates,
Inc., develops, markets, distributes and supports network security and
management software products. The Company's markets are worldwide and include
corporate, governmental, and institutional users as well as resellers and
distributors throughout the world. Software products and updates are delivered
primarily through electronic distribution under two-year subscription licenses
and as boxed product sold through the retail channel. International sales and
support are provided by subsidiaries in principal European markets and
independent agents and distributors elsewhere internationally. The Company
changed its name to Networks Associates, Inc. in connection with the merger with
Network General, in December 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Presentation:
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates.
Certain Risks and Concentrations:
The Company's product revenues are concentrated in the personal computer
software industry which is highly competitive and rapidly changing. Significant
technological changes in the industry or customer requirements, or the emergence
of competitive products with new capabilities or technologies could adversely
affect operating results. In addition, a significant portion of the Company's
revenue and net income is derived from international sales and independent
agents and distributors. Fluctuations of the U.S. dollar against foreign
currencies, changes in local regulatory or economic conditions, piracy or
nonperformance by independent agents could adversely affect operating results.
The Company maintains the majority of cash balances and all of its
marketable securities with six financial institutions. The Company invests with
high credit quality financial institutions and, by policy, limits the amount of
credit exposure to any one financial institution. The Company has significant
amounts receivable from customers across a broad demographic base. Management of
the Company performs ongoing credit evaluations of its customers and maintains
allowances for doubtful accounts.
Certain of the Company's products contain critical components supplied by a
single or a limited number of third parties. The Company has been required to
purchase and inventory certain of the computer platforms around which it designs
its products so as to ensure an available supply of the product for its
customers. Any significant shortage of these platforms or other components or
the failure of the third party supplier to maintain or enhance these products
could materially adversely affect the Company's results of operations.
Foreign Currency Translation:
The Company considers the local currency to be the functional currency for
its international subsidiaries. Assets and liabilities denominated in foreign
currencies are translated using the exchange rate on the balance sheet date.
Revenues and expenses are translated at average exchange rates prevailing during
the year. Translation adjustments resulting from this process are charged or
credited to equity. Foreign currency
42
44
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
transaction gains and losses, which to date have not been material, are included
in the determination of net income.
Revenue Recognition:
Revenue from product licenses is generally recognized when a customer
purchase order has been received, a license agreement has been delivered, the
software or system has been shipped (or software has been electronically
delivered), remaining obligations are insignificant, and collection of the
resulting account receivable is probable. Maintenance revenue for providing
product updates and customer support is deferred and recognized ratably over the
service period. For subscription sales that have the maintenance fee included
with the licensing fee, maintenance revenue is derived based upon the amount
charged for such services when they are sold separately. Revenue from hardware
products is recognized upon shipment subject to a reserve for returns. Revenues
on rental units under operating leases and service agreements are recognized
ratably over the term of the rental or service period.
Revenue generated from products sold through traditional channels where the
right of return exists is reduced by reserves for estimated sales returns. Such
reserves are based on estimates developed by management. As unsold products in
these distribution channels are exposed to rapid changes in consumer preferences
or technological obsolescence due to new operating environments, product updates
or competing products, it is reasonably possible that these estimates will
change in the near term.
Prior to July 1, 1995 revenue from subscription licenses for anti-virus
software was recognized ratably over a two year period as the Company did not
separately sell the product license and maintenance. Effective July 1, 1995, the
Company began to sell these components separately and currently recognizes, upon
the initial sale, 80% of the total fee as product license revenue and defers 20%
of the fee as maintenance. The maintenance fee is recognized over the service
period, generally two years. The effect of this change was to increase 1995 net
income by $7.7 million ($0.16 per share).
Advertising:
Advertising costs are expensed as incurred and included in "Marketing and
Sales Expenses."
Research and Development:
Research and development expenditures are charged to operations as
incurred. Under the Company's development process, technological feasibility is
established on completing a working model. Subsequent costs for the Company have
not been significant and all software development costs have therefore been
expensed.
Cash and Cash Equivalents:
Cash equivalents are comprised of highly liquid debt instruments with
original maturities of 90 days or less.
Marketable Securities:
All marketable securities are classified as either available-for-sale or
held-to-maturity. Available-for-sale securities are carried at fair value, and
held-to-maturity securities are stated at cost, adjusted for amortization or
premiums and accretion of discounts to maturity, in accordance with Statement of
Financial Accounting Standards No. 115 ("SFAS 115). Current marketable
securities are those with maturities less than one year from the balance sheet
date. Non-current marketable securities are those with maturities greater than
one year from the balance sheet date. Unrealized gains and losses on marketable
securities classified as available-for-sale, when material, are reported net of
related taxes as a separate component of stockholders' equity. Realized gains
and losses on sales of all such investments are reported in earnings and
computed using the specific
43
45
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
identification cost method. No debt or equity securities were classified as
held-to-maturity at December 31, 1997.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out) or market
and include material and related manufacturing overhead.
Fixed Assets:
Fixed assets are stated at cost. Depreciation and amortization of fixed
assets is provided using the straight-line method over the estimated useful
lives of the assets (2 to 5 years).
Intangible Assets:
Intangible assets include the estimated fair market values of purchased
technology when the related products or products under development are
considered technologically feasible and goodwill arising from acquisitions and
other intangibles. Intangibles are amortized over their estimated useful lives
(typically three years to five years).
Fair Value of Financial Instruments:
Carrying amounts of the Company's financial instruments including cash and
cash equivalents, marketable securities, accounts receivable, accounts payable
and accrued liabilities approximate fair value due to their short maturities.
Stock Based Compensation:
The Company accounts for stock based compensation using the intrinsic value
method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, compensation cost for stock options is measured as the
excess, if any, of the quoted market price of the Company's stock at the date of
the grant over the amount an employee must pay to acquire the stock. The Company
has adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation."
Net Income Per Share:
Net income (loss) per share has been computed in accordance with SFAS 128.
Basic net income (loss) per share is computed using the weighted average common
shares outstanding during the period. Diluted net income per share is computed
using the weighted average common shares and common equivalent shares
outstanding during the period.
Stock Dividend:
During October 1995 and April and October, 1996, the Company declared and
paid stock dividends of one share of common stock for every two shares of common
stock outstanding. All per share data contained herein has been restated to
reflect the increased number of shares outstanding.
3. BUSINESS COMBINATIONS AND ACQUISITIONS
Merger with Network General Corporation
On December 1, 1997, the Company acquired Network General Corporation
("Network General"), a provider of network fault and performance management
solutions for approximately 17.9 million shares of the
44
46
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
common stock. The Company also assumed and exchanged all options to purchase
Network General stock for options to purchase approximately 3.3 million shares
of the Company's common stock. The transaction was accounted for as a pooling of
interests and therefore all prior period financial statements have been restated
to include the results of Network General for all periods presented. On December
2, 1997, in connection with the merger, McAfee changed its name to Networks
Associates, Inc. Network General had a fiscal year ended March 31. Restated
financial statements combine Network General results for the fiscal years ended
March 31, 1997 and 1996 with the results for the years ended December 31, 1996
and 1995, respectively. In order to conform Network General's fiscal year end to
the Company's fiscal year end, the consolidated statement of operations for the
year ended December 31, 1997 includes the three months ended March 31, 1997 for
Network General which are also included in the consolidated statement of income
for the year ended December 31, 1996. Revenue and net loss of Network General
for such period were $68.0 million and $6.4 million, respectively. Stockholders'
equity for the year ended December 31, 1997 has been adjusted to eliminate these
amounts.
Separate and combined results of operations for the periods prior to the
merger are as follows:
NINE MONTHS
ENDED YEAR ENDED DECEMBER
SEPTEMBER 31, 31,
------------- ---------------------
1997 1996 1995
------------- -------- --------
Revenues:
McAfee........................................ $ 247,960 $181,126 $ 90,065
Network General............................... 190,928 240,668 188,845
-------- -------- --------
Combined...................................... $ 438,888 $421,794 $278,910
======== ======== ========
Net income (loss):
McAfee........................................ $ 67,850 $ 39,017 $ 14,916
Network General............................... (15,310) 25,093 27,425
-------- -------- --------
Combined...................................... $ 52,540 $ 64,110 $ 42,341
======== ======== ========
Net income (loss) per share:
McAfee........................................ $ 1.26 $ 0.73 $ 0.30
Network General............................... (0.86) 1.32 1.44
-------- -------- --------
Combined...................................... $ 0.73 $ 0.89 $ 0.62
======== ======== ========
45
47
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During 1997, 1996 and 1995 the Company acquired other companies or assets
for common stock as poolings of interests or for cash and other consideration in
purchase transactions. The companies acquired in poolings of interests were not
significant and the financial statements were not restated. The following is a
summary of such acquisitions:
COMMON STOCK ISSUED
IN POOLINGS OF PURCHASE PRICE OF PURCHASE
INTEREST TRANSACTIONS
------------------- -------------------------------
1997
Jade K.K............................. 336,071 shares
Schuijers Holdings B.V............... 63,721 shares
3DV Technology, Inc.................. $20.0 million
Compusul Consultores de Informatica, $2.6 million plus $1.0 million
Ltda............................... contingently payable
Cinco Networks, Inc.................. $26.0 million
Paradigm Agency Pty Ltd.............. $2.0 million
Helix Software Company............... 550,000 shares
Pretty Good Privacy, Inc............. $35 million plus warrants to
purchase 250,000 shares of
Common Stock at $60 per share.
1996
Vycor Corporation.................... $9.0 million
Assets acquired from Interactive $2.1 million
Distributed Systems Software
Gmbh...............................
FSA Corporation...................... 534,000 shares
1995
Saber Software Corporation........... 2,100,000 shares
AIM Technology....................... $7.1 million
IPE.................................. $2.5 million
Assurdata............................ $1.6 million plus a warrant to
purchase 33,750 shares of
Common Stock at $11.26 per
share
Distribution rights from three German
distribution entities.............. $1.9 million
Of the total purchase price paid for the acquisitions treated as purchases
in 1997, 1996 and 1995, the company expensed (primarily as in-process R&D), in
the year acquired, approximately $74.4 million, $9.9 million and $11.4 million,
respectively and capitalized (primarily as developed technology and goodwill)
approximately $11.2 million, $1.2 million and $1.7 million, respectively.
Amounts are being amortized over 3 to 6 years.
46
48
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. MARKETABLE SECURITIES
At December 31, 1997 and 1996, marketable securities are summarized as
follows (in thousands):
AGGREGATE
AMORTIZED FAIR UNREALIZED
1997: COST VALUE GAINS
--------------------------------------------------- -------- -------- ----------
(IN THOUSANDS)
Available-for-Sale Securities
U.S. Government debt securities.................... $ 6,014 $ 6,021 $ 7
Municipal debt securities.......................... 245,671 246,049 379
Corporate debt securities.......................... 35,655 36,273 618
-------- -------- ------
$287,340 $288,343 $1,004
======== ======== ======
At December 31, 1997, all marketable debt securities have scheduled
maturities of less than three years.
AGGREGATE
AMORTIZED FAIR UNREALIZED
1996: COST VALUE GAINS
----------------------------------------------------- --------- ------- ----------
(IN THOUSANDS)
Held-to-Maturity Securities
U.S. Government debt securities...................... $ 9,955 $ 9,955 $ --
Municipal debt securities............................ 74,784 74,890 106
-------- -------- ----
$84,739 $84,845 $106
======== ======== ====
AMORTIZED AGGREGATE UNREALIZED
COST FAIR VALUE GAINS
--------- ---------- ----------
(IN THOUSANDS)
Available-for-Sale Securities
U.S. Government debt securities..................... $ 1,002 $ 1,000 $ (2)
Municipal debt securities........................... 85,084 85,014 (70)
Corporate debt securities........................... 10,171 9,759 (412)
------- ------- -----
$96,257 $ 95,773 $ (484)
======= ======= =====
5. DERIVATIVES
During fiscal year 1997, the Company began using forward foreign exchange
contracts to hedge certain assets denominated in foreign currencies. For these
instruments, risk reduction is assessed on a transaction basis and the
instruments are designated as, and effective as a hedge and are highly inversely
correlated to the hedged item as required by generally accepted accounting
principles. Gains and losses on these hedges are included in the carrying amount
of the assets and are ultimately recognized in income. If a hedging instrument
ceases to qualify for hedge accounting, it is accounted for on a mark to market
basis and any subsequent gains and losses are recognized currently in income.
The Company does not use any derivatives for trading or speculative purposes.
Forward Exchange Contracts
The Company conducts business globally. As a result, it is exposed to
movements in foreign currency exchange rates. The Company enters into forward
exchange contracts to hedge exposures associated with nonfunctional currency
assets and liabilities denominated in Canadian, Australian and several European
currencies.
The Company does not generally hedge anticipated foreign currency cash
flows nor does the Company enter into forward contracts for trading purposes.
Gains and losses on the contracts are reported in other income and generally
offset gains or losses from the revaluation of nonfunctional currency assets and
liabilities.
47
49
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The forward contracts range from one to three months in original maturity. The
forward contracts outstanding and their unrealized gains and (losses) are
presented below (in thousands):
NOTIONAL NOTIONAL
VALUE VALUE UNREALIZED
PURCHASED SOLD GAIN/(LOSS)
--------- -------- -----------
Australian Dollar........................... $ -- $ 866 $ (2)
Canadian Dollar............................. -- 2,486 8
Dutch Guilder............................... 2,900 -- (23)
Other European Currencies................... -- 8,878 (59)
------ ------- ----
$ 2,900 $ 12,230 $ (76)
====== ======= ====
6. BALANCE SHEET DETAIL (IN THOUSANDS)
DECEMBER 31,
---------------------
1997 1996
-------- --------
Fixed assets:
Furniture and fixtures............................... $ 19,321 $ 39,536
Computers, demonstration and rental equipment........ 61,204 19,416
Leasehold improvements............................... 9,026 6,021
-------- --------
89,551 64,973
Less accumulated depreciation and amortization....... (60,981) (36,610)
-------- --------
$ 28,570 $ 28,363
======== ========
Intangibles assets:
Purchased technology................................. $ 6,678 $ 3,516
Other................................................ 1,261 1,261
Goodwill............................................. 13,285 2,046
-------- --------
21,224 6,823
Less accumulated amortization........................ (7,338) (5,822)
-------- --------
13,886 1,001
Other assets........................................... 3,846 1,840
-------- --------
$ 17,732 $ 2,841
======== ========
Accrued liabilities:
Accrued compensation................................. $ 18,175 $ 12,223
Accrued acquisition and merger costs................. 65,225 2,708
Accrued taxes........................................ 29,298 1,198
Other accrued expenses............................... 28,385 20,231
-------- --------
$141,083 $ 36,360
======== ========
7. COMMITMENTS
The Company leases its operating facilities under non-cancelable operating
leases through December 2002. In addition, the Company has leased certain
equipment under various leases which expire no later than 1998.
48
50
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1997, future minimum payments under non-cancelable
operating leases are as follows (in thousands):
YEAR ENDING DECEMBER 31,
----------------------------------------------------------
1998...................................................... $ 15,460
1999...................................................... 15,440
2000...................................................... 14,696
2001...................................................... 12,271
2002 and thereafter....................................... 115,306
-------
$173,173
=======
Rent expense for the years ended December 31, 1997, 1996 and 1995 amounted
to $10.0 million, $7.3 million and $5.9 million, respectively.
The Company presently intends to move its headquarters to larger facilities
in Santa Clara, California. To that end, the Company has agreed, as the assignee
of certain rights of the existing tenant, to rent a facility of approximately
200,000 square feet commencing on or about April 1, 1998. The underlying lease
is set to expire in 2013.
8. NETWORK GENERAL SHARE REPURCHASE PROGRAM
In July 1993, the Board of Directors of Network General authorized Network
General to repurchase up to 1,666,800 shares of its common stock on the open
market to satisfy commitments under its stock option and stock purchase plans.
In fiscal year 1996, up to an additional 1,666,800 shares of Network General
common stock were authorized for repurchase for the same purpose. At December 1,
1997, Network General had repurchased and retired 1,954,323 shares at an
aggregate cost of $92,574,000.
9. EMPLOYEE BENEFIT PLANS
401(k) and Profit Sharing Plan:
Under the Company's 401(k) and Profit Sharing Plans, the Board of
Directors, at its discretion, can match employee contributions in an amount not
to exceed 20% of total compensation. Annual amounts provided by the Company
under the plan to date have not been material.
Employee Stock Purchase Plan:
Under the 1994 Employee Qualified Stock Purchase Plan, the Company can
grant stock purchase rights to all eligible employees during one year offering
periods with exercise dates approximately every six months (beginning each
August and February). The Company has reserved 506,250 shares of common stock
for issuance under the plan. Shares are purchased through employees' payroll
deductions at exercise prices equal to 85% of the lesser of the fair market
value of the Company's common stock at either the first day of an offering
period or the last day of such offering period. No participant may purchase more
than $25,000 worth of common stock in any one calendar year.
10. STOCKHOLDERS' EQUITY
Preferred Stock:
The Company has authorized 5,000,000 shares of preferred stock, par value
$.01 per share. The Company's Board of Directors has authority to provide for
the issuance of the shares of preferred stock in series, to establish from time
to time the number of shares to be included in each such series and to fix the
49
51
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
designation, powers, preferences and rights of the shares of each such series
and the qualifications, limitations or restrictions thereof, without any further
vote or action by the shareholders.
In connection with the acquisition of FSA, the Company issued one share of
Series A preferred stock. The share of Series A preferred stock has no
preferential rights other than the right to cast a number of votes equal to the
number of common shares issuable in exchange for certain exchangeable non-voting
shares of FSA. At December 31, 1997, 325,062 shares of the Company's common
stock were reserved for conversion.
Stock Option Plans:
In June 1997, the Board of Directors approved the 1997 Stock Incentive Plan
(the "1997 Plan") to replace the 1995 Stock Incentive Plan. Under the 1997 Plan,
the Company has reserved 5,850,000 shares for issuance to employees, officers,
directors, third-party contractors and consultants. The plan provides for an
option price no less than 100% of the fair market value of the Company's common
stock on the date of grant for incentive stock options granted to employees and
officers (including directors who are also employees) or 85% of the fair market
value on the date of grant for all others. The options may be exercisable
immediately, or over time, generally vest 25% one year after commencing
employment or from date of grant and vest thereafter in monthly increments over
three years. All options under the option plan expire ten years after grant.
Under the amended Stock Option Plan for Outside Directors, the Company has
reserved 421,875 shares for issuance to certain members of its Board who are not
employees of the Company or any affiliated corporation. The plan provides for an
option price at fair market value of the Company's common stock on the date of
grant. The initial grant to each outside director generally vests ratably over a
three-year period. Subsequent option grants will vest after three years from the
date of grant. All options under the option plan expire ten years after grant.
Aggregate activity under stock option plans is as follows:
OUTSTANDING OPTIONS
--------------------------------------------------------
SHARES WEIGHTED
AVAILABLE NUMBER OF PRICE PER AGGREGATE AVG. EX.
FOR GRANT SHARES SHARE PRICE PRICE
---------- ---------- -------------- ------------ --------
Balances, December 31, 1994... 5,157,492 8,329,889 $ .00 - $24.60 $ 64,076,423 $ 7.69
Additional shares
authorized.................. 6,750,000 -- -- -- --
Shares granted................ (7,525,651) 7,525,651 $5.48 - $48.00 114,919,788 $15.27
Shares exercised.............. -- (2,586,378) $ .00 - $34.13 (13,061,481) $ 5.05
Shares canceled............... 1,609,600 (1,723,056) $1.70 - $46.80 (16,620,144) $ 9.65
---------- ---------- ------------
Balances, December 31, 1995... 5,991,440 11,546,106 $ .00 - $48.00 149,314,586 $12.93
Shares granted................ (4,197,370) 4,197,370 $1.13 - $65.69 134,948,924 $32.15
Shares exercised.............. -- (3,328,493) $0.01 - $48.00 (28,567,332) $ 8.58
Shares canceled............... 1,528,694 (1,528,694) $1.70 - $60.30 (27,610,011) $18.06
---------- ---------- ------------
Balances, December 31, 1996... 3,322,765 10,886,289 $ .01 - $65.69 228,086,167 $20.95
Eliminate duplicate period.... 55,318 148,985 $0.80 - $60.30 1,017,800 $6.830
Additional shares
authorized.................. 7,850,000
Shares granted................ (5,973,398) 5,973,398 $0.98 - $60.30 260,853,796 $43.67
Shares exercised.............. -- (2,752,673) $0.80 - $60.30 (36,259,606) $12.71
Shares canceled............... 2,721,278 (2,721,278) $0.98 - $66.63 (76,792,667) $28.22
---------- ---------- ------------ ------------ ------
Balances, December 31, 1997... 7,975,963 11,534,721 $0.98 - $66.63 $376,905,490 $43.01
========== ========== ============ ============ ======
50
52
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1997, a total of 2,963,535 options to purchase common stock
were exercisable at an aggregate average exercise price of $25.66.
The following information regarding the stock option program and employee
stock purchase programs is provided in compliance with SFAS 123, "Accounting for
Stock Based Compensation".
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ ------------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
RANGE OF OUTSTANDING REMAINING EXERCISABLE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE(YRS) PRICE AT 12/31/97 PRICE
- ------------------------- ----------- --------------------- ---------------- ----------- ----------------
$ 0.98 - $ 8.37.......... 718,198 6.98 $ 5.50 381,147 $ 5.06
$ 8.89 - $11.11.......... 1,487,544 7.38 $10.00 451,723 $10.17
$12.67 - $20.55.......... 820,316 6.91 $16.88 449,514 $17.15
$20.67 - $31.50.......... 1,131,303 7.76 $24.52 477,187 $24.71
$32.38 - $36.30.......... 708,524 9.07 $35.29 353,484 $35.83
$38.55 - $39.30.......... 946,969 8.82 $38.93 280,078 $38.85
$40.00 - $40.00.......... 1,761,000 9.22 $40.00 4,000 $40.00
$40.25 - $43.95.......... 1,419,522 9.42 $42.65 94,368 $41.47
$44.13 - $48.15.......... 1,182,611 8.52 $46.17 422,399 $46.97
$49.38 - $66.63.......... 1,358,734 9.38 $55.02 49,635 $51.92
----------- -----------
$ 0.98 - $66.63.......... 11,534,721 7.43 $32.97 2,963,535 $25.66
========= =========
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ ------------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
RANGE OF OUTSTANDING REMAINING EXERCISABLE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/96 CONTRACTUAL LIFE(YRS) PRICE AT 12/31/96 PRICE
- ------------------------- ----------- --------------------- ---------------- ----------- ----------------
$ 0.80 - $ 6.03.......... 1,700,597 7.55 $ 3.44 643,152 $ 3.28
$ 8.37 - $ 8.37.......... 734,937 8.28 $ 8.37 49,809 $ 8.37
$ 8.89 - $ 9.70.......... 1,437,072 8.53 $ 9.67 110,094 $ 9.69
$10.95 - $20.01.......... 2,243,669 8.03 $14.24 492,451 $13.85
$20.33 - $37.55.......... 2,209,395 8.69 $25.26 311,980 $24.71
$38.10 - $38.55.......... 315,773 9.45 $38.55 33,632 $38.54
$39.15 - $46.80.......... 1,415,462 9.26 $42.64 163,131 $42.38
$47.10 - $48.15.......... 470,613 9.09 $47.90 30,647 $47.98
$49.50 - $65.69.......... 358,771 9.73 $53.59 1,997 $55.94
----------- -----------
$ 0.80 - $65.69.......... 10,886,289 8.47 $20.94 1,836,893 $15.20
========= =========
The fair market value of options granted has been calculated using the
Black-Scholes option pricing model using the multiple option approach. A typical
option grant vests over a four year period. Parameters for the option analysis
are listed below.
1995 1996 1997
---- ---- ----
Risk free interest rate................................ 5.50% 5.85% 5.39%
Expected life (yrs).................................... 4 4 4
Volatility............................................. 0.66 0.66 0.66
Dividend yield......................................... 0 0 0
The weighted average expected life of the option grants was estimated based
on examination of previously exercised options over the life of the program.
Volatility was estimated on a monthly basis since the company became public in
October of 1992. The average volatility for the twelve months ending December
1997 and 36
51
53
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
month period from January 1995 through December 1997 was 66%. Since the
volatility has been relatively stable one value was selected for all segments.
The Company has not paid a dividend, and has no plans to do so.
The weighted average fair value of options granted in 1997,1996 and 1995
was $27.85, $17.44 and $10.05, respectively.
The Company has also estimated the fair value of purchase rights issued
under the Employee Stock Purchase Program. Rights under this plan were also
evaluated using the Black-Scholes option pricing model. The Company's plan is
described in Note 7 . Purchase periods occur twice yearly and each effectively
contains a 6 and 12 month option.
FEB. 1995 AUG. 1995 FEB. 1996 AUG. 1996 FEB. 1997 AUG. 1997
--------- --------- --------- --------- --------- ---------
Risk Free Interest Rate........ 6.06% 5.47% 4.84% 5.73% 5.40% 5.44%
Expected Life.................. 6, 12 mos 6, 12 mos 6, 12 mos 6, 12 mos 6, 12 mos 6, 12 mos
Volatility..................... 0.66 0.66 0.66 0.66 0.66 0.66
Dividend Yield................. -- -- -- -- -- --
The weighted average fair value of options granted pursuant to the Employee
Stock Purchase Program in 1997, 1996 and 1995 was $16.66 , $10.51 and $9.03,
respectively.
The following pro forma income information has been prepared following the
provisions of SFAS 123.
1997 1996 1995
-------- ------- -------
Net income (loss) -- pro forma (thousands)....................... $(77,284) $38,993 $33,721
Net income (loss) per share -- diluted -- pro forma.............. $ (1.12) $ 0.54 $ 0.49
The impact on pro forma earnings per share and net income in the table
above may not be indicative of the effect in future years as options vest over
several years and the company continues to grant stock options to new employees.
This policy may or may not continue.
Warrants:
Pursuant to the acquisition of PGP, the Company issued warrants to purchase
250,000 shares of common stock at a price of $60 per share, which expire,
subject to certain extensions, on June 5, 1999, all of which were outstanding at
December 31, 1997. In addition, warrants for the purchase of 4,227 shares of
Common Stock issued in connection with the Company's 1995 acquisition of
Assurdata were outstanding at December 31, 1997.
11. PROVISION FOR INCOME TAXES
Taxable income from continuing operations from the years ended December 31,
was earned in the following jurisdictions (in thousands):
1997 1996 1995
------- -------- -------
Domestic..................................... $16,506 $119,623 $67,073
Foreign...................................... 16,458 (4,229) 1,422
------- -------- -------
$32,964 $115,394 $68,495
======= ======== =======
52
54
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Significant components of the provision for income taxes attributable to
continuing operations are as follows (in thousands):
YEARS ENDED DECEMBER 31, 1997 1996 1995
--------------------------------------------- ------- -------- -------
Federal:
Current payable............................ $24,784 $ 43,337 $23,114
Deferred................................... 20,173 (3,856) (2,992)
------- ------- -------
Total federal................................ 44,957 39,481 20,122
------- ------- -------
State:
Current payable............................ 6,477 9,878 5,530
Deferred................................... 2,270 55 (38)
------- ------- -------
Total state.................................. 8,747 9,933 5,492
------- ------- -------
Foreign...................................... 7,616 1,870 540
------- ------- -------
Provision for income taxes................... $61,320 $ 51,284 $26,154
======= ======= =======
Significant components of net deferred tax assets at December 31, are as
follows (in thousands):
YEARS ENDED DECEMBER 31, 1997 1996 1997
---------------------------------------------- ------- ------- -------
Deferred revenue.............................. $ 1,387 $ 1,865 $ 4,753
In-process technology......................... 6,190 6,355 6,349
State taxes................................... 1,740 1,631 502
Accrued liabilities and reserves.............. 26,939 8,690 5,292
Depreciation and amortization................. 5,727 3,868 2,927
Subsidiaries operating loss carryover......... 10,597 968 2,472
------- ------- -------
52,580 23,377 22,295
Valuation allowance........................... (7,728) (968) (2,472)
------- ------- -------
$44,852 $22,409 $19,823
======= ======= =======
Current portion............................... $28,679 $10,321 $ 5,794
Non-current portion........................... 16,173 12,088 14,029
------- ------- -------
$44,852 $22,409 $19,823
======= ======= =======
The valuation allowance relates to the tax benefit of operating losses of
PGP and 3DV. The operating losses are subject to certain annual limitations as a
result of the acquisition and may expire before the company can utilize them.
Accordingly, a valuation allowance has been established.
Realization of the remaining net deferred tax assets of $44,852,000 as of
December 31, 1997 is dependent on generating sufficient taxable income to offset
future deduction of the related items. Although realization is not assured,
management believes it is more likely than not that all of the net deferred tax
assets will be realized. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income are reduced.
U.S. income taxes were not provided for on a cumulative total of
approximately $17,038,000 of undistributed earnings for certain non-U.S.
subsidiaries. The Company intends to reinvest these earnings indefinitely in
operations outside the United States.
53
55
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company's effective tax rate on income before income taxes differs from
the U.S. Federal statutory regular tax rate as follows:
YEARS ENDED DECEMBER 31, 1997 1996 1995
---------------------------------------------------- ----- ---- ----
U.S. Federal statutory income tax rate.............. 35.0% 35.0% 35.0%
State taxes, net of federal income tax benefit...... 4.7 5.9 5.1
Non deductible acquisition and other costs.......... 159.3 8.5 4.9
Other, net.......................................... (13.0) (4.9) (6.8)
----- ---- ----
186.0% 44.4% 38.2%
===== ==== ====
12. NET INCOME (LOSS) PER SHARE:
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted net income
(loss) per share calculations is provided as follows (in thousands, except per
share amounts):
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- ------- -------
NUMERATOR -- BASIC AND DILUTED
Net income (loss).......................... $(28,356) $64,110 $42,341
======= ======= =======
Net income (loss) available to common
stockholders............................. $(28,356) $64,110 $42,341
======= ======= =======
DENOMINATOR
Basic weighted average common shares
outstanding.............................. 68,748 65,835 63,651
Effect of dilutive securities:
Common stock options..................... -- 6,386 5,042
------- ------- -------
Diluted weighted average common shares 68,748 72,221 68,693
======= ======= =======
Diluted net income (loss) per share........ $ (0.41) $ 0.89 $ 0.62
======= ======= =======
13. BUSINESS SEGMENT INFORMATION:
The Company operates in one industry segment and markets and services its
products in the United States and in foreign countries through its own direct
sales organization and through independent agents and distributors. In 1997,
foreign operations accounted for approximately 28% of the Company's net revenue,
but less than 10% of the Company's net income, and identifiable assets. No one
customer accounted for more than 10% of net revenue during fiscal 1997, 1996 and
1995.
Net revenue information by geographic area is as follows (in thousands):
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
-------- -------- --------
North America.............................. $437,948 $321,002 $208,495
International.............................. 174,245 100,792 70,415
-------- -------- --------
$612,193 $421,794 $278,910
======== ======== ========
14. LITIGATION:
On April 24, 1997, the Company was served by Symantec with a suit filed in
the United States District Court, Northern District of California, San Jose
Division, alleging copyright infringement and unfair competition by the Company.
Symantec alleges that the Company's computer software program called "PC Medic"
copied portions of Symantec's computer software program entitled "CrashGuard."
Symantec's
54
56
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
complaint sought injunctive relief and unspecified money damages. On July 20,
1997, Symantec sought leave to amend its complaint to include additional
allegations of copyright infringement and trade secret misappropriation
pertaining to the Company's "VirusScan" product. Symantec sought injunctive
relief and unspecified money damages. On October 6, 1997, the Court issued an
order granting Symantec's motion to amend its complaint and enjoining the
Company from shipping any product containing either an approximately 30-line
routine found in Crash Guard or an approximately 100-line routine found in a
Symantec DLL. The Court's order expressly stated that "the court is not
enjoining the sale or distribution of [McAfee's] current product." On December
19, 1997, the Court denied Symantec's motion to enjoin sale or distribution of
the Company's current PC Medic product. On February 11, 1998, Symantec filed
another motion seeking leave to again amend its complaint to include additional
allegations of trade secret misappropriation, interference with economic
advantage and business relations and violations of the Racketeer Influenced and
Corrupt Organization Act ("RICO"), in connection with the alleged use at the
Company by a former Symantec employee of allegedly proprietary Symantec customer
information. Symantec also filed a motion for a preliminary injunction relating
to these new allegations, and has scheduled both motions for hearing on May 15,
1998. Trial is currently set for September 1998.
On May 13, 1997, Trend Micro, Inc. ("Trend") filed suit in United States
District Court for the Northern District of California against both the Company
and Symantec. Trend alleges that the Company's "WebShield" and "GroupShield"
products infringe a Trend patent which issued on April 22, 1997. Trend's
complaint seeks injunctive relief and unspecified money damages. On June 6,
1997, the Company filed its answer denying any infringement. The Company also
filed a counterclaim against Trend alleging unfair competition, false
advertising, trade libel, and interference with prospective economic advantage.
On September 19, 1997, Symantec filed a motion to sever Trend's action against
the Company from its action against Symantec. The Company did not oppose
Symantec's motion to sever, other than to recommend a joint hearing on patent
claim interpretation. On December 19, 1997, the Court granted Symantec's motion
to sever and adopted the Company's recommendation regarding a joint hearing on
patent claim interpretation. As a result of the Court's decision, Trend's
actions against the Company and Symantec will proceed separately. The exact
terms of the severance order have not yet been approved by the Court, and the
Court has yet to reset key dates for discovery and trial in the two cases. The
Company anticipates that the Court will shortly reset the date for the joint
patent claim interpretation hearing for late June or July, 1998. Thirty days
after the joint patent claim interpretation hearing, the Court has indicated it
will set further dates for discovery and trial.
On May 6, 1997, RSA Data Security, Inc. ("RSA") filed a lawsuit against
PGP, a wholly owned subsidiary of the Company since December 9, 1997, in San
Mateo County Superior Court. RSA seeks a declaration from the court that certain
paragraphs of a license agreement between PGP and Public Key Partners (the
"License Agreement") have been terminated and certain other paragraphs have
survived RSA's purported termination of the License Agreement. RSA, which
purports to act on behalf of Public Key Partners, also seeks an accounting of
PGP's sales of products subject to the License Agreement. PGP denies that RSA
has the authority to act on behalf of Public Key Partners, and denies that the
License Agreement has been breached or terminated in whole or in part. On May
22, 1997, PGP filed a motion to compel arbitration of the action pursuant to an
arbitration clause in the License Agreement. PGP's motion was granted on October
9, 1997. The Court stayed the state court proceedings and ordered the action to
arbitration. The arbitration proceedings are in the preliminary stages.
On October 14, 1997, RSA filed a patent infringement lawsuit against PGP in
the United States District Court for the Northern District of California. RSA
alleges PGP has infringed one of the patents which was licensed to PGP under the
License Agreement. On November 4, 1997, PGP moved to stay the federal action,
or, in the alternative, compel it to arbitration. On December 23, 1997, RSA
filed a motion to amend its complaint to include the Company as defendant. PGP's
motion to stay and RSA's motion to amend its complaint are scheduled to be heard
by the federal court in February 1998.
55
57
NETWORKS ASSOCIATES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On September 15, 1997, the Company was named as a defendant in a patent
infringement action filed by Hilgraeve Corporation ("Hilgraeve") in the United
States District Court, Eastern District of Michigan. Hilgraeve alleges that the
Company's "VirusScan" product infringes a Hilgraeve patent which was issued on
June 7, 1994. Hilgraeve's action seeks injunctive relief and unspecified money
damages. The case is in discovery.
Although the Company has not been served in any suit, three companies
(including Network Associates Corporation in California and Network Associates,
Inc. in Oregon) have made claims (including various trademark claims) or demands
with respect to the Company's use of the name Network Associates.
While there can be no assurance that the above litigation will not have a
material adverse effect on the Company, management does not expect that the
ultimate costs to resolve these matters will have a material adverse effect on
the Company's consolidated financial position, results of operations, or cash
flow.
15. RECENT ACCOUNTING PRONOUNCEMENTS
In July 1997, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income", which
requires a separate financial statement showing changes in comprehensive income,
is effective for financial statements issued for fiscal years beginning after
December 15, 1997. SFAS 130 requires reclassification of all prior-period
financial statements for comparative purposes. The Company is evaluating
alternative formats for presenting this information, but does not expect this
pronouncement to materially impact the Company's results of operations.
In July 1997, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an
Enterprise and Related Information", which requires companies to report certain
information about operating segments, including certain information about their
products, services, the geographic areas in which they operate and their major
customers. This statement supersedes FASB Statements Nos. 14, 18, 24 and 30.
SFAS 131 is effective for financial statements for fiscal years beginning after
December 15, 1997. The Company is evaluating the requirements of SFAS 131 and
the effects, if any, on the Company's current reporting and disclosures.
Statement of Position (SOP) 97-2, "Software Revenue Recognition" was issued
in October 1997 and addresses software revenue recognition matters primarily
from a conceptual level and does not include specific implementation guidance.
The SOP supersedes SOP 91-1 and is effective for transactions entered into for
fiscal years beginning after December 15, 1997. Based on its reading and
interpretation of SOP 97-2, the Company believes it is currently in compliance
with the final standard. However, detailed implementation guidelines for this
standard have not yet been issued. Once issued, such detailed implementation
guidance could lead to unanticipated changes in the Company's current revenue
accounting practices, and such changes could be material to the Company's
revenues and earnings.
16. SUBSEQUENT EVENTS:
On February 10, 1998, the Company agreed to issue in a private placement
zero coupon convertible subordinated debentures due in 2018. The debentures,
with an aggregate face amount at maturity of $770 million, are expected to
generate net proceeds to the Company of approximately $293.6 million (after
deducting the fee paid to the initial purchaser of the debentures but no other
expenses of the placement). The initial price to the public for the debentures
was $391.06 per $1,000 of face amount at maturity, which equates to a yield to
maturity over the term of the bonds of 4.75% (on a semi-annual bond equivalent
basis). The debentures are convertible into Common Stock at the rate of 5.692
shares per $1,000 of face amount at maturity, which equates to an initial
conversion price of $68.70 per share. On such date, the Company also granted an
option to purchase on or prior to March 10, 1998 up to an additional $115.5
million aggregate principal amount due at maturity of debentures to cover
over-allotments, if any. If such over-allotment option is exercised in full, the
Company would expect to receive additional net proceeds of approximately $44
million (after deducting the fees paid to the initial purchaser of the
debentures but no other expenses of the placement). On February 13, the initial
purchaser exercised the option in full.
56
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Santa
Clara, State of California, on the 13th day of February, 1998.
Networks ASSOCIATES, INC.
By: /s/ WILLIAM L. LARSON
--------------------------------------
William L. Larson
Chief Executive Officer and Chairman
of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on February 13, 1998 by the following persons on
behalf of the Registrant and in the capacities indicated.
SIGNATURE TITLE
- --------------------------------------------- ----------------------------------------------
/s/ WILLIAM L. LARSON Chief Executive Officer and Chairman of the
- --------------------------------------------- Board (Principal Executive Officer)
(William L. Larson)
/s/ LESLIE G. DENAND President and Director
- ---------------------------------------------
(Leslie G. Denend)
/s/ PRABHAT K. GOYAL Vice President of Administration, Chief
- --------------------------------------------- Financial Officer, Treasurer and Secretary
(Prabhat K. Goyal) (Principal Financial Officer and Principal
Accounting Officer)
/s/ JOHN C. BOLGER Director
- ---------------------------------------------
(John C. Bolger)
/s/ VIRGINIA GEMMELL Director
- ---------------------------------------------
(Virginia Gemmell)
/s/ EDWIN L. HARPER Director
- ---------------------------------------------
(Edwin L. Harper)
/s/ HARRY J. SAAL Director
- ---------------------------------------------
(Harry J. Saal)
57
59
INDEX TO EXHIBITS
EXHIBIT NO. EXHIBIT TITLE
- ----------- --------------------------------------------------------------------------------
2.1 Agreement and Plan of Reorganization, dated as of October 13, 1997, among McAfee
Associates, Inc., Mystery Acquisition Corp. and Network General Corporation, as
amended by the First Amendment thereto, dated as of October 22, 1997,
incorporated by reference from the Registrant's Registration Statement on Form
S-4 filed with the Commission on October 31, 1997.
2.2 Combination Agreement dated August 16, 1996 among the Registrant, FSA
Combination Corp., FSA Corporation and Daniel Freedman.(1)
2.3 Stock Exchange Agreement dated January 13, 1996 among the Registrant, FSA
Combination Corp., Kabushiki Kaisha Jade and the shareholders of Jade.(2)
2.4 Agreement and Plan of Reorganization dated December 1, 1997 between the
Registrant, Helix Software Company and DNA Acquisition Corp.(4)
2.5 Agreement and Plan of Reorganization dated December 1, 1997 between the
Registrant, PGP and PG Acquisition Corp., incorporated by reference to the
Report on Form 8-K of the Registrant as filed with the Securities and Exchange
Commission on December 11, 1997 (the "December 11, 1997 Form 8-K").
4.1 Registration Rights Agreement dated January 13, 1996 between the Registrant and
all the shareholders of Jade.(2)
4.2 Registration Rights Agreement dated August 30, 1996 between the Registrant and
Daniel Freedman.(1)
4.3 Registration Rights Agreement dated February 27, 1997 between the Registrant and
the shareholders of Schuijers, incorporated by reference from Exhibit 10.50 to
the Registrant's Report on Form 10-K for the year ended December 31, 1996.
4.4 Registration Rights Agreement dated December 1, 1997 between the Registrant and
the shareholders of Helix.(4)
4.5 Registration Rights Agreement dated December 9, 1997 between the Registrant and
certain of the shareholders of PGP.(4)
10.1 Standard Business Lease (Net) for Network General's principal facility dated
June 18, 1991, between Network General and Menlo Oaks Partners, L.P., which is
incorporated by reference to Exhibit 10.3 of Network General's Annual Report on
Form 10-K for the year ended March 31, 1991.(3)
10.2 First Amendment to Lease dated June 10, 1992, between Network General and Menlo
Parks Partners, L.P., which is incorporated by reference to Exhibit 10.3 of
Network General's Annual Report on Form 10-K for the year ended March 31, 1992
("Network General 1992 Form 10-K").(3)
10.3 Standard Business Lease (Net) for Network General's principal facility dated
March 11, 1992, between Network General and Menlo Oaks Partners, L.P., which is
incorporated by reference to Exhibit 10.4 of the Network General 1992 Form
10-K.(3)
10.4 First Amendment to Lease dated June 18, 1992, between Network General and Menlo
Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.5 of the
Network General 1992 Form 10-K.(3)
10.5 Lease dated March 31, 1992, between Network General and Equitable Life Assurance
Society of the United States, which is incorporated by reference to Exhibit 10.4
of the Network General 1992 Form 10-K.(3)
10.6 Second Amendment to Lease dated February 1, 1995, between Network General and
Menlo Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.2 of
Network General's Quarterly Report on Form 10-Q for the quarter ended December
31, 1994 ("Network General December 1994 Form 10-Q").(3)
10.7 Third Amendment to Lease dated February 1, 1995 between Network General and
Menlo Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.23
of the Network General December 1994 Form 10-Q.(3)
60
EXHIBIT NO. EXHIBIT TITLE
- ----------- --------------------------------------------------------------------------------
10.8 Fourth Amendment to Lease dated May 31, 1995, between Network General and Menlo
Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.27 of
Network General's Quarterly Report on Form 10-Q for the quarter ended June 30,
1995 ("Network General June 1995 Form 10-Q").(3)
10.9 Fifth Amendment to Lease dated June 13, 1995, between Network General and Menlo
Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.28 of the
Network General June 1995 Form 10-Q.(3)
10.10 Lease dated July 3, 1996, between Network General and Campbell Avenue
Associates, which is incorporated by reference to Exhibit 10.21 of Network
General's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.(3)
10.11 Sixth Amendment to Lease dated November 29, 1996, between Network General and
Menlo Oaks Partners, L.P., which is incorporated by reference to Exhibit 10.22
of Network General's Quarterly Report on Form 10-Q for the quarter ended
December 31, 1996.(3)
10.12 Sublease Agreement for facility at 2805 Bowers Avenue, Santa Clara, California,
dated as of February 20, 1997, by and between McAfee Associates, Inc. and
National Semiconductor Corporation, incorporated by reference to Exhibit 10.51
of the Form 10-Q of McAfee Associates, Inc. for the Quarter ended June 30, 1997.
10.13 Lease Agreement dated November 17, 1997 for facility at 3965 Freedom Circle,
Santa Clara, California by and between Informix Corporation and McAfee
Associates, Inc.(4)
10.14 Consent to Assignment Agreement dated December 19, 1997 by and among Birk S.
McCandless, LLC, Guaranty Federal Bank, F.S.B., Informix Corporation and
Networks Associates, Inc.(4)
10.15 Subordination, Nondisturbance and Attornment Agreement dated December 18, 1997
between Guaranty Federal Bank, F.S.B., Networks Associates, Inc., and Birk S.
McCandless, LLC.(4)
10.16 Lease dated November 22, 1996 by and between Birk S. McCandless, LLC and
Informix Corporation for facility at 3965 Freedom Circle, Santa Clara,
California.(4)
10.17 Quota Purchase Assignment Agreement, dated as of April 14, 1997, by and among
McAfee Associates, Inc. and McAfee Do Brasil Ltda., Compusul-Consultoria E
Comericio De Informatica Ltda., and the stockholders of Compusul-Consultoria E
Comericio De Informatica Ltda., incorporated by reference to Exhibit 10.52 of
the Form 10-Q of McAfee Associates, Inc. for the Quarter ended June 30, 1997.
10.18 1997 Stock Incentive Plan, incorporated by reference to Exhibit 4.1 to the
Registration Statement on Form S-8 of McAfee Associates, Inc., filed with the
Securities and Exchange Commission on August 8,1997.
10.19* Change in control agreement between the Company and Dennis Cline dated April 14,
1995 incorporated by reference to Exhibit 10.2 of the Company's Registration
Statement No. 33-93296 on Form S-4 (the "S-4").
10.20* Change in control agreement between the Company and Peter Watkins May 1, 1995
incorporated by reference to Exhibit 10.6 of the S-4.
10.21* Change in control agreement between the Company and William L. Larson dated
April 14, 1995 incorporated by reference to Exhibit 10.7 of the S-4.
10.22* Change in control agreement between the Company and Prabhat K. Goyal
incorporated by reference to Exhibit 10.43 of the Company's Form 10-Q for the
quarter ended June 30, 1996.
21.1 Subsidiaries of Networks Associates, Inc.(4)
23.2 Consent of Coopers & Lybrand L.L.P.
24.1 Power of Attorney (included in Part II of this Registration Statement under the
caption "Signatures")
27.1 Financial Data Sheet
- ---------------
(1) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on September 24, 1996.
(2) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on March 14, 1997.
(3) Network General's filings with the Commission were made under File Number
0-17431.
61
(4) Incorporated by reference from the Registrant's Registration Statement on
Form S-3, filed with the Commission on February 12, 1998.
* Management contracts or compensatory plans or arrangements covering
executive officers or directors of Networks Associates, Inc.
62
SCHEDULE II
NETWORKS ASSOCIATES, INC.
VALUATION AND QUALIFYING ACCOUNTS AT DECEMBER 31, 1997
(DOLLARS IN THOUSANDS)
BALANCE AT ADDITIONS BALANCE AT
BEGINING OF CHARGED TO END OF
PERIOD EXPENSE DEDUCTIONS PERIOD
------------ ---------- ---------- ----------
Year Ended December 31, 1997(1)
Allowance for Doubtful Accounts.................... 4,206 2,129 (2,673) 3,662
Year Ended December 31, 1996(2)
Allowance for Doubtful Accounts.................... 3,429 2,785 (2,137) 4,077
Year Ended December 31, 1995 (3)
Allowance for Doubtful Accounts.................... 2,333 1,837 (741) 3,429
- ---------------
(1) Includes Network General balance sheet data as at December 31, 1997
(2) Includes Network General balance sheet data as at March 31, 1997
(3) Includes Network General balance sheet data as at March 31, 1996
63
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders
Networks Associates, Inc.:
Our report on the consolidated financial statements of Networks Associates,
Inc. and subsidiaries is included on page 37 of this Form 10-K. In connection
with our audits of such financial statements, we have also audited the related
financial statement schedule listed in the index on page 36 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 20, 1998 except for
the matters discussed in Notes 14 and 16
as to which the date is February 13, 1998