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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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 31,1999 was approximately $4,236,866,941. The number of
shares outstanding of the issuer's common stock as of March 31, 1998 was
138,062,661.
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 June 24, 1999.
THIS REPORT CONTAINS 89 PAGES. THE EXHIBIT INDEX IS ON PAGE 82.
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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 or our industry's 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 we nor any other person assumes responsibility
for the accuracy and completeness of such statements. We are under no duty to
update any of the forward-looking 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 as a result of the
merger of McAfee Associates, Inc. and Network General Corporation. Following the
merger, McAfee, changed its legal name to Networks Associates, Inc. During 1998,
we acquired the following companies:
COMPANY NAME REFERRED TO AS: DESCRIPTION OF BUSINESS COUNTRY
- ------------ --------------- ----------------------- -------
Dr Solomon's Group PLC Dr Solomon's Provider of anti-virus U.K.
software
Trusted Information Systems, Inc. TIS Provider of comprehensive U.S.A
security systems for
computer networks
Magic Solutions International, Inc. Magic Privately held provider of U.S.A
internal help desk and asset
management solutions
CyberMedia, Inc. CyberMedia Provider of desktop utility U.S.A
solutions
Secure Networks Systems, Inc. Secure Privately held provider of Canada
internal security systems for
computer networks
Anyware Seguridad Informatica S.A. Anyware Distributor Spain
CSB Consulenza Software di Base
S.r.l. CSB Distributor Italy
Nordic Lantools OY and AB Nordic Distributor Scandanavia
QA Information Security Holding AB QA Distributor Scandanavia
Syscon (Proprietary) Limited Syscon Distributor South Africa
OVERVIEW
We are a leading developer and provider of software products that address
two of the most important concerns of information technology or IT
professionals: network security and network management. In the network security
arena, the majority of the our revenue has historically been derived from our
McAfee anti-virus product line. In the network management arena, the majority of
our revenue has historically been derived from our Sniffer network fault and
performance management product line. These two flagship
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product lines form the customer base and product base from which the balance of
our product line has developed.
To continue expanding our revenue base, we have focused our efforts on
building a full line of complementary network security and network management
solutions. On the network security side, during 1998 we strengthened our
anti-virus lineup by adding complementary products in the firewall, intrusion
protection, encryption, and virtual private networking categories. On the
network management side, during 1998 we built upon our Sniffer line by adding
products in the help desk, asset management, network monitoring, and network
reporting categories. We continuously seek to expand our product line. We have
combined complementary products into "suites", offering customers the ability to
license multiple products at the same time. Our products are currently organized
into four primary product suites: McAfee Total Virus Defense and PGP Total
Network Security, which combine to form "Net Tools Secure" and Sniffer Total
Network Visibility and Magic Total Service Desk, which combine to form "Net
Tools Manager". These four product suites together form a single integrated
suite called "Net Tools".
We organize our products for sale to corporate customers into four
product suites:
NET TOOLS
NET TOOLS SECURE NET TOOLS MANAGER
----------------------------------------- ----------------------------------------------
MCAFEE TOTAL VIRUS PGP TOTAL NETWORK SNIFFER TOTAL NETWORK MAGIC TOTAL SERVICE
DEFENSE SECURITY VISIBILITY DESK
------------------ ---------------- --------------------- -------------------
- - VirusScan Security - PGP Enterprise - Sniffer Distributed - Magic HelpDesk
Suite Security Suite Analysis Suite Suite
- - NetShield Security - Gauntlet Active - Sniffer Pro 98 - Self ServiceDesk
Suite Firewall Suite Portable Analysis Suite
Suite
- - GroupShield - CyberCop - Network Informant - Zero Admin Client
Security Suite Intrusion Detection Suite Suite
Suite
- Zero Admin Client
2001 Suite
Many of our network security and management products are also available
as stand-alone products or as part of smaller product suites. Electronic
software distribution is one of the principal means by which we distribute our
software products to our customers. We generally license our products to
corporate customers, our primary customer base, under either a one-year or a
two-year product license.
In addition to our corporate customer base, our primary customer base, we
also offer a full range of consumer-oriented security and management software
products to retail customers, both through traditional retail stores and via the
Internet.
Our retail products for sale to consumers and small business customers
are organized into three categories:
- Anti-virus
- Internet security/privacy; and
- Desktop utilities.
Our retail products are available as stand-alone products. Our VirusScan
and Nuts & Bolts products also leverage the suite sales model by being sold in
Deluxe
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and Platinum level suites. The Deluxe and Platinum level suites offer the
consumer name brand products bundled together. We generally utilize a perpetual
or unlimited license for products sold in the retail channel.
NET TOOLS SECURE
The Net Tools Secure product suite is comprised of McAfee Total Virus
Defense and PGP Total Active Network Security. The current U.S. list price for a
1,000 node Net Tools Secure license is $108 per node for a two-year license. A
number of the products incorporated in the Net Tools Secure product suite may be
purchased as stand-alone products or as part of smaller product suites.
MCAFEE TOTAL VIRUS DEFENSE
McAfee Total Virus Defense or TVD is designed to provide a single
integrated line of defense against computer viruses by providing security at the
desktop, network server, groupware server and Internet gateway levels of an
enterprise. With more than 400 new viruses discovered each month, many of them
increasingly destructive, it is critical that corporations protect themselves
from all possible entry points into the network. McAfee TVD includes a package
of products that cover each point in the corporate network: VirusScan for
desktops, NetShield for network servers, GroupShield for groupware servers, and
WebShield for Internet gateway protection. Management tools for central control
and deployment of these products are also included in the TVD package through a
set of tools called Management Edition. The current U.S. list price for a 1,000
node McAfee Total Virus Defense license is $40 per node for a two-year license.
The following products are part of the McAfee Total Virus Defense package:
- - VIRUSSCAN: DESKTOP VIRUS SECURITY
Whether from floppy disks or connection to the Internet, individual PCs
are still a key source of viruses. VirusScan provides PCs with protection
against computer viruses, including macro viruses, malicious Java and
ActiveX attacks, and email intrusions. VirusScan is available for all
major desktop operating systems, including Window 3.x, 95, 98, and NT as
well as Macintosh and DOS. VirusScan is available in a retail version for
home users at a suggested list price of $49. The corporate edition of
VirusScan is included as part of TVD.
- - NETSHIELD: NETWORK SERVER VIRUS SECURITY
Central computers that perform administrative tasks and oversee many
groups of individual PCs in an enterprise are known as servers, and are
another source of virus proliferation in organizations. Servers keep
information flowing by storing and forwarding files to not only other
users, but often to customers and e-commerce partners as well. If a
network server is infected by a virus, it can be spread rapidly
throughout the organization causing multiple infections in a short amount
of time. NetShield, available for Windows NT, Novell NetWare, and several
versions of Unix, offers comprehensive server-based virus protection that
helps prevent the spread of viruses at critical servers in the corporate
network. NetShield is included as part of TVD.
- - GROUPSHIELD: GROUPWARE VIRUS SECURITY
Since many of today's companies rely on email, shared electronic files,
and shared workgroups, viruses are also spread through "groupware"
programs such as Microsoft Exchange and Lotus Notes. GroupShield stops
virus proliferation at the electronic mail level of an enterprise,
scanning files sent through Exchange and Notes servers and catching
viruses before they can be passed on to other users. GroupShield is
included as part of TVD. It is also sold separately at a price of $35 per
node for a two-year license.
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- - WEBSHIELD: INTERNET GATEWAY PROTECTION
As a corporation connects to the Internet, it opens its network of
individual and server computers to the outside world and to potential new
viruses. WebShield serves as a final layer of corporate virus security by
scanning email, firewall and web traffic for viruses and other hostile
code before it enters the corporation. WebShield is included as part of
TVD.
TVD MANAGEMENT EDITION
Because new viruses are discovered at a rate of over 400 per month, it is
critical that network administrators keep their anti-virus software updated with
the latest virus signature files. TVD Management Edition gives administrators an
easy way to install, configure and upgrade anti-virus software across enterprise
networks scaling to any size. TVD Management Edition protects a network from
virus attacks by enabling centralized upgrading of the network's anti-virus
software. When attacks do occur, Management Edition detects the occurrence and
offers alerting via a variety of channels including pager, e-mail, SNMP message,
and DMI alert. It reduces the time a network administrator has to spend
installing and managing anti-virus software, particularly on large networks,
ensuring uninterrupted network security. Management Edition is included as part
of the TVD package.
ENTERPRISE SECURE CAST
To get new virus updates rapidly to network administrators for
distribution within their companies, TVD also includes a web-based "push"
technology called Enterprise Secure Cast. Enterprise Secure Cast uses advanced
web technology to provide registered companies with lists of new viruses that
help the enterprise continually maintain their virus protection at the highest
possible level. Enterprise Secure Cast is also included as part of the TVD
package.
PGP TOTAL NETWORK SECURITY
PGP Total Network Security or TNS completes the Net Tools Secure line by
adding best-in-class firewall, intrusion protection, encryption and virtual
private network security products. The Total Network Security product line
features Gauntlet for firewall, CyberCop for intrusion protection, PGP for
encryption and PGP VPN for virtual private networking .We have also integrated
these individual security products so that they can "actively" communicate with
one another in an effort to respond to security threats automatically. This
integration, known as "Active Security" is achieved by integrating each of the
individual TNS products with Event Orchestrator, the "Active Ingredient". The
PGP Total Network Security suite is currently priced at $80 per node for a
two-year license.
- - GAUNTLET FIREWALL is the flagship product of our security product line.
It was originally developed by Trusted Information Systems a company we
acquired in April 1998, on contract from the Defense Advanced Research
Project Agency in an effort to find a more secure way of building
firewalls. In addition to its security features, Gauntlet offers an
enterprise management console, enabling one-to-many configuration control
over numerous firewalls throughout the enterprise, and allows for direct
interface with anti-virus scanning technology. Gauntlet Firewall also has
strong encryption capabilities for VPN technology which are deployable
without sacrificing network throughput. Gauntlet is used by customers
around the world as an Intranet, Extranet, and an internal network
firewall. Gauntlet Firewall is currently available at a price of $17,000
per server for a two-year license.
- - CYBERCOP INTRUSION PROTECTION SUITE provides a comprehensive suite of
software tools designed to protect all aspects of enterprise systems and
network devices from external and internal attacks. The multi-tiered
approach of penetration testing through CyberCop Scanner, real-time
surveillance of systems through CyberCop Monitor and decoy servers
through CyberCop Sting combine to ensure survivability of mission
critical devices against increasingly sophisticated and hostile threats.
The current U.S. list price for a 1,000 node CyberCop Intrusion
Protection Suite site license is $31 per node for a two-year license.
- - 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
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interface. Integrated into our "Active Security" architecture, CyberCop
Scanner provides event orchestration and security management. With the
ability to scan network devices for multiple policy, mis-configuration
and system vulnerabilities that diminish security within a network,
CyberCop Scanner provides a means of quantifying and qualifying the
enterprise security risk. Engine, scan tests and vulnerability databases
are kept current utilizing VirusScan's "AutoUpdate" technology to
automatically download monthly product updates on a scheduled basis.
CyberCop Scanner includes a number of unique testing tools to audit the
security of your firewalls, intrusion detection systems and routers. In
addition, CyberCop Scanner also includes functionality to produce
multi-layer reporting options and network diagrams via a 3D Graphical
Interface via an easy to use report generator. CyberCop Scanner is used
extensively by value added resellers or VARs, and independent security
consultants providing services to enhance security on enterprise
networks. CyberCop Scanner is currently available on the Windows NT and
Linux platform. The current U.S. list price for a 1,000 node CyberCop
Scanner Site License is $13 per node for a two-year license.
- - CYBERCOP MONITOR, scheduled for a mid-1999 release, provides host based,
real-time intrusion detection. CyberCop Monitor supports a multi-tiered
detection architecture that monitors not only host log file activities
and system events, but also host-based packet analysis providing event
correlation and trend analysis. CyberCop Monitor provides a central
monitor to facilitate one to many configuration, remote installation and
reporting options. Integrated into our "Active Security" architecture,
CyberCop Monitor provides event orchestration and increased security
integration. The "AutoUpdate" feature, already used by millions of
VirusScan customers, enables CyberCop Monitor to automatically download
monthly updates on a scheduled basis keeping the engine, scan tests and
signature databases current.
- - CYBERCOP STING, also scheduled for a mid-1999 release, completes the
CyberCop line by offering a new approach to intrusion detection. CyberCop
Sting provides an additional information gathering device to help combat
snooping on internal networks. Configured as an inviting host, CyberCop
Sting utilizes replication technology 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.
- - PGP ENTERPRISE SECURITY encrypts, authenticates and provides the complete
infrastructure and applications necessary for data protection for a wide
range of desktop computers. PGP, which is used by millions of consumers
and corporations around the world, is based on the principle of strong
encryption without compromise. PGP Enterprise Security suite combines the
worldwide de-facto standard for file, disk and email encryption with
precise management tools both at the desktop and server level. Included
in this suite are several tightly integrated components: PGP Desktop
Security, PGP Certificate Server, PGP Policy Management Agent, PGP VPN
client and the PGPsdk. The PGP Enterprise Security suite is currently
sold at a price of $44 per node for a two-year license.
- - PGP DESKTOP encrypts and authenticates e-mail, files and disks
automatically, ensuring that only the authorized recipient can read their
contents. It integrates seamlessly with all commonly used e-mail
applications, allowing users with different email systems to communicate
securely. Complete enterprise management features are built-in, allowing
administrators to easily pre-configure and deploy PGP to users throughout
the corporation.
- - PGP CERTIFICATE SERVER acts as a central dispatch for PGP digital
certificates. Digital certificates allow users to "authenticate"
communications so that the recipient can be certain of the sender's true
identity. When users run PGP Desktop, their computers automatically
access the PGP Certificate Server and retrieve the appropriate
certificates needed.
- - PGP POLICY MANAGEMENT AGENT works in conjunction with PGP Desktop to
ensure that incoming and outgoing email adheres to the appropriate
corporate email security policies.
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- - PGP VPN CLIENT adds a robust, standards-based virtual private networking
(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 with complete security.
- - PGP VPN SUITE provides a standards-based infrastructure for end-to-end
"virtual private network" security. The PGP VPN suite offers low cost
virtual private network security to cover multiple business needs
including server-to-server for supply chain and remote office extranets,
server-to-client for secure remote access for mobile users and
client-to-client for secure network communications. The PGP VPN suite
includes Gauntlet Firewall, Gauntlet VPN server, PGP VPN client and Net
Tools PKI, a standards-based public key infrastructure that ships with
several our security suites to enable secure integration The PGP VPN
suite also works with other public key infrastructure, or PKI, vendors
such as VeriSign and Entrust, allowing customers to communicate securely,
regardless of the preferred PKI.
NAI LABS SECURITY RESEARCH
NAI Labs is the division of Networks Associates that performs advanced
research in the network security technology area. Over 100 dedicated researchers
company-wide are engaged in fulltime research. Research efforts are grouped into
two different categories: rapid response research, and advanced research.
RAPID RESPONSE RESEARCH teams are responsible for researching new viruses
and security threats and providing updates to customers rapidly. We have the
ability to quickly respond to new security risks around the clock across all
continents. These research teams currently fall into two categories:
- - AVERT, the Anti-virus Emergency Response Team, formerly known as McAfee
Labs; and
- - COVERT, the Computer Vulnerability Emergency Response Team, staffed
primarily with researchers from the Secure Networks, which we acquired in
1998.
ADVANCED RESEARCH is pursued by the Advanced Security Research Division
or ASRD, formerly part of TIS, and focuses on long-term scientific,
mathematical, cryptographic, and technological issues which reside outside the
standard product development pathway. The advanced security research division
pursues its formalized research using funds awarded by the U.S. Defense Advanced
Research Project Agency, National Security Agency, and other government
agencies. Research topics include theoretical cryptographic models,
survivability studies, advanced OS development, next generation Internet or NGI
initiatives. Integrated within the advanced research model is mandatory planning
for technology transfer into the commercial marketplace. To date, we have
incorporated this advanced research into a number of our products.
NET TOOLS MANAGER
Net Tools Manager, or NTM, is a network management and service desk
solution designed to make networks more efficient and network users more
productive. The Net Tools Manager product suite is comprised of Sniffer Total
Network Visibility and Magic Total Service Desk. A number of the products
incorporated in the Net Tools Manager product suite may be purchased as
stand-alone products or as part of smaller product suites. The current U.S. list
price for a 1,000 node Net Tools Manager license is $144 per node for a two-year
license.
SNIFFER TOTAL NETWORK VISIBILITY
Sniffer Total Network Visibility, or Sniffer TNV, offers comprehensive
network fault and performance solutions designed to provide optimum network
performance. Sniffer TNV is comprised of three product
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suites: Sniffer Portable Analysis, Sniffer Distributed Analysis and Network
Informant Suite. The U.S. list price for a 1,000 node Sniffer TNV license is
$92 per node for a two year license.
- - SNIFFER PRO 98 PORTABLE ANALYSIS SUITE, or Sniffer PAS, consists of
portable tools designed to automatically pinpoint and analyze network
problems and to recommend solutions. To address the growing complexity of
multi-vendor, multi-protocol, multi-topology network environments,
Sniffer PAS is designed and tested to run on a variety of computer
platforms. The product is intended to be used as a portable tool, either
on a portable or notebook size computer platform. The Sniffer PAS
addresses a variety of network needs ranging from departments coverage to
high-speed, mission-critical or backbone networks. Products sold under
the Sniffer PAS range from products which capture data, monitor network
traffic and collect key network statistics for small networks, to
products which optimize network performance and increase network
reliability by uncovering and analyzing network problems and recommending
solutions to such problems, automatically and in real-time for mid-level
and high-speed networks. The U.S. list price for the Sniffer Portable
Analysis Suite is $16,995 per copy for a two-year license.
- - SNIFFER DISTRIBUTED ANALYSIS SUITE, or Sniffer DAS, is designed to allow
customers to monitor and diagnose problems on complex, multi-segment
networks from centralized locations. Distributed Sniffer System/RMON, or
DSS/RMON, is available in Basic and Pro configurations. DSS/RMON Basic
incorporates an industry standard RMON2 agent with the protocol capture
and decode capabilities of a portable Sniffer. DSS/RMON Pro adds expert
analysis capabilities and automatic problem diagnosis to recommends
solutions which are displayed on a central console. The Sniffer DAS
addresses a variety of network needs ranging from high speed backbones,
WAN links and switched networks. The U.S. list price for a 1,000 node
Sniffer DAS license is $50 per node for a two-year license.
- - 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 problems and assessing trends.
The Network Informant Suite is comprised of products designed to
automatically collect data on instrumented network components and to
provide real-time and historic health and availability summaries; to
monitor and analyze the long-term performance of routers, switches, hubs,
and frame relay devices; and to provide immediate access to service desk
trouble tickets from any browser. The U.S. list price for a 1,000 node
Network Informant Suite license is $22 per node for a two-year
license.
MAGIC TOTAL SERVICE DESK
Magic Total Service Desk, or Magic TSD, provides proactive network
management and help desk technology in one integrated service desk solution.
Magic TSD comprises two suites: Magic HelpDesk Suite and Zero Administration
Suite. The current U.S. list price for a 1,000 node Magic TSD license is $68 per
node for a two year license.
- - MAGIC HELPDESK SUITE is designed to provide complete call management,
problem resolution, crisis management, change management and reporting
for mid-range and departmental help desks. The Magic HelpDesk Suite
automates the process of entering caller information and automatically
displays information about a caller allowing faster service and
minimizing duplication of efforts. In addition, the Magic HelpDesk Suite
is designed to provide automated crisis management, by posting notices of
known problems on a centralized "white board." Related calls can be
linked, automatically generating or resolving, and subsequently closing,
all linked trouble tickets. Finally, the Magic HelpDesk Suite is designed
to automate change management throughout the enterprise, allowing work
orders for a selected task to be automatically sent to all appropriate
parties. Detailed reports generated by the Magic HelpDesk Suite help
measure the impact of each problem and the use of enterprise resources to
solve each problem. The current U.S. list price for a 10-users Magic
HelpDesk Suite is $2,915 for a two-year license.
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- - SELF SERVICEDESK SUITE provides information services organizations with
self service oriented applications designed to make all supported PCs
help desk ready. The Self ServiceDesk Suite integrates PC diagnostic
software with remote control and web-based access, allowing cost savings
for help desk and network administrators. The Self ServiceDesk Suite
allows employees to solve their own PC application problems over the web
using SupportWeb 98, a searchable information database that gives
employees instant answers to thousands of common hardware and software
application questions. The Self ServiceDesk Suite also includes PCMedic
and Remote Desktop 32. PCMedic is designed to automatically diagnose and
correct PC system problems, as well as prevents errors and crashes which
damage data. Remote Desktop 32 provides remote management capabilities
for network administrators. The current U.S. list price for a 1,000 node
Self Service Desk Suite site license is $47 per node for a two-year
license.
- - 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. The ZAC Suite also includes
management/menuing capabilities which enable central configuration of
application access and desktop layout. In addition, the ZAC Suite
provides software metering capabilities, allowing the efficient
management of license sharing, and transfers and reducing the number of
licenses that need to be purchased based on actual usage. Furthermore,
the ZAC Suite is designed to allow compliance with license limitations by
restricting concurrent usage of a software product to only the total of
number of licenses purchased. Finally, the ZAC Suite is designed to allow
remote access to critical information on multiple platforms. The Zero
Administrator Client Suite console controls DOS, Windows, Windows 95 and
Windows NT-based PC assets connected to NT and NetWare file servers, and
its open database structure is designed to ensure accessibility. The
current U.S. list price for a 1,000 node ZAC Suite site license is $47
per node for a two-year license.
- - ZERO ADMINISTRATION CLIENT 2001 SUITE combines the inventory and remote
control capabilities of the ZAC Suite with a Year 2000 compliance checker
for applications and data on PCs. ZAC2001 detects packaged applications
across the network and compares the data against a year 2000 compliance
catalog and produces management reports to assess the Y2K readiness of
desktop applications. ZAC2001 scans potential Y2K problems in two-digit
and pivot dates in popular spreadsheet and ODBC data source files. The
current U.S. list price for a 1,000 node ZAC2001 site license is $27 per
node for a two-year license.
PROFESSIONAL SERVICES
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. Professional Services is focused on three services
segments: Consulting Services, Education Services and PrimeSupport.
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.
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
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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 online and telephone-based technical
support is necessary to ensure that our products are installed and working
properly. PrimeSupport offers a choice of the online KnowledgeCenter, or the
telephone-based Connect, Connect 24X7 and Enterprise options to meet customers'
varying business needs. PrimeSupport is available to all customers on a
worldwide basis from a nearby global support center.
PRODUCT LICENSING 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, customers are contacted by us 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 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 licenses for our products under traditional
perpetual licenses with product updates, upgrades and support available to
customers under separate maintenance contracts.
ELECTRONIC SOFTWARE DISTRIBUTION
We were the first company to successfully utilize electronic software
distribution to reach corporate and government customers. Through the World Wide
Web and various online services such as America Online, Compuserve and the
Microsoft Network, we are able to electronically communicate and interact with
our customers from pre-sales evaluation through product delivery and post-sales
support. We believe that the electronic channel is an important source of
information and support for IT professionals. By making fully-functioning,
unencrypted versions of many of our products widely available for evaluation, we
seek to encourage product sampling among these sophisticated users. Potential
customers desiring to evaluate our products for a 30-day period can anonymously
download our products from our World Wide Web site. This contrasts favorably to
traditional software evaluation programs, where potential customers often are
required to identify themselves, typically resulting in their inclusion in a
sales database, go through a qualification process and then wait for the
evaluation copy to be shipped.
We use electronic software distribution as a principal means of
delivering licensed software, as well as upgrades and updates to our customers.
Electronic software distribution offers a number of advantages to us over
traditional software distribution methods including the ability to distribute
our products and upgrades more rapidly and at a lower cost than traditional
distribution methods. Since all of the software and documentation can be
distributed electronically, the cost of internal distribution by the customer is
also lower than with traditional software and printed documentation.
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We also seek to increase awareness of our products, to provide customer
and technical support and to encourage dialogue regarding our products by
maintaining a World Wide Web site and forums on CompuServe, America Online and
The Microsoft Network. We also provide support through the World Wide Web. By
providing support electronically, we believe that we are often able to identify
and solve customer problems more rapidly.
MCAFEE.COM
McAfee.com is an Internet destination dedicated to updating, upgrading,
and managing PCs over the web. Described below are services under development
which are being developed to enable McAfee.com to provide powerful online
applications over the Internet, including delivering recommendations,
comparative shopping, and powerful Internet based utilities for both the novice
and expert PC users.
- MCAFEE PC OILCHANGE ONLINE is an Internet service which is being
developed to automatically recommends updates and upgrades based
on a user's installed hardware and software. Updates, such as a
software fix or a printer driver, can be quickly found and freely
downloaded from the web. Recommended upgrades can also be found
and purchased online. Accessories related to a user's PC
configuration, such as books, training videos, or peripherals are
also available for purchase online.
- MCAFEE CLINIC is a web-based PC management service which is being
developed to defend, diagnose, and repair PCs over the web. This
service is based on the underlying technology found in the McAfee
desktop products: VirusScan, First Aid, Nuts & Bolts, ToolBox
2000, UnInstaller, and Guard Dog. As an Internet-based service,
this set of version-less, PC applications never needs to be
upgraded by the user.
- MCAFEE STORE offers a convenient one-stop-shop experience on the
Internet. Customers can purchase McAfee software and services or
other related PC products, as well as other helpful PC
information.
In December 1998, we created McAfee.com Corporation as our subsidiary. In
1999, we intend to transfer the McAfee.com domain name to this subsidiary and to
enter into the agreements and arrangements necessary to allow McAfee.com
Corporation to operate the McAfee.com web site independently, with its own
workforce and research and development staff.
SALES AND MARKETING
To augment and capitalize upon the awareness of our products resulting
from our electronic distribution model, 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
Our North American direct sales force is organized into three tiers. The
first tier focuses on the sale of all our products to enterprise and national
account customers. The second tier consists of two separate sales groups focused
on the sale of the two product supersuites, Net Tools Secure and Net Tools
Manager, to the departmental level. The third tier consists of four separate
outbound corporate telesales forces who actively market our individual product
suites for transactions of less than 1,000 nodes. 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. Another significant focus of our corporate telesales force is to
contact existing customers to cross-sell additional products and product suites.
To augment our sales organization, our executives are involved with sales to
many major accounts. We have
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not historically had a large enterprise or national accounts sales force and
only recently developed a direct sales group focused on these larger accounts.
We devote a portion of our corporate telesales force to the renewal of
our existing licenses. Prior to expiration of a license, a corporate telesales
representative contacts the customer and encourages renewal of the expiring
license while determining if increasing the number of computers licensed is
appropriate and, additionally, marketing new products and product suites to this
existing customer.
INTERNATIONAL SALES
We have sales and support operations in Europe, Asia, South America and
Australia. In 1998, international revenues accounted for approximately 36% 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 periods we have focused our efforts on expanding
internationally including through distribution acquisitions. In 1998, we
acquired distributors in Scandinavia, South Africa and Spain. 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 our agents 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 either us or the agent to terminate the agreement upon proper
prior written notice. International agents invoice their own orders and collect
payment, remitting the license fee, net of commissions, to us in United States
dollars.
RESELLERS AND DISTRIBUTORS
To complement its direct sales, 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, over the past two years our presence in these
channels has expanded significantly. We currently utilize corporate resellers,
including STREAM, Software Spectrum, Softmart and ASAP, 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 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 Staples,
CompUSA, Computer City, Software Etc. and Best Buy. Several members of our
channel sales force work closely with our major reseller and distributor
accounts on the management of orders and inventory level, as well as on
promotion 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. These
distributors may not continue to represent our products.
ORIGINAL EQUIPMENT MANUFACTURERS
Original Equipment Manufacturers, or OEMs, license our products (mainly
anti-virus products) 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 updates. We typically receive a
per copy royalty from our OEMs.
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OTHER MARKETING ACTIVITIES
Our principal means of marketing our products is through the World Wide
Web. Not only do our NAI.com and McAfee.com Websites contain various marketing
materials and information about our products, but Website customers may download
and purchase products and potential customers may download our products for a
30-day free trial. We also promote our products through advertising activities
in trade publications and direct mail campaigns. We also attend trade shows,
sponsor conferences and publish a quarterly newsletter which is mailed to
existing and prospective customers. In addition, we also maintain forums on
CompuServe, America Online and The Microsoft Network which provide electronic
forums for subscribers of these services to discuss issues related to computer
viruses and make inquiries regarding our products.
CUSTOMERS
We primarily market our products directly to large corporate and
government customers as well as to resellers and distributors.
A significant majority of the Company's products are sold through two
tiers of distribution. In the US, substantially all of the Company's sales are
through four major distributors. In Europe, substantially all sales are through
five major distributors. At December 31,1998, one customer had an accounts
receivable balance representing 11% of our total accounts receivable balance. No
other distributor had an accounts receivable balance that exceeded 10% at
December 31, 1998. The Company relies upon a broad base of second tier
distribution partners, specifically large retailers, resellers and VARS to
maintain and grow its business. For the year ended December 31,1998, the largest
retailer accounted for 1% of total revenue and in aggregate the five largest
retailers accounted for approximately 4% of total revenue. The largest reseller
accounted for 2% of total revenue.
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 investment sin complementary businesses, products and technologies. In
addition, we recently began making 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 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 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
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computer users would have a material adverse effect on our business, results of
operations and financial condition.
We expended $135.5 million$103.1 million and $63.8 million in the years
ended December 31, 1998, 1997 and 1996, 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 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.
Our Sniffer products are designed to work with a variety of network
topologies and computer platforms available from multiple manufacturers. We rely
on a limited number of suppliers for certain critical components of our
products. Some of the Sniffer products are designed around a specific computer
platform available only from certain manufacturers. In the case of Sniffer
products, customers purchase the required platform either from us or from
suppliers. As a result of product transitions by our computer platform vendors,
we have found it necessary to purchase and inventory computer platforms for
resale to customers. Any significant shortage of computer platforms or other
critical components for Sniffer products could lead to cancellations or delays
of purchases of these products, which could materially and adversely affect our
results of operations. If purchases of computer platforms or other components
exceed demand, we could incur expenses for disposing of excess inventory, which
would also adversely affect our results of operations.
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;
- 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.
Performance and quality of our anti-virus software products are measured
by number and type of viruses detected, the speed at which the products run and
ease of use. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources.
These factors may provide our competitors with an advantage in penetrating the
original equipment manufacturer market with their
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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,
could cause our business to suffer. In addition, competitive pressures may make
it difficult for us to maintain or exceed our growth rate.
As the network management market develops, we may face increased
competition from these large companies, as well as other companies seeking to
enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and support capabilities. In addition, to the extent that we
are successful in developing our Net Tools suite of products designed around a
centralized management and administration console for the Windows NT platform,
we will likely compete with large computer systems management companies such as
Tivoli Systems and Computer Associates or Unicenter. However, both of these
companies products have been characterized as framework systems requiring a
multi-year product rollout and having products plug into their frameworks as a
secondary focus. In contrast to this, our Net Tools product suite follows a
philosophy of providing "best-of-breed" products with integration where it makes
sense. By focusing on products first, customers can begin deriving benefit
immediately. Several of our individual Net Tools products already support
interaction with framework products including Tivoli's TME framework and
Computer Associates Unicenter framework.
We cannot assure you that we will continue to compete effectively against
existing and potential competitors, many of whom have substantially greater
financial, technical, marketing and support resources and name recognition than
we do. In addition, software companies who currently use traditional
distribution methods may in the future decide to compete more directly with us
by utilizing electronic software distribution.
NET TOOLS SECURE COMPETITION
Our principal competitor in the anti-virus market worldwide the Peter
Norton Group of Symantec in the network security market. Trend Micro remains the
strongest competitor in the Asian anti-virus market. Other competitors include
Computer Associates/Cheyenne Software, IBM and Trend Micro, Inc., as well as
numerous smaller companies and shareware authors that may in the future develop
into stronger competitors or be consolidated into larger competitors.
In the firewall market, Checkpoint owns the top market share position
(1998 Information Security Market Survey - Computers Security Institute/Zona
Research) and is currently Gauntlet's most frequently-encountered competitor.
Axent, with our recently acquired Raptor firewall, is a strong competitor in the
growing market for Windows NT-based firewalls. Larger companies such as Cisco
Systems and Microsoft each have firewall products as well and are beginning to
make inroads in this space. Our CyberCop intrusion protection products compete
primarily with ISS, the earliest entry into this small, but rapidly growing
market segment. Axent and Cisco also have competitive intrusion protection
products. The encryption and VPN markets are still extremely fragmented with
numerous small and large vendors. Public key infrastructure, or PKI, vendors
such as Entrust Technologies offer some products with similar functionality to
PGP, while the VPN space is crowded with hardware and software vendors,
including telecommunications companies as well as traditional networking
suppliers.
NET TOOLS MANAGER COMPETITION
Our principal competitor in the network management market is Hewlett
Packard Company, or HP. Some of our competitors have been in the network
management market longer than the we have, and competitors, such as Cisco,
Computer Associates and HP are larger and have greater name recognition than we
do.
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Our other competitors include Remedy, Royalblue Group PLC, Bendata,
Peregrine Systems and Tivoli Systems in the help desk market and HP, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies , Shomiti Systems, Inc. and Wandel & Goltermann, Inc. in the
software-based network fault and performance management market. We also face
competition from large and established software companies such as Microsoft,
Intel, Novell and HP, which offer network management products as enhancements to
their network operating systems
RETAIL MARKET COMPETITION
As a result of our acquisitions of CyberMedia and Dr. Solomon's, we have
increased our retail presence and established our commitment to the retail
marketplace with the development of the McAfee Software Division. We expect
competition to increase in the near-term due to consolidation of the retail
personal productivity/utility market with the acquisition of Quarterdeck by
Symantec. With price erosion in the traditional superstore and mail order
channels by our key retail competitor in 1998, we have been forced to lower our
retail prices. We are also expanding into the mass merchant and club channel.
However, while the industry's personal productivity/utility software sales
through these channels have increased, the profit margins and average selling
prices in the retail channel are considerably lower than in traditional software
channels.
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.
EMPLOYEES
As of December 31, 1998, we employed approximately 2,700 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 success of our Net Tools product suite and related pricing
model;
- our continued evolution as an enterprise-wide software provider
and the related impact on the length of our sales cycle;
- changes in product prices by us or our competitors;
- trends in the computer industry;
- delays or reductions in customer software purchases related to
their Year 2000 compliance issues;
- costs related to acquisitions of technology or businesses;
- our investment experience related to our strategic minority equity
investments; 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 revenue is typically higher in the
fourth quarter, as many customers complete annual budgetary cycles, and lower
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.
IT WILL BE DIFFICULT TO SUSTAIN OR EXCEED OUR HISTORIC GROWTH RATE
We have experienced significant growth in net income (before acquisition
and related costs) and net revenue. However, our rate of growth has slowed in
recent periods due to increased price competition, a maturing anti-virus market
and an increasingly higher base from which to grow. Our growth rate and net
revenue depend significantly on renewals of existing orders. Recently, we began
a strategy of up-selling existing licenses to higher level product suites. If
our renewal or up-sale rates slow or decline, our net revenues and operating
results would be adversely affected. In addition, like a number of other
enterprise-wide software providers, we have recently identified and expect a
continued slowing or reduction in customer capital spending related to Year 2000
compliance issues. If the purchasing patterns of our current
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or potential customers, particularly those to whom we market broader enterprise
solutions, are meaningfully impacted by Year 2000 concerns, we could experience
a significant reduction in our net revenue, net income and related growth.
THE TIMING AND AMOUNT OF OUR REVENUES ARE SUBJECT TO A NUMBER OF FACTORS
THAT MAKE IT DIFFICULT TO ESTIMATE OPERATING RESULTS PRIOR TO THE END OF A
QUARTER
We do not expect to maintain a significant level of backlog. As a result,
product revenues in any quarter are dependent on contracts entered into or
orders booked and shipped in that quarter. We have generally experienced a trend
toward higher order receipt, and therefore a higher percentage of revenue
shipments, toward the end of the last month of a quarter. This trend makes
predicting revenues more difficult. The timing of closing larger orders
increases the risk of quarter-to-quarter fluctuation. As we have evolved as an
enterprise-wide software provider and continued with our efforts to license
larger product suites under the Net Tools umbrella, the size of our orders and
the length of our sales cycle have increased and may increase further. If orders
forecasted for a specific customer for a particular quarter are not realized or
revenues are not otherwise recognized in that quarter, our operating results for
that quarter could be materially adversely affected.
OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE
During 1998 our stock price ranged from a per share high of $66.25 to a
low of $26.63. At the close of market on April 12, 1999, our stock price was
$16.75 per share. Announcements, litigation developments, and our ability to
meet the expectations of brokerage firms, industry analysts or investors with
respect to our operating and financial results, may contribute to this
volatility. We may not discover, or be able to confirm, revenue or earnings
shortfalls until the end of a quarter, which could result in an immediate drop
in our stock price. In 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. In April 1999,
a number of putative class actions were brought against us, our officers and
directors. 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. For example, Cisco incorporated a firewall in its hardware
products and Microsoft Corporation introduced limited anti-virus functionality
into versions of MS-DOS in 1993. The widespread inclusion of products that
perform the same or similar function as our products within computer hardware or
other software could render our products obsolete and unmarketable. Furthermore,
even if these incorporated products are inferior or more limited than our
products, customers may elect to accept the incorporated products rather than
purchase our products. If we are unable to develop new network security and
management products to further enhance operating systems or other software and
to successfully replace any obsolete products, our business could suffer.
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WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE TRANSACTIONS
The software industry has experienced, and is expected to continue to
experience, a significant amount of consolidation. As part of our growth
strategy, we may buy or make investments in, complementary companies, products
and technologies. Since 1994 we have completed a large number of significant
acquisitions involving both public and private companies, including:
- CyberMedia in September 1998;
- Dr Solomon's in August 1998;
- Magic Solutions and TIS in April 1998;
- Network General, PGP and Helix Software in December 1997;
- Vycor Corporation in February 1996;
- Saber Software in August 1995; and
- Pro Tools in January 1994.
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. In the three
months ended March 31, 1999, these minority investments totaled $26.5 million.
We are currently investigating acquisitions of additional foreign distributors
and other strategic minority investments.
Our acquisitions and strategic investments involve a number of risks and
we may not realize the expected benefits of these transactions. We may lose all
or a portion of our investment, particularly in the case of our strategic
minority investments.
The integration of transactions involves a complex, time consuming and
expensive process. Prior to any acquisition, each company has its own business,
culture, clients, employees and systems. Following any acquisition, we must
operate as a combined organization utilizing common information communication
systems, operating procedures, financial controls and human resource practices.
In order to successfully integrate acquired companies, we must, among other
things, successfully:
- attract and retain key management and other personnel;
- integrate, both from an engineering and a sales and marketing
perspective, the acquired products into our suite of product
offerings;
- coordinate research and development efforts;
- integrate sales forces; and
- consolidate duplicate facilities.
The difficulties of integrating an acquired company may be worsened by the
geographic distance between the companies, the complexity of the technologies
and operations being integrated, and the disparate corporate cultures being
combined. Successful acquisitions may be more difficult to accomplish in the
high technology industry than in other industries, and will require the
dedication of our management resources. Management's focus on the integration of
operations may distract attention from our day-to-day business, and may disrupt
key research and development, marketing or sales efforts. In addition, it is
common in the technology industry for aggressive competitors to attract
customers and recruit key employees away from companies during the integration
phase of an acquisition. If we cannot successfully integrate any acquisition,
our business could suffer.
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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 the
incurrence of significant acquisition-related charges to earnings and dilution
to our stockholders. Moreover, if we buy a company, we may have to incur or
assume that company's liabilities, including liabilities that are unknown at the
time of acquisition, which may result in a material adverse effect on us.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF
FUTURE NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT.
In connection with our previous acquisitions accounted for under the
purchase method of accounting, in future periods we will experience significant
charges related to the amortization of purchased technology and goodwill. In
addition, if we later determine that this purchased technology and goodwill is
impaired, we will be required to take a related non-recurring charge to
earnings.
WE FACE RISKS RELATED TO OUR NET TOOLS MEGA-SUITE BUSINESS STRATEGY
Historically, a majority of our revenues resulted from the licensing of
our flagship anti-virus products and Sniffer products. Over the last year we
have been focusing our efforts on broadening our revenue base by providing
network security and management solutions to enterprise customers, targeting in
particular the Windows NT/Intel platform. To this end, we organized our products
into four product suites -- McAfee Total Virus Defense, PGP Total Active
Security, Sniffer Total Network Visibility and McAfee Total Service Desk--which
form our integrated "Net Tools" mega-suite solution. The Net Tools product suite
model involves a modified product pricing structure. Potential customers may not
respond favorably to this modified pricing structure and the lack of a favorable
response could materially adversely affect our operating results. In addition,
as part of the Net Tools concept, we are in the process of designing a
centralized console from which the various component suites can be operated,
administered and maintained utilizing a common look and feel. We face
significant engineering challenges related to these efforts. Success of our Net
Tools suite strategy will also depend, in part, on the following factors:
- successful development and coordination of our sales force;
- successful development of a national accounts sales force; and
- the development and expansion of an effective professional
services organization.
WE FACE RISKS RELATED TO OUR SNIFFER PRODUCT STRATEGY
Although we will continue to offer perpetual licenses with annual support
and maintenance contracts for our Sniffer products, we have recently developed a
subscription licensing model for these products. We are also seeking to increase
our total Sniffer unit sales through recently developed software-only versions
of some of our Sniffer products, which we would mean that we would no longer
sell the hardware components contained in those products. However, there is a
risk that customers will continue to require that we provide the hardware
platform and components currently contained in our Sniffer products. Despite our
efforts, total unit license of Sniffer products may not increase and customers
may not accept the subscription pricing model for Sniffer products. To the
extent that customers do license Sniffer products on a two-year subscription
basis or license significant amounts of software-only Sniffer products, our
operating results and financial condition would be likely be affected in the
following ways:
- in the case of subscription licenses, we would expect an increase
in deferred revenues related to the service portion of the
two-year Sniffer license that would be capitalized on our balance
sheet;
- in the initial year of the subscription license, the corresponding
revenue would be lower than if the license were perpetual; and
- in the case of the software-only Sniffer product license, we would
expect lower total revenues and a higher overall gross margin
related to that license, as we would not be selling the
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corresponding hardware component (currently the hardware component
has a lower gross margin than the total product gross margin).
WE FACE RISKS RELATED TO OUR STRATEGY OF ACQUIRING INDEPENDENT AGENTS AND
DISTRIBUTORS
We have been acquiring existing independent agents and distributors of our
products in certain strategic markets. We may be required to provide the
technical support to customers 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.
OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISKS
ASSOCIATED WITH PRODUCT DEVELOPMENT
The network security and management market is highly fragmented and
characterized by ongoing technological developments, evolving industry standards
and rapid changes in customer requirements. Our success will depend on our
ability to:
- offer a broad range of network security and management software
products;
- continue to enhance existing products and expand product
offerings;
- develop and introduce in a timely manner new products with
technological advances;
- respond promptly to new customer requirements;
- comply with evolving industry standards without delays in
compliance;
- provide upgrades and updates to users frequently and at low cost;
and
- remain compatible with popular operating systems such as Windows
95, Windows NT and NetWare.
We may not be able to successfully develop and market, on a timely basis,
enhancements to our existing products or new products. Our product enhancements
or new products may not adequately address the changing needs of the
marketplace. New products with new technological capabilities could replace or
shorten the life cycle of our products or cause our customers to defer or cancel
purchases of our products.
We may continue to experience delays in software development as we have at
times in the past. Complex software products like ours may contain undetected
errors or version compatibility problems, particularly when first released,
which could delay or cost us our market acceptance. For example, we experienced
compatibility issues in connection with our recent NetShield upgrade, and our
anti-virus software products have in the past falsely detected viruses that did
not actually exist. Difficulties and delays associated with new product
introductions, performance or enhancements could have a material adverse effect
on our business, financial condition and results of operation.
Our product development efforts are impacted by the adoption or evolution
of industry standards. For example, no uniform industry standard has developed
in the market for encryption security products. As industry standards are
adopted or evolve, we may have to modify existing products or develop and
support new versions of existing products. In addition, if no industry standard
develops, our products and our competitors' products could be incompatible,
which could prevent or delay overall development of the
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market for a particular product. If our products fail to comply with existing or
evolving industry standards in a timely fashion, our business, results of
operation and financial condition could be materially and adversely affected.
Our long-term success depends on our ability to upgrade and update existing
product offerings, modify and enhance acquired products and introduce new
products which meet our customers' needs. Future upgrades and updates may
include additional functionality, respond to user problems or address
compatibility problems with changing operating systems and environments. We
believe that our ability to provide these upgrades and updates frequently and at
low costs is key to our success. For example, the proliferation of new and
changing viruses makes it imperative to update anti-virus products frequently to
avoid obsolescence. Failure to release upgrades and updates could have a
material adverse effect on our business, results of operations and financial
condition. We may not be successful in these efforts. In addition, future
changes in Windows 95, Windows NT, NetWare or other popular operating systems
could cause compatibility problems with our products. Further, delays in the
introduction of future versions of operating systems or lack of market
acceptance of these future versions would delay or reduce demand for our future
products which were designed to operate with these future operating systems. Our
failure to introduce in a timely manner new products that are compatible with
operating systems and environments preferred by desktop computer users would
have a material adverse effect on our business, results of operation and
financial condition.
WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenue from our
flagship McAfee anti-virus software products and Sniffer network fault and
performance management products. These products are expected to continue to
account for a significant portion of our net revenue for the foreseeable future.
Because of this concentration of revenue, a decline in demand for or in the
prices of these products as a result of competition, technological change, a
change in our pricing model, inclusion of anti-virus or network management and
analysis software as a standard part of hardware or operating system software or
other software, or a maturation in the markets for these products, could harm
our business.
IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE
ANTICIPATE, OUR BUSINESS COULD SUFFER
The markets for our network management and network security products are
evolving, and their growth depends upon broader market acceptance of this
software, including help desk software. Although the number of personal
computers, or PCs, attached to large-area networks has increased dramatically,
the network management and network security markets continue to be emerging
markets. These markets may not continue to develop or may not develop rapidly
enough to benefit our business significantly. In addition, there are a number of
potential approaches to network management and network security, including the
incorporation of management and security tools into network operating systems.
Therefore, even if network management and network security tools gain broader
market acceptance, our products may not be selected by potential purchasers. To
the extent that either the network management or network security market does
continue to develop, we expect that competition will increase.
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WE ARE SUBJECT TO INTENSE COMPETITION IN THE NETWORK MANAGEMENT AND
SECURITY MARKETS AND WE EXPECT TO FACE INCREASED COMPETITION IN THE FUTURE
The markets for our products are intensely competitive, and we expect
competition to increase in the near-term. We believe that the principal
competitive factors affecting the markets for our products include:
- performance;
- functionality;
- quality;
- customer support;
- breadth of product line;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
- brand name recognition;
- company reputation; and
- price.
Performance and quality of our anti-virus software products are measured
by number and type of viruses detected, the speed at which the products run and
ease of use. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors, and/or greater financial, technical and marketing resources.
These factors may provide our competitors with an advantage in penetrating the
original equipment manufacturer, or OEM, market with their network security and
management products. As is the case in many segments of the software industry,
we have been encountering, and we expect to further encounter, increasing
competition. This increased competition could reduce average selling prices and,
therefore, profit margins. Competitive pressures could result not only in price
reductions but also in a decline in sales volume, which could cause our business
to suffer. In addition, competitive pressures may make it difficult for us to
maintain or exceed our historic growth rate.
Although there is a trend toward consolidation in the network security and
management market, the market is currently highly fragmented with products
offered by many companies. Our principal competitors in the anti-virus market
include Symantec, Computer Associates/Cheyenne Software, IBM, and Trend Micro,
as well as numerous smaller companies and shareware authors that may in the
future develop into stronger competitors or be consolidated into larger
competitors. In the encryption portion of the security market, our principal
competitors are Security Dynamics, Cylink, Entrust Technologies and VeriSign.
Our principal competitors in the help desk market are Remedy and Software
Artistry, recently acquired by Tivoli Systems/IBM. Our principal competitor in
the software-based network fault and performance management market is
Hewlett-Packard with other competitors including Azure Technologies, Concord
Communications, DeskTalk Systems, Kaspia Systems, Shomiti Systems, and Wandel &
Goltermann. We also face competition in the security market from Cisco, Security
Dynamics, Checkpoint Software, Internet Security Systems and Axent, and other
vendors in the encryption/firewall/intrusion detection market. In addition, we
face competition from large and established software companies such as
Microsoft, Intel, Novell and HP which offer network management products as
enhancements to their network operating systems.
As the network management market develops, we may face increased
competition from these large companies, as well as other companies seeking to
enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and
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support capabilities. In addition, to the extent that we are successful in
developing our Net Tools suite of products designed around a centralized
management and administration console for the Windows NT platform, we will
likely compete with large computer systems management companies such as Tivoli
Systems and Computer Associates. We may be unable to continue to compete
effectively against existing and potential competitors, many of whom have
substantially greater financial, technical, marketing and support resources and
name recognition than we do. In addition, software companies who currently use
traditional distribution methods may in the future decide to compete more
directly with us by utilizing electronic software distribution.
OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH
COULD ADVERSELY AFFECT OUR BUSINESS; OUR SALES CYCLE IS LONG, WHICH COULD
ADVERSELY AFFECT OUR QUARTERLY RESULTS.
Our products may be considered to be capital purchases by certain
customers or prospective customers. Capital purchases are often discretionary
and, therefore, are canceled or delayed if the customer experiences a downturn
in its business or prospects or as a result of economic conditions in general.
Any cancellation or delay could adversely affect our results of operations.
In addition, as we have continued to evolve as an enterprise-wide software
provider and continue to focus on the sale of product suites under the Net Tools
umbrella, our sales cycle has lengthened and may continue to lengthen. Sales of
large complex products, particularly product suites, frequently require a long
education process and significant technical evaluation and commitment of capital
and other resources. Moreover, these sales may be subject to the risk of delays
associated with customers' internal budget and other procedures for approving
large capital expenditures, deploying new technologies within their network and
testing and accepting new technologies that affect key operations. Because of
these longer sales cycles and the potential large size of such orders, if
anticipated orders are not realized or revenues are not otherwise recognized in
a particular quarter, our operating results for that quarter could suffer
WE HAVE ONLY RECENTLY DEVELOPED OUR LARGE ACCOUNTS SALES FORCE; WE FACE
RISKS RELATED TO OUR SALES FORCE STRUCTURE.
Our North American direct sales force is divided into three tiers. The
first tier focuses on the sale of all of our product suites under the Net Tools
umbrella to enterprise and national account customers. The second tier consists
of tow separate sales groups focused on the sale of the two product supersuites
(Net Tools Secure and Net Tools Manage) to the departmental level. The third
tier consists of four separate outbound corporate telesales forces who actively
market our individual product suites to customers with less than 1,000 end
users. Historically, we have not a large enterprise or national accounts sales
force and only recently developed a direct sales group focused on these larger
accounts.
To succeed in the direct sales channel for the enterprise and national
accounts market and for the sale of the separate security product suite, we must
build a significant direct sales organization and must attract and retain
qualified personnel. These individuals will require training about, and
knowledge of, product attributes for our various product suites. We may not
succeed in building the necessary sales organization or in attracting, retaining
or training these individuals. Historically, we sold our products at the
departmental level. To succeed in the enterprise and national accounts market
requires, among other
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things, our establishing relationships and contacts with senior technology
officers at these accounts. Our sales force may not succeed in these efforts.
Our sales organization structure may result in multiple customer contacts
by our different sales representatives, particularly in circumstances where the
customer has multiple facilities and offices. These multiple contacts may likely
result from a lack of coordination between our various sales organizations and a
lack of focus by the individual sales representatives on their designated
customers or products. The occurrence of these events could lead to customer
confusion, disputes in the sales force and lost revenue opportunities which
could have a material adverse effect on our business, results of operations and
financial condition. In addition, while the development of a direct sales
channel reduces our dependence on resellers and distributors, it may lead to
conflicts for the same customers and further customer confusion, pressure by
current and prospective customers for price reductions on products and,
consequently, in reductions in our gross margin and operating profit.
WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES, WHO MAY NOT VIGOROUSLY MARKET
OUR PRODUCTS, HAVE RIGHTS OF RETURN OR MAY HAVE DIFFICULTY IN TIMELY PAYING FOR
PURCHASED PRODUCTS.
We market a significant portion of our products to end-users through
intermediaries, including distributors, resellers and value-added resellers.
Beginning in 1998, our dependence on these indirect sales channels increased
significantly with the development of a software-only version of our Sniffer
product and the acquisition of CyberMedia in September 1998. The Sniffer product
was previously only a combined software/hardware product with a limited number
of resellers. CyberMedia sold its products only through indirect channels.
Our distributors sell other products that are complementary to, or compete
with, our products. While we encourage our distributors to focus on our products
through market and support programs, these distributors may give greater
priority to products of other suppliers, including competitors. Our agreements
with our distributors generally permit our distributors to return our product to
us in the event of end user returns to the distributor, inaccurate estimates of
end user demand by the distributor, increased purchases by distributors in
response to sales incentives or transitions to new products. We record sales to
distributors as revenue and at the same time establish a reserve for returns.
Returns could exceed reserves as a result of distributors holding excessive
amounts of our product in inventory. Our current or future reserves for returns
could be inadequate which would adversely impact our operating results.
Many of our distributors are experiencing economic difficulties worldwide,
which may adversely impact our collection of accounts receivable. For example,
CHS, our largest European distributor, has experienced a significant downturn in
its business. As a result, we have experienced a delay in collections from them
and may experience difficulties in collecting amounts owed to us. 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
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provide inadequate levels of professional services. Moreover, reliance on these
third parties both places a greater burden on them and reduces our ability to
control and establish standards for providing these support services. Our
reliance on these third parties could, delay our recognition of product revenue,
harm our relationships or reputation with these third parties or the end users
of our products or result in decreased future sales of, or prices for, our
products.
To more effectively service our customer's evolving needs, we intend to
significantly expand and develop our worldwide professional service
organization. We may not succeed in these efforts. Effectively expanding and
developing our professional services organization will require that we hire and
train more service professionals who must be continually trained and educated to
ensure that they possess sufficient technical skills and product knowledge. The
market for qualified professionals is intensely competitive, making hiring and
retention difficult. We expect significant competition in this market from
existing providers of professional services and future entrants. We must also
properly price our services to attract customers, while maintaining sufficient
margins for these services. We therefore expect that we will have lower profit
margins on our service revenues. The failure to develop an effective
professional services organization could have a material adverse effect on our
business, results of operations and financial condition.
WE RELY ON THE CONTINUED PROMINENCE OF MICROSOFT TECHNOLOGY
Although we intend to support other operating systems, our mission is to be
the leading supplier of network security and management products for Windows
NT/Intel based Network. Sales of our products would be materially and adversely
affected by market developments which are adverse to the Windows operating
environments, including the failure of users and application developers to
accept Windows NT. In addition, our ability to develop products using the
Windows operating environments is dependent on our ability to gain timely access
to, and to develop expertise in, current and future developments by Microsoft.
We may not be able to gain the necessary access from Microsoft.
WE MUST EFFECTIVELY MANAGE OUR GROWTH
Our business has grown rapidly, both internally and through acquisitions.
This growth has placed, and any future growth would continue to place, a
significant strain on our limited personnel, management and other resources. Our
ability to manage any future growth, particularly with the anticipated expansion
of our international business and growth in distribution business, will require
us to:
- attract, train, 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.
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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 none of these licenses are signed by the licensee, many legal
authorities believe that such licenses may not be enforceable under the laws of
many states and foreign jurisdictions. In addition, the laws of some foreign
countries either do not protect these rights at all or offer only limited
protection for these rights. The steps taken by us to protect our proprietary
software technology may be inadequate to deter misuse or theft of this
technology. For example, we are aware that a substantial number of users of our
anti-virus products have not paid any registration or license fees to us.
Changing legal interpretations of liability for unauthorized use of the our
software, or lessened sensitivity by corporate, government or institutional
users to avoiding infringement of intellectual property, could have a material
adverse effect on our business, results of operations and financial condition.
There has been substantial litigation regarding intellectual property
rights of technology companies. In the past we have been, and we currently are,
subject to litigation related to our intellectual property, including a pending
unfair trade practice case and separate patent infringement cases involving each
of Symantec, Hilgraeve and Trend Micro. See "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 us or our products. Uncertainties inherent in the litigation
process involve, among other things, the complexity of the technologies
involved, potentially adverse changes in the law and discovery of facts
unfavorable to us.
In addition, as we may acquire a portion of software included in its
products from third parties, our exposure to infringement actions may increase
because we must rely upon such third parties as to the origin and ownership of
any software being acquired. Similarly, exposure to infringement claims will
increase to the extent that we employ or hire additional software engineers
previously employed by competitors, notwithstanding measures taken by these
competitors to protect their intellectual property. In the future, litigation
may be necessary to enforce and protect trade secrets and other intellectual
property rights that we own. We may also be subject to litigation to defend
against claimed infringement of the rights of others or determine the scope and
validity of the proprietary rights of others. This litigation could be costly
and
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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 1998, 1997 and 1996, net revenue from international licenses
represented approximately 36%, 36%, and 32%, 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 revenue. 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
nonleveraged forward currency contracts. However, our future results of
operations may be adversely affected by currency fluctuations or by costs
associated with currency risk management strategies. Other risks inherent in
international revenue generally include:
- the impact of longer payment cycles;
- greater difficulty in accounts receivable collection;
- unexpected changes in regulatory requirements;
- seasonality due to the slowdown in European business activit
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 will may have a material adverse effect on our future
international license revenue. Further, in countries with a high incidence of
software piracy, we may experience a higher rate of piracy of our products.
In addition, a portion of our international revenue is expected to
continue to be generated through independent agents. Since these agents are not
our employees and are not required to offer our products exclusively, they may
discontinue marketing our products entirely. Also, we may have limited control
over these agents, limited access to the names of the customers to whom these
agents sell its products and limited knowledge of the information provided by,
or representations made by, these agents to its customers.
COMPUTER "HACKERS" MAY DAMAGE OUR PRODUCTS
Given our high profile in the security software market, we have been a
target of computer hackers"who have, among other things, created viruses to
sabotage or otherwise attack our products. While to date these efforts have been
discovered quickly and their adverse impact has been limited, similar viruses or
efforts may be created or replicated in the future. In this event, users'
computer systems could be damaged and demand for our software products may
suffer as a result. In addition, since we do not control diskette duplication by
distributors or our independent agents, diskettes containing our software may be
infected with viruses.
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FALSE DETECTION OF VIRUSES AND ACTUAL OR PERCEIVED SECURITY BREACHES
COULD ADVERSELY AFFECT OUR BUSINESS
Our anti-virus software products have in the past and may at times in the
future falsely detect viruses that do not actually exist. These false alarms,
while typical in the industry, may impair the perceived reliability of our
products and may therefore adversely impact market acceptance of our products.
In addition, we have in the past been subject to litigation claiming damages
related to a false alarm, and there can be no assurance that similar claims will
not be made in the future. Similarly, an actual or perceived breach of network
or computer security at one of our customers, regardless of whether the breach
is attributable to our products, could adversely affect the market's perception
of our security products. This could adversely effect our business, results of
operations and financial condition.
OUR CRYPTOGRAPHY TECHNOLOGY IS SUBJECT TO EXPORT RESTRICTIONS AND MAY
BECOME OBSOLETE
Certain of our network security products, technology and associated
assistance are subject to export restrictions imposed by the U.S. Department of
State and the U.S. Department of Commerce. These restrictions permit the export
of encryption products so long as certain requirements are met, but prohibit the
export of these products to countries deemed hostile by the U.S. Government.
U.S. export regulations regarding the export of encryption technology require
either a transactional export license or the granting of Department of Commerce
Commodity jurisdiction. As result of this regulatory regime, foreign competitors
facing less stringent controls may be able to compete more effectively than we
can in the global market. While we have obtained approval from the Department of
Commerce to export to certain end users, the U.S. Government may not approve
pending or future export license requests. Further, the list of products and
countries for which export approval is required, and the regulatory policies
with respect thereto, may be revised from time to time. Failure to obtain the
required licenses or the costs of compliance 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. The
security afforded by public key cryptography technology is based on our belief
that the factoring of large prime numbers is difficult. Should an easy factoring
method be developed, 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, factoring problems can theoretically be solved by
computer systems significantly faster and more powerful than those presently
available. If these improved techniques for attacking cryptographic systems are
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
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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 may not be successful in retaining
our existing key personnel and in attracting and retaining the personnel we
require, and our failure to retain and hire key employees could adversely affect
our business and operating results. For example, in early April 1998, Messrs.
Leslie Denend, David Carver and John Stringer resigned from their positions as
executive officers, although Mr. Denend remains a director. 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.
WE FACE RISKS ASSOCIATED WITH U.S. GOVERNMENT CONTRACTING
We expect that in the near term, a meaningful portion of our revenues
will result from existing 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. However, we may be unable to
procure additional government contracts.
Minimum fee awards for companies entering into government contracts are
generally between 3% and 7% of the costs incurred by them in performing their
duties under the related contract. However, these fee awards may be as low as 1%
of the contract costs. Furthermore, these contracts are subject to cancellation
at the convenience of the governmental agencies. Although we have been awarded
contract fees of more than 1% of the contract costs in the past and there have
been no terminations of any government contracts in the past, minimum fee awards
or cancellations may occur in the future. Reductions or delays in federal funds
available for projects we are performing could also have an adverse impact on
our government business. Contracts involving the U.S. government are also
subject to the risks of disallowance of costs upon audit, changes in government
procurement policies, required competitive bidding and, with respect to
contracts involving prime contractors or government-designated subcontractors,
the inability of those parties to perform under their contracts. Any of the
foregoing events could adversely affect our results of operations or financial
conditions.
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POTENTIAL YEAR 2000 PROBLEMS COULD ADVERSELY IMPACT OUR BUSINESS
Many currently installed computer systems and software products
experience difficulty in functionality with respect to distinguishing between
twenty-first century dates and twentieth century dates. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to function properly in the future.
We have tested our current products for Year 2000 compliance and believe
that they are Year 2000 compliant. However, the failure of our current or prior
products to operate properly with regard to Year 2000 requirements could cause
us to incur unanticipated expenses to remedy any problems, cause a reduction in
sales and expose us to related litigation by our customers, each of which could
harm our business. In addition, we and the third parties with whom we conduct
business may utilize equipment or software that may not be Year 2000 compliant.
Failure of our or any of these third party's equipment or software to operate
properly with regard to the Year 2000 requirements could result in, among other
things, unanticipated expenses or efforts to remedy any problems, which could
harm our or such third party's respective business. Furthermore, the purchasing
patterns of customers or potential customers may be affected by Year 2000
issues. Companies may expend significant resources to evaluate and correct their
own equipment or software for Year 2000 compliance while they simultaneously
evaluate the preparedness of the third parties with whom they deal. These
expenditures may result in reduced funds available to purchase products and
services such as those offered by us, which could adversely affect our business.
WE RELY ON A LIMITED NUMBER OF SUPPLIERS AND THIRD-PARTY MANUFACTURERS,
WHO MAY NOT CONSISTENTLY MEET OUR BUSINESS NEEDS
Some of our products contain critical componen