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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[X] 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) (I.R.S. EMPLOYER
IDENTIFICATION NO.)
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 December 31, 2000 was approximately $559,277,366. The number of
shares outstanding of the issuer's common stock as of December 31, 2000 was
138,089,775.
DOCUMENTS INCORPORATED BY REFERENCE:
Items 10, 11, 12, and 13 of Part III are incorporated by reference from the
Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held
May 24, 2001.
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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, including but not limited to those specifically
identified as such, that involve risks and uncertainties. The statements
contained in the Report on Form 10-K that are not purely historical are forward
looking statements within the meaning of Section 27A of the Securities Act and
Section 21E of the Exchange Act, including without limitation statements
regarding our expectations, beliefs, intentions or strategies regarding the
future. All forward looking statements included in this Report on Form 10-K are
based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. These statements
involve known and unknown risks, uncertainties and other factors, which may
cause our actual results to differ materially from those implied by the
forward-looking statements. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "potential," or "continue"
or the negative of these terms or other comparable terminology. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. Moreover, neither any other person nor we assumes
responsibility for the accuracy and completeness of such statements. Important
factors that may cause actual results to differ from expectations include those
discussed in "Risk Factors" beginning on page 12 in this document.
Networks Associates, Inc. was formed in December 1997, by the combination
of McAfee Associates, Inc. and Network General Corporation. Following the
combination, McAfee changed its legal name to Networks Associates, Inc. Since
then, we have acquired over 10 companies and in 1999 we publicly sold Class A
common stock of one of our subsidiaries as part of that subsidiary's initial
public offering.
OVERVIEW
We are a leading supplier of security and availability solutions for
e-business. Our products focus on two important areas of e-business: network
security and network management. In the network security and network management
arenas, the majority of our revenue has historically been derived from our
McAfee anti-virus product group and our Sniffer network availability and
performance management product group, respectively. These two flagship product
groups form the customer base and product base from which the balance of our
product line has developed.
In recent years, we have focused our efforts on building a full line of
complementary network security and network management solutions. On the network
security side, we strengthened our anti-virus lineup by adding complementary
products in the firewall, intrusion protection, encryption, and virtual private
networking categories. On the network management side, we built upon our Sniffer
line by adding products in the help desk, asset management, network monitoring,
and network reporting categories. We continuously seek to expand our product
lines. In order to more effectively market our products, we have combined
complementary products into separate product groups, as follows:
- McAfee, which primarily markets the McAfee Active Virus Defense (AVD)
product group;
- Sniffer Technologies, which primarily markets the Sniffer Total Network
Visibility (TNV) product group;
- PGP Security, which primarily markets the PGP Total Network Security
(TNS) product group; and
- Magic Solutions, which primarily markets the Magic Total Support Desk
(TSD) product group.
The four product groups represent our infrastructure segment. The
reorganization around our product groups is designed to allow us to, among other
things, react faster to customers' changing needs and better specialize our
sales force so they know our products and their markets in greater depth. In
addition, although specialization between security (anti-virus and security
product lines) and manageability (availability and
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service desk product lines) previously existed, with the reorganization we seek
to better differentiate anti-virus from security and availability from service
desk.
For the twelve months ended December 31, 2000, our infrastructure segment
accounted for approximately $691.1 million in net revenue and a net loss of
$50.4 million.
In addition to our product groups, we also have two subsidiaries that are
applications service providers, or ASPs. McAfee.com, our publicly traded
subsidiary, is a consumer applications service provider. myCIO.com, a wholly
owned subsidiary, is an infrastructure ASP targeted at business uers.
For the twelve months ended December 31, 2000, McAfee.com accounted for
approximately $46.9 million in net revenue and a net loss of $27.5 million. For
the twelve months ended December 31, 2000, myCIO.com accounted for approximately
$7.7 million in net revenue and a net loss of $24.9 million.
MCAFEE
McAfee's products and services provide solutions designed to enforce
anti-virus policies and measure the performance of anti-virus activities. The
McAfee product group consists of products and services that provide multi-layer
anti-virus protection, management and reporting for desktops, servers,
GroupWare, internet technologies, and wireless technologies. McAfee's anti-virus
protection products include VirusScan for desktop protection, NetShield for file
server protection, GroupShield for GroupWare protection, WebShield for internet
gateway protection, and VirusScan Wireless for wireless technology protection.
McAfee's anti-virus management and reporting products include Anti-Virus
Informant and ePolicy Orchestrator, an anti-virus management and reporting tool
designed specifically for the internet. McAfee's services are provided by
McAfee's Anti-Virus Emergency Response Team (AVERT). AVERT augments McAfee's
product offerings by identifying new viruses and deploying anti-virus solutions
to our customers. McAfee customers are primarily corporate customers, including
customers in the managed service market (includes Application Service Providers,
ASPs, and Managed Service Providers, MSPs.)
SNIFFER TECHNOLOGIES
Sniffer Technologies' products and services provide customers with network
and application management solutions designed to maximize network availability
and performance. Sniffer Technologies' products capture data, monitor network
traffic and collect key network statistics for small networks as well as
optimizing network and application performance and increasing 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. In addition, Sniffer Technologies' products proactively
monitor and diagnose network and application-level problems on complex,
multi-segment networks from centralized locations as well as troubleshooting
high-speed telecommunications and Internet service provider networks. The
Sniffer Technologies product group consists of the Sniffer Portable Analysis
Line, the Sniffer Distributed Analysis Line, the Sniffer Reporter Line and
Sniffer Pro for Packet over SONET. Sniffer Technologies' service offerings
consist primarily of network and application management education and consulting
services. Sniffer Technologies' customers are primarily corporate customers,
including customers in the managed service market (MSPs and ASPs.)
PGP SECURITY
PGP Security's products help organizations worldwide secure their networks
using firewall, encryption, intrusion detection, risk assessment and Virtual
Private Network (VPN) technologies. PGP Security's products include E-Business
Server, Gauntlet Firewall, CyberCop Scanner and e-ppliance. E-Business Server
provides an encryption and data authentication solution designed to protect the
integrity and security of the customers' data using self-decrypting archives for
a wide range of server platforms and integrates with our customers' existing
network architectures. Gauntlet Firewall delivers integrated anti-virus
protection, a built-in standards-based VPN server, and spam and content
filtering to assure broad protection. CyberCop Scanning tools deliver risk
assessment solutions that continually scan networks for weak spots, enabling
network administrators to prevent security breaches before they occur. PGP's
e-ppliance, a web-based
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configuration tool, deploys the latest firewall technologies and continually
administers anti-virus protection. PGP Security's security consulting and
support services are provided by its COVERT Labs which identifies and works to
resolve serious customer vulnerabilities before attackers are able to exploit
them. PGP Security's customers include individuals, government agencies,
financial institutions, and corporations, including e-businesses.
MAGIC SOLUTIONS
Magic Solutions' products provide customers with a set of tools to manage
their customer support and problem management needs. Magic Solutions' product
group consists of products that promote information sharing, facilitate
workflow, and improve service delivery. Magic Solutions' products include the
Magic Total Service Desk Suite, a 100% browser based service desk and problem
management solution. The Magic Total Service Desk Suite includes customization
features (Database, User Interface and Business Rules). In addition, Magic
Solutions' stand-alone products include Magic HelpDesk, SelfServiceDesk, Remote
Desktop and Event Management. Magic Solutions' customers are primarily
corporations.
MCAFEE.COM
Effective January 1, 1999, we contributed our consumer e-commerce business
to our then wholly owned subsidiary, McAfee.com. In December 1999, McAfee.com
completed its initial public offering in which it sold to the public
approximately 7.2 million shares of its Class A common stock, entitled to one
vote per share. As of December 31, 2000, we owned 36,000,000 shares of
McAfee.com Class B common stock, entitled to three votes per share and
representing approximately 81% of McAfee.com's outstanding common stock and 93%
of its total voting power.
McAfee.com's products and services provide customers with an on-line
systems security solution. McAfee.com is a security Application Service Provider
(ASP) that delivers security applications software and related services through
an Internet browser. The McAfee.com applications allow consumers to detect and
eliminate viruses on their PCs, repair their PCs from damage caused by viruses,
optimize their hard drives and update their PCs' virus protection system with
current software patches and upgrades. The McAfee.com web site provides the
online products and services personalized for consumers based on their PC
configurations, software and attached peripherals. McAfee.com's offerings
include McAfee Clinic to scan their PC's for viruses, protect their data, clean
and optimize their hard drives and update applications and operating systems.
Additionally, McAfee.com offers customers access to McAfee.com Personal
Firewall, McAfee.com Wireless Security Center and McAfee.com Internet Privacy
Service.
In November 2000, McAfee.com expanded its home page and offerings to
include, on a preview basis, its .NET initiative, a managed application service
for small to medium sized businesses. Services available to these businesses on
a preview basis through April 2001, include:
- Security.NET -- up-to-date anti-virus and firewall security at work,
home, and on the road -- all via the Internet;
- HelpDesk.NET -- self-help tutorials, file management, and PC maintenance
services on a 24x7 basis;
- Productivity.NET -- anytime, anyplace computing with Microsoft Office
compatible applications.
In addition, McAfee.com has developed strategic relationships with original
equipment manufacturers and suppliers and other software companies, to
incorporate McAfee.com technology into hardware and other software applications.
McAfee.com's customers include individuals and corporations.
Our existing license agreement with McAfee.com currently restricts
McAfee.com's business to offering products and services incorporating our
technology to consumers over the Internet. However, we are in the process of
negotiating arrangements which would allow McAfee.com to offer its .NET
initiative to small to medium sized businesses over the Internet. We may not
reach agreement to terms acceptable to both parties or at all.
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MYCIO.COM
In January 2000, we launched myCIO.com, a wholly owned subsidiary, as an
infrastructure ASP targeted at business users. myCIO.com delivers managed
security services hosted on our servers, or certain intermediaries' servers, to
businesses via the Internet or to OEMs. myCIO.com's services are designed to be
simple and cost-effective as well as more rapidly deployable than if the
customer were to internally install network security applications. myCIO.com's
services include Virus Scan ASaP, CyberCop ASaP, Firewall ASaP, VirusScreen ASaP
and VPN ASaP.
In February 2001, we announced our plan to reintegrate myCIO.com's
operations with our own, while continuing to offer myCIO.com's products and
services as key offerings. Going forward, myCIO.com will no longer constitute a
separate business segment.
PROFESSIONAL SERVICES & TECHNICAL SUPPORT
As our products and computer networks become more complex, customers
increasingly require greater professional assistance in the design,
installation, configuration and implementation of their networks and acquired
products. To meet these evolving customer needs, we have established
Professional Services and Technical Support. Professional Services is focused on
two service segments: Consulting Services and Education Services. Technical
Support consists primarily of one program called PrimeSupport.
Consulting Services supports product integrations and deployment with an
array of standardized and custom offerings. Consulting Services also offers
other services ranging from proactive and emergency troubleshooting to network
design, planning and simulation. We supplement our Consulting Service
capabilities through the use of outside professional service providers,
including our distributors, resellers and system integrators. In conjunction
with our recent reorganization to establish product groups, we reorganized our
U.S. Consulting Services organization, in part, to enable the service providers
to become more specialized on individual products and product lines.
Education Services represents the combined training organizations of
Sniffer University, TIS University, McAfee University, and Magic University.
Together, these training organizations offer customers an extensive curriculum
of computer network technology courses, including protocol analysis and
troubleshooting, security, help-desk and network management tools. Education
Services provides public classes and customized on-site training at customer
locations.
The PrimeSupport program provides our customers online and telephone-based
technical support in an effort to ensure that our products are installed and
working properly. To meet customers' varying needs, PrimeSupport offers a choice
of the online KnowledgeCenter or the telephone-based Connect, Priority and
Enterprise. PrimeSupport is available to all customers on a worldwide basis from
a nearby global support center.
- PrimeSupport KnowledgeCenter -- Consists of a searchable, intelligent
knowledge base of technical solutions and links to a variety of technical
documents such as product FAQ's and technical notes. The KnowledgeCenter
also allows users to submit questions by email if their answer is not
found in the KnowledgeCenter's technical resources.
- PrimeSupport Connect -- Provides toll-free telephone access to technical
support during regular business hours and access to the online
KnowledgeCenter.
- PrimeSupport Priority -- Provides support for critical operations with
priority, unlimited, toll-free telephone access to technical support 24
hours a day, 7 days a week and access to the online KnowledgeCenter.
- PrimeSupport Enterprise -- Offers proactive, personalized service for the
most business critical operations and includes an assigned technical
support engineer from our elite Enterprise support team; proactive
support contact (telephone or email) with customer-defined frequency; and
election of five designated customer contacts, and access to the online
KnowledgeCenter.
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PRODUCT LICENSING MODEL
Our product licensing model consists of one-year subscription licenses,
two-year subscription licenses and perpetual licenses. We typically license our
products to corporate and government customers on a subscription basis, for a
period of one year or two years or on a perpetual basis. We believe that the
subscription license that includes related maintenance offers several benefits
to our customers. Under the subscription licensing model, for one initial fee,
the customer receives the software and maintenance, which gives the customer the
right to receive all upgrades, updates and technical support for the
subscription period. 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, our one-year and two-year
licensing models create the opportunity for recurring revenue for us through the
renewal of existing licenses. By offering one-year or two-year licenses as
opposed to traditional perpetual licenses, we are able to meet a lower initial
cost threshold for customers with annual budgetary constraints. The renewal
process also provides an opportunity to cross-sell new products and product
lines to existing customers. 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 users licensed at existing sites and to expand our licenses to new sites in
an organization. However, we may be unable to sustain current renewal rates in
the future. We also provide single user and corporate user licenses for our
products under traditional perpetual licenses with product updates, upgrades and
support available to customers under separate maintenance contracts.
In 2001, we will introduce two-year subscription licenses that include only
one year of maintenance. During the first year of the two-year subscription
license, the customer has the option to purchase the second year of maintenance
at a fixed price. As the software licenses or maintenance contracts near
expiration, we contact customers to renew their licenses or maintenance
contracts, as applicable. We believe that the two-year subscription license that
includes the related first year of maintenance offers several benefits to our
customers. For one initial fee, the customer receives the software and all
upgrades, updates and technical support for the first year. Going forward, we
believe that providing the customer the option to purchase the second year of
maintenance provides the customer greater flexibility in selecting the
appropriate level of maintenance support.
HOSTED APPLICATIONS SUBSCRIPTION MODEL
For our ASP or hosted products and services customers who "rent versus buy"
the software, McAfee.com and myCIO.com have a related subscription model. Paid
McAfee Clinic and myCIO.com subscribers receive a time-based subscription to the
service. Because our ASP services are "version-less," or self updating,
customers using our hosted services are assured of using the most recent version
of the software application, eliminating the need for purchase product updates
or upgrades.
SALES AND MARKETING
To augment and capitalize upon our marketing efforts, our sales and
marketing efforts are directed primarily at large corporate and government
customers, as well as to resellers, distributors and system integrators
worldwide through the channels listed below.
NORTH AMERICAN DIRECT SALES
Our North American direct sales force, constituting the majority of our
sales force, is organized by product group, with four separately focused sales
organizations selling by product group. Each of these sales organizations
consists of field sales representatives who are located regionally and outbound
telesales representatives who actively market our individual product groups,
focusing on small customers and transactions. Our corporate telesales
representatives also respond to prospective customers who contact us as a result
of a particular marketing program or after electronically evaluating one of our
products. To augment our sales organization, our executives are involved with
sales to many major accounts.
All of our North American sales representatives are responsible for
developing new business as well as the renewal of our existing licenses. Prior
to expiration of a license, a sales representative contacts the customer
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and encourages the customer to renew the expiring license and determines if the
number of computers licensed needs adjustment and, additionally, markets new
products and product groups to this existing customer.
INTERNATIONAL SALES
We have sales and support operations in Europe, Asia, South America and
Australia. In 2000, international revenues accounted for approximately 37% of
our net revenues. We expect that international revenues will continue to account
for a significant percentage of net revenues.
In 2001, we intend to organize our international direct sales force by our
four product groups when and where local demand and sales force considerations
make this action advisable.
RESELLERS AND DISTRIBUTORS
To complement our direct sales efforts, we market many of our products
through corporate resellers and distributors, and indirectly through retailers.
We currently utilize corporate resellers, including Software Spectrum, ASAP
Software, Softmart, Corporate Software & Technology and Software House
International, which focus primarily on selling site licenses for our software
to corporate customers.
Independent software distributors who currently 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 larger
computer and software retailers in the United States, including Comp USA, Fry's,
Staples, Best Buy, Office Max and Office Depot. Several members of our channel
sales force work closely with our major reseller and distributor accounts to
manage orders, inventory levels, promotions and selling activities.
Our independent software distributors are permitted stock balancing and
stock rotation rights. We often rely on resellers and distributors, including
retail outlets, to market and support our products. Our agreements with our
distributors are not exclusive and may be terminated by either party without
cause. Terminated distributors may not continue to represent our products.
In December 2000, in light of the business decision by some of our
distributors, including our largest distributor, to reduce inventory levels and
due to the unpredictability of demand in the distribution channel, we began a
transition from a sell-in to a sell-through business model. Subject to certain
limitations, we agreed to accept requests from certain distributors to return
inventory over and above permitted contractual levels. Under our new business
model we will enter into amended distribution arrangements under which we will
permit our distributors to purchase software licenses at the same time they fill
customer orders and to pay for hardware and retail products only when these
products are resold to the distributors' customers. In addition, we will permit
our distributors to make hardware and retail product returns at any time prior
to the time they sell these products to their customers. This right of return
will be unconditional. After sale by the distributor to its customer, there will
be no right of return from the distributor to us with respect to such product,
unless we approve the return from the final customer to the distributor.
Accordingly, due to this change in business practice, commencing on January 1,
2001, we will recognize revenue on products when products are sold through by
the distributor. We expect the transition to a sell-through model will be
completed in the first quarter of 2001.
ORIGINAL EQUIPMENT MANUFACTURERS
Original Equipment Manufacturers, or OEMs, license our products and bundle
them with PC hardware or software. OEMs typically sublicense a single version of
our products to end users who must contact us in order to receive their 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 and services is through the
Internet. In addition to the NAI.com website, each of our product groups and
McAfee.com have their own individual websites. Not only do each of these
websites contain various marketing materials and information about our products,
but website visitors may download and purchase products or obtain free trials of
our products or trial subscriptions for hosted products and services. We also
promote our products and services through advertising activities in trade
publications and direct mail campaigns and strategic arrangements. We also
attend trade shows, sponsor conferences and publish a quarterly newsletter,
which is mailed to existing and prospective customers.
CUSTOMERS
We primarily market our products to large corporate and government
customers directly through our direct sales organization and indirectly through
resellers and distributors. In terms of number of products available for sale, a
majority of our products are distributed indirectly through resellers and
distributors. In the U.S., substantially all our indirect sales are through four
major distributors. In Europe, substantially all indirect sales are made through
five major distributors. During 2000, one customer, Ingram Micro, accounted for
approximately 20% of our net revenue. See Note 14 of Notes to Condensed
Consolidated Financial Statements for major customer information.
We primarily market our products directly to individual consumers through
online distribution channels and indirectly through traditional distribution
channels, such as retail stores. McAfee.com is responsible for online
distribution of our products sold to individual consumers over the Internet or
for Internet-based products and for the licensing of technology to original
equipment manufacturers for sale to individual consumers.
PRODUCT DEVELOPMENT AND ACQUISITION
We believe that our ability to maintain our competitiveness will depend in
large part upon our ability to enhance existing products, develop and acquire
new products and develop and integrate acquired products. The market for
computer software includes low barriers to entry, rapid technological change,
and is highly competitive with respect to timely product introductions. Product
enhancements or new products may not be developed or acquired on a timely basis
or at all. As part of our growth strategy, we have made and expect to continue
to make investments in complementary businesses, products and technologies.
In addition to developing new products, our internal development staff is
also focused on developing updates to existing products and modifying and
enhancing any acquired products. Future upgrades and updates may include
additional functionality, respond to user problems or address compatibility
problems with changing operating systems and environments. We believe that our
ability to provide these upgrades and updates frequently and at low cost is key
to our success. For example, the proliferation of new and changing viruses makes
it imperative to update anti-virus products frequently to avoid obsolescence.
Failure to release upgrades and updates could have a material adverse effect on
our business, results of operations and financial condition. We may not be
successful in these efforts. In addition, future changes in Windows 98, Windows
NT, NetWare or other popular operating systems could cause compatibility
problems with our products. Further, delays in the introduction of future
versions of operating systems or lack of market acceptance of these future
versions would delay or reduce demand for our future products which were
designed to 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 operations and financial
condition.
Excluding stock-based compensation charges, we expended $171.6 million,
$148.2 million and $135.5 million in the years ended December 31, 2000, 1999,
and 1998, respectively, on research and development.
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MANUFACTURING AND SUPPLIERS
Our manufacturing operations consist primarily of assembly, testing and
quality control of materials, components, subassemblies and systems for our
Sniffer-based and E-ppliance products. We use third-party manufacturers for
these manufacturing operations. Reliance on third-party manufacturers involves a
number of risks, including the lack of control over the manufacturing process
and the absence or unavailability of adequate capacity.
We have developed software-only versions of some of our Sniffer products.
Purchasers of these Sniffer software products are required to already own, or
purchase directly from the manufacturer or other vendors, the necessary hardware
products, such as computer platforms and components. Customers may require that
we continue to provide the necessary hardware products.
COMPETITION
The markets for our products are intensely competitive 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 group;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
- brand name recognition;
- reputation; and
- price.
We may be unable to compete effectively against existing and potential
competitors. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources. As
is the case in many segments of the software industry, we have been
encountering, and we expect to further encounter, increasing competition. This
increased competition could reduce average selling prices and, therefore, profit
margins. Competitive pressures could result not only in price reductions but
also in a decline in sales volume.
Performance and quality of our anti-virus software products are measured by
number and type of viruses detected, the speed at which the products run and
ease of use. Our principal competitor in the anti-virus market serviced by our
McAfee product group and McAfee.com is the Peter Norton Group of Symantec. Trend
Micro remains the strongest competitor in the Asian anti-virus market. Other
competitors include numerous smaller companies and shareware authors that may in
the future develop into stronger competitors or be consolidated into larger
competitors.
Our principal competitors in the security market vary by product type. For
firewalls, our principal competitors include CheckPoint, Symantec, and larger
companies such as Cisco Systems and Microsoft. For intrusion detection products,
we compete with ISS, Symantec and Cisco. The markets for encryption and virtual
private network, or VPN, products are highly fragmented with numerous small and
large vendors. Public key infrastructure, or PKI, encryption vendors such as
Entrust Technologies offer some products that compete with our PGP products. VPN
competitors include hardware and software vendors, including telecommunications
companies and traditional networking suppliers.
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Our principal competitor in the network management market is Agilent. Other
competitors include Cisco, Computer Associates, Compuware, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies, Shomiti Systems and Acterna Corporation.
Our principal competitors in the help desk market are Computer Associates,
FrontRange Solutions, Peregrine and Remedy.
We also face competition from large software companies such as Microsoft,
Intel, Novell and HP, which may offer network security and management products
as enhancements to their operating system.
Finally, as the network management market develops, we may face increased
competition from a number of large companies, as well as other companies seeking
to enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and support capabilities.
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 to our software. However,
these protections may be inadequate or competitors may independently develop
technologies or products that are substantially equivalent or superior to our
products. We do not typically obtain signed license agreements from our
corporate, government and institutional customers who license products directly
from us. Rather we include an electronic version of a "shrink-wrap" license in
all of our electronically distributed software and a printed license in the box
for our products distributed through traditional distributors in order to
protect our copyrights and trade secrets in those products. Since none of these
licenses are signed by the licensee, many legal authorities believe that such
licenses may not be enforceable under the laws of many states and foreign
jurisdictions. In addition, the laws of some foreign countries either do not
protect these rights at all or offer only limited protection for these rights.
The steps taken by us to protect our proprietary software technology may be
inadequate to deter misuse or theft of this technology. For example, we are
aware that a substantial number of users of our anti-virus products have not
paid any registration or license fees to us. Changing legal interpretations of
liability for unauthorized use of our software, or lessened sensitivity by
corporate, government or institutional users to avoiding infringement of
intellectual property, could have a material adverse effect on our business,
results of operations and financial condition.
NETWORK ASSOCIATES/MCAFEE.COM INTERCOMPANY AGREEMENTS
For the purposes of defining our ongoing relationship with McAfee.com, our
publicly traded subsidiary, we have entered into a number of ongoing agreements.
These agreements are filed as exhibits to the public disclosure documents that
we file with the Securities and Exchange Commission and are described briefly
below. The description is subject in all respects to the terms of the actual
agreements.
License Agreement: Under the terms of this agreement:
Licensed Technology. Network Associates and McAfee.com granted to each
other limited rights to each others' patents, copyrights, trademarks and trade
secrets for use in defined markets. Network Associates has worldwide,
non-exclusive rights to McAfee.com's patents and exclusive rights to use
copyrights, trademarks and trade secrets to deliver products and services to
enterprise customers and individual consumers by any means other than the
Internet. Under the agreement, McAfee.com is granted worldwide, non-exclusive
rights to Network Associates' patents and exclusive rights to use Network
Associates' copyright, trademark and trade secret rights to create and deliver
products and services directly or indirectly to individual consumers over the
Internet or for Internet-based products. Each party is also permitted to create
products derived from the technology licensed to it by the other. The creating
party retains ownership of their newly derived products but these derived
products are licensed to the other party subject to the terms of the license
agreement.
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Royalty Payments. In consideration for the rights granted under the license
agreement, Network Associates is required to pay McAfee.com a flat quarterly
royalty of $250,000. In consideration for the rights granted by Network
Associates to McAfee.com under the license agreement, McAfee.com is required to
pay Network Associates a royalty on revenues recognized from product and
subscription sales that include Network Associates' technology, initially at a
rate of 20% commencing on January 1, 1999, and declining 1.625% per quarter
until the rate is 7% in the quarter beginning January 1, 2001, and remaining at
7% thereafter.
Limitations on Offered Products. During the term of the agreement, each
party has agreed that it will not offer products incorporating third-party
technology if those products are competitive with the products offered by the
other party.
Indemnification. Under the agreement, each party has agreed to indemnify,
defend and hold harmless the other for any losses incurred in connection with
claims arising in the covered countries if the technology licensed under the
agreement violates the patent, copyright, trademark or trade secrets or other
proprietary rights of a third party. Covered countries are those countries that
are party to the Berne Convention for the Protection of Literary and Artistic
Works, which include the U.S. and substantially all U.N. member nations.
Term and Termination. The license agreement will remain in effect
indefinitely, but may be terminated, among other circumstances, by the
non-defaulting party, in the event of a material breach by the other party that
remains uncured for 30 days following notice of the breach, subject to mandatory
dispute resolution prior to the effectiveness of any proposed termination.
We are currently negotiating an arrangement with McAfee.com so that it may
offer its .NET initiative to small to medium sized businesses over the Internet.
However, we may not reach agreement on terms acceptable to both parties or at
all.
Services Agreement: Under this agreement, Network Associates provides
services relating to tax, insurance, employee benefits and administration,
corporate record keeping and information technology. For these services, Network
Associates charges a portion of the cost of our provision of the services to
McAfee.com, including all related expenses, which is allocated based on
headcount, plus a ten percent mark-up. In addition, Network Associates may
provide additional services, including legal and accounting services, from
time-to-time in the future. The services agreement may be terminated either by
McAfee.com on 30 days notice or by Network Associates when it ceases to own a
majority of the outstanding voting stock of McAfee.com.
Registration Rights Agreement: Under this agreement, Network Associates, or
any transferee of at least 10% of its McAfee.com shares, can include its shares
of McAfee.com common stock in any future registration of common stock made by
McAfee.com, other than any registration statement relating to an acquisition or
stock option plan. In addition, after June 1, 2000, Network Associates or any
transferees of at least 10% of its McAfee.com shares can request that McAfee.com
file a registration statement so it can publicly sell its shares of McAfee.com
stock.
Joint Cooperation Agreement: The joint cooperation and master services
agreement with McAfee.com governs the provision of technology services among the
parties. Under this agreement, the Network Associates' anti-virus emergency
response team, known as AVERT, will provide McAfee.com with research and
solutions for virus events. The agreement also contains standard terms and
conditions governing the provision of technology services from one party to the
other under statements of work that may be negotiated from time to time. We pay
McAfee.com a fee for these services in an amount equal to 10% of McAfee.com's
total quarterly technology costs plus a 10% service charge.
Tax Sharing Agreement: Under this agreement, McAfee.com pays federal, state
and local income tax liability amounts to Network Associates, determined on a
pro forma basis, as if McAfee.com filed its own separate income tax returns for
each year. Network Associates will not reimburse McAfee.com for McAfee.com's or
any other group member's use of their net operating loss or other tax benefits
in any consolidated or combined return. However, McAfee.com will be able, during
the term of the agreement, to
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take into account its past and future net operating loss and other tax
attributes for purposes of computing its hypothetical separate income tax return
liability payment to, or refund from, Network Associates.
The tax sharing agreement will terminate if McAfee.com is no longer
eligible to join Network Associates in the filing of a consolidated federal
income tax return. In the event of such termination, any net operating losses or
other carryforward amounts would not be available to McAfee.com upon departure
from the group. Under the agreement, McAfee.com will not be reimbursed for any
such loss of tax benefits.
Indemnification and Voting Agreement: Under this agreement, except as
contemplated below, Network Associates will indemnify and defend McAfee.com
harmless for all losses related to any third party claims relating to events or
circumstances arising out of any action or inaction of Network Associates,
including its subsidiaries and officers and directors, on or prior to December
2, 1999, the date on which McAfee.com completed its initial public offering.
Matters for which Network Associates is not obligated to indemnify McAfee.com
include:
- any obligations assumed by McAfee.com, or payments required to be made by
McAfee.com, under its agreements with Network Associates;
- any losses resulting from third party claims that are related to
intellectual property developed by McAfee.com between August 20, 1999 and
December 2, 2000;
- any obligations incurred by McAfee.com in the ordinary course of
business;
- any losses resulting from third parties claims made against McAfee.com
alleging infringement of intellectual property rights unknown as of the
closing of McAfee.com's initial public offering; and
- any losses resulting from third parties claims related to or arising from
a material misstatement contained in or material omission from the
prospectus or the registration statement for McAfee.com's initial public
offering.
As a result of the above indemnification, we are, for example, required to
hold McAfee.com harmless from our existing litigation related to the anti-virus
technology licensed under the cross license agreement. In the event of a claim
relating to a product that includes components supplied by McAfee.com and
components supplied by us, Network Associates has the right to determine whether
and to what extent McAfee.com is entitled to indemnification, after reasonable
consultation with McAfee.com.
For so long as we own at least 20% of McAfee.com's outstanding voting
power, we must vote our shares of McAfee.com's capital stock in favor of the
election of two independent directors. Additionally, if, as described below
under the stockholders agreement, there is a Network Associates' change of
control which is not approved by the continuing Network Associates directors, we
have agreed to vote to elect a majority of independent directors to McAfee.com's
board.
Stockholders Agreement: Under this agreement, we have agreed that if (1)
without the prior approval of the Network Associates continuing directors, as
defined below, any person acquires or agrees to acquire 15% or more of our
outstanding common stock or (2) the Network Associates continuing directors
cease to constitute a majority of serving directors, then for so long but only
for so long as that condition exists:
- our shares of McAfee.com Class B common stock are entitled to only one
vote per share instead of three votes per share; and
- we are obligated to vote our McAfee.com shares to cause, and to take such
actions reasonably within our control to cause, and to seek to cause the
McAfee.com directors appointed by us to cause, McAfee.com's board of
directors to consist of at least a majority of independent directors.
Network Associates continuing directors will consist of our current directors
and any subsequent directors approved or not objected to by a majority of our
then-continuing directors.
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EMPLOYEES
As of December 31, 2000, we employed 3,461 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.
RISK FACTORS
Investing in our common stock involves a high degree of risk. The risks
described below are not the only ones facing our company. Additional risks not
presently known to us or that we deem immaterial may also impair our business
operations. Any of the following risks could materially adversely affect our
business, operating results and financial condition and could result in a
complete loss of your investment.
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 ability to timely and accurately obtain end-user sales information
and information related to inventory levels from our distributors;
- introduction of new products, product upgrades or updates by us or our
competitors;
- the mix of products we sell;
- the size and timing of our non-cash stock-based charges;
- changes in product prices by us or our competitors;
- trends in the computer industry and general economic conditions;
- our ability to develop, market and sell our products;
- costs related to acquisitions of technology or businesses;
- fluctuations in McAfee.com's expenditure levels related to its efforts to
build brand awareness and establish strategic relationships with various
Internet companies;
- fluctuations in our expenditure levels related to our efforts to expand
our international sales organization;
- our investment experience related to our strategic minority equity
investments;
- the percentage of our revenue, particularly that portion attributable to
our ASP subscription model, that is deferred;
- the effectiveness of our channel strategy and our mix of direct and
indirect revenues;
- pressure on employee wages as competition for skilled employees
increases; and
- costs related to extraordinary events including litigation, acquisitions
or any reductions in forces.
Our business is impacted by 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 in
the summer months when many businesses experience lower sales, particularly in
the European market. Our European business has been adversely impacted in recent
periods primarily because of the continued weakness of the Euro against the
dollar. For some time, our business in Asia and Latin America has
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been adversely impacted by the adverse economic conditions there. Most recently,
our business in the U.S. and elsewhere has been adversely impacted by customer
concerns about weakening economic conditions.
We have not been profitable for the last two years. In addition to risks we
face in operating our business, continued economic weakness in the U.S. and
other countries could slow or prevent our efforts to successfully expand
internationally and regain profitability.
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 maintain a significant level of backlog. As a result, product and
service revenues in any quarter are dependent on contracts entered into, product
shipped and services rendered in that quarter. Historically, we have 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. In the past, distributors made
significant purchases at the end of each quarter. We anticipate that our change
to a sell-through revenue model for sales to distributors, where we recognize
revenue on product sales to distributors, when the related product is sold by
our distributors to their customers, will lead to orders being received and
shipped more evenly during each quarter. The timing of closing larger orders
sold directly to end-users of our products increases the risk of
quarter-to-quarter fluctuation. In addition, as we transition to the
sell-through revenue model for products sold through the distribution channel,
it is essential that we gather sales information from our distributors to
accurately record our financial results for a particular quarter in a timely
manner. 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.
WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES, WHO MAY NOT VIGOROUSLY MARKET OUR
PRODUCTS, MAY NOT ACCEPT OUR SELL-THROUGH BUSINESS MODEL, MAY NOT PROVIDE US
REQUIRED INFORMATION TO ACCURATELY RECOGNIZE REVENUE 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.
These 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.
In December 2000, in light of the business decision by some of our
distributors, including our largest distributor, to reduce inventory levels and
due to the unpredictability of demand in the distribution channel, we began a
transition from a sell-in to a sell-through business model. Subject to certain
limitations, we agreed to accept requests from certain distributors to return
inventory over and above permitted contractual levels. Under our new business
model we will enter into amended distribution arrangements under which we will
permit our distributors to purchase software licenses at the same time they fill
customer orders and to pay for hardware and retail products only when these
products are resold to the distributors' customers. In addition, we will permit
our distributors to make hardware and retail product returns at any time prior
to the time they sell these products to their customers. This right of return
will be unconditional. After sale by the distributor to its customer, there will
be no right of return from the distributor to us with respect to such product,
unless we approve the return from the final customer to the distributor.
Accordingly, due to this change in business practice, commencing on January 1,
2001, we will recognize revenue on products when products are sold
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by the distributor. We expect the transition to a sell-through model will be
completed in the first quarter of 2001. Among other risks in connection with
this transition are the following:
- our intermediaries may resist or be slow to adopt our new business
practice;
- to determine our business performance at any point in time or for any
given period, we must timely and accurately gather sales information from
our intermediaries' information systems, at an increased cost to us; and
- our intermediaries' information systems may be less accurate or reliable
than our internal systems.
Some of our distributors are experiencing financial difficulties worldwide,
which may adversely impact our collection of accounts receivable. We regularly
review the collectibility and credit worthiness of our distributors to determine
an appropriate allowance for doubtful accounts. Our uncollectible accounts could
exceed our current or future allowance for doubtful accounts, which would
adversely impact our operating results.
COMPETITORS MAY INCLUDE PRODUCTS SIMILAR TO OURS IN THEIR HARDWARE OR SOFTWARE
AND RENDER OUR PRODUCTS OBSOLETE
Vendors of hardware and of operating system software or other software
(such as firewall or e-mail software) may enhance their products or bundle
separate products to include network security and management software similar to
our products. The widespread inclusion of products that perform the same or
similar functions as our products within computer hardware or other software
could render our products obsolete and unmarketable. Furthermore, even if these
incorporated products are inferior or more limited than our products, customers
may elect to accept the incorporated products rather than purchase our products.
If we are unable to develop new network security and management products to
further enhance operating systems or other software and to successfully replace
any obsolete products, our business could suffer.
WE FACE RISK ASSOCIATED WITH EMPLOYEE RETENTION AND NEW EMPLOYEE ASSIMILATION
Many of our employees are located in areas and have skills in fields where
there is high worker mobility and work force turnover. The departure of a large
number of our employees or a meaningful number of key non-executive employees
could have a material adverse impact on many facets of our business, including
our ability to develop new products, upgrade existing products, sell our
products and provide adequate internal infrastructure. After April 22, 2000, the
end of the 12-month lock-up period for options repriced in April 1999, we
experienced a larger than normal level of employee departures as many of these
employees elected to terminate their employment with us. We anticipate that we
will continue to have difficulties in retaining employees because most of our
employees hold options to purchase our stock at prices significantly above the
current market price for our stock.
We hired a significant number of new employees in 2000 and we may continue
to add new employees to fill positions vacated by departing employees and to
expand our business. We will face challenges in attracting and assimilating
qualified new employees. We expect that there may be reduced levels of
productivity as these individuals are trained and otherwise adapt to our
organization. We also may experience employee retention and assimilation issues
in connection with the integration of our myCIO.com service offerings into our
key offerings.
WE FACE RISKS RELATED TO ORGANIZING OUR SALES EFFORT INTO PRODUCT GROUPS
In order to more effectively market our products, we have combined
complementary products into separate product groups, as follows: McAfee, which
markets the McAfee Active Virus Defense (AVD) product group; Sniffer
Technologies, which markets the Sniffer Total Network Visibility (TNV) product
line; PGP Security, which markets the PGP Total Network Security (TNS) product
group; and Magic Solutions, which markets the Magic Total Support Desk (TSD)
product group. This structure is intended to allow us to react faster to
customers' needs and to focus each product group's sales force on selling
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their respective product line and the individual point products contained in
those product groups. Our U.S. professional services organization is also
organized around our product groups. Our customers and potential customers may
not respond to this structure and our business and future financial performance
could suffer. This structure may be unsuccessful due to, among other things:
- uncertainty and customer dissatisfaction surrounding our shift in focus
to our product group strategy, including uncertainty as to our level of
support for our combined product groups, previously marketed as one line
and integration of our various product groups;
- customer confusion or irritation related to multiple sales calls from
different members of our reorganized sales force;
- a loss of potential cross selling opportunities and a lack of lead
sharing between the separate product groups' sales representatives who
are primarily compensated for sales made by them of products within their
respective product groups;
- the possibility that our centralized general and administrative group may
be unable to meet on a timely basis or at all each product group's
individualized infrastructure and support requirements; and
- one or more of our product groups may lack sufficient qualified
professional services personnel to support its products.
WE COULD EXPERIENCE CUSTOMER AND MARKET CONFUSION DUE TO OUR MARKETING AND
ADVERTISING EFFORTS TARGETED AT THE PRODUCT GROUP OR SUBSIDIARY LEVEL, RATHER
THAN AT THE CORPORATE LEVEL, AND DUE TO SIMILARITIES IN THE NAMES USED BY OUR
PRODUCT GROUPS AND SUBSIDIARIES
Networks Associates, Inc. was formed in December 1997, by the combination
of McAfee Associates, Inc. and Network General Corporation. We have spent a
significant portion of our total marketing efforts and advertising spending
building awareness of the Network Associates name. Our marketing efforts and
advertising spending have been focused on building brand awareness at the
product group and subsidiary level, rather than at the Network Associates
corporate level. This has created and could continue to create confusion in the
marketplace and in the investor community if people are unclear about the
relationships between Network Associates and our product groups, our McAfee.com
subsidiary and myCIO.com subsidiary. Our myCIO.com products and service
offerings are being reintegrated into our core business. These groups and
subsidiaries also have potentially confusing names and products. For example,
our online consumer anti-virus products, our retail and corporate anti-virus
products and our hosted anti-virus products to date have been marketed and sold,
respectively, by our publicly traded McAfee.com subsidiary, our retail division
which is called McAfee Retail and our McAfee product group.
WE MAY EXPERIENCE HIGHER OVERALL REVENUE IN THE NEAR-TERM BUT LOWER FUTURE
SOFTWARE LICENSE REVENUE DUE TO EXPECTED INCREASED LEVELS OF PERPETUAL LICENSES
We expect an increase in the number of, and amount of, our net revenue
attributable to our sale of perpetual software licenses. Under a perpetual
license, a customer purchases the base-line software and subsequently acquires
software upgrades and updates. In contrast, under a time-based license model,
customers license the software, including upgrades and updates, for a specified
period of time. At the end of the initial license period, the customer must
renew their software time-based license to use our software. Sales of perpetual
licenses typically result in significantly higher up-front revenue and lower
recurring and future revenues as the sales price for upgrades and updates tends
to be significantly lower than that of a perpetual license. Factors contributing
to this expected increase in perpetual licenses include greater sales of
hardware-based Sniffer and E-ppliance products where software is bundled on to
the hardware platform and a general customer preference for perpetual licenses.
To offset potential reductions in future revenue, among other things, it will be
incumbent upon us to introduce new software products for sale and we may elect
to unbundle some of the products previously offered by us on a bundled
subscription basis.
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OUR REVENUES MAY BE ADVERSELY IMPACTED BY OUR SHIFT TO A TWO-YEAR SUBSCRIPTION
LICENSE THAT INCLUDES ONLY ONE-YEAR OF MAINTENANCE
Historically, our two-year subscription license included two years of
maintenance. However, in 2001, we will introduce two-year subscription licenses
that include the first year of maintenance. During the first year of the
subscription license, the customer has the option to purchase the second year of
maintenance. We believe this new offering allows the customer greater
flexibility in selecting the appropriate level of maintenance support. However,
if customers delay the purchase of their second year of maintenance support,
this could adversely affect our near term revenue and cash flows.
OUR STOCK PRICE HAS BEEN VOLATILE AND IS LIKELY TO REMAIN VOLATILE
During 2000, our stock price was extremely volatile and ranged from a
per-share high of $36.69 to a low of $4.13. Announcements, litigation
developments, and our ability to meet the expectations of investors with respect
to our operating and financial results may contribute to current and future
stock price volatility. We may not discover, or be able to confirm, revenue or
earnings shortfalls until the end of a quarter, which could result in an
immediate drop in our stock price. In addition, similar events with respect to
McAfee.com, our publicly traded subsidiary, and fluctuations in its stock price
may also contribute to the volatility of our stock price. In the past, following
periods of volatility in the market price of a company's stock, securities class
action litigation has often been instituted. A number of putative class actions
were brought against our officers, directors and us. See Note 15, Notes to the
Condensed Consolidated Financial Statements. This litigation, and any other
litigation if instituted, could result in substantial costs and a diversion of
management's attention and resources.
WE EXPECT SIGNIFICANT STOCK-BASED COMPENSATION CHARGES RELATED TO REPRICED
OPTIONS
In light of the decline in our stock price at the time and in an effort to
retain our employee base, in April 1999, we offered to reprice options held by
all employees, other than directors and executive officers. If the employee
agreed not to exercise any of the repriced options for a period of twelve
months, the exercise price of their eligible employee options with an exercise
price in excess of $11.0625 was reduced to $11.0625, the closing market price on
the NASDAQ on April 22, 1999. Option holders electing to have their options
repriced were required to acknowledge their acceptance by April 28, 1999. As a
result of the increase in price between the date on which the options were
repriced, April 22, 1999, and the date on which the employees elected to reprice
their option grants, April 28, 1999, we have incurred a stock-based compensation
charge. In accordance with Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees," the Company incurred an initial
stock-based compensation charge in connection with this repricing. This charge
was calculated based on the difference between the exercise price of the new
options and their market value on the date of acceptance by employees.
Approximately $6.7 million was expensed in the twelve months ended December 31,
2000. This charge is fixed and will continue to be amortized through the
remaining vesting period of the repriced options.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25 ("Interpretation"). The
Interpretation is intended to clarify certain problems that have arisen in
practice since the issuance of APB 25. The Interpretation provides guidance,
some of which is a significant departure from current practice. The
Interpretation provides for prospective application for grants or modifications
to existing stock options or awards made after June 30, 2000. However, for
certain transactions the guidance is effective after December 15, 1998 and
January 12, 2000.
We have incurred and will continue to incur variable accounting charges and
credits related to our repriced options and our subsidiaries' replacement
options. The valuation of this charge has and will be based on any excess of the
closing price at the end of the reporting period or date of exercise,
forfeiture, cancellation without replacements, if earlier, over the fair value
of our common stock at July 1, 2000, which was $20.375.
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Depending upon movements in the market value of our common stock, this
accounting treatment may result in significant additional compensation charges
in future periods.
In addition, variable plan accounting as described above, applies to
options issued to employees of McAfee.com and myCIO.com as a replacement for
Network Associates options which were subject to the repricing described above.
As a result, Network Associates will record variable charges based on the
movements in the fair value of McAfee.com and myCIO.com. During the twelve
months ended December 31, 2000, we recorded a compensation charge to earnings of
approximately $2.0 million related to variable plan accounting.
WE HAVE RECENTLY EXPERIENCED A SIGNIFICANT CHANGE IN SENIOR MANAGEMENT AND WE
MAY BE UNABLE TO ATTRACT QUALIFIED MANAGEMENT REPLACEMENTS ON A TIMELY BASIS
On January 3, 2001, our board of directors appointed George Samenuk as our
new chief executive officer and president. George Samenuk was also named to the
board of directors. As part of this appointment, William Larson, our former
chairman of the board of directors and chief executive officer, and Prabhat
Goyal, our former chief financial officer, left their former positions. In
addition, Peter Watkins, our former president and chief operating officer, left
his former position on December 31, 2000.
This change in executive management may be disruptive to our business and
may result in the departure of existing employees and/or customers. We are
currently operating with an interim chief financial officer. It may take
significant time to locate, retain and integrate qualified management personnel.
OUR MANAGEMENT AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, THESE
INDIVIDUALS MAY NOT REMAIN WITH US IN THE FUTURE
We rely, and will continue to rely, on a number of key technical and
management employees. While employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, our employees are
generally not otherwise subject to employment agreements or to noncompetition
covenants. If any of our key employees leave, our business, results of
operations and financial condition could suffer. Furthermore, we do not maintain
life insurance policies on our key employees.
Our ability to achieve our revenue and operating performance objectives
will depend in large part on our ability to attract and retain technically
qualified and highly skilled sales, consulting, technical, marketing and
management personnel. Competition for these employees is intense and is expected
to remain so for the foreseeable future. We have seen upward pressure on wages
as a result of this intense competition for employees, which could cause an
increase in our operating expenses. We may not be successful in retaining our
existing key personnel and in attracting and retaining the personnel we require,
and our failure to retain and hire key employees could adversely affect our
business and operating results. Additions of new, and departures of existing,
employees, particularly in key positions, can be disruptive and can result in
departures of existing employees, which could adversely affect our business.
WE FACE RISKS ASSOCIATED WITH PAST AND FUTURE TRANSACTIONS
Our industry has experienced, and is expected to continue to experience, a
significant amount of consolidation. As part of our growth strategy, we may buy
or make investments in complementary companies, products and technologies. Since
1995 we have completed a large number of significant acquisitions involving both
public and private companies, including:
- CyberMedia in September 1998;
- Dr. Solomon in August 1998;
- Secure Networks in May 1998;
- Magic Solutions and TIS in April 1998;
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- Network General, PGP and Helix Software in December 1997;
- Cinco Networks in August 1997;
- Vycor Corporation in February 1996; and
- Saber Software in August 1995.
We have also completed a number of smaller acquisitions and acquired a
number of our international distributors. In 2000, we continued making strategic
minority investments in pre-public companies with complimentary products,
services and technologies. As of December 31, 2000, the minority venture
investments we continue to hold totaled $18.6 million valued at cost less
reductions for other than temporary impairments. In the fourth quarter of 2000,
we recorded a $10.0 million impairment charge in connection with these
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. We plan to continue investing and may make acquisitions of other
strategic investments in the future.
In 1997 and 1998, we incurred significant nonrecurring charges associated
with our previous acquisitions. Our available cash and securities may be used to
buy or invest in companies or products, which could result in significant
acquisition-related charges to earnings and dilution to our stockholders.
Moreover, if we buy a company, we may have to incur or assume that company's
liabilities, including liabilities that are unknown at the time of acquisition,
which may result in a material adverse effect on us.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE
NON-RECURRING CHARGES IN THE EVENT OF IMPAIRMENT
In connection with our previous acquisitions accounted for under the
purchase method of accounting, in future periods we will experience significant
charges related to the amortization of purchased technology and goodwill. In
addition, if we later determine that this purchased technology and goodwill is
impaired, we will be required to take a related non-recurring charge to
earnings. For the fiscal year ended December 31, 2000, our amortization expense
related to purchased technology and goodwill was $66.3 million.
WE MAY BE REQUIRED TO USE A LARGE PORTION OF OUR CASH BALANCES, OR ISSUE A
SIGNIFICANT AMOUNT OF OUR COMMON STOCK, IF OUR DEBENTUREHOLDERS REQUIRE THAT WE
REDEEM THEIR DEBENTURES IN FEBRUARY 2003
On February 13, 1998, we issued zero coupon debentures, which have an
aggregate face amount at maturity of $885.5 million and generated net proceeds
to us of approximately $337.6 million (after deducting fees and expenses). The
initial price for the debentures was $391.06 per $1,000 of face amount at
maturity. At the option of the holder, we are required to redeem the debentures
as of February 13, 2003, February 13, 2008 and February 13, 2013 at purchase
prices equal to the initial issue price plus the accretion of the discount on
the debentures to such dates (or $494.52, $625.35 and $790.79 per $1,000 of face
amount at maturity, respectively). At our option, we may pay the aggregate
redemption price in cash, shares of our common stock or a combination thereof.
The number of shares of common stock required to be issued by us will be based
on the fair value of our common stock at the time of any redemption. As of
December 31, 2000, our aggregate cash and cash equivalents and long-term
securities were approximately $694 million. Assuming that as of February 13,
2003 all debenture holders require that we redeem their debentures, we would be
required to pay an aggregate redemption price in cash and/or shares of common
stock equal to approximately $437.9 million.
OUR HARDWARE BASED PRODUCTS FACE MANUFACTURING, SUPPLY, INVENTORY, LICENSING AND
OBSOLESCENCE RISKS
Some of our Sniffer products and E-ppliance products include, in addition
to our software, a hardware platform as well as software licensed from other
companies. We expect the number of our hardware-based
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products to increase as, among other things, the data rate in computer networks
increases, making a software-only solution a less viable solution. Third party
manufacturers do the manufacturing of these products under contract for us.
Reliance on third party manufacturers involves a number of risks, including the
lack of control over the manufacturing process and the potential absence or
unavailability of adequate capacity. In the event that any third party
manufacturers cannot or will not continue to manufacture our products in
required volumes, on a cost effective basis, in a timely manner or at all, we
will have to secure additional manufacturing capacity. Even if such additional
capacity is available at commercially acceptable terms, the qualification
process could be lengthy and could create delays in product shipments.
Our hardware-based products contain critical components supplied by a
single or a limited number of third parties. We have been required to purchase
certain computer platforms around which we design our network fault and
performance management products to ensure an available supply of these products
for our customers. Any significant shortage of these platforms or other
components or the failure of the third party supplier to maintain or enhance
these products could lead to cancellations of customer orders or delays in
placement of orders.
Some of our hardware based products incorporate licensed software, such as
operating system software. Our ability to successfully market these products
depends on our ability to obtain reasonably priced licenses from third party
software providers, as well as on our ability to integrate our hardware and
software with the software provided from third parties. If we are unable to
obtain software licenses from third parties or to integrate third party software
with our hardware products, our ability to market hardware based products would
suffer.
Hardware based products may face greater obsolescence risks than software
products. If our hardware products are not easily upgradable to meet future
market needs, they may become obsolete. In addition to lost future sales, we
could incur losses or other charges in disposing of obsolete inventory, both of
which could also materially adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR APPLICATION SERVICE PROVIDER STRATEGY
With our ASP or hosted products and services, customers "rent versus buy"
the software. For example, McAfee.com is dedicated to updating, upgrading and
managing PCs over the Internet for single use retail, non-corporate, consumers.
This web-based model is a relatively new concept and there is a risk that our
ASP products and services may fail to gain market acceptance. The growth, market
acceptance and ultimate profitability of our ASP services is highly uncertain
and subject to a number of factors, including:
- our ability to successfully adapt existing products or develop new or
enhanced products that operate in a fast, secure and reliable manner over
the Internet;
- increased expenditures associated with the creation of a new business or
delivery platform, such as product development, marketing and technical
and administrative support;
- the introduction of new products by third party competitors;
- potential unwillingness of customers to pay for ASP subscription based
products and services and our ability to properly price our products and
services to generate the greatest revenue opportunities;
- our ability to cost effectively offer our ASP products and services;
- reluctance by businesses and consumers to change their software
purchasing behavior in favor of services hosted on our, or third parties,
servers; and
- concerns of businesses and consumers about whether the Internet is fast,
reliable and secure enough to deliver critical network security and
availability services effectively.
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Our corporate ASP services were historically offered through our myCIO.com
subsidiary. In February 2001, we announced our plan to reintegrate myCIO.com's
operations with our own, while continuing to offer myCIO.com's products and
services as key offerings. The success of this decision is dependent on our
ability to successfully:
- retain myCIO.com's existing customers and employees;
- migrate myCIO.com's experience and knowledge in the development and
marketing of hosted products and services to our other product groups;
and
- coordinate future product group and McAfee.com ASP offerings so as to
avoid or minimize, among other things, customer confusion, redundant
development efforts and expenses.
OUR MANAGED SERVICE PROVIDER STRATEGY EXPOSES US TO RISKS IN ADDITION TO THOSE
GENERALLY EXPERIENCED AS AN ASP
We also make our hosted products and services available over the Internet
in what we refer to as a managed environment. These MSP solutions differ from
our ASP solutions, among other ways, in that our solutions are customized to
service a specific customer's needs and are monitored and updated by networking
professionals for that customer. To successfully offer MSP services we must:
- effectively monitor and customize each customer's managed services;
- attract and retain qualified networking professionals to manage customer
accounts; and
- effectively price our products and services to account for the higher
costs associated with selling managed services.
We also allow intermediaries, such as Internet Service Providers, to sell
and host our products and services in a managed environment. This MSP reseller
strategy exposes us to additional risks:
- we must select, train and maintain qualified and financially stable MSP
resellers;
- it is more difficult for us to ensure customer satisfaction as we do not
have direct customer contact and we rely on our resellers to timely and
properly customize and administer our products and services;
- we must develop and maintain mutually satisfactory revenue sharing
arrangements with our MSP resellers; and
- our MSP resellers may compete with our own MSP efforts.
WE FACE RISKS RELATED TO RELATIONSHIP WITH MCAFEE.COM
We have entered into various inter-company arrangements including
technology, licenses, shared facilities, functions, services and tax sharing
agreements with McAfee.com. At December 31, 2000, we owned 36.0 million shares
of McAfee.com's Class B common stock, which is generally entitled to three votes
per share and converts to shares of McAfee.com Class A common stock if sold by
us to a third party. McAfee.com Class A common stock is entitled to one vote per
share. At December 31, 2000, our McAfee.com holdings represented approximately
81% of McAfee.com's outstanding capital stock and approximately 93% of its total
voting power.
Pursuant to our cross license agreement with McAfee.com, we have licensed
all our technology to McAfee.com for use in the markets specified below and
McAfee.com has licensed its technology to us for our use outside of McAfee.com's
markets. Under our license and other agreements with McAfee.com, among other
things:
- McAfee.com has the exclusive right to use the licensed technology for
providing single-user consumer licenses for our products and services
sold over the Internet or for Internet-based products and licensing the
technology to original equipment manufacturers for sale to individual
consumers;
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- we are permitted to continue to sell our consumer products through
non-online channels, such as traditional retail stores, however
McAfee.com's sales of online products and services could significantly
reduce sales of these products;
- we may not offer a product incorporating third party technology if those
products are competitive with products offered by McAfee.com;
- McAfee.com is required to pay us a license fee of 7% of net revenue
derived from product sales that include the licensed technology;
- the license agreement is perpetual and may only be terminated by us if
McAfee.com fails to cure a material breach of the license within 30 days
after we notify it of the breach, subject to mandatory dispute resolution
prior to the effectiveness of any proposed termination;
- we are required to indemnify McAfee.com with respect to existing
litigation related to the licensed technology to which we are a party,
including the litigation described in Note 15 of the Notes to the
Consolidated Financial Statements;
- generally, we are required to cause to be elected to the McAfee.com board
of directors at least two independent directors, which term would exclude
any serving Network Associates officer or director; and
- if, without the prior approval of our continuing directors (being our
current directors and directors approved or not objected to by our
current directors), someone acquires 15% or more of our outstanding
capital stock or our continuing directors cease to constitute a majority
of our board (1) we are required to vote our shares of McAfee.com common
stock and otherwise seek to cause to the McAfee.com board of directors to
consist of at least a majority of independent directors and (2) our
shares of McAfee.com Class B common stock will be entitled to only one
vote per share instead of three.
WE FACE RISKS RELATED TO THE ALLOCATION OF OPPORTUNITIES WITH RESPECT TO
PRODUCTS, CUSTOMERS AND TERRITORIES AMONG OUR PRODUCT GROUPS AND SUBSIDIARIES
We are continuing to focus our business on our products, our customers and
geographic territories. Our product groups are primarily product focused. Our
McAfee.com subsidiary sells its products and services over the Internet to
consumers and businesses. Nihon Network Associates K.K. ("Network Associates
Japan") is both geographically and customer focused, selling Network Associates'
products on a generally exclusive basis in Japan and to large Japanese business
customers outside of Japan and acting as McAfee.com's reseller in Japan. Except
as provided under our technology licensing agreements and arrangements, we do
not currently have in place a policy to govern the pursuit or allocation of
business opportunities between our subsidiaries and product groups. These and
any future internal allocation of products, customers and territories could
result in, among other things:
- sales force conflict;
- customer confusion surrounding the entity or party with whom they are
expected to deal;
- disputes over product and research and development priorities;
- disputes over allocation of corporate resources and focus; and
- loss of management focus due to efforts spent to resolve internal
conflicts.
WE MUST ADAPT TO THE RAPIDLY CHANGING BUSINESS ENVIRONMENT BROUGHT ON BY THE
WIDESPREAD USE OF THE INTERNET
We utilize the Internet and depend on its functionality and reliability in
many parts of our business, including sales, distribution and support of our
products. There are still many uncertainties regarding many
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facets of the Internet, including reliability, security, access, tax, government
regulation and cost. We also run the risk of not adapting to the latest changes
in the Internet, which could affect our business operations. If growth of the
Internet does not develop at the rapid pace we expect, our operating results
could be adversely affected.
OUR MARKET IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE; WE FACE RISK
ASSOCIATED WITH PRODUCT DEVELOPMENT
The network security and management market is highly fragmented and
characterized by ongoing technological developments, evolving industry standards
and rapid changes in customer requirements. Our success will depend on our
ability to:
- offer a broad range of network security and management software products;
- continue to enhance existing products and expand product offerings;
- develop and introduce in a timely manner new products with technological
advances;
- respond promptly to new customer requirements;
- comply with evolving industry standards without delays in compliance;
- provide upgrades and updates to users frequently and at low cost; and
- remain compatible with popular operating systems such as Windows 98,
Windows 2000, Windows NT and NetWare, and develop products that are
compatible with new or otherwise emerging operating systems.
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 existing 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 market acceptance. For example, our anti-virus
software products have in the past falsely detected viruses that did not
actually exist. Difficulties and delays associated with new product
introductions, performance or enhancements could have a material adverse effect
on our business, financial condition and results of operation.
Our product development efforts are impacted by the adoption or evolution
of industry standards. For example, no uniform industry standard has developed
in the market for encryption security products. As industry standards are
adopted or evolve, we may have to modify existing products or develop and
support new versions of existing products. In addition, if no industry standard
develops, our products and our competitors' products could be incompatible,
which could prevent or delay overall development of the market for a particular
product. If our products fail to comply with existing or evolving industry
standards in a timely fashion, our business, results of operation and financial
condition could be materially and adversely affected.
Our long-term success depends on our ability to upgrade and update existing
product offerings, modify and enhance acquired products and introduce new
products which meet our customers' needs. Future upgrades and updates may
include additional functionality, respond to user problems or address
compatibility problems with changing operating systems and environments. We
believe that our ability to provide these upgrades and updates frequently and at
low costs is key to our success. For example, the proliferation of new and
changing viruses makes it imperative to update anti-virus products frequently to
avoid obsolescence. Failure to release upgrades and updates could have a
material adverse effect on our business, results of operations and financial
condition. We may not be successful in these efforts. In addition, future
changes in Windows 98, Windows 2000, 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
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products which were designed to operate with these future operating systems. Our
failure to introduce in a timely manner new products that are compatible with
operating systems and environments preferred by desktop computer users would
have a material adverse effect on our business, results of operation and
financial condition.
WE DEPEND ON REVENUE FROM OUR FLAGSHIP ANTI-VIRUS AND SNIFFER PRODUCTS
We have historically derived a majority of our net revenues from our
flagship McAfee anti-virus software products and Sniffer network fault and
performance management products. These products are expected to continue to
account for a significant portion of our net revenues for the foreseeable
future. Because of this concentration of revenue, a decline in demand for, or in
the prices of, these products as a result of competition, technological change,
a change in our pricing model, inclusion of anti-virus or network management and
analysis software as a standard part of hardware or operating system software or
other software, or a maturation in the markets for these products, could harm
our business.
IF THE NETWORK MANAGEMENT AND NETWORK SECURITY MARKETS DO NOT EVOLVE AS WE
ANTICIPATE, OUR BUSINESS COULD SUFFER
The markets for our network management and network security products are
evolving, and their growth depends upon broader market acceptance of this
software, including help desk software. Although the number of PCs attached to
large-area networks has increased dramatically, the network management and
network security markets continue to be emerging markets. These markets may not
continue to develop or may not develop rapidly enough to benefit our business
significantly. In addition, there are a number of potential approaches to
network management and network security, including the incorporation of
management and security tools into network operating systems. Therefore, even if
network management and network security tools gain broader market acceptance,
potential purchasers may not select our products. To the extent that either the
network management or network security market does continue to develop, we
expect that competition will increase.
WE ARE SUBJECT TO INTENSE COMPETITION IN THE NETWORK MANAGEMENT AND SECURITY
MARKETS AND WE EXPECT TO FACE INCREASED COMPETITION IN THE FUTURE
The markets for our products are intensely competitive. 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 group;
- frequency of upgrades and updates;
- integration of products;
- manageability of products;
- brand name recognition;
- reputation; and
- price.
We may be unable to compete effectively against existing and potential
competitors. Some of our competitors have longer operating histories, greater
name recognition, larger technical staffs, established relationships with
hardware vendors and/or greater financial, technical and marketing resources.
These factors may provide our competitors with an advantage in penetrating the
market with their network security and management products. As is the case in
many segments of the software industry, we have been encountering,
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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.
Performance and quality of our anti-virus software products are measured by
number and type of viruses detected, the speed at which the products run and
ease of use. Our principal competitor in the anti-virus market serviced by our
McAfee product groups and McAfee.com is the Peter Norton Group of Symantec.
Trend Micro remains the strongest competitor in the Asian anti-virus market.
Other competitors include numerous smaller companies and shareware authors that
may in the future develop into stronger competitors or be consolidated into
larger competitors.
Our principal competitors in the security market vary by product type. For
firewalls, our principal competitors include CheckPoint, Symantec, and larger
companies such as Cisco Systems and Microsoft. For intrusion detection products,
we compete with ISS, Symantec and Cisco. The markets for encryption and virtual
private network, or VPN, products are highly fragmented with numerous small and
large vendors. Public key infrastructure, or PKI, encryption vendors such as
Entrust Technologies offer some products that compete with our PGP products. VPN
competitors include hardware and software vendors, including telecommunications
companies and traditional networking suppliers.
Our principal competitor in the network management market is Agilent. Other
competitors include Cisco, Computer Associates, Compuware, Concord
Communications, DeskTalk Systems, GN Nettest, Network Instruments, Radcom
Technologies, Shomiti Systems and Acterna Corporation.
Our principal competitors in the help desk market are Computer Associates,
FrontRange Solutions, Peregrine and Remedy.
We also face competition from large software companies such as Microsoft,
Intel, Novell and HP, which may offer network security and management products
as enhancements to their operating system.
Finally, as the network management market develops, we may face increased
competition from a number of large companies, as well as other companies seeking
to enter the market. The trend toward enterprise-wide network management and
security solutions may result in a consolidation of the network management and
security market around a smaller number of companies who are able to provide the
necessary software and support capabilities.
OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH COULD
ADVERSELY AFFECT OUR BUSINESS
Our products may be considered to be capital purchases by certain customers
or prospective customers. Capital purchases are often discretionary and,
therefore, are canceled or delayed if the customer experiences a downturn in its
business prospects or as a result of economic conditions in general. Any
cancellation or delay could adversely affect our results of operations.
WE FACE RISKS RELATED TO OUR SALES FORCE STRUCTURE
Our sales force is organized by product group, with four separately focused
sales organizations selling our McAfee, Sniffer Technologies, PGP Security and
Magic Solutions products. All four sales organizations consist of field sales
representatives who are located regionally and outbound telesales
representatives who actively focus on selling our individual product lines. The
telesales representatives focus on small customers and transactions. McAfee.com
has developed a separate sales force of 34 employees, focusing on selling their
ASP solution directly to consumers and businesses. To succeed in the direct
sales channel, we must build a significant direct sales organization and must
attract and retain qualified personnel. These individuals will require training
about, and knowledge of, attributes of the products and product lines sold by
them. We may not succeed in building the necessary sales organization or in
attracting, retaining or training these individuals.
We have divided our U.S. direct sales force among our four product groups,
in part, to focus our sales force on selling specialized products. In 2001, we
intend to organize our international direct sales force by our
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four product groups when and where local demand and sales force considerations
make this action advisable. Our customers and potential customers and sales
force may not respond favorably to the restructuring and our revenues, business
and future financial performance could suffer materially. In addition to
customer and sales related risks described above:
- disputes may occur between our product group sales forces;
- sales representatives may lose productivity while being retrained or
while refocusing their sales efforts; and
- sales representatives may terminate their employment with us.
Although our increased direct sales efforts may also reduce our dependence
on resellers and distributors, it may also lead to conflicts for the same
customers, further customer confusion and may result in pressure by current and
prospective customers for price reductions on products.
WE NEED TO EXPAND AND DEVELOP AN EFFECTIVE PROFESSIONAL SERVICES ORGANIZATION;
WE RELY ON THIRD-PARTY PROFESSIONAL SERVICES
As our products and computer networks in general increase in complexity,
customers require greater professional assistance to design, install, configure
and implement our products. To date, we have relied on our limited professional
services capabilities and increasingly on outside professional service
providers, including our distributors, resellers and system integrators. These
third party service providers may provide inadequate levels of professional
services. Moreover, reliance on these third parties places a greater burden on
them and reduces our ability to control and establish standards for providing
these support services. Our reliance on these third parties could delay our
recognition of product revenue, harm our relationships or reputation with these
third parties or the end users of our products or result in decreased future
sales of, or prices for, our products.
The failure to develop and maintain an effective professional services
organization could have a material adverse effect on our business. To more
effectively service our customers' evolving needs, we intend to significantly
expand and develop our worldwide professional services 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. In addition, we reorganized our U.S. professional
services organization, in part, to enable the professional services organization
to become more specialized on individual products and product groups. As a
result, a particular product group may have insufficient qualified personnel to
perform its professional services needs as there will no longer be a "pool" of
professional services personnel from which to draw. A product group's lack of
sufficient professional services personnel could lead to customer
dissatisfaction, missed revenue opportunities and a loss of future business.
WE RELY ON THE CONTINUED PROMINENCE OF MICROSOFT TECHNOLOGY
Although we intend to support other operating systems, our mission is to be
the leading supplier of network security and management products for Windows
NT/Intel based networks. Sales of our products would be materially and adversely
affected by market developments that are adverse to the Windows operating
environments, including the failure of users and application developers to
accept Windows NT. In addition, our ability to develop products using the
Windows operating environments is dependent on our ability to gain timely access
to, and to develop expertise in, current and future developments by Microsoft.
We may not be able to gain the necessary access from Microsoft.
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WE MAY FAIL TO SUPPORT OPERATING SYSTEMS WHICH SUCCESSFULLY COMPETE WITH
MICROSOFT'S TECHNOLOGY, INCLUDING COMPETING VERSIONS OF THE UNIX OPERATING
SYSTEM
We are expanding our product support to include the Unix operating system
and the Linux operating system. Sales of our products could be materially and
adversely impacted by our failure to support those versions of the Unix
operating system or competing operating systems that receive broad market
acceptance. The Unix system encompasses many separate operating systems of which
we only support a few, including for example, Sun Microsystems' Solaris Unix
operating system.
WE MUST EFFECTIVELY MANAGE OUR GROWTH
Our business has grown both internally and through acquisitions. This
growth has placed, and any future growth would continue to place, a significant
strain on our limited personnel, management and other resources. Our ability to
manage any future growth, particularly with the anticipated expansion of our
international business and our ASP businesses, and growth in distribution
business, will require us to:
- attract, train, retain, motivate and manage new employees successfully;
- effectively integrate new employees into our operations; and
- continue to improve our operational, financial, management and
information systems and controls.
If we continue to grow, our management systems currently in place may be
inadequate or we may not be able to effectively manage this growth. We are
currently investing in our Internet infrastructure in anticipation of expected
growth from the Internet, which may fail to materialize.
WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WHICH OFFER ONLY LIMITED
PROTECTION AGAINST POTENTIAL INFRINGERS; WE MAY FACE LITIGATION RELATED TO OUR
PROPRIETARY TECHNOLOGY AND RIGHTS
Our success depends significantly upon our proprietary software technology.
We rely on a combination of contractual rights, trademarks, trade secrets,
patents and copyrights to establish and protect proprietary rights in our
software. However, these protections may be inadequate or competitors may
independently develop technologies or products that are substantially equivalent
or superior to our products. We do not typically obtain signed license
agreements from our corporate, government and institutional customers who
license products directly from us. Rather, we include an electronic version of a
"shrink-wrap" license in all of our electronically distributed software and a
printed license in the box for our products distributed through traditional
distributors in order to protect our copyrights and trade secrets in those
products. Since the licensee has not signed any of these licenses, many legal
authorities believe that such licenses may not be enforceable 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.
There has been substantial litigation regarding the intellectual property
rights of technology companies. The increased issuance of software patents in
recent years has led to and is likely to continue to lead to increased patent
and intellectual property litigation in the software industry. In the past we
have been, and we currently are, subject to litigation related to our
intellectual property, including patent infringement cases involving Hilgraeve.
See Note 15, Notes to the Condensed Consolidated Financial Statements. We may
also be subject to litigation in connection with our advertising and marketing
programs. 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
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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, including monetary liabilities;
- require us to seek licenses from third parties; or
- prevent us from manufacturing or selling our products.
The litigation process is subject to inherent uncertainties and we may not
prevail in these matters, or we may be unable to obtain licenses with respect to
any patents or other intellectual property rights that may be held valid or
infringed upon by our products or us. Uncertainties inherent in the litigation
process include, 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 our
products from third parties, our exposure to infringement actions may increase
because we must rely upon such third parties as to the origin and ownership of
any software being acquired. Similarly, exposure to infringement claims will
increase to the extent that we employ or hire additional software engineers
previously employed by competitors, notwithstanding measures taken by these
competitors to protect their intellectual property. In the future, litigation
may be necessary to enforce and protect trade secrets and other intellectual
property rights that we own. We may also be subject to litigation to defend
against claimed infringement of the rights of others or determine the scope and
validity of the proprietary rights of others. This litigation could be costly
and cause diversion of management's attention, either of which could have a
material adverse effect on our business, results of operations and financial
condition.
OUR INTERNATIONAL OPERATIONS SUBJECT US TO FOREIGN CURRENCY FLUCTUATIONS AND
OTHER INHERENT RISKS RELATED TO DOING BUSINESS IN FOREIGN COUNTRIES
For the fiscal years ended December 31, 2000, 1999 and 1998, net revenue
from international sales represented approximately 37%, 40%, and 36%,
respectively, of our net revenue. Historically, we have relied upon independent
agents and distributors to market our products internationally. We expect that
international revenue 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 non-leveraged forward currency contracts. However,
our future results of operations may be adversely affected by currency
fluctuations or by costs associated with currency risk management strategies.
Other risks inherent in international revenue generally include:
- the impact of longer payment cycles;
- greater difficulty in accounts receivable collection;
- unexpected changes in regulatory requirements;
- seasonality due to the slowdown in European business activities during
the third quarter;
- tariffs and other trade barriers;
- export restrictions on our encryption and other security products;
- uncertainties relative to regional economic circumstances including the
continued economic weakness in Asia;
- political instability in emerging markets and difficulties in staffing;
- hiring and retaining key international employees; and
- managing foreign operations.
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These factors may have a material adverse effect on our future
international license revenue. Further, in countries with a high incidence of
software piracy, we may experience a higher rate of piracy of our products.
In addition, a portion of our international revenue is expected to continue
to be generated through independent agents. Since these agents are not our
employees and are not required to offer our products exclusively, they may
discontinue marketing our products entirely. Also, we may have limited control
over these agents, limited access to the names of the customers to whom these
agents sell products and limited knowledge of the information provided by, or
representations made by, these agents to customers.
COMPUTER "HACKERS" MAY DAMAGE OUR PRODUCTS AND SERVICES
Given our high profile in the security software market, we have been a
target of computer hackers who have, among other things, created viruses to
sabotage or otherwise attack our products. While to date, these efforts have
been discovered quickly and their adverse impact has been limited, similar
viruses or efforts may be created or replicated in the future. In this event,
users' computer systems could be damaged and demand for our software products
may suffer as a result. In addition, since we do not control diskette
duplication by distributors or our independent agents, diskettes containing our
software may be infected with viruses. Given our increased use of the Internet
to deliver products and services, any successful sabotage or other attack on our
websites, including the McAfee.com and myCIO.com web sites, could disrupt our
ability to provide products and services to customers. Recently a number of
websites have been subject to denial of service attacks, where a web site is
bombarded with information requests eventually causing the website to overload,
which causes a delay or disruption of service. A successful sabotage of one of
our affiliates' web based businesses could result in reduced demand for our or
our affiliates' web based products and services and could have a material
adverse effect on our business and our results of operation.
FALSE DETECTION OF VIRUSES AND ACTUAL OR PERCEIVED SECURITY BREACHES COULD
ADVERSELY AFFECT OUR BUSINESS
Our anti-virus software products have in the past and may at times in the
future falsely detect viruses that do not actually exist. These false alarms,
while typical in the industry, may impair the perceived reliability of our
products and may therefore adversely impact market acceptance of our products.
In addition, we have in the past been subject to litigation claiming damages
related to a false alarm, and similar claims may be made in the future. In
addition, an actual or perceived breach of network or computer security at one
of our customers, regardless of whether the breach is attributable to our
products, could adversely affect the market's perception of our security
products. This could adversely affect our business, results of operations and
financial condition.
OUR CRYPTOGRAPHY TECHNOLOGY IS SUBJECT TO EXPORT RESTRICTIONS AND MAY BECOME
OBSOLETE
All of our products are subject to the U.S. Export Administration
Regulations, governed by the U.S. Department of Commerce. Certain of our network
security products, technology and associated technical assistance, particularly
products and technology incorporating encryption, may be subject to export
restrictions. Recent changes to U.S. laws enable Network Associates to export
more products without restrictions; however, certain products still may not be
exported to foreign customers without prior approval from the U.S. government.
The list of products and end users for which export approval is required, and
the regulatory policies with respect thereto, are subject to revision by the
U.S. government at any time. The cost of compliance with U.S. and international
export laws and changes in existing laws could affect our ability to sell
certain products in certain markets, and could have a material adverse effect on
our international revenues.
In addition, some of our network security products are dependent on the use
of public key cryptography technology. This technology depends in part upon the
application of certain mathematical principles known as factoring and discrete
logarithms. The security afforded by public key cryptography technology is based
on our belief that the factoring of large prime numbers and solving the discrete
log problem is not computationally practical. Should an easy factoring method be
developed or the discrete log problem is solved, the security
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