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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 0-20558
NETWORKS ASSOCIATES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0316593
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
3965 FREEDOM CIRCLE
SANTA CLARA, CALIFORNIA 95054
(408) 988-3832
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the issuer as of March 27, 2000 was approximately $4,836,549,019. The number of
shares outstanding of the issuer's common stock as of March 27, 2000 was
139,430,034.
DOCUMENTS INCORPORATED BY REFERENCE: Items 10, 11, 12, and 13 of Part III
are incorporated by reference from the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held May 25, 2000.
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PART I
ITEM 1. BUSINESS
GENERAL
Some of the statements contained in this Annual Report on Form 10-K are
forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors, which may cause our actual results to differ
materially from those implied by the forward-looking statements. In some cases,
you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," or "continue" or the negative of these terms or other
comparable terminology. Although we believe that the expectations reflected in
the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance or achievements. Moreover, neither any
other person nor we assumes responsibility for the accuracy and completeness of
such statements. Important factors that may cause actual results to differ from
expectations include those discussed in "-- Risk Factors" and elsewhere in this
document.
Networks Associates, Inc. was formed in December 1997, by the combination
of McAfee Associates, Inc. and Network General Corporation. Following the
combination, McAfee, changed its legal name to Networks Associates, Inc. Since
then, we have acquired over 10 companies and in 1999 we publicly sold Class A
common stock of one of our subsidiaries as part of that subsidiaries initial
public offering.
OVERVIEW
We are a leading supplier of security and availability solutions for
e-business. Our products focus on two important area of e-business: network
security and network management. In the network security and network management
arenas, the majority of our revenue has historically been derived from our
McAfee anti-virus product line and our Sniffer network fault and performance
management product line, respectively. These two flagship product lines form the
customer base and product base from which the balance of our product line has
developed.
In recent years, we have focused our efforts on building a full line of
complementary network security and network management solutions. On the network
security side, we strengthened our anti-virus lineup by adding complementary
products in the firewall, intrusion protection, encryption, and virtual private
networking categories. On the network management side, we built upon our Sniffer
line by adding products in the help desk, asset management, network monitoring,
and network reporting categories. We continuously seek to expand our product
line. We have combined complementary products into "suites," offering customers
the ability to license multiple products at the same time. Our products are
organized into the suites described below.
In January 2000, we reorganized into four product groups based on our
product suites:
- McAfee, which primarily markets the McAfee Active Virus Defense (AVD)
product suite;
- Sniffer Technologies, which primarily markets the Sniffer Total Network
Visibility (TNV) product suite;
- PGP Security, which primarily markets the PGP Total Security Defense
(TSD) product suite; and
- Magic Solutions, which primarily markets the Magic Total Support Desk
(TSD) product suite.
The four individual product suites form our single Net Tools mega suite.
The reorganization around our product groups is designed to allow us to, among
other things, react faster to customers' changing needs and better specialize
our sales force so they know our products and their markets in greater depth. In
addition, although specialization between security (anti-virus and security
product suites) and manageability (availability and service product suites)
previously existed, with the reorganization we seek to better differentiate
anti-virus from security and availability from service desk.
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In addition, to our product groups, we also have two subsidiaries that are
applications service providers. McAfee.com, our publicly traded subsidiary, is a
consumer applications service provider, or ASP, and myCIO, our wholly owned
subsidiary, is a business applications service provider.
MCAFEE
McAfee sells anti-virus products to corporate customers. The McAfee Active
Virus Defense, or AVD, product suite incorporates the following products into a
multi-tier virus defense system: VirusScan for desktop protection, NetShield for
file server protection, GroupShield for groupware protection and WebShield for
Internet gateway protection. McAfee also provides tools to manage and enforce
corporate virus security policy, updates and reporting with ePolicy Orchestrator
and Anti-Virus Informant. McAfee products are backed by our anti-virus research
organization, McAfee AVERT (Anti-Virus Emergency Response Team), which protects
McAfee customers against virus attacks that have become increasingly complex and
frequent in recent years.
The following anti-virus products are part of the McAfee Active Virus
Defense product suite:
- VirusScan: Desktop Virus Security is designed to provide PCs with
protection against computer viruses, including macro viruses, malicious
Java and ActiveX attacks, and email intrusions. The corporate edition of
VirusScan is included as part of McAfee AVD. VirusScan is also available
in a retail version for home users.
- NetShield: Network Server Virus Security offers server-based virus
protection that is designed to prevent the spread of viruses at critical
servers in the corporate network.
- GroupShield: Groupware Virus Security is designed to prevent virus
proliferation in the groupware environment of an enterprise by scanning
files sent through Microsoft Exchange and Lotus Notes servers and
catching viruses before they can be passed on to other users. GroupShield
is both sold separately and is designed as part of AVD.
- E-Policy Orchestrator is a scaleable anti-virus tool designed to allow
corporate system administrators to manage and enforce anti-virus policies
by providing updates or upgrades to up to 20,000 users.
- Anti-Virus Informant provides detailed anti-virus coverage reports which
identify users that need updates and also provides infection reports that
track vulnerable system entry points.
- AutoUpdate is designed to keep anti-virus products running with the
latest versions and the most current virus signature files.
- Enterprise SecureCast is a free, optional Internet service designed to
automatically deliver to system administrators new upgrades, updates, and
security news bulletins after they are released from McAfee AVERT.
Enterprise SecureCast is included as part of AVD.
- Management Edition is an anti-virus software distribution and management
system that is designed to allow complete and centralized control over
the VirusScan and NetShield product line. Management Edition is included
as part of AVD.
Additional McAfee products sold separately from the Active Virus Defense product
suite include:
- WebShield: Internet Gateway Protection is designed to guard the perimeter
of computer networks by scanning vulnerable Internet traffic for viruses
and other hostile code before they enter the system.
- WebShield E-ppliance 100: Internet Gateway Protection; combines hardware
and software in an integrated appliance that protects Internet gateways
by scanning vulnerable SMTP, FTP or HTTP traffic for malicious code.
WebShield E-ppliance 100 is offered as a portable component that plugs
directly into servers.
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SNIFFER TECHNOLOGIES
Sniffer Technologies sells network monitoring, analysis, reporting and
capacity planning tools. Sniffer Technologies principal product suite, Total
Network Visibility, or TNV, is an integrated product that enables enterprises
and service providers to maintain the availability and performance of their
networks and applications. The TNV product suite consists of the Sniffer
Portable Analysis Suite, the Sniffer Distributed Analysis Suite, the Sniffer
Network Informant Suite and the Sniffer Pro for Packet over SONET.
- Sniffer Portable Analysis Suite, or Sniffer PAS, consists of portable
tools designed to automatically pinpoint and analyze network problems and
to recommend solutions. Products sold under the Sniffer PAS range from
products which capture data, monitor network traffic and collect key
network statistics for small networks, to products which optimize network
and application performance and increase network reliability by
uncovering and analyzing network problems and recommending solutions to
such problems, automatically and in real-time for mid-level and
high-speed networks.
- Sniffer Distributed Analysis Suite, or Sniffer DAS, is designed to allow
customers to proactively monitor and diagnose network and
application-level problems on complex, multi-segment networks from
centralized locations. The Sniffer DAS addresses a variety of network
needs ranging from high-speed backbones, wide area network, or WAN, links
and switched networks.
- Network Informant Suite, or Network Informant, is a web browser-based
network management suite that is designed to automate and manage the
process of resolving network problems proactively by identifying,
analyzing, tracking and resolving network and application problems and
assessing trends.
- Sniffer Pro for Packet Over SONET, is a portable system for monitoring
and troubleshooting high-speed telecommunications and Internet service
provider networks.
PGP SECURITY
PGP Security, or TNS, sells security products to corporate customers. PGP
Security's principal product suite, PGP Total Network Security includes
firewall, intrusion protection, encryption and virtual private network (VPN)
security products. The TNS product line features Gauntlet for firewall and VPN,
CyberCop for intrusion protection and PGP for encryption and VPN.
The following security products and product suites are part of the PGP
Total Network Security product suite:
- Gauntlet Firewall is the flagship product of our security product line.
Gauntlet is offered as an enterprise management console, designed to
enable large-scale configuration control over numerous firewalls
throughout a computer network, and allow for direct interface with
anti-virus scanning products. Gauntlet Firewall also has encryption
capabilities for VPN technology.
- Gauntlet Active Firewall Suite; integrates several of the individual TNS
products with Event Orchestrator, our event management system. This
design is intended to allow the individual TNS security products to
communicate with one another and provide automatic response and security
service level management.
- CyberCop Scanner is an integrated network-scanning tool designed to
locate system and network device vulnerabilities, exposing previously
undiscovered security threats via an easy-to-use graphical interface.
- CyberCop Monitor is a second-generation intrusion detection product
utilizing an intelligent agent architecture designed to provide a
multi-tiered detection system that can monitor networks, servers, and
applications with centralized event correlation and trend analysis.
- CyberCop Sting completes the CyberCop line by offering a new proprietary
approach to extend intrusion detection. CyberCop Sting utilizes
replication technology designed to simulate "virtual machines" in a
simulated environment, allowing any unauthorized activity to be logged
while at the same time not placing systems or data at risk.
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- PGP Desktop encrypts and authenticates e-mail, files and disks
automatically, ensuring that only the authorized recipient can read their
contents.
- PGP Policy Management Agent works in conjunction with PGP Desktop and is
designed to ensure that incoming and outgoing email adheres to the
appropriate corporate email security policies.
- PGP VPN Client adds a standards-compliant virtual private networking, or
VPN, client to the PGP suite. By encrypting and authenticating remote
communications, PGP VPN Client users can securely connect remotely over
inexpensive local Internet connections.
- PGP VPN Suite provides a standards-based infrastructure for end-to-end
VPN security. The PGP VPN suite is designed to offer secure networking
including server-to-server for supply chain and remote office extrants,
server-to-client for secure remote access, and client-to-client for
secure network communications.
- WebShield E-ppliance 300 combines hardware and software in an integrated
appliance that combines the Gauntlet Firewall and McAfee anti-virus
products with a Gauntlet VPN server. WebShield E-ppliance 300 is offered
as a portable component that plugs directly into servers and is sold
separately from TNS.
MAGIC SOLUTIONS
Magic Solutions sells help desk, network management and other service
tools. Magic Solutions' principal product suite, Magic Total Service Desk, or
Magic TSD, provides proactive network management and help desk technology in one
integrated service desk solution. Magic TSD is comprised of the following
suites:
- Magic HelpDesk Suite is designed to provide call management, problem
resolution, crisis management, change management and reporting for help
desks. The Magic HelpDesk Suite automates the process of entering caller
information and automatically displays information about a caller. In
addition, the Magic HelpDesk Suite is designed to provide automated
crisis management.
- Self ServiceDesk Suite provides applications designed to make all
supported PCs help desk ready. The Self ServiceDesk Suite integrates PC
diagnostic software with remote control and web-based access.
- Zero Administration Client Suite, or ZAC Suite is designed to provide
enterprise wide control of network software with integrated software
distribution, software and hardware inventory, desktop
management/menuing, license metering and remote control features. The ZAC
Suite is designed to automatically distribute, install and track new
software and updates throughout an enterprise and to perform an
enterprise-wide hardware, software and system file inventory without
having to visit each station.
MYCIO.COM
We launched our new wholly owned subsidiary, myCIO.com in January 2000.
myCIO.com is an infrastructure ASP targeted at business users. myCIO.com
delivers network security and availability services hosted on its servers to
businesses via the Internet. myCIO's products and services are designed to be
simple and cost-effective and more rapidly deployed than if the customer were to
install network security and availability applications internally. myCIO.com's
hosted services are also designed to remove the burden and cost of managing the
software, while seeking to ensure continuous protection against threats to a
company's e-business infrastructure. myCIO's products include:
- VirusScan ASaP is a computer virus service that allows users to scan
hardware and software systems and detect and eliminate viruses online.
The service is "versionless" or self updating as the most recent version
of the software is running on a server operated by myCIO.com with only a
small portion of the VirusScan ASaP Resident on the user's hardware.
- CyberCop ASaP is a vulnerability assessment service designed to remotely
assess the security of the customer's network perimeter. The service
operates at the myCIO.com website and the customer does
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not need to download any software. Vulnerability reports are delivered
over the Internet through a web interface at the myCIO.com website.
- Firewall ASaP is a remotely managed firewall service. The firewall unit
is shipped to the customer site, but is remotely configured and managed
by the myCIO.com staff from their data center. Firewall ASaP combines
Gauntlet Firewall, Gauntlet Virtual Private Network and gateway-based
McAfee anti-virus scanning for SMTP, HTTP, and FTP.
MCAFEE.COM
Effective January 1, 1999, we contributed our consumer e-commerce business
to our then wholly owned subsidiary, McAfee.com. In December 1999 McAfee.com
completed its initial public offering in which it sold to the public
approximately 7.2 million shares of its Class A common stock, entitled to one
vote per share. As of March 1, 2000, we owned 36,000,000 shares of the
McAfee.com Class B common stock, entitled to three votes per share and
representing approximately 83% of McAfee.com's outstanding common stock and 94%
of its total voting power.
McAfee.com is an online provider of PC security and management products and
services for consumers. Through the McAfee.com web site, consumers can secure,
repair, update and upgrade their PCs online. The McAfee.com web site provides a
suite of online products and services personalized for consumers based on their
PC configurations, software and attached peripherals, such as scanners, printers
and modems. McAfee.com began operations as one of the first consumer
applications service providers, or ASPs, hosting PC security and management
software applications. The McAfee.com applications allow consumers to detect and
eliminate viruses on their PCs, repair their PCs from damage caused by viruses,
optimize their hard drives and update their PCs with current software patches
and upgrades. The McAfee.com home page provides access to free product and
service centers, such as the Shopping Center, and subscriber services, such as
the McAfee Clinic. Subscribers to the McAfee Clinic service can access all of
McAfee.com's online centers including:
- McAfee Clinic -- the central access point for all of McAfee.com's hosted
online application services;
- Anti-Virus Center -- a computer virus protection and information service;
- PC CheckUp Center -- a PC optimization and maintenance service;
- Firewall Center -- a personal firewall service to protect against hackers
- Shopping Center -- a shopping resource where consumers can research and
purchase computer products, accessories and books;
- Download Center -- a service that allows users to download evaluation
software titles and browser plug-ins; and
- Support Center -- a product registration, technical support and customer
care service.
For the year ended December 31, 1999, on a segment basis McAfee.com
accounted for approximately $24.5 million in net revenues and a loss of $27.9
million. See Note 14 of the Notes to the Consolidated Financial Statements. In
addition, Network Associates and McAfee.com have entered into various inter-
company arrangements. See "Network Associates/McAfee.com Intercompany
Agreements."
NAI KK
Network Associates sells its product suites in Japan through NAI KK, our
Japanese subsidiary. NAI KK is also negotiating an agreement with McAfee.com to
act as its Japanese distributor. On February 4, 2000, several companies acquired
a less than 4% minority equity interest in NAI KK for a combined total of
approximately $11.9 million.
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PROFESSIONAL SERVICES & TECHNICAL SUPPORT
As our products and computer networks become more complex, customers
increasingly require greater professional assistance in the design,
installation, configuration and implementation of their networks and acquired
products. To meet these evolving customer needs, we have established
Professional Services and Technical Support. Professional Services is focused on
two service segments: Consulting Services and Education Services. Technical
Support consists primarily of one program called PrimeSupport, which is
described below.
Consulting Services supports product integrations, customization and
deployment with an array of standardized and custom offerings. Consulting
Services also offers other services ranging from proactive and emergency
troubleshooting to network design, planning and simulation. We supplement our
Consulting Service capabilities through the use of outside professional service
providers, including our distributors, resellers and system integrators. In
conjunction with our recent reorganization to establish product groups, in
January 2000 we reorganized our U.S. Consulting Services organization, in part,
to enable the service providers to become more specialized on individual
products and product suites.
Education Services represents the combined training organizations of
Sniffer University, TIS, McAfee University, and Magic University. Together,
these training organizations offer customers an extensive curriculum of computer
network technology courses, including protocol analysis and troubleshooting,
security, help-desk and network management tools. Education Services provides
public classes and customized on-site training at customer locations. To date we
have trained over 35,000 individuals in Fortune 500 and other companies.
The PrimeSupport program provides our customers online and telephone-based
technical support in an effort to ensure that our products are installed and
working properly. To meet customers' varying needs, PrimeSupport offers a choice
of the online KnowledgeCenter or the telephone-based Connect, Priority and
Enterprise. PrimeSupport is available to all customers on a worldwide basis from
a nearby global support center.
- PrimeSupport KnowledgeCenter -- Consisting of a searchable, intelligent
knowledge base of technical solutions and links to a variety of technical
documents such as product FAQ's and technical notes. The KnowledgeCenter
also allows users to submit questions by email if their answer is not
found in the KnowledgeCenter's technical resources.
- PrimeSupport Connect -- Providing toll-free telephone access to technical
support during regular business hours and access to the online
KnowledgeCenter.
- PrimeSupport Priority -- Providing support for critical operations with
priority, unlimited, toll-free telephone access to technical support 24
hours a day, 7 days a week and access to the online KnowledgeCenter.
- PrimeSupport Enterprise -- Offering proactive, personalized service for
the most business critical operations and including an assigned technical
support engineer from our elite Enterprise support team; proactive
support contact (telephone or email) with customer-defined frequency;
election of five designated customer contacts, and access to the online
KnowledgeCenter.
PRODUCT LICENSING MODEL; HOSTED APPLICATIONS SUBSCRIPTION MODEL
We typically license our products, together with the related maintenance,
to corporate and government customers for a period of two years. Upon expiration
of the two-year period, we contact customers to renew their license. We believe
that the two-year license and related maintenance offers several benefits to our
customers. For one initial fee, the customer receives the software and all
upgrades, updates and technical support for two years. In addition, the customer
only has to make a decision on its investment in the software every two years.
Since we are able to distribute our products and upgrades at a lower cost than
companies using traditional distribution methods, we also have the ability to
offer upgrades and updates and address user feature requirements on a more
regular basis. In addition, by offering a two-year license, as opposed to a
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traditional perpetual license, we are able to meet a lower initial cost
threshold for customers with annual budgetary constraints.
Our two-year licensing model creates the opportunity for recurring revenue
for us through the renewal of existing licenses. Since we typically license our
products on a per user basis, at the time of renewal we have the potential to
increase the number of computers licensed at existing sites and to expand our
licenses to new sites in an organization. The renewal process also provides an
opportunity to cross-sell new products and product suites to existing customers.
However, we may be unable to sustain current renewal rates in the future.
We also provide single user and corporate user licenses for our products
under traditional perpetual licenses with product updates, upgrades and support
available to customers under separate maintenance contracts.
For our hosted products and services customers "rent versus buy" the
software. McAfee.com, our consumer ASP, has and myCIO.com, our business
infrastructure ASP, is developing a related subscription model. Paid McAfee
Clinic subscribers receive a one year subscription to the service. Because the
McAfee Clinic service is "version-less" or self updating consumers using McAfee
Clinic are assured of using the most recent version of the software application,
eliminating the need to the purchase product updates or upgrades.
SALES AND MARKETING
To augment and capitalize upon our website based marketing efforts, our
sales and marketing efforts are directed primarily at large corporate and
government customers as well as to resellers, distributors and system
integrators worldwide through the following channels:
NORTH AMERICAN DIRECT SALES
The balance of our North American direct sales force, constituting the
majority of our sales force, is organized by product group; with four separately
focused sales organizations selling by product line. Each of these sales
organizations consists of field sales representatives who are located regionally
and outbound telesales representatives who actively market our individual
product suites, focusing on small customers and transactions. Our corporate
telesales representatives also respond to prospective customers who contact us
as a result of a particular marketing program or after electronically evaluating
one of our products. To augment our sales organization, our executives are
involved with sales to many major accounts.
All of our North American sales representatives are responsible for
developing new business as well as the renewal of our existing licenses. Prior
to expiration of a license, a sales representative contacts the customer and
encourages the customer to renew the expiring license and determines if the
number of computers licensed needs adjustment and, additionally, markets new
products and product suites to this existing customer.
McAfee.com and myCIO.com have independent sales organizations.
INTERNATIONAL SALES
We have sales and support operations in Europe, Asia, South America and
Australia. In 1999, international revenues accounted for approximately 40% of
our net revenues. We expect that international revenues will continue to account
for a significant percentage of net revenues. Historically, we have relied
primarily upon independent agents and distributors to market our products
internationally. In recent years we have focused our efforts on expanding
internationally including through distribution acquisitions. We expect to
continue using independent agents primarily in smaller markets where a direct
sales presence is not currently warranted. While our agents and distributors
include some large systems integrators, most are small companies that market our
software along with products of other companies that they represent. We
typically enter into agreements with our agents which obligate them to provide
technical support and the most current versions of our products to our customers
and to provide us with information about our licensees. These agreements permit
the agent or us to terminate the agreement upon proper prior written notice.
International
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agents invoice their own orders and collect payment, remitting the license fee,
net of commissions, to us in United States dollars.
RESELLERS AND DISTRIBUTORS
To complement our direct sales efforts, we market many of our products
through corporate resellers and distributors, and indirectly through retailers.
While historical sales through these distribution channels have generated a
relatively small portion of our net revenue, during the last three years our
presence in these channels has expanded. We currently utilize corporate
resellers, including Software Spectrum, ASAP Software, Softmart, Corporate
Software & Technology and Software House International, which focus primarily on
selling site licenses for our software to corporate customers.
Independent software distributors who market our products include Ingram
Micro, Merisel America, Pinacor, Inc., and Tech Data. These distributors stock
our products in inventory for redistribution primarily to large retailers, value
added resellers, or VARs, and mail order companies. Through our authorized
distributors, we sell our retail packaged products to several of the large
computer and software retailers in the United States, including Comp USA,
Staples, Best Buy, Office Max and Office Depot. Several members of our channel
sales force work closely with our major reseller and distributor accounts to
manage orders, inventory level, promotions and selling activities.
Our distributors generally are permitted stock balancing and stock rotation
rights but are typically required to place offsetting orders of equal value. We
often rely on resellers and distributors, including retail outlets, to market
and support our products. Our agreements with our distributors are not exclusive
and may be terminated by either party without cause. Terminated distributors may
not continue to represent our products.
ORIGINAL EQUIPMENT MANUFACTURERS
Original Equipment Manufacturers, or OEMs, license our products (mainly
anti-virus products licensed through McAfee.com) and bundle them with personal
computer hardware or software. OEMs typically sublicense a single version of our
products to end users who must contact us in order to license their updates. We
typically receive a per-copy royalty from our OEMs.
OTHER MARKETING ACTIVITIES
Our principal means of marketing our products and services is through the
Internet. In addition to the NAI.com website, each of our product groups,
McAfee.com and myCIO.com have their own individual websites. Not only do each of
these websites contain various marketing materials and information about our
products, but website visitors may download and purchase products or obtain free
trials or our products or trial subscriptions for hosted products and services.
We also promote our products and services through advertising activities in
trade publications and direct mail campaigns and strategic arrangements. For
example, in December 1999 McAfee.com entered into an agreement with America
Online, or AOL, under which McAfee.com is the premier anti-virus service
provider on AOL, AOL.COM, and AOL's Shop@AOL marketplace. AOL will also sponsor
on a number of AOL's properties an anti-virus center, a PC download center and a
software development center. We also attend trade shows, sponsor conferences and
publish a quarterly newsletter, which is mailed to existing and prospective
customers.
CUSTOMERS
We primarily market our products to large corporate and government
customers directly through our direct sales organization and indirectly through
resellers and distributors. In terms of number of products available for sale, a
majority of our products are distributed indirectly through resellers and
distributors. In the U.S., substantially all our indirect sales are through five
major distributors. In Europe, substantially all indirect sales are also made
through five major distributors. See Note 14 of Notes to Condensed Consolidated
Financial Statements for major customer information.
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We primarily market our products directly to individual consumers through
online distribution channels and indirectly through traditional distribution
channels, such as retail stores. McAfee.com is responsible for online
distribution of our products sold to individual consumers over the Internet or
for Internet-based products and for the licensing of technology to original
equipment manufacturers for sale to individual consumers.
PRODUCT DEVELOPMENT AND ACQUISITION
We believe that our ability to maintain our competitiveness will depend in
large part upon our ability to enhance existing products, develop and acquire
new products and develop and integrate acquired products. The market for
computer software includes low barriers to entry and rapid technological change,
and is highly competitive with respect to timely product introductions. Product
enhancements or new products may not be developed or acquired on a timely basis
or at all. As part of our growth strategy, we have made and expect to continue
to make investments in complementary businesses, products and technologies. In
addition, we have made, and will continue to make, strategic minority
investments in complementary Internet-related companies.
In addition to developing new products, our internal development staff is
also focused on developing updates to existing products and modifying and
enhancing any acquired products. Future upgrades and updates may include
additional functionality, respond to user problems or address compatibility
problems with changing operating systems and environments. We believe that our
ability to provide these upgrades and updates frequently and at low cost is key
to our success. For example, the proliferation of new and changing viruses makes
it imperative to update anti-virus products frequently to avoid obsolescence.
Failure to release upgrades and updates could have a material adverse effect on
our business, results of operations and financial condition. We may not be
successful in these efforts. In addition, future changes in Windows 98, Windows
NT, NetWare or other popular operating systems could cause compatibility
problems with our products. Further, delays in the introduction of future
versions of operating systems or lack of market acceptance of these future
versions would delay or reduce demand for our future products which were
designed to operation with these future operating systems. Our failure to
introduce in a timely manner new products that are compatible with operating
systems and environments preferred by desktop computer users would have a
material adverse effect on our business, results of operations and financial
condition.
We expended $148.2 million, $135.5 million and $103.1 million in the years
ended December 31, 1999, 1998 and 1997, respectively, on research and
development.
MANUFACTURING AND SUPPLIERS
Our manufacturing operations consist primarily of assembly, testing and
quality control of materials, components, subassemblies and systems for our
Sniffer-based and E-ppliance products. We use third-party manufacturers for
these manufacturing operations. Reliance on third-party manufacturers involves a
number of risks, including the lack of control over the manufacturing process
and the absence or unavailability of adequate capacity.
We have developed software-only versions of some of our Sniffer products.
Purchasers of these Sniffer software products are required to already own or
purchase directly from the manufacturer or other vendors the necessary hardware
products, such as computer platforms and components. Customers may require that
we continue to provide the necessary hardware products.
COMPETITION
The markets for our products are intensely competitive we expect
competition to increase in the near-term. We believe that the principal
competitive factors affecting the markets for our products include:
- performance;
- functionality;
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- quality;
- customer support;
- breadth of product line;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
- brand name recognition;
- reputation; and
- price.
We may be unable to compete effectively against existing and potential
competitors. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources. As
is the case in many segments of the software industry, we have been
encountering, and we expect to further encounter, increasing competition. This
increased competition could reduce average selling prices and, therefore, profit
margins. Competitive pressures could result not only in price reductions but
also in a decline in sales volume. In addition, competitive pressures may make
it difficult for us to maintain or exceed our growth rate.
Performance and quality of our anti-virus software products are measured by
number and type of viruses detected, the speed at which the products run and
ease of use. Our principal competitor in the anti-virus market serviced by our
McAfee product group and McAfee.com is the Peter Norton Group of Symantec. Trend
Micro remains the strongest competitor in the Asian anti-virus market. Other
competitors include numerous smaller companies and shareware authors that may in
the future develop into stronger competitors or be consolidated into larger
competitors.
Our principal competitors in the security market generally varies by
product type. For firewalls, our principal competitors include CheckPoint,
Axent, particularly for Windows NT-based firewalls, and larger companies such as
Cisco Systems and Microsoft. For intrusion detection products, we compete with
ISS, Axent and Cisco. The markets for encryption and virtual private network, or
VPN, products are highly fragmented with numerous small and large vendors.
Public key infrastructure, or PKI, encryption vendors such as Entrust
Technologies offer some products that compete with our PGP products. VPN
competitors include hardware and software vendors, including telecommunications
companies and traditional networking suppliers.
Our principal competitor in the network management market is Agilent. Other
competitors include Cisco, Computer Associates, Compuware, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies, Shomiti Systems and Wavetek Wandel & Goltermann, Inc.
Our principal competitors in the help desk market are Computer Associates,
Heat, Peregrine and Remedy.
We also face competition from large software companies such as Microsoft,
Intel, Novell and HP, which may offer network security and management products
as enhancements to their operating system.
Finally, as the network management market develops, we may face increased
competition from a number of large companies, as well as other companies seeking
to enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and support capabilities. In addition, to the extent that we
continue to develop our Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
we will likely compete with large computer systems management companies such as
Tivoli Systems and Computer Associates.
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PROPRIETARY TECHNOLOGY
Our success depends significantly upon proprietary software technology. We
rely on a combination of contractual rights, trademarks, trade secrets and
copyrights to establish and protect proprietary rights in our software. However,
these protections may be inadequate or competitors may independently develop
technologies or products that are substantially equivalent or superior to our
products. We do not typically obtain signed license agreements from our
corporate, government and institutional customers who license products directly
from us. Rather we include an electronic version of a "shrink-wrap" license in
all of our electronically distributed software and a printed license in the box
for our products distributed through traditional distributors in order to
protect our copyrights and trade secrets in those products. Since none of these
licenses are signed by the licensee, many legal authorities believe that such
licenses may not be enforceable under the laws of many states and foreign
jurisdictions. In addition, the laws of some foreign countries either do not
protect these rights at all or offer only limited protection for these rights.
The steps taken by us to protect our proprietary software technology may be
inadequate to deter misuse or theft of this technology. For example, we are
aware that a substantial number of users of our anti-virus products have not
paid any registration or license fees to us. Changing legal interpretations of
liability for unauthorized use of our software, or lessened sensitivity by
corporate, government or institutional users to avoiding infringement of
intellectual property, could have a material adverse effect on our business,
results of operations and financial condition.
NETWORK ASSOCIATES/MCAFEE.COM INTERCOMPANY AGREEMENTS
For the purposes of defining our ongoing relationship with McAfee.com, our
publicly traded subsidiary, we have entered into a number of ongoing agreements.
These agreements are filed as exhibits to the public disclosure documents that
we file with the Securities and Exchange Commission and are described briefly
below. The description is subject in all respects to the terms of the actual
agreements.
LICENSE AGREEMENT: Under the terms of this agreement:
Licensed Technology. Network Associates and McAfee.com granted to each
other limited rights to each others' patents, copyrights, trademarks and
trade secrets for use in defined markets. Network Associates has worldwide,
non-exclusive rights to McAfee.com's patents and exclusive rights to use
copyrights, trademarks and trade secrets to deliver products and services
to enterprise customers and individual consumers by any means other than
the Internet. Under the agreement, McAfee.com is granted worldwide,
non-exclusive rights to Network Associate's patents and exclusive rights to
use Network Associate's copyright, trademark and trade secret rights to
create and deliver products and services directly or indirectly to
individual consumers over the Internet or for Internet, based products.
Each party is also permitted to create products derived from the technology
licensed to it by the other. The creating party retains ownership of their
newly derived products but these derived products are licensed to the other
party subject to the terms of the license agreement.
Royalty Payments. In consideration for the rights granted under the
license agreement, Network Associates is required to pay McAfee.com a flat
quarterly royalty of $250,000. In consideration for the rights granted by
Network Associates to McAfee.com under the license agreement, McAfee.com is
required to pay Network Associates a royalty on revenues recognized from
product and subscription sales that include Network Associates' technology,
initially at a rate of 20% commencing on January 1, 1999 and declining
1.625% per quarter until the rate is 7% in the quarter beginning January 1,
2001, and remaining at 7% thereafter.
Limitations on Offered Products. During the term of the agreement,
each party has agreed that it will not offer products incorporating
third-party technology if those products are competitive with the products
offered by the other party.
Indemnification. Under the agreement, each party has agreed to
indemnify, defend and hold harmless the other for any losses incurred in
connection with claims arising in the covered countries if the technology
licensed under the agreement violates the patent, copyright, trademark or
trade secrets or other proprietary rights of a third party. Covered
countries are those countries that are party to the Berne
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Convention for the Protection of Literary and Artistic Works, which include
the U.S. and substantially all U.N. member nations.
Term and Termination. The license agreement will remain in effect
indefinitely, but may be terminated, among other circumstances, by the
non-defaulting party, in the event of a material breach by the other party
that remains uncured for 30 days following notice of the breach, subject to
mandatory dispute resolution prior to the effectiveness of any proposed
termination.
Services Agreement: Under this agreement, Network Associates provides
services relating to tax, insurance, employee benefits and administration,
corporate record keeping and information technology. For these services, Network
Associates charges a portion of the cost of our provision of the services to
McAfee.com, including all related expenses, which is allocated based on
headcount, plus a ten percent mark-up. In addition, Network Associates may
provide additional services, including legal and accounting services, from
time-to-time in the future. The services agreement may be terminated either by
McAfee.com on 30 days notice or by Network Associates when it ceases to own a
majority of the outstanding voting stock of McAfee.com.
Registration Rights Agreement: Under this agreement, Network Associates, or
any transferee of at least 10% of its McAfee.com shares, can include its shares
of McAfee.com common stock in any future registration of common stock made by
McAfee.com, other than any registration statement relating to an acquisition or
stock option plan. In addition, after June 1, 2000, Network Associates or any
transferees of at least 10% of its McAfee.com shares can request that McAfee.com
file a registration statement so it can publicly sell their shares of McAfee.com
stock.
Joint Cooperation Agreement: The joint cooperation and master services
agreement with McAfee.com governs the provision of technology services among the
parties. Under this agreement, the Network Associates' anti-virus emergency
response team, known as AVERT, will provide McAfee.com with research and
solutions for virus events. The agreement also contains standard terms and
conditions governing the provision of technology services from one party to the
other under statements of work that may be negotiated from time to time. We pay
McAfee.com a fee for these services in an amount equal to 10% of McAfee.com's
total quarterly technology costs plus a 10% service charge.
Tax Sharing Agreement: Under this agreement, McAfee.com pays federal, state
and local income tax liability amounts to Network Associates, determined on a
pro forma basis, as if McAfee.com filed its own separate income tax returns for
each year. Network Associates will not reimburse McAfee.com for McAfee.com's or
any other group member's use of their net operating loss or other tax benefits
in any consolidated or combined return. However, McAfee.com will be able, during
the term of the agreement, to take into account its past and future net
operating loss and other tax attributes for purposes of computing its
hypothetical separate income tax return liability payment to, or refund from,
Network Associates.
The tax sharing agreement will terminate if McAfee.com is no longer
eligible to join Network Associates in the filing of a consolidated federal
income tax return. In the event of such termination, any net operating losses or
other carryforward amounts would not be available to McAfee.com upon departure
from the group. Under the agreement, McAfee.com will not be reimbursed for any
such loss of tax benefits.
Indemnification and Voting Agreement: Under this agreement, except as
contemplated below, Network Associates will indemnify and defend McAfee.com
harmless for all losses related to any third party claims relating to events or
circumstances arising out of any action or inaction of Network Associates,
including its subsidiaries and officers and directors, on or prior to December
2, 1999, the date on which McAfee.com completed its initial public offering.
Matters for which Network Associates is not obligated to indemnify McAfee.com
include:
- any obligations assumed by McAfee.com, or payments required to be made by
McAfee.com, under its agreements with Network Associates;
- any losses resulting from third party claims that are related to
intellectual property developed by McAfee.com between August 20, 1999 and
December 2, 2000;
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- any obligations incurred by McAfee.com in the ordinary course of
business;
- any losses resulting from third parties claims made against McAfee.com
alleging infringement of intellectual property rights unknown as of the
closing of McAfee.com's initial public offering; and
- any losses resulting from third parties claims related to or arising from
a material misstatement contained in or material omission from the
prospectus or the registration statement for McAfee.com's initial public
offering.
As a result of the above indemnification, we are, for example, required to
hold McAfee.com harmless from our existing litigation related to the anti-virus
technology licensed under the cross license agreement. In the event of a claim
relating to a product that includes components supplied by McAfee.com and
components supplied by us, Network Associates has the right to determine whether
and to what extent McAfee.com is entitled to indemnification, after reasonable
consultation with McAfee.com.
For so long as we own at least 20% of McAfee.com's outstanding voting
power, we must vote our shares of McAfee.com's capital stock in favor of the
election of two independent directors. Additionally, if, as described below
under the stockholders agreement, there is a Network Associates' change of
control which is not approved by the continuing Network Associates directors, we
have agreed to vote to elect a majority of independent directors to McAfee.com's
board.
Stockholders Agreement: Under this agreement, we have agreed that if (1)
without the prior approval of the Network Associates continuing directors, as
defined below, any person acquires or agrees to acquire 15% or more of our
outstanding common stock or (2) the Network Associates continuing directors
cease to constitute a majority of serving directors, then for so long but only
for so long as that condition exists:
- our shares of McAfee.com Class B common stock are entitled to only one
vote per share instead of three votes per share; and
- we are obligated to vote our McAfee.com shares to cause, and to take such
actions reasonably within our control to cause, and to seek to cause the
McAfee.com directors appointed by us to cause, McAfee.com's board of
directors to consist of at least a majority of independent directors.
Network Associates continuing directors will consist of our current directors
and any subsequent directors approved or not objected to by a majority of our
then-continuing directors.
EMPLOYEES
As of December 31, 1999, we employed 2,686 individuals worldwide.
Competition for qualified management and technical personnel is intense in the
software industry. Our continued success will depend in part upon our ability to
attract and retain qualified personnel. None of our employees is represented by
a labor union and we believe that our employee relations are good.
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RISK FACTORS
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.
OUR QUARTERLY FINANCIAL RESULTS WILL LIKELY FLUCTUATE
Our quarterly operating results have varied greatly in the past and will
likely vary greatly in the future depending upon a number of factors. Many of
these factors are beyond our control. Our revenues, gross margins and operating
results may fluctuate significantly from quarter to quarter due to, among other
things:
- volume, size and timing of new licenses and renewals of existing
licenses;
- our distributor inventory levels and product return rates;
- our inventory levels;
- introduction of new products, product upgrades or updates by us or our
competitors;
- the mix of products we sell;
- the size and timing of our non-cash stock-based charges;
- changes in product prices by us or our competitors;
- trends in the computer industry;
- our ability to develop, market and sell our products particularly in
light of our recent sales force reorganization;
- costs related to acquisitions of technology or businesses;
- fluctuations in McAfee.com's expenditure levels related to its efforts to
build brand awareness, and establish strategic relationships with various
Internet companies;
- fluctuations in myCIO.com's expenditure levels related to its efforts to
develop new products, adapt existing products to an application service
provider (or ASP) delivery model and build brand awareness;
- our investment experience related to our strategic minority equity
investments;
- the effectiveness of and the expenditure levels related to the recent
expansion of our European Sniffer organization;
- the effectiveness of our channel strategy and our mix of direct and
indirect revenues;
- pressure on employee wages as competition for skilled employee's
increases; and
- costs related to extraordinary events including litigation and
acquisitions.
Our business is impacted by the seasonal trends and global or regional
macroeconomic trends. For example, our net revenues is typically higher in the
fourth quarter, as many customers complete annual budgetary cycles, and lower in
the summer months when many businesses experience lower sales, particularly in
the European market. Our business in Japan, Asia generally and Latin America has
been adversely impacted by the adverse economic conditions there. If these
conditions were to spread to Europe or the U.S., our business, results of
operations and financial condition would be adversely impacted.
WE FACE RISKS RELATED TO THE DIVISION OF OUR BUSINESS INTO PRODUCT GROUPS
On January 1, 2000, we divided our business into four product groups:
McAfee, which markets the McAfee Active Virus Defense (AVD) product suite;
Sniffer Technologies, which markets the Sniffer Total Network Visibility (TNV)
product suite; PGP Security, which markets the PGP Total Security Defense
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(TSD) product suite; and Magic Solutions, which markets the Magic Total Support
Desk (TSD) product suite. These four individual product suites form our single
Net Tools mega suite. This reorganization, along with a related product group
sales force reorganization, is intended to allow us to react faster to
customer's needs and to focus each product group's sales force on selling their
respective product suite and the individual point products contained in those
product suites. As part of this reorganization, we also reorganized our U.S.
professional services organization around our product groups. Our customers and
potential customers, sales force and professional services organization may not
respond favorably to the change and our business and future financial
performance could suffer. This reorganization may be unsuccessful due to, among
other things:
- uncertainty and customer dissatisfaction surrounding our shift in focus
from our "Net Tools" mega-suite strategy to our product group's strategy,
including uncertainty as to our continued level of support for the Net
Tools mega suite and continued integration of our various product suites;
- customer confusion or irritation related to multiple sales calls from
different members of our reorganized sales force;
- a loss of potential cross selling opportunities and a lack of lead
sharing between the separate product group's sales representatives who
are generally only compensated for sales made by them of products within
their product groups;
- failure by our employees to embrace the changes, resulting in possible
declines in sales force productivity or employee departures;
- the possibility that our centralized general and administrative group may
be unable to meet on a timely basis or at all each product group's
individualized infrastructure and support requirements; and
- one or more of our product groups may lack sufficient qualified
professional services personnel to support its products.
WE COULD EXPERIENCE CUSTOMER AND MARKET CONFUSION DUE TO OUR MARKETING AND
ADVERTISING EFFORTS TARGETED AT THE PRODUCT GROUP OR SUBSIDIARY LEVEL, RATHER
THAN AT THE CORPORATE LEVEL, AND DUE TO SIMILARITIES IN THE NAMES USED BY OUR
PRODUCT GROUPS AND SUBSIDIARIES
Networks Associates, Inc. was formed in December 1997, by the combination
of McAfee Associates, Inc. and Network General Corporation. Over the last two
years, we have spent a significant portion of our total marketing efforts and
advertising spending building awareness of the Network Associates name. In the
future, we plan to focus our marketing efforts and advertising spending on
building brand awareness at the product group and subsidiary level, rather than
at the Network Associates corporate level. This could create confusion in the
market place and in the investor community if people are not clear about the
relationship between Network Associates, our product groups and our McAfee.com
and myCIO.com subsidiaries, many of which have potentially confusing names and
products. For example, our online consumer anti-virus products, our retail and
corporate anti-virus products (other than those hosted online) and our corporate
hosted anti-virus products are marketed and sold, respectively, by our publicly
traded McAfee.com subsidiary, our retail division which is called McAfee Retail
and our McAfee product group and our myCIO.com subsidiary.
THE TIMING AND AMOUNT OF OUR REVENUES ARE SUBJECT TO A NUMBER OF FACTORS THAT
MAKE IT DIFFICULT TO ESTIMATE OPERATING RESULTS PRIOR TO THE END OF A QUARTER
We do not expect to maintain a significant level of backlog. As a result,
product revenues in any quarter are dependent on contracts entered into or
orders' booked and shipped in that quarter. We have generally experienced a
trend toward higher order receipt, and therefore a higher percentage of revenue
shipments, toward the end of the last month of a quarter. This trend makes
predicting revenues more difficult. The timing of closing larger orders
increases the risk of quarter-to-quarter fluctuation. If orders forecasted for a
specific customer for a particular quarter are not realized or revenues are not
otherwise recognized in that quarter, our operating results for that quarter
could be materially adversely affected.
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OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE
During 1999, our stock price ranged from a per-share high of $61.25 to a
low of $11.06. Announcements, litigation developments, and our ability to meet
the expectations of brokerage firms, industry analysts or investors with respect
to our operating and financial results may contribute to current and future
stock price volatility. We may not discover, or be able to confirm, revenue or
earnings shortfalls until the end of a quarter, which could result in an
immediate drop in our stock price. In addition, similar events with respect to
McAfee.com, our publicly traded subsidiary, and fluctuations in its stock price
may also contribute to the volatility of our stock price. In the past, following
periods of volatility in the market price of a company's securities, securities
class action litigation has often been instituted against companies with public
traded securities. A number of putative class actions were brought against our
officers, directors and us. See Item 3 Legal Proceedings. This litigation, and
any other litigation if instituted, could result in substantial costs and a
diversion of management's attention and resources.
COMPETITORS MAY INCLUDE PRODUCTS SIMILAR TO OURS IN THEIR HARDWARE OR SOFTWARE
AND RENDER OUR PRODUCTS OBSOLETE
Vendors of hardware and of operating system software or other software
(such as firewall or e-mail software) may enhance their products or bundle
separate products to include network security and management software similar to
our products. The widespread inclusion of products that perform the same or
similar function as our products within computer hardware or other software
could render our products obsolete and unmarketable. Furthermore, even if these
incorporated products are inferior or more limited than our products, customers
may elect to accept the incorporated products rather than purchase our products.
If we are unable to develop new network security and management products to
further enhance operating systems or other software and to successfully replace
any obsolete products, our business could suffer.
WE EXPECT SIGNIFICANT STOCK BASED COMPENSATION CHARGES RELATED TO REPRICED
OPTIONS
In light of the decline in our stock price at the time and in an effort to
retain our employee base, in April 1999, we offered to reprice options held by
all employees, other than directors and executive officers. If the employee
agreed not to exercise any of the repriced options for a period of twelve
months, the exercise price of their eligible employee options with an exercise
price in excess of $11.0625 was reduced to $11.0625, the closing market price on
the NASDAQ on April 22, 1999. Option holders electing to have their options
repriced were required to acknowledge their acceptance by April 28, 1999. As a
result of the increase in price between the date on which the options were
repriced, April 22, 1999, and the date on which the employees elected to reprice
their option grants, April 28, 1999, we have and will continue to incur a
stock-based compensation charge. The total compensation charge expensed for 1999
was approximately $8.8 million, and approximately $11.6 million will be expensed
over the remaining vesting period of the repriced options.
On March 31, 1999, the FASB issued an exposure draft of its Proposed
Interpretation, "Accounting for Certain Transactions involving Stock
Compensation -- an interpretation of APB Opinion No. 25" (the "Proposed
Interpretation"). Under the Proposed Interpretation, stock options repriced
after December 15, 1998 will be subject to variable plan accounting treatment.
If adopted, this proposed guidance will require us to remeasure compensation
cost for outstanding repriced options each reporting period based on changes in
the market value of the underlying common stock after the date of adoption. The
FASB currently expects to approve the interpretation sometime in the year 2000.
Depending upon movements in the market value of our common stock, this
accounting treatment may result in significant additional compensation charges
in future periods.
EMPLOYEES MAY LEAVE AFTER THE 12-MONTH LOCK UP PERIOD ON THE EXERCISE OF
REPRICED EMPLOYEES OPTIONS
Employees whose options were repriced to $11.0625 per share, as described
above, agreed to not exercise any of the repriced options for a period of twelve
months. After April 22, 2000, the end of this 12-month lock-up period, employees
may elect to terminate their employment with us and exercise and sell some or
all of their repriced vested options. The departure of a large number of our
employees or a meaningful number of
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key non-executive employees could have a material adverse impact on many facets
of our business, including our ability to develop new products, upgrade existing
products, sell our products and provide adequate internal infrastructure.
WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE TRANSACTIONS
The software industry has experienced, and is expected to continue to
experience, a significant amount of consolidation. As part of our growth
strategy, we may buy or make investments in, complementary companies, products
and technologies. Since 1995 we have completed a large number of significant
acquisitions involving both public and private companies, including:
- CyberMedia in September 1998;
- Dr. Solomon's in August 1998;
- Secure Networks in May 1998;
- Magic Solutions and TIS in April 1998;
- Network General, PGP and Helix Software in December 1997;
- Cinco Networks in August 1997 (acquired by Network General);
- Vycor Corporation in February 1996; and
- Saber Software in August 1995.
We have also completed a number of smaller acquisitions and acquired a
number of our international distributors. Recently, we began making strategic
minority investments in complementary Internet related companies. As of December
31, 1999, these minority investments totaled $20.2 million. We are currently
investigating acquisitions of additional foreign distributors and other
strategic minority investments.
Our acquisitions and strategic investments involve a number of risks and we
may not realize the expected benefits of these transactions. We may lose all or
a portion of our investment, particularly in the case of our strategic minority
investments.
In 1997 and 1998, we incurred significant nonrecurring charges associated
with our previous acquisitions. Our available cash and our securities may be
used to buy or invest in companies or products, which could result in
significant acquisition-related charges to earnings and dilution to our
stockholders. Moreover, if we buy a company, we may have to incur or assume that
company's liabilities, including liabilities that are unknown at the time of
acquisition, which may result in a material adverse effect on us.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE
NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT
In connection with our previous acquisitions accounted for under the
purchase method of accounting, in future periods we will experience significant
charges related to the amortization of purchased technology and goodwill. In
addition, if we later determine that this purchased technology and goodwill is
impaired, we will be required to take a related non-recurring charge to
earnings.
WE FACE RISKS RELATED TO OUR SNIFFER STRATEGY
We recently began investing significant resources to increase the European
Sniffer sales organization in an effort to increase brand awareness in Europe.
There is no guarantee that this investment will produce the desired results.
Certain of the Sniffer products contain critical components supplied by a
limited number of third party suppliers.
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OUR HARDWARE BASED PRODUCTS FACE MANUFACTURING, SUPPLY, INVENTORY, LICENSING AND
OBSOLESCENCE RISKS
Some of our Sniffer products and E-ppliance products include, in addition
to our software, a hardware platform as well as software licensed from other
companies. Third party manufacturers do the manufacturing of these products
under contract for us. Reliance on third party manufacturers involves a number
of risks, including the lack of control over the manufacturing process and the
potential absence or unavailability of adequate capacity. In the event that any
third party manufacturers cannot or will not continue to manufacture our
products in required volumes, on a cost effective basis, in a timely manner or
at all, we will have to secure additional manufacturing capacity. Even if such
additional capacity is available at commercially acceptable terms, the
qualification process could be lengthy and could create delay in product
shipments.
Our hardware-based products contain critical components supplied by a
single or a limited number of third parties. We have been required to purchase
certain computer platforms around which we design our network fault and
performance management products to ensure an available supply of these products
for our customers. Any significant shortage of these platforms or other
components or the failure of the third party supplier to maintain or enhance
these products could lead to cancellations of customer orders or delays in
placement of orders.
Some of our hardware based products incorporate licensed software, such as
operating system software. Our ability to successfully market these products
depends on our ability to obtain reasonably priced licenses from third party
software providers, as well as on our ability to integrate our hardware and
software with the software provided from third parties. If we are unable to
obtain software licenses from third parties or to integrate third party software
with our hardware products, our ability to market hardware based products would
suffer.
Hardware based products may face greater obsolescence risks than software
products. If our hardware products are not easily upgradable to meet future
market needs, they may become obsolete. In addition to lost future sales, we
could incur losses or other charges in disposing of obsolete inventory, both of
which could also materially adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR MYCIO.COM STRATEGY
In January 2000, we launched a new wholly owned subsidiary, myCIO.com.
myCIO.com is an infrastructure ASP which delivers to businesses hosted network
security and availability services via the Internet. This web-based model is a
relatively new concept and there is a risk that myCIO.com and its products may
fail to gain market acceptance.
The growth, market acceptance and ultimate profitability of myCIO.com's
online network security and availability services is highly uncertain and
subject to a number of factors, including:
- myCIO.com's ability to successfully adapt existing products or develop
new or enhanced products that operate in fast, secure and reliable manner
over the Internet;
- increased expenditures associated with the creation of a new business,
such as product development, marketing and technical and administrative
support;
- the introduction of new products by myCIO.com or myCIO.com's competitors;
- potential unwillingness of businesses to pay for myCIO.com's subscription
based products and services and its ability to properly price its
products and services to generate the greatest revenue opportunities;
- business reluctance to change their software purchasing behavior in favor
of services hosted on the myCIO.com servers; and
- business concerns about whether the Internet is fast, reliable and secure
enough to deliver critical network security and availability services
effectively.
There is a risk that sales of myCIO.com's products may significantly reduce
the sales of the products offered by our product groups. These sales may result
in less overall revenue and profit for us if the prices and
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profit margins of myCIO.com's products are less than the prices and profit
margins of comparable products offered by our product groups.
myCIO.com is likely to incur significant losses for the foreseeable future.
These losses will be funded by us and will impact our consolidated financial
results.
WE FACE RISKS RELATED TO OUR MCAFEE.COM STRATEGY
In December 1998, we incorporated McAfee.com as our Internet destination
dedicated to updating, upgrading and managing PCs, over the Internet for single
use retail, non-corporate, consumers. We have entered into various inter-company
arrangements including technology, licenses, shared facilities, functions,
services and tax sharing agreements with McAfee.com. On December 2, 1999,
McAfee.com completed an initial public offering. At December 31, 1999, we owned
36.0 million shares of McAfee.com's Class B common stock, which is generally
entitled to three votes per share and converts to shares of McAfee.com Class A
common stock if sold by us to a third party. McAfee.com Class A common stock is
entitled to one vote per share. At December 31, 1999, our McAfee.com holdings
represented approximately 83% of McAfee.com's outstanding capital stock and
approximately 94% of its total voting power.
Pursuant to our cross license agreement with McAfee.com, we have licensed
all our technology to McAfee.com for use in the markets specified below and
McAfee.com has licensed its technology to us for our use outside of McAfee.com's
markets. Under our license and other agreements with McAfee.com, among other
things:
- McAfee.com has the exclusive right to use the licensed technology for
providing single-user consumer licenses for our products and services
sold over the Internet or for Internet-based products and licensing the
technology to original equipment manufacturers for sale to individual
consumers;
- we are permitted to continue to sell our consumer products through
non-online channels, such as traditional retail stores, however
McAfee.com's sales of online products and services could significantly
reduce sales of these products;
- we may not offer a product incorporating third party technology if those
products are competitive with products offered by McAfee.com;
- McAfee.com is required to pay us a license fee of 20% of net revenue
derived from product sales that include the licensed technology
commencing on January 1, 1999 and declining 1.625% per quarter until the
rate is 7% in the quarter beginning January 1, 2001;
- the license agreement is perpetual and may only be terminated by us if
McAfee.com fails to cure a material breach of the license within 30 days
after we notify it of the breach, subject to mandatory dispute resolution
prior to the effectiveness of any proposed termination;
- we are required to indemnify McAfee.com with respect to existing
litigation related to the licensed technology to which we are a party,
including the litigation described in Note 15 of the Notes to the
Consolidated Financial Statements;
- McAfee.com has agreed to provide, and we are dependent on McAfee.com to
provide continuously and successfully, the infrastructure and technical
support for our web site;
- generally, we are required to cause to be elected at least two
independent directors to the McAfee.com board of directors, which term
would exclude any serving Network Associates officer or director; and
- if, without the prior approval of our continuing directors (being our
current directors and directors approved or not objected to by our
current directors), someone acquires 15% or more of our outstanding
capital stock or our continuing directors cease to constitute a majority
of our board (1) we are required to vote our shares of McAfee.com common
stock and otherwise seek to cause to the McAfee.com board of directors to
consist of at least a majority of independent directors and (2) our
shares of McAfee.com Class B common stock will be entitled to only one
vote per share instead of three.
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We expect that the McAfee.com business will incur significant losses for
the foreseeable future. These losses will impact our consolidated financial
results. The growth and market acceptance of McAfee.com's online PC security and
management products and services is highly uncertain and subject to a number of
factors, including:
- potential unwillingness of consumers to pay for McAfee.com's subscription
based products and services and its ability to properly price its
products and services to generate the greatest revenue opportunities;
- consumer reluctance to change their software purchasing behavior in favor
of services hosted on the McAfee.com's servers; and
- consumer concerns about whether the Internet is fast and reliable enough
to deliver critical PC security and management functions effectively.
McAfee.com's services are designed to protect consumer privacy by ensuring
that all PC scans are done locally at the PC, all information about the user's
PC is transmitted to it anonymously and no scanned data is stored by it.
However, consumers' misconceptions about this process could prevent McAfee.com's
ASP model from achieving market acceptance.
WE FACE RISKS RELATED TO THE ALLOCATION OF PRODUCTS, CUSTOMERS AND TERRITORIES
AMONG OUR PRODUCT GROUPS AND SUBSIDIARIES
We are continuing to focus our business around our products, our customers
and geographic territories. Our product groups are primarily product focused
selling their specific product suites. McAfee.com and myCIO.com are both product
and customer focused primarily selling their products and services over the
Internet to consumers and businesses, respectively. NAI KK is both
geographically and customer focused, selling Network Associates' products on a
generally exclusive basis in Japan and to large Japanese business customers
outside of Japan. Except as provided under our technology licensing agreements
and arrangements, we do not currently have in place a policy to govern the
pursuit or allocation of business opportunities between our subsidiaries and
product groups. These and any future internal allocation of products, customers
and territories could result in, among other things:
- sales force conflict;
- customer confusion surrounding the entity or party with whom they are
expected to deal;
- disputes over product and research and development priorities;
- disputes over allocation of corporate resources and focus; and
- loss of management focus due to efforts spent to resolve internal
conflicts.
WE MUST ADAPT TO THE RAPIDLY CHANGING BUSINESS ENVIRONMENT BROUGHT ON BY THE
WIDESPREAD USE OF THE INTERNET
We have integrated the use of the Internet in many parts of our business,
including sales, distribution and support of our products. There are still many
uncertainties regarding many facets of the Internet, including reliability,
security, access, tax, government regulation and cost. We also run the risk of
not adapting to the latest changes in the Internet, which could affect our
business operations. If growth of the Internet does not develop at the rapid
pace we expect, our operating results could be adversely affected.
WE FACE RISKS RELATED TO OUR STRATEGY OF ACQUIRING INDEPENDENT AGENTS AND
DISTRIBUTORS
We have acquired existing independent agents and distributors of our
products in certain strategic markets. We may be required to provide customers
the same level of technical support that was previously provided by the acquired
agents and distributors. We may be unable to provide technical support or
operate any acquired distributor or agent as well as previous operators or at
all. The acquisition of any distributor or agent may not result in increased
foreign revenues.
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OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISK
ASSOCIATED WITH PRODUCT DEVELOPMENT
The network security and management market is highly fragmented and
characterized by ongoing technological developments, evolving industry standards
and rapid changes in customer requirements. Our success will depend on our
ability to:
- offer a broad range of network security and management software products;
- continue to enhance existing products and expand product offerings;
- develop and introduce in a timely manner new products with technological
advances;
- respond promptly to new customer requirements;
- comply with evolving industry standards without delays in compliance;
- provide upgrades and updates to users frequently and at low cost; and
- remain compatible with popular operating systems such as Windows 98,
Windows NT and NetWare.
We may not be able to successfully develop and market, on a timely basis,
enhancements to our existing products or new products. Our product enhancements
or new products may not adequately address the changing needs of the
marketplace. New products with new technological capabilities could replace or
shorten the life cycle of our products or cause our customers to defer or cancel
purchases of our products.
We may continue to experience delays in software development as we have at
times in the past. Complex software products like ours may contain undetected
errors or version compatibility problems, particularly when first released,
which could delay or cost us our market acceptance. For example, our anti-virus
software products have in the past falsely detected viruses that did not
actually exist. Difficulties and delays associated with new product
introductions, performance or enhancements could have a material adverse effect
on our business, financial condition and results of operation.
Our product development efforts are impacted by the adoption or evolution
of industry standards. For example, no uniform industry standard has developed
in the market for encryption security products. As industry standards are
adopted or evolve, we may have to modify existing products or develop and
support new versions of existing products. In addition, if no industry standard
develops, our products and our competitors' products could be incompatible,
which could prevent or delay overall development of the market for a particular
product. If our products fail to comply with existing or evolving industry
standards in a timely fashion, our business, results of operation and financial
condition could be materially and adversely affected.
Our long-term success depends on our ability to upgrade and update existing
product offerings, modify and enhance acquired products and introduce new
products, which meet our customers' needs. Future upgrades and updates may
include additional functionality, respond to user problems or address
compatibility problems with changing operating systems and environments. We
believe that our ability to provide these upgrades and updates frequently and at
low costs is key to our success. For example, the proliferation of new and
changing viruses makes it imperative to update anti-virus products frequently to
avoid obsolescence. Failure to release upgrades and updates could have a
material adverse effect on our business, results of operations and financial
condition. We may not be successful in these efforts. In addition, future
changes in Windows 98, Windows NT, NetWare or other popular operating systems
could cause compatibility problems with our products. Further, delays in the
introduction of future versions of operating systems or lack of market
acceptance of these future versions would delay or reduce demand for our future
products which were designed to operate with these future operating systems. Our
failure to introduce in a timely manner new products that are compatible with
operating systems and environments preferred by desktop computer users would
have a material adverse effect on our business, results of operation and
financial condition.
WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenues from our
flagship McAfee anti-virus software products and Sniffer network fault and
performance management products. These products are expected to
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continue to account for a significant portion of our net revenues for the
foreseeable future. Because of this concentration of revenue, a decline in
demand for or in the prices of these products as a result of competition,
technological change, a change in our pricing model, inclusion of anti-virus or
network management and analysis software as a standard part of hardware or
operating system software or other software, or a maturation in the markets for
these products, could harm our business.
IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE
ANTICIPATE, OUR BUSINESS COULD SUFFER
The markets for our network management and network security products are
evolving, and their growth depends upon broader market acceptance of this
software, including help desk software. Although the number of PCs, attached to
large-area networks has increased dramatically, the network management and
network security markets continue to be emerging markets. These markets may not
continue to develop or may not develop rapidly enough to benefit our business
significantly. In addition, there are a number of potential approaches to
network management and network security, including the incorporation of
management and security tools into network operating systems. Therefore, even if
network management and network security tools gain broader market acceptance,
potential purchasers may not select our products. To the extent that either the
network management or network security market does continue to develop, we
expect that competition will increase.
WE ARE SUBJECT TO INTENSE COMPETITION IN THE NETWORK MANAGEMENT AND SECURITY
MARKETS AND WE EXPECT TO FACE INCREASED COMPETITION IN THE FUTURE
The markets for our products are intensely competitive we expect
competition to increase in the near-term. We believe that the principal
competitive factors affecting the markets for our products include:
- performance;
- functionality;
- quality;
- customer support;
- breadth of product line;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
- brand name recognition;
- our reputation; and
- price.
We may be unable to compete effectively against existing and potential
competitors. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources.
These factors may provide our competitors with an advantage in penetrating the
original equipment manufacturer market with their network security and
management products. As is the case in many segments of the software industry,
we have been encountering, and we expect to further encounter, increasing
competition. This increased competition could reduce average selling prices and,
therefore, profit margins. Competitive pressures could result not only in price
reductions but also in a decline in sales volume, which could cause our business
to suffer. In addition, competitive pressures may make it difficult for us to
maintain or exceed our growth rate.
Performance and quality of our anti-virus software products are measured by
number and type of viruses detected, the speed at which the products run and
ease of use. Our principal competitor in the anti-virus
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market serviced by our McAfee product groups and McAfee.com is the Peter Norton
Group of Symantec. Trend Micro remains the strongest competitor in the Asian
anti-virus market. Other competitors include numerous smaller companies and
shareware authors that may in the future develop into stronger competitors or be
consolidated into larger competitors.
Our principal competitors in the security market generally varies by
product type. For firewalls, our principal competitors include CheckPoint,
Axent, particularly for Windows NT-based firewalls, and larger companies such as
Cisco Systems and Microsoft. For intrusion detection products, we compete with
ISS, Axent and Cisco. The markets for encryption and virtual private network, or
VPN, products are highly fragmented with numerous small and large vendors.
Public key infrastructure, or PKI, encryption vendors such as Entrust
Technologies offer some products that compete with our PGP products. VPN
competitors include hardware and software vendors, including telecommunications
companies and traditional networking suppliers.
Our principal competitor in the network management market is Agilent. Other
competitors include Cisco, Computer Associates, Compuware, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies, Shomiti Systems and Wavetek Wandel & Goltermann, Inc.
Our principal competitors in the help desk market are Computer Associates,
Heat, Peregrine and Remedy.
We also face competition from large software companies such as Microsoft,
Intel, Novell and HP, which may offer network security and management products
as enhancements to their operating system.
Finally, as the network management market develops, we may face increased
competition from a number of large companies, as well as other companies seeking
to enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and support capabilities. In addition, to the extent that we
continue to develop our Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
we will likely compete with large computer systems management companies such as
Tivoli Systems and Computer Associates.
OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH COULD
ADVERSELY AFFECT OUR BUSINESS
Our products may be considered to be capital purchases by certain customers
or prospective customers. Capital purchases are often discretionary and,
therefore, are canceled or delayed if the customer experiences a downturn in its
business or prospects or as a result of economic conditions in general. Any
cancellation or delay could adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR SALES FORCE STRUCTURE AND ITS RECENT RESTRUCTURING
Our non-governmental sales force is organized by product group, with four
separately focused sales organizations selling our McAfee, Sniffer Technology,
PGP Security and Magic Solutions products and product suites. All four sales
organizations consist of field sales representatives who are located regionally
and outbound telesales representatives who actively focus on selling our
individual product suites. The telesales representatives focus on small
customers and transactions. McAfee.com has, and myCIO.com is developing, a
separate sales force, focusing on selling their ASP solution directly to
consumers and businesses, respectively. To succeed in the direct sales channel,
we must build a significant direct sales organization and must attract and
retain qualified personnel. These individuals will require training about, and
knowledge of, product attributes of the products and product suites sold by
them. We may not succeed in building the necessary sales organization or in
attracting, retaining or training these individuals.
In January 2000 we divided our U.S. direct sales force among our four
product groups, in part, to focus our sales force on selling specialized product
suites versus selling each of the various product suites that form our Net Tools
mega suite. Our customers and potential customers and sales force may not
respond favorably
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to the restructuring and our revenues, business and future financial performance
could suffer materially. In addition to customer and sales related risks
described above:
- disputes may occur between our product group sales forces;
- sales representatives may lose productivity while being retrained or
while refocusing their sales efforts; and
- sales representatives may terminate their employment with us.
Although our increased direct sales efforts may also reduce our dependence
on resellers and distributors, it may also lead to conflicts for the same
customers, further customer confusion and may result in pressure by current and
prospective customers for price reductions on products.
WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES, WHO MAY NOT VIGOROUSLY MARKET OUR
PRODUCTS, HAVE RIGHTS OF RETURN OR MAY HAVE DIFFICULTY IN TIMELY PAYING FOR
PURCHASED PRODUCTS
We market a significant portion of our products to end-users through
intermediaries, including distributors, resellers and value-added resellers. Our
distributors sell other products that are complementary to, or compete with, our
products. While we encourage our distributors to focus on our products through
market and support programs, these distributors may give greater priority to
products of other suppliers, including competitors. Our agreements with our
distributors generally permit our distributors to return our product to us in
the event of end user returns to the distributor, inaccurate estimates of end
user demand by the distributor, increased purchases by distributors in response
to sales incentives or transitions to new products. We record sales to
distributors as revenue and at the same time establish a reserve for returns.
Actual returns could exceed reserves as a result of distributors holding
excessive amounts of our product in inventory. Our current or future reserves
for returns could be inadequate which would adversely impact our operating
results.
Some of our distributors are experiencing economic difficulties worldwide,
which may adversely impact our collection of accounts receivable. For example,
one of our major European distributors, which had been experiencing significant
cash flow issues, declared bankruptcy. As a result, in the quarter ended June
30, 1999 we recorded a $31.8 million reserve for payment default. We regularly
review the collectibility and credit worthiness of our distributors to determine
an appropriate allowance for doubtful accounts' reserve. Our uncollectible
accounts could exceed our current or future allowance for doubtful accounts'
reserve, which would adversely impact our operating results.
WE NEED TO EXPAND AND DEVELOP AN EFFECTIVE PROFESSIONAL SERVICES ORGANIZATION;
WE RELY ON THIRD-PARTY PROFESSIONAL SERVICES
As our products and computer networks in general increase in complexity,
customers require greater professional assistance to design, install, configure
and implement our products. To date, we have relied on our limited professional
services capabilities and increasingly on outside professional service
providers, including our distributors, resellers and system integrators. These
third party service providers may provide inadequate levels of professional
services. Moreover, reliance on these third parties both places a greater burden
on them and reduces our ability to control and establish standards for providing
these support services. Our reliance on these third parties could, delay our
recognition of product revenue, harm our relationships or reputation with these
third parties or the end users of our products or result in decreased future
sales of, or prices for, our products.
The failure to develop and maintain an effective professional services
organization could have a material adverse effect on our business. To more
effectively service our customer's evolving needs, we intend to significantly
expand and develop our worldwide professional service organization. We may not
succeed in these efforts. Effectively expanding and developing our professional
services organization will require that we hire and train more service
professionals who must be continually trained and educated to ensure that they
possess sufficient technical skills and product knowledge. The market for
qualified professionals is intensely competitive, making hiring and retention
difficult. We expect significant competition in this market from
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existing providers of professional services and future entrants. We must also
properly price our services to attract customers, while maintaining sufficient
margins for these services. We therefore expect that we will have lower profit
margins on our service revenues. In addition, in January 2000, we reorganized
our U.S. professional services organization, in part, to enable the professional
services organization to become more specialized on individual products and
product suites. As a result, a particular product group may have insufficient
qualified personnel to perform its professional services needs as there will no
longer be a "pool" of professional service personnel from which to draw. A
product group's lack of sufficient professional services personnel could lead to
customer dissatisfaction, missed revenue opportunities and a loss of future
business.
WE RELY ON THE CONTINUED PROMINENCE OF MICROSOFT TECHNOLOGY
Although we intend to support other operating systems, our mission is to be
the leading supplier of network security and management products for Windows
NT/Intel based networks. Sales of our products would be materially and adversely
affected by market developments that are adverse to the Windows operating
environments, including the failure of users and application developers to
accept Windows NT. In addition, our ability to develop products using the
Windows operating environments is dependent on our ability to gain timely access
to, and to develop expertise in, current and future developments by Microsoft.
We may not be able to gain the necessary access from Microsoft.
WE MAY FAIL TO SUPPORT OPERATING SYSTEMS WHICH SUCCESSFULLY COMPETE WITH
MICROSOFT'S TECHNOLOGY, INCLUDING COMPETING VERSIONS OF THE UNIX OPERATING
SYSTEM
We are expanding our product support to include the Unix operating system
and the Linux operating system. Sales of our products could be materially and
adversely impacted by our failure to support those versions of the Unix
operating system or competing operating systems that receive broad market
acceptance. The Unix system encompasses many separate operating systems of which
we only support a few, including for example, Sun Microsystem's Solaris Unix
operating system.
WE MUST EFFECTIVELY MANAGE OUR GROWTH
Our business has grown rapidly, both internally and through acquisitions.
This growth has placed, and any future growth would continue to place, a
significant strain on our limited personnel, management and other resources. Our
ability to manage any future growth, particularly with the anticipated expansion
of our international business and our ASP businesses, and growth in distribution
business, will require us to:
- attract, train, retain, motivate and manage new employees successfully;
- effectively integrate new employees into our operations; and
- continue to improve our operational, financial, management and
information systems and controls.
If we continue to grow, our management systems currently in place may be
inadequate or we may not be able to effectively manage this growth. We are
currently investing in our Internet infrastructure in anticipation of expected
growth from the Internet, which may fail to materialize.
WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WHICH OFFER ONLY LIMITED
PROTECTION AGAINST POTENTIAL INFRINGERS; WE MAY FACE LITIGATION RELATED TO OUR
PROPRIETARY TECHNOLOGY AND RIGHTS.
Our success depends significantly upon our proprietary software technology.
We rely on a combination of contractual rights, trademarks, trade secrets,
patents and copyrights to establish and protect proprietary rights in our
software. However, these protections may be inadequate or competitors may
independently develop technologies or products that are substantially equivalent
or superior to our products. We do not typically obtain signed license
agreements from our corporate, government and institutional customers who
license products directly from us. Rather, we include an electronic version of a
shrink-wrap license in all of our electronically distributed software and a
printed license in the box for our products distributed through traditional
distributors in order to protect our copyrights and trade secrets in those
products. Since the licensee has not signed any of these licenses, many legal
authorities believe that such licenses may not be enforceable
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under the laws of many states and foreign jurisdictions. In addition, the laws
of some foreign countries either do not protect these rights at all or offer
only limited protection for these rights. The steps taken by us to protect our
proprietary software technology may be inadequate to deter misuse or theft of
this technology. For example, we are aware that a substantial number of users of
our anti-virus products have not paid any registration or license fees to us.
Changing legal interpretations of liability for unauthorized use of the our
software, or lessened sensitivity by corporate, government or institutional
users to avoiding infringement of intellectual property, could have a material
adverse effect on our business, results of operations and financial condition.
There has been substantial litigation regarding the intellectual property
rights of technology companies. The increased issuance of software patents in
recent years has led to and is likely to continue to lead to increased patent
and intellectual property litigation in the software industry. In the past we
have been, and we currently are, subject to litigation related to our
intellectual property, including separate patent infringement cases involving
Hilgraeve and Trend Micro. See Item 3 Legal Proceedings. Although we intend to
defend ourselves vigorously against claims asserted against us in the foregoing
actions or matters, developments arising out of this pending litigation or any
other litigation to which we are or may become a party could have a material
adverse effect on our business, results of operation and financial condition.
Adverse determinations in litigation could:
- result in the loss of our proprietary rights;
- subject us to significant liabilities;
- require us to seek licenses from third parties; or
- prevent us from manufacturing or selling our products.
The litigation process is subject to inherent uncertainties and we may not
prevail in these matters, or we may be unable to obtain licenses with respect to
any patents or other intellectual property rights that may be held valid or
infringed upon by our products or us. Uncertainties inherent in the litigation
process involve, among other things, the complexity of the technologies
involved, potentially adverse changes in the law and discovery of facts
unfavorable to us.
In addition, as we may acquire a portion of software included in its
products from third parties, our exposure to infringement actions may increase
because we must rely upon such third parties as to the origin and ownership of
any software being acquired. Similarly, exposure to infringement claims will
increase to the extent that we employ or hire additional software engineers
previously employed by competitors, notwithstanding measures taken by these
competitors to protect their intellectual property. In the future, litigation
may be necessary to enforce and protect trade secrets and other intellectual
property rights that we own. We may also be subject to litigation to defend
against claimed infringement of the rights of others or determine the scope and
validity of the proprietary rights of others. This litigation could be costly
and cause diversion of management's attention, either of which could have a
material adverse effect on our business, results of operations and financial
condition.
OUR INTERNATIONAL OPERATIONS SUBJECT US TO FOREIGN CURRENCY FLUCTUATIONS AND
OTHER INHERENT RISKS RELATED TO DOING BUSINESS IN FOREIGN COUNTRIES
In 1999, 1998 and 1997, net revenue from international sales represented
approximately 40%, 36%, and 36%, respectively, of our net revenue. Historically,
we have relied upon independent agents and distributors to market our products
internationally. We expect that international revenues will continue to account
for a significant percentage of net revenues. We also expect that a significant
portion of this international revenue will be denominated in local currencies.
To reduce the impact of foreign currency fluctuations, we use non-leveraged
forward currency contracts. However, our future results of operations may be
adversely affected by
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currency fluctuations or by costs associated with currency risk management
strategies. Other risks inherent in international revenue generally include:
- the impact of longer payment cycles;
- greater difficulty in accounts receivable collection;
- unexpected changes in regulatory requirements;
- seasonality due to the slowdown in European business activities during
the third quarter;
- tariffs and other trade barriers;
- export restrictions on our encryption and other security products;
- uncertainties relative to regional economic circumstances, including the
current economic turbulence in Asia;
- political instability in emerging markets and difficulties in staffing;
and
- managing foreign operations.
These factors may have a material adverse effect on our future
international license revenue. Further, in countries with a high incidence of
software piracy, we may experience a higher rate of piracy of our products.
In addition, a portion of our international revenue is expected to continue
to be generated through independent agents. Since these agents are not our
employees and are not required to offer our products exclusively, they may
discontinue marketing our products entirely. Also, we may have limited control
over these agents, limited access to the names of the customers to whom these
agents sell its products and limited knowledge of the information provided by,
or representations made by, these agents to its customers.
COMPUTER "HACKERS" MAY DAMAGE OUR PRODUCTS AND SERVICES
Given our high profile in the security software market, we have been a
target of computer hackers who have, among other things, created viruses to
sabotage or otherwise attack our products. While to date these efforts have been
discovered quickly and their adverse impact has been limited, similar viruses or
efforts may be created or replicated in the future. In this event, users'
computer systems could be damaged and demand for our software products may
suffer as a result. In addition, since we do not control diskette duplication by
distributors or our independent agents, diskettes containing our software may be
infected with viruses. Given our increased use of the Internet to deliver
products and services, any successful sabotage or other attack on our websites,
including the McAfee.com and myCIO.com web sites, could disrupt our ability to
provide products and services to customers. A successful sabotage of one of our
or our affiliates web based businesses could result in reduced demand for our or
our affiliates web based products and services and have a material adverse
affect on our business and our results of operation. Recently a number of
websites have been subject to denial of service attacks where a web site is
bombarded with information requests eventually causing the website to overload,
which causes a delay or disruption of service.
FALSE DETECTION OF VIRUSES AND ACTUAL OR PERCEIVED SECURITY BREACHES COULD
ADVERSELY AFFECT OUR BUSINESS
Our anti-virus software products have in the past and may at times in the
future falsely detect viruses that do not actually exist. These false alarms,
while typical in the industry, may impair the perceived reliability of our
products and may therefore adversely impact market acceptance of our products.
In addition, we have in the past been subject to litigation claiming damages
related to a false alarm, and similar claims may be made in the future. In
addition, an actual or perceived breach of network or computer security at one
of our customers, regardless of whether the breach is attributable to our
products, could adversely affect the market's perception of our security
products. This could adversely effect our business, results of operations and
financial condition.
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OUR CRYPTOGRAPHY TECHNOLOGY IS SUBJECT TO EXPORT RESTRICTIONS AND MAY BECOME
OBSOLETE
All of our products are subject to the U.S. Export Administration
Regulations, governed by the U.S. Department of Commerce. Certain of our network
security products, technology and associated technical assistance, particularly
products and technology incorporating encryption, may be subject to export
restrictions. Recent changes to U.S. laws enable Network Associates to export
more products without restrictions; however certain products still may not be
exported to foreign government customers without prior approval from the U.S.
government. The list of products and end users for which export approval is
required, and the regulatory policies with respect thereto, are subject to
revision by the U.S. Government at any time. The cost of compliance with U.S.
and international export laws and changes in existing laws could affect our
ability to sell certain products in certain markets, and could have a material
adverse effect on our international revenues.
In addition, some of our network security products are dependent on the use
of public key cryptography technology. This technology depends in part upon the
application of certain mathematical principles known as factoring and discrete
logarithms. The security afforded by public key cryptography technology is based
on our belief that the factoring of large prime numbers and solving the discrete
log problem is not computationally practical. Should an easy factoring method be
developed or the discrete log problem is solved, the security afforded by
encryption products using public key cryptography technology would be reduced or
eliminated. Furthermore, any significant advance in techniques for attacking
cryptographic systems could also render some or all of our existing products and
services obsolete or unmarketable. Moreover, the cryptographic algorithms used
in our products can theoretically be solved by computer systems significantly
faster and more powerful than those presently available. If these improved
techniques for attacking cryptographic systems were ever developed, our business
would be adversely affected.
PRODUCT LIABILITY CLAIMS ASSERTED AGAINST US IN THE FUTURE COULD ADVERSELY
AFFECT OUR BUSINESS
Our network security and management software products are used to protect
and manage computer systems and networks that may be critical to organizations.
As a result, our sale and support of these products involves the risk of
potential product liability and related claims. Our license agreements with our
customers typically contain provisions designed to limit our exposure to
potential product liability claims. It is possible, however, that the limitation
of liability provisions contained in these license agreements may not be
effective under the laws of certain jurisdictions, particularly in circumstances
involving unsigned licenses. A product liability claim brought against us could
have a material adverse effect on our business, results of operations and
financial condition.
OUR MANAGEMENT AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, THESE
INDIVIDUALS MAY NOT REMAIN WITH US IN THE FUTURE
We rely, and will continue to rely, on a number of key technical and
management employees. While employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, our employees are
generally not otherwise subject to employment agreements or to noncompetition
covenants. If any of our key employees leave, our business, results of
operations and financial condition could suffer. Furthermore, we do not maintain
life insurance policies on our key employees.
Our ability to achieve our revenue and operating performance objectives
will depend in large part on our ability to attract and retain technically
qualified and highly skilled sales, consulting, technical, marketing and
management personnel. Competition for these employees is intense and is expected
to remain so for the foreseeable future. We have seen upward pressure on wages
as a result of this intense competition for employees, which could cause an
increase in our operating expenses. We may not be successful in retaining our
existing key personnel and in attracting and retaining the personnel we require,
and our failure to retain and hire key employees could adversely affect our
business and operating results. Additions of new and departures of existing
employees, particularly in key positions, can be disruptive and can result in
departures of existing employees, which could adversely affect our business.
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WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING
We are currently engaged in several research and development contracts with
agencies of the U.S. government. We believe that the willingness of these
government agencies to enter into future contracts with us will in part be
dependent upon our continued ability to meet their expectations.
Minimum fee awards for companies entering into government contracts are
generally between 3% and 7% of the costs incurred by them in performing their
duties under the related contract. However, these fee awards may be as low as 1%
of the contract costs. Furthermore, these contracts are subject to