##### Table of Contents









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549




---

Form 10-K

|  |  |                                                                                                 
|- |  | ------------------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|  |  | For the Fiscal Year Ended December 31,
    2003                                                 
|  |  | or                                                                                              
|o |  | 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 or other jurisdiction
    of incorporation or organization)                          |  | (I.R.S. Employer
    Identification Number)
|                                                                                           
|3965 Freedom Circle
    Santa Clara, California(Address of principal executive
    offices) |  | 95054(Zip Code)                            

Registrants telephone number, including
area code:

(408) 988-3832


Securities registered pursuant to
Section 12(b) of the Act:

None

Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $0.01 Par Value, together with
associated Rights


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

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.     o

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes þ No o

The aggregate market value of the voting stock
held by non-affiliates of the issuer as of the last business day
of the Registrants most recently completed second fiscal
quarter (June 30, 2003) was approximately
$2.0 billion. The number of shares outstanding of the
issuers common stock as of January 31, 2004 was
163,239,520.

DOCUMENTS INCORPORATED BY REFERENCE

Items 10, 11, 12, 13 and 14 of Part III are
incorporated by reference from the Registrants Proxy
Statement for the Annual Meeting of Stockholders to be held on
May 27, 2004.

This document contains 126 pages.



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NETWORKS ASSOCIATES INC.

FORM 10-K

For the fiscal year ended December 31,
2003

TABLE OF CONTENTS






|                                                  |  |                                                                                                        |     |      |    | 
|------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------ | --- | ---- | -- | 
|                                                  |  |                                                                                                        |     | Page
|                                                  |  |                                                                                                        |     |     
|PART I                                           
|Item 1.                                           |  | Business                                                                                               |     |      | 2  | 
|Item 2.                                           |  | Properties                                                                                             |     |      | 25 | 
|Item 3.                                           |  | Legal Proceedings                                                                                      |     |      | 25 | 
|Item 4.                                           |  | Submission of Matters to a
    Vote of Security Holders                                                |     |      | 25 | 
|                                                 
|PART II                                          
|Item 5.                                           |  | Market for Registrants
    Common Equity and Related Stockholder Matters                              |     |      | 27 | 
|Item 6.                                           |  | Selected Financial Data                                                                                |     |      | 28 | 
|Item 7.                                           |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operation               |     |      | 29 | 
|Item 7A.                                          |  | Quantitative and Qualitative
    Disclosure about Market Risk                                          |     |      | 55 | 
|Item 8.                                           |  | Financial Statements and
    Supplementary Data                                                        |     |      | 56 | 
|Item 9.                                           |  | Changes In and Disagreements
    with Accountants on Accounting and Financial Disclosure               |     |      | 57 | 
|Item 9A.                                          |  | Controls and Procedures                                                                                |     |      | 57 | 
|                                                 
|PART III                                         
|Item 10.                                          |  | Directors and Executive
    Officers of the Registrant                                                 |     |      | 58 | 
|Item 11.                                          |  | Executive Compensation                                                                                 |     |      | 58 | 
|Item 12.                                          |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |     |      | 59 | 
|Item 13.                                          |  | Certain Relationships and
    Related Transactions                                                     |     |      | 59 | 
|Item 14                                           |  | Principal Accountant Fees
    and Services                                                             |     |      | 59 | 
|                                                 
|PART IV                                          
|Item 15.                                          |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                                    |     |      | 60 | 
|Signatures                                        |  |                                                                                                        | 122 |     
|Employment Agreement - Kevin M. Weiss            
|Form of Indemnification Agreement                
|Computation of Ratio of Earnings to Fixed Charges
|Subsidiaries of the Registrant                   
|Consent of PricewaterhouseCoopers LLP            
|Certification of CEO and CFO Pursuant to Sec. 302
|Certification of CEO and CFO Pursuant to Sec. 906



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PART I




Item 1.     Business

General

This Annual Report on Form 10-K contains
forward-looking statements that involve risks and uncertainties.
The statements contained 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. 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,
could, expects, plans,
anticipates, believes,
estimates, predicts,
potential, targets, goals,
projects, continue, or variations of
such words, similar expressions, 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. Therefore, actual results
may differ materially and adversely from those expressed in any
forward-looking statements. Neither we nor any other person can
assume responsibility for the accuracy and completeness of
forward-looking statements. Important factors that may cause
actual results to differ from expectations include, but are not
limited to, those discussed in Risk Factors
beginning on page 9 in this document. We undertake no obligation
to revise or update publicly any forward-looking statements for
any reason.

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., and we do business
under the name Network Associates. In 1999, our subsidiary
McAfee.com sold to the public its Class A common stock as a
part of its initial public offering. In September 2002, we
repurchased the 25% minority interest in McAfee.com and merged
McAfee.com into Networks Associates, Inc. McAfee Associates,
Inc. was incorporated in 1992 and Network General Corporation
was incorporated in 1987.

This report includes registered trademarks and
trade names of Network Associates and other corporations.
Trademarks or trade names owned by Network Associates and/or its
affiliates include: Network Associates,
McAfee and Sniffer.

Networks Associates, Inc. is headquartered at
3965 Freedom Circle, Santa Clara, California, 95054, and the
telephone number at that location is (408) 988-3832. The Network
Associates web site is www.networkassociates.com.

OVERVIEW

We are a leading supplier of computer security
solutions designed to prevent intrusions on networks and protect
computer systems from the next generation of blended attacks and
threats. We offer two families of products, McAfee System
Protection Solutions and McAfee Network Protection Solutions.
Our computer security solutions are offered primarily to large
enterprises, governments, small and medium-sized businesses and
consumer users. We operate our business in five geographic
regions: North America; Europe, Middle East and Africa, or EMEA;
Japan; Asia-Pacific and Latin America. See note 19 to the
consolidated financial statements for a description of revenues,
operating income and assets by geographic region.

Our McAfee Protection-in-Depth Strategy is
designed to provide a complete set of system and network
protection solutions differentiated by intrusion prevention
technology that can detect and block known and

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unknown attacks. To more effectively market our
products in our various geographic sales regions, as more fully
described below, we have combined complementary products into
separate product groups as follows:




| |   |                                                                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | McAfee System Protection Solutions, which
    delivers anti-virus and security products and services designed
    to protect systems such as desktops and servers and                                                                                                                                             
|
| |  | McAfee Network Protection Solutions, which offers
    products designed to maximize the performance and security of
    networks, including Sniffer Technologies network analysis and
    availability technologies, network intrusion prevention with
    McAfee IntruShield and InfiniStream Security Forensics.

The majority of our net revenue has historically
been derived from our McAfee Security anti-virus products and
our Sniffer Technologies network fault identification and
application performance management products. In addition to
these two flagship products, we have focused our efforts on
building a full line of complementary network and system
protection solutions. On the system protection side, we
strengthened our anti-virus lineup by adding complementary
products in the anti-spam and host intrusion prevention
categories. On the network protection side, we built upon our
Sniffer Technologies line by adding products in the network
monitoring, network reporting, network application performance
monitoring, network intrusion prevention and forensics
categories. We continuously seek to expand our product lines.

In 2003, our net revenue was $936.3 million
and net income was $70.2 million.

McAfee System Protection Solutions

McAfee System Protection Solutions helps large
enterprises, small/medium businesses, consumers, government
agencies and educational organizations assure the availability
and security of their desktops, application servers and web
service engines. The McAfee System Protection Solutions
portfolio features a range of products including anti-virus,
managed services, McAfee SpamKiller anti-spam solutions, McAfee
ThreatScan vulnerability assessment and McAfee Entercept for
host-based intrusion prevention. Each is backed by the McAfee
Anti-Virus Emergency Response Team, a leading threat research
organization.

McAfee System Protection Solutions also includes
McAfee Consumer Security, offering both traditional retail
products and our on-line subscription services. Our consumer
retail and on-line subscription applications allow users to
protect their PCs from malicious code and other attacks, repair
PCs from damage caused by viruses and block spam and other
undesirable content. Our retail products are sold through retail
outlets, including Best Buy, CompUSA, Dixons and Staples, to
single users and small home offices in the form of traditional
boxed product. These products include free and for-fee software
updates and technical support services. Our on-line subscription
services are delivered through the use of an Internet browser at
our McAfee.com web site and through multiple on-line service
providers and original equipment manufacturers, or OEMs.

Until recently, McAfee System Protection
Solutions also included our Magic Service Desk business,
offering management and visibility of desktop and server
systems. In December 2003, we agreed to sell our Magic Service
Desk business to BMC Software. The transaction closed in January
2004.

McAfee Network Protection Solutions

McAfee Network Protection Solutions helps
enterprises, small businesses, government agencies, educational
organizations and service providers maximize the availability,
performance and security of their network infrastructure. The
McAfee Network Protection Solutions portfolio features a range
of products including Sniffer and the nPO Solution for network
management. Sniffers products capture data, monitor
network traffic and collect and report on key network
statistics. These products are also designed to optimize network
and application performance and increase network reliability by
uncovering and analyzing network problems and network security
vulnerabilities and recommending solutions to such problems.
Other McAfee Network Protection Solutions products include
InfiniStream Security Forensics for security forensics and
McAfee IntruShield for network intrusion detection and
prevention. Customers for these products include enterprises,
government agencies and educational organizations, as well as
service providers.

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Expert Services and Technical
Support

We have established Expert Services and Technical
Support to provide professional assistance in the design,
installation, configuration and implementation of our
customers networks and acquired products. Expert Services
is focused on two service markets: Consulting Services and
Education Services.

Consulting Services support product integrations
and deployment with an array of standardized and custom
offerings. Consulting Services also offer other services in both
the security and networking areas, including early assessment
and design work, as well as emergency outbreak and network
troubleshooting assistance. Our consulting services organization
is organized around our product groups.

Education Services offer customers an extensive
curriculum of computer network technology courses, including
protocol analysis and troubleshooting, security and network
management tools. Education Services provides public classes and
customized on-site training at customer locations.

The PrimeSupport program provides our customers
on-line 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 on-line ServicePortal or the telephone-based Connect,
Priority and Enterprise. All PrimeSupport programs include
software updates and upgrades. PrimeSupport is available to all
customers worldwide from various regional support centers.



| |   |                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | PrimeSupport ServicePortal  Consists of a
    searchable, knowledge base of technical solutions and links to a
    variety of technical documents such as product FAQs and
    technical notes.                                                                                                                                                 
|
| |  | PrimeSupport Connect  Provides toll-free
    telephone access to technical support during regular business
    hours and access to the on-line ServicePortal.                                                                                                                                                                                   
|
| |  | PrimeSupport Priority  Provides priority,
    unlimited, toll-free (where available) telephone access to
    technical support 24 hours a day, 7 days a week and access
    to the on-line ServicePortal.                                                                                                                                       
|
| |  | PrimeSupport Enterprise  Offers proactive,
    personalized service and includes an assigned technical support
    engineer from our Enterprise support team, proactive support
    contact (telephone or email) with customer-defined frequency,
    election of five designated customer contacts and access to the
    on-line ServicePortal.

In addition, we also offer our consumer users
technical support services made available at our McAfee.com
website on both a free and fee-based basis, depending on the
support level required.

Network Associates Labs

Network Associates Labs, or NAI Labs, is our
research and development organization dedicated to advanced
network and host system intrusion detection and prevention and
security technology. NAI Labs currently conducts research in the
areas of host intrusion prevention, network intrusion
prevention, wireless intrusion prevention, malicious code
defense, security policy and management, high-performance
assurance and forensics and threats, attacks, vulnerabilities
and architectures. NAI Labs has ongoing projects funded through
the U.S. Defense Advanced Research Projects Agency, the U.S.
Intelligence Community Advanced Research & Development
Activity, Air Force, Navy, Army, NSA and other Department of
Defense and U.S. government agencies. NAI Labs focuses on
exploiting government research to advance the capabilities of
our product-line offerings.

Strategic Alliances

From time to time, we enter into strategic
alliances with third parties to serve as a catalyst for our
future growth. These relationships may include joint technology
development and integration, research cooperation, co-marketing
activities and sell-through arrangements. For example, we have
an alliance with America Online under which, among other things,
we offer our on-line PC anti-virus services to AOL members as a
co-branded premium service and provide our host-based email
scanning services and personal firewall services as

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a value-added service. We also have alliances
with, among others, Cox Communications, Dell, Microsoft, MSN,
NEC, NTT DoCoMo, Phoenix Technologies and Telefonica.


Product Licensing Model

We typically license our products to corporate
and government customers on a perpetual basis. Most of our
licenses are sold with maintenance contracts, and typically
these are sold on an annual basis. As the maintenance contracts
near expiration, we contact customers to renew their contracts,
as applicable. We typically sell perpetual licenses in
connection with sales of our hardware-based products in which
software is bundled with the hardware platform.

For our largest customers (over 2000 nodes), we
also offer two-year term-based licenses. Our two-year term
licensing model also creates the opportunity for recurring
revenue through the renewal of existing licenses. By offering
two-year licenses, as opposed to traditional perpetual licenses,
we are also 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.

On-Line Subscriptions and Managed
Applications

For our on-line subscription services, customers
essentially rent the use of our software. Because
our on-line subscription services are version-less,
or self-updating, customers subscribing to these services are
assured of using the most recent version of the software
application, eliminating the need to purchase product updates or
upgrades. Our on-line subscription consumer products and
services are found at our McAfee.com web site where consumers
download our anti-virus application using their Internet browser
which allows the application 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.
Our McAfee.com web site also offers customers access to McAfee
Personal Firewall Plus, McAfee SpamKiller and McAfee Internet
Privacy Service, as well as combinations of these services
through suites.

Similarly, our small and medium sized business
on-line subscription products and services, or our ASaP
offerings, provide these customers the most up-to-date
anti-virus software. Our ASaP offerings include VirusScan ASaP,
which provides anti-virus protection to desktops and file
servers, VirusScreen ASaP, which screens e-mails to detect and
quarantine viruses and infected attachments and Desktop Firewall
ASaP, which blocks unauthorized network access and stops known
network threats. At December 31, 2003, we had
3.7 million McAfee.com subscribers.

We also make our on-line subscription products
and services available over the Internet in what we refer to as
a managed environment. Unlike our on-line subscription service
solutions, these managed service providers; or MSP, solutions
are customized, monitored and updated by networking
professionals for a specific customer. We also allow
intermediaries, such as Internet service providers, to sell and
host our products and services in a managed environment.

Sales and Marketing

To augment and capitalize upon our marketing
efforts, our sales and marketing activities are directed
primarily at large corporate and government customers, small and
medium-sized accounts, as well as resellers, distributors,
system integrators, internet service providers and Original
Equipment Manufacturers worldwide through the channels listed
below.



| |                           
| | --------------------------
| | United States Direct Sales

Our United States direct sales force, comprising
the majority of our total sales force, is organized by market
segment. The direct field force consists of strategic account
executives that call upon our large enterprise, and in some
cases, global accounts. Their focus is to promote our vision and
strategy as well as increase the penetration of our products.
Our major account managers have similar responsibilities but are
focused on our next tier of large U.S. customers and provide
sales leadership and promote all of our product

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offerings. Our other named accounts are covered
by territory account managers. These accounts are large enough
to require face-to-face sales coverage and are led by account
managers with McAfee System Protection Solutions or McAfee
Network Protection Solutions backgrounds. The small and
medium-sized business segment is comprised of accounts not
serviced by territory account managers. These accounts are
serviced primarily by our telesales representatives and channel
partners. We have made a significant investment in our channel
partner programs to increase sales and ultimately drive growth
in this market segment. The small office, home office and
consumer segments are the focus of our McAfee Consumer team.


All of our United States sales representatives
are responsible for developing new business as well as the
renewal of our existing licenses. Prior to expiration of a
license, a sales representative contacts the customer and
encourages the customer to renew the expiring license and
determines if the number of computers licensed needs adjustment
and, additionally, markets new products and product groups to
this existing customer. Our account teams are also responsible
for maintaining and nurturing long-term customer relationships.



| |                    
| | -------------------
| | International Sales

We have sales and support operations in EMEA,
Japan, North America, Asia-Pacific and Latin America. In 2003,
2002, and 2001 based on net revenue in our regions,
international revenues accounted for approximately 35%, 37% and
35% of our net revenues, respectively. Within our international
sales regions, sales forces are organized by country when and
where local demand and sales force considerations make it
advisable.



| |                           
| | --------------------------
| | Resellers and Distributors

To complement our direct sales efforts, we market
many of our products through corporate resellers, retailers and,
indirectly, through distributors. In addition, our channel
efforts include strategic alliances with complementary
manufacturers and publishers to expand our reach and scale. We
currently utilize corporate resellers, including ASAP Software,
CDW, Dell, Insight, Softmart, Software House International and
Software Spectrum, as well as network integrators who offer our
solutions and sell site licenses of our software to corporate,
small business and government customers.

Independent software distributors who currently
supply our products include Digital River, Ingram Micro, Merisel
America, MOCA and Tech Data. These distributors supply our
products primarily to large retailers, value-added resellers, or
VARs, mail order and telemarketing companies. Both through our
authorized distributors and directly with certain retail
resellers through a consignment model, we sell our retail
packaged products to several of the larger computer and software
retailers, including Best Buy, CompUSA, Dixons, Office Depot,
Office Max and Staples. Members of our channel sales force work
closely with our major reseller and distributor accounts to
manage demand generating activities, training, order flow, and
affiliate relationship management.

Our top ten distributors typically account for
between 46% and 62% of our net sales in any quarter. 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. If one
of our significant distributors terminated its relationship with
us, we could experience a significant interruption in the
distribution of our products.

We utilize a sell-through business model for
distributors under which we recognize revenue on products sold
through distributors at the time our distributors resell the
products to their customers. Under this business model, our
distributors are permitted 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, prior to the resale
of our products, our distributors are permitted unlimited,
unconditional rights of return. After sale by the distributor to
its customer, there is 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.

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| |                                     
| | ------------------------------------
| | Original Equipment
    Manufacturers

OEMs license our products and bundle them with PC
hardware or software. For example, we are an anti-virus provider
for PC hardware manufacturers such as Apple, Dell, NEC, Phoenix
Technologies and Sony. 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, or revenue share with, our OEMs.



| |                           
| | --------------------------
| | Other Marketing Activities

Channel marketing is the means by which we
market, promote, train and incent our resellers and distributors
to promote our products to their end-user customers. We offer
our resellers and distributors technical and sales training
classes, marketing and sales assistance kits. We also provide
specific cooperative marketing programs for end-user seminars,
catalogs, demand creation and sales events.

One of the principal means of marketing our
products and services is through the Internet. In addition to
the www.networkassociates.com website, each of our product
groups has their own individual websites. A number of these
websites are localized to serve the various geographic regions
in which we operate. 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
on-line subscription products and services. We also promote our
products and services through advertising activities in trade
publications, direct mail campaigns and strategic arrangements.
In addition, we attend trade shows, sponsor conferences and
publish a quarterly newsletter, which is mailed to existing and
prospective customers.

We also market our products through the use of
rebate programs. Within most countries we typically offer two
types of rebate programs, volume incentive rebates to channel
partners and promotional rebates to end-users. The channel
partner earns a volume incentive rebate primarily based upon its
sale of our products to end-users. From time to time, we also
make rebates available to individual users of various products
purchased through multiple channels.

Customers

We primarily market our products to large
corporate and government customers through our direct sales
organization and indirectly through resellers and distributors.
A majority of our products are distributed indirectly through
resellers and distributors. During 2003, one distributor, Ingram
Micro, accounted for more than 20% of our net revenue and
together with another distributor, TechData, in total accounted
for approximately 33% of our net revenue.

We market our products to individual consumers
directly through on-line distribution channels and indirectly
through traditional distribution channels, such as retail
stores, OEMS and on-line partners. McAfee Consumer is
responsible for on-line distribution of our products sold to
individual consumers over the Internet or for Internet-based
products, including products distributed by our on-line
partners, and for the licensing of technology to strategic
distribution partners for sale to individual consumers, with
certain exceptions.

Product Development, Investments, and
Acquisitions

We believe that our ability to maintain our
competitiveness depends in large part upon our ability to
successfully 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. 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 focused on developing upgrades and
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 new or changing operating systems
and environments.

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For 2003, 2002 and 2001, we expensed
$184.6 million, $148.8 million and $146.7 million
(or, excluding stock based compensation charges,
$179.4 million, $144.8 million and
$142.1 million), respectively, on research and development.
See Managements Discussion and Analysis of Financial
Condition and Results of Operations.

Manufacturing and Suppliers

Our manufacturing operations consist primarily of
assembly, testing and quality control of materials, components,
subassemblies and systems for our Sniffer hardware-based,
IntruShield and E-ppliance products. We use a limited number of
third-party manufacturers for these manufacturing operations.
Reliance on third-party manufacturers, including software
replicators, involves a number of risks, including the lack of
control over the manufacturing process and the potential absence
or unavailability of adequate capacity. The loss of one of our
third-party manufacturers could disrupt our business.
Hardware-based products entail other risks, such as the
unavailability of critical components that are supplied by a
limited number of parties and greater obsolescence risks.

Competition

The markets for our products are intensely
competitive and are subject to rapid changes in technology. We
also expect competition to increase in the near-term. We believe
that the principal competitive factors affecting the markets for
our products include, but are not limited to:



| |   |                                  
| | - | ---------------------------------
| |  | performance                      
|
| |  | quality                          
|
| |  | breadth of product group         
|
| |  | integration of products          
|
| |  | brand name recognition           
|
| |  | price                            
|
| |  | functionality                    
|
| |  | customer support                 
|
| |  | frequency of upgrades and updates
|
| |  | manageability of products        
|
| |  | reputation                       

We believe that we compete favorably against our
competitors in each of these areas. However, some of our
competitors have longer operating histories, greater name
recognition, stronger relationships with channel partners,
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 markets with their network security and
management products.

Anti-Virus.Our
principal competitors in the anti-virus market are Symantec and
Computer Associates. Trend Micro remains the strongest
competitor in the Asian anti-virus market. Sophos, Fsecure,
Panda, and Dr. Ahns are also showing growth in their
respective markets. As a result of its GeCAD Software
acquisition, at some point we may also compete directly against
Microsoft.

Network Security and Intrusion Detection and
Protection.Our principal competitors
in the security market vary by product type. For intrusion
detection and prevention products, we compete with Cisco
Systems, Computer Associates, Enterasys, Fortinet, Internet
Security Systems, NetScreen (which recently agreed to be
acquired by Juniper Networks, Inc.), Sourcefire, Symantec and
TippingPoint Technologies. The markets for encryption and
virtual private network, or VPN, products are highly fragmented
with numerous

8



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small and large vendors. VPN competitors include
hardware and software vendors, including telecommunications
companies and traditional networking suppliers.


Network Fault Identification and Application
Performance Management.Our principal
competitors in the network fault identification and application
performance management market are NetScout and WildPackets.
Other competitors include Agilent, Cisco Systems, Compuware
Corporation, Concord Communications, Finisar, Fluke Networks,
Network Instruments and Niksun.

Other Competitors.In addition to competition from large
technology companies such as HP, IBM, Intel, Microsoft, and
Novell that may offer network and system protection products as
enhancements to their operating systems, we also face
competition from smaller companies and shareware authors that
may develop competing products.

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. Often, we
do not obtain signed license agreements from customers who
license products from us. In these cases, we include an
electronic version of an end-user license in all of our
electronically distributed software and a printed license in the
box for our 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.

Employees

As of December 31, 2003, we employed
approximately 3,700 individuals worldwide including
approximately 1,000 in research and development, approximately
2,000 in sales and marketing, and approximately 700 in finance
and administration. Approximately 1,600 employees are in
locations outside the United States. With limited exceptions,
none of our employees are represented by a labor union. We
consider the relationships with our employees to be positive.
Competition for qualified management and technical personnel is
intense in the software industry. Our continued success depends
in part upon our ability to attract and retain qualified
personnel. To date, we believe that we have been successful in
recruiting qualified employees, but there is no assurance that
we will continue to be successful in the future.

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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 Financial Results Will Likely
Fluctuate.

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



| |                    
| | -------------------
| | Operational Factors

Operational factors that may cause our revenues,
gross margins and operating results to fluctuate significantly
from period to period, include, but are not limited to:



| |   |                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | volume, size, timing and contractual terms of new
    licenses and renewals of existing licenses;                                                                                                                                                                                                                                                                       
|
| |  | introduction of new products, product upgrades or
    updates by us or our competitors;                                                                                                                                                                                                                                                                                 
|
| |  | the mix of products we sell and services we offer
    and whether (i) our products are sold directly by us or
    indirectly through distributors, resellers and others,
    (ii) the product is hardware or software based and
    (iii) in the case of software licenses, the licenses are
    time-based subscription licenses or perpetual licenses;                
|
| |  | costs or charges related to our acquisitions or
    dispositions, including our acquisition of the publicly held
    shares of McAfee.com in September 2002, our acquisitions of
    Entercept Security Technologies and IntruVert Networks in 2003
    and the dispositions of our Magic business at the beginning of
    2004 and PGP and Gauntlet businesses in 2002;
|
| |  | the components of our revenue that are deferred,
    including our on-line subscriptions and that portion of our
    perpetual and subscription software licenses attributable to
    support and maintenance;                                                                                                                                                          
|
| |  | stock-based compensation charges; and                                                                                                                                                                                                                                                                                                                                   
|
| |  | costs related to extraordinary events, including
    litigation, reductions in force, relocation of personnel and
    restatement of our consolidated financial statements, and
    factors that lead to substantial drops in estimated values of
    long-lived assets below their carrying value.                                                                     



| |                                       
| | --------------------------------------
| | Seasonal and Macroeconomic
    Factors

Our net revenue is typically lower in the first
quarter when many businesses experience lower sales, flat in the
summer months, due in part to the European holiday season, and
higher in the fourth quarter as customers typically complete
annual budgetary cycles. In recent periods, continued poor
economic conditions throughout the world have hurt our business.

It Is Difficult for Us to Estimate Operating
Results Prior to the End of a Quarter.

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

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We Face Risks Related to the Pending Formal
Securities and Exchange Commission and Department of Justice
Investigations and Our Accounting Restatements.

In the first quarter of 2002, the SEC commenced a
Formal Order of Private Investigation into our
accounting practices. In the first quarter of 2003, we became
aware that the DOJ had commenced an investigation into our
consolidated financial statements. In April and May 2002, we
announced our intention to file, and in June 2002 we filed with
the SEC, restated consolidated financial statements for 2000,
1999 and 1998 to correct certain discovered inaccuracies for
these periods.

As a result of information obtained in connection
with the ongoing SEC and DOJ investigations, we concluded in
March 2003 we would restate our consolidated financial
statements to, among other things, reflect revenue on sales to
our distributors for 1998 through 2000 on a sell-through basis
(which is how we reported sales to distributors since the
beginning of 2001). Although we filed these restated
consolidated financial statements on October 31, 2003, the
SEC and DOJ inquiries have resulted, and may continue to result
in, a diversion of managements attention and resources and
may contribute to current and future stock price volatility.

The filing of our restated consolidated financial
statements does not resolve the pending SEC inquiry into our
accounting practices. We are engaged in ongoing discussions
with, and continue to provide information to, the SEC regarding
our consolidated financial statements for calendar year 2000 and
prior periods. The resolution of the SEC inquiry into our prior
accounting practices could require the filing of additional
material restatements of our prior consolidated financial
statements or require that we take other actions not presently
contemplated, including actions resulting from the SECs
inquiry into the nature and manner of our recent restatement.

We Are Subject to Intense Competition in the
System And Network Protection Markets, and We Expect to Face
Increased Competition in the Future.

The markets for our products are intensely
competitive and we expect both product and pricing competition
to increase. 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.

We face competition in specific product markets.
Principal competitors include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | in the anti-virus product market, Symantec and
    Computer Associates. Trend Micro remains the strongest
    competitor in the Asian anti-virus market. Sophos, Fsecure,
    Panda, and Dr. Ahns are also showing growth in their
    respective markets. As a result of its GeCAD Software
    acquisition, at some point we may also compete directly against
    Microsoft;
|
| |  | in the network fault identification and
    application performance management product market, Netscout and
    WildPackets, with other competitors including Agilent, Cisco
    Systems, Compuware Corporation, Concord Communications, Finisar,
    Fluke Networks, Network Instruments and Niksun; and                                                                       
|
| |  | in the market for our other intrusion detection
    and protection products, Cisco Systems, Computer Associates,
    Enterasys Internet Security Systems, Netscreen (which recently
    agreed to be acquired by Juniper Networks, Inc.), Sourcefire,
    Symantec and TippingPoint Technologies.                                                                               

Other competitors for our various products could
include large technology companies. We also face competition
from numerous smaller companies and shareware authors that may
develop competing products.

Increasingly, our competitors are large vendors
of hardware or operating system software. These competitors are
continuously developing or incorporating system and network
protection functionality into their products. For example,
Juniper Networks recently agreed to acquire Netscreen and,
through its acquisition of Okena, Cisco Systems may incorporate
functionality that competes with our content filtering and
anti-virus products. Similarly, following its acquisition of
GeCAD Software, Microsoft indicated its plans to boost security
of its Windows platform. The widespread inclusion of products
that perform the same or similar functions as our products
within computer hardware or other companies software
products could

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reduce the perceived need for our products or
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. In addition, the
software industry is currently undergoing consolidation as firms
seek to offer more extensive suites and broader arrays of
software products, as well as integrated software and hardware
solutions. This consolidation may negatively impact our
competitive position.


We Face Risks Related to Our Recent Product
Reorganization and Our Intrusion Prevention Focus.

Following our IntruVert and Entercept
acquisitions in the first half of 2003, we reorganized our
products into our McAfee System Protection Solutions and McAfee
Network Protection Solutions product groups. At the end of 2003,
we agreed to dispose of our Magic Solutions business. These
activities are intended to better leverage the McAfee brand and
better position us as a provider of a complete set of system and
network protection solutions differentiated by intrusion
prevention technology. Risks related to these activities include:



| |   |                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we may be unable to successfully expand our
    McAfee brand beyond our anti-virus products;                                                                                                
|
| |  | our strategic positioning may result in our
    competing more directly with larger, more established
    competitors, such as Cisco Systems and Microsoft;                                 
|
| |  | many of our network and system protection
    products were recently acquired and the income potential for
    these products is unproven and the market for these products is
    volatile;
|
| |  | our sales force requires additional specialized
    training to sell a number of our products;                                                                                              
|
| |  | disposition activities may result in significant
    accounting charges, management distraction and undesired loss of
    personnel; and                                                    
|
| |  | there may be customer confusion around our
    strategy.                                                                                                                                    

Critical Personnel May Be Difficult to
Attract, Assimilate and Retain.

Our success depends in large part on our ability
to attract and retain, in addition to senior management
personnel, technically qualified and highly-skilled sales,
consulting, technical and marketing personnel. Competition for
qualified individuals is intense. To attract and retain critical
personnel, we believe that we must provide a competitive
compensation package, including stock options. Increases in
shares available for issuance under our stock option plans
require stockholder approval. Institutional stockholders, or our
other stockholders generally, may not approve future requests
for option increases. At our most recent annual meeting held in
December 2003, our stockholders did not approve a proposed
increase in options available for grant under our employee stock
option plans. Additionally, the accounting industry continues to
consider whether corporations must include a compensation
expense in their statement of income relating to the issuance of
employee stock options. If options are required to be
expensed,we may decide to issue fewer stock options and may be
impaired in our efforts to attract and retain necessary
personnel. Conversely, issuing a comparable number of stock
options could adversely impact our results of operations.

In recent periods, we have taken and may continue
to take efforts to rationalize the size of our employee base,
including after the sale of our Magic Solutions, PGP and TIS
businesses. While our overall employee level at the end of 2003
decreased to approximately 3,700 from approximately 3,800 at the
end of 2002, through our 2003 acquisitions, we hired a number of
new employees. Reductions in personnel may harm our business,
employee retention or our ability to attract new personnel by,
among other things, reducing overall employee morale, requiring
remaining personnel to perform a greater amount of, or new and
different, responsibilities or result in the loss of personnel
otherwise critical to our business. For new employees, there
also may be reduced levels of productivity as recent additions
or hires are trained and otherwise assimilate and adapt to our
organization and culture. In addition, we may face difficulties
in recruiting, hiring and training qualified employees for our
Bangalore facility, where we have increased our employee levels
in connection with the relocation of a significant portion of
our research and development operations.

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Other than executive management who have at
will employment agreements, our employees are not
typically subject to an employment agreement or non-competition
agreement. We may be unsuccessful in retaining management or
other critical personnel. It could be difficult, time consuming
and expensive to replace any key management member or other
critical personnel, particularly if the individual is highly
skilled. Integrating new management and other key personnel also
may be difficult and costly. The loss of management or other
critical personnel may be disruptive to our business and might
also result in our loss of unique skills and the departure of
existing employees and/or customers.

We Face Risks Associated With Past and Future
Acquisitions.

We may buy or make investments in complementary
companies, products and technologies. In addition to our
acquisition of the publicly traded shares of McAfee.com, in 2003
we completed strategic acquisitions of Entercept and IntruVert.



| |            
| | -----------
| | Integration

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



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | integrate and retain key management, sales,
    research and development, and other personnel;                                  
|
| |  | integrate the acquired products into our product
    offerings both from an engineering and sales and marketing
    perspective;
|
| |  | integrate and support preexisting supplier,
    distribution and customer relationships;                                        
|
| |  | coordinate research and development efforts; and                                                                                
|
| |  | consolidate duplicate facilities and functions.                                                                                 

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



| |                     
| | --------------------
| | Open Source Software

Products or technologies acquired by us may
include so-called open source software. Open source
software is typically licensed for use at no initial charge, but
imposes on the user of the open source software certain
requirements to license to others both the open source software
as well as the software that relates to, or interacts with, the
open source software. Our ability to commercialize products or
technologies incorporating open source software or otherwise
fully realize the anticipated benefits of any such acquisition
may be restricted because, among other reasons:



| |   |                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | open source license terms may be ambiguous and
    may result in unanticipated obligations regarding our products;                                                                             
|
| |  | competitors will have improved access to
    information that may help them develop competitive products;                                                                                      
|
| |  | open source software cannot be protected under
    trade secret law;                                                                                                                           
|
| |  | it may be difficult for us to accurately
    determine the developers of the open source code and whether the
    acquired software infringes third party intellectual property
    rights; and
|
| |  | open source software potentially increases
    customer support costs because licensees can modify the software
    and potentially introduce errors.                                          

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| |                           
| | --------------------------
| | Use of Cash and Securities

Our available cash and securities may be used to
acquire or invest in companies or products, possibly resulting
in significant acquisition-related charges to earnings and
dilution to our stockholders. For example, 2003 and 2002, we
used approximately $217.3 million and $118.3 million
of cash to make various acquisitions, including approximately
$217.1 million in net cash used in 2003 to acquire
IntruVert and Entercept and approximately $98.4 million
used in 2002 to acquire the publicly traded shares of
McAfee.com, our previously publicly traded subsidiary. Moreover,
if we acquire a company, we may have to incur or assume that
companys liabilities, including liabilities that may not
be fully known at the time of acquisition.

We Have Recently Experienced Significant
Additions to Our Senior Management and Changes in Our Sales
Organization.

Several members of our senior management were
only added in the last year, and we may add new members to
senior management. In December 2003, we promoted Mike Dalton to
President of our EMEA region. In July 2003, we reorganized our
sales organization and, among other actions, we elevated Kevin
Weiss to the newly created position of executive vice president
of worldwide sales. Also, in September 2003, we named James
Lewandowski executive vice president of North American sales and
Donna Troy executive vice president of worldwide channels.
Changes in management and our sales organization may be
disruptive to our business and may result in the departure of
existing employees and/or customers. It may take significant
time to locate, retain and integrate qualified management
personnel.

We Face Risks Related to Our International
Operations.

For 2003, 2002 and 2001, net revenue in our
international operating regions represented approximately 35%,
37% and 35% of our net revenue. We intend to focus on
international growth and expect international revenue to remain
a significant percentage of our net revenue.

Related risks include:



| |   |                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | longer payment cycles and greater difficulty in
    collecting accounts receivable;                                                                                                                                                                      
|
| |  | increased costs and management difficulties
    related to the building of our international sales and support
    organization;                                                                                                                         
|
| |  | the acceptance of the reorganization of our
    international sales forces by regions;                                                                                                                                                                   
|
| |  | the ability to successfully localize software
    products for a significant number of international markets;                                                                                                                                            
|
| |  | uncertainties relative to regional economic
    circumstances, including the economic weakness throughout Asia
    and Latin America over the past several years and pricing
    pressures associated with weak economic conditions in these
    regions;
|
| |  | our ability to adapt to sales practices and
    customer requirements in different cultures;                                                                                                                                                             
|
| |  | compliance with more stringent consumer
    protection laws;                                                                                                                                                                                             
|
| |  | currency fluctuations and risks related to
    hedging strategies;                                                                                                                                                                                       
|
| |  | political instability in both established and
    emerging markets;                                                                                                                                                                                      
|
| |  | tariffs, trade barriers and export restrictions;
    and                                                                                                                                                                                                 
|
| |  | a high incidence of software piracy in some
    countries.                                                                                                                                                                                               

Additionally, our sales forces are organized by
geographic region. This structure may lead to sales force
competition for sales to multinational customers and may reduce
our ability to effectively market our products to multinational
customers.

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We May Incur Significant Stock-Based
Compensation Charges Related to Repriced Options, Assumed
Mcafee.Com and IntruVert Options and Compensation Expenses
Related to the Entercept Retention Payments.

We may incur stock-based compensation charges
related to (i) employee options repriced in April 1999
(Repriced Options), (ii) McAfee.com options we
assumed in the acquisition of the publicly traded McAfee.com
shares in September 2002 (McAfee.com Options)
(iii) unvested IntruVert options that were cancelled in May
2003 related to this acquisition (the IntruVert
Options) and exchanged for cash placed in escrow, and
(iv) unvested IntruVert restricted stock that was cancelled
in May 2003 related to this acquisition (the IntruVert
Restricted Stock), and exchanged for monthly cash payments
as the former employees provide services to us. The size of the
charges related to the Repriced Options and McAfee.com Options
could be significant depending on the movements in the market
value of our common stock. As a result of Financial Accounting
Standards Board Interpretation No. 44, effective
July 1, 2000, Repriced Options and McAfee.com Options are
subject to variable accounting treatment. The stock-based
compensation charge (or credit) for the Repriced Options is
determined by the excess of our closing stock price at the end
of a reporting period over the fair value of our common stock on
July 1, 2000, equivalent to $20.375. The stock-based
compensation charge (or credit) for the McAfee Options is
determined by the excess of our closing stock price over the
exercise price of the option minus $11.85 payable upon exercise
of the option. Remeasurement of the charge continues until the
earlier of the date of exercise, forfeiture or cancellation
without replacement. The resulting compensation charge (or
credit) to earnings will be recorded over the remaining life of
the options subject to variable accounting treatment.

For 2003 and 2002, stock-based compensation
charges of approximately $3.4 million and $16.1 million,
respectively, were recorded for McAfee.com Options. In 2002,
credits of approximately $5.5 million were recorded for the
Repriced Options. No stock based compensation charges were
recorded for the Repriced Options in 2003.

During the remaining life of both the McAfee.com
Options and Repriced Options, we may record additional
stock-based compensation charges or credits. We estimate that a
$1 increase in our stock price at December 31, 2003 would
increase our future stock compensation charge by approximately
$0.5 million.

For the cash paid to cancel the IntruVert Options
that was placed in escrow, we will recognize compensation
expense as the former IntruVert employees provide services to
us. For the IntruVert Restricted Stock, we will recognize
compensation expense monthly over the next three to four years
as the former IntruVert employees provide services to us. For
2004, we expect the expense to be approximately
$2.8 million with respect to the IntruVert Options and
Restricted Stock.

We may also incur significant compensation
payments under the Entercept Retention Plan (the Retention
Plan Payments). For the Retention Plan Payments, we will
recognize compensation expense as the required service periods
for the retention payments expire over one year. The Retention
Plan Payments were funded at the time of the Entercept
acquisition, and amounts not paid to the Retention Plan
participants will be paid to the former Entercept stockholders.
For 2004, we expect the remaining expenses to be approximately
$0.6 million.

We Depend on Revenue from Our Flagship
Anti-Virus and Sniffer Products.

We have historically derived a majority of our
net revenue from our flagship McAfee anti-virus software
products and our Sniffer network fault identification and
application performance management products. These products are
expected to continue to account for a significant portion of our
net revenues. Because of this revenue concentration, our
business could be harmed by a decline in demand for, or in the
prices of, these products as a result of, among other factors,
any change in our pricing model, a maturation in the markets for
these products or other risks described in this document. In
recent periods, our Sniffer-based revenues have been adversely
impacted by, among other things, customer budgetary constraints
and a slowing in network infrastructure deployments.

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Customers May Cancel or Delay
Purchases.

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

We Face a Number of Risks Related to Our
Product Sales Through Distributors.

We sell a significant amount of our products
through intermediaries such as distributors. Our top ten
distributors typically represent approximately 46% to 62% of our
net sales in any quarter. Our two largest distributors, Ingram
Micro and Tech Data, together accounted for approximately 33% in
2003 and 35% in 2002 of net revenue.



| |                      
| | ---------------------
| | Loss of a Distributor

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



| |                                              
| | ---------------------------------------------
| | Need for Accurate Distributor
    Information

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



| |                           
| | --------------------------
| | Sale of Competing Products

Our distributors may sell other vendors
products that are complementary to, or compete with, our
products. While we encourage our distributors to focus on our
products through market and support programs, these distributors
may give greater priority to products of other suppliers,
including competitors.



| |                     
| | --------------------
| | Payment Difficulties

Some of our distributors may experience financial
difficulties, which could adversely impact our collection of
accounts receivable. Our allowance for doubtful accounts was
approximately $2.9 million at December 31, 2003, $6.6
million at December 31, 2002 and $8.4 million at
December 31, 2001. 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 allowances.

We Face the Risk of Future Charges in The
event of Impairment and Will Experience Significant Amortization
Charges Related to Purchased Technology.

We adopted Statement of Financial Accounting
Standard (SFAS) No. 142 (SFAS 142)
beginning in 2002 and, as a result, we no longer amortize
goodwill. However, we continue to have significant amortization
related to purchased technology, trademarks, patents and other
intangibles. For the years ended December 31, 2003, 2002,
and 2001, our amortization charge for purchased technology and
other intangibles was approximately $27.0 million,
$13.9 million and $12.9 million respectively. In
addition, we must evaluate our goodwill, at least annually for
impairment according to the guidance provided by SFAS 142.
We completed the annual impairment review during the fourth
quarter of 2003. As a result of this review, goodwill was
determined not to be impaired. If during subsequent testing, we
determine that goodwill is impaired, we will be required to take
a non-cash charge to earnings.

In addition, we will continue to evaluate
potential impairments of our long lived assets, including our
property and equipment and amortizable intangibles under
SFAS 144 Accounting for Impairment or

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Disposal of Long-Lived
Assets . In 2003, we have
determined that we have no impairment of our property and
equipment and amortizable intangibles.


We Face Risks Related to the Recent
Reorganization of Our Expert Services Organization.

Historically, our professional service
organization was organized by product group. In October 2002, we
announced the formation of our Expert Services organization.
This organization will be located in each of our geographical
regions. The Expert Services organization combines the
professional service teams from our network protection and
system protection product groups to serve as our professional
services and educational organization. Risks related to this
reorganization include:



| |   |                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the failure to identify and close upon
    significant consulting opportunities;                                                                                
|
| |  | the integration of our professional services
    teams may prove to be unsuccessful, might take more time than
    anticipated or might cost more than expected;
|
| |  | the highly discretionary nature of consulting
    expenditures;                                                                                                 
|
| |  | integration of the professional services teams
    and related activities may divert managements attention;
    and                                            
|
| |  | integration of the professional services teams
    may be disruptive to pre-existing customer relationships.                                                    

We Face Risks Related to Our Strategic
Alliances.

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



| |   |                                                                                                                                                                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our strategic alliances are generally terminable
    by either party with no or minimal notice or penalties. We may
    expend significant time, money and resources to further
    strategic alliances that are thereafter terminated.                                                                                                      
|
| |  | Business interests may diverge over time, which
    might result in conflict, termination or a reduction in
    collaboration. For example, our alliance with Internet Security
    Systems was terminated following the announcement of our
    acquisition in 2003 of Entercept and IntruVert.                                             
|
| |  | Strategic alliances require significant
    coordination between the parties involved. To be successful, our
    alliances may require the integration of other companies
    products with our products, which may involve significant time
    and expenditure by our technical staff and the technical staff
    of our strategic allies.
|
| |  | Our sales and marketing force may require
    additional training to market products that result from our
    strategic alliances. The marketing of these products may require
    additional sales force efforts and may be more complex than the
    marketing of our own products.                                                        
|
| |  | The integration of products from different
    companies may be more difficult than we anticipate, and the risk
    of integration difficulties, incompatible products and
    undetected programming errors or bugs may be higher than that
    normally associated with new products.                                                      
|
| |  | Our strategic alliances may involve providing
    professional services, which might require significant
    additional training of our professional services personnel and
    coordination between our professional services personnel and
    other third-party professional service personnel.                                           
|
| |  | Due to the complex nature of our products and of
    those parties with whom we have strategic alliances, it may take
    longer then we anticipate to successfully integrate and market
    our respective products.                                                                                                                        

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We Face Product Development Risks Associated
with Rapid Technological Changes in Our Market.

The markets for our products are highly
fragmented and characterized by ongoing technological
developments, evolving industry standards and rapid changes in
customer requirements. Our success depends on our ability to
timely and effectively:



| |   |                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | offer a broad range of network and system
    protection products;                                                                                                                                                                  
|
| |  | enhance existing products and expand product
    offerings;                                                                                                                                                                         
|
| |  | respond promptly to new customer requirements and
    industry standards; and                                                                                                                                                       
|
| |  | remain compatible with popular operating systems
    such as Linux, NetWare, Windows XP, Windows 2000, Windows 98 and
    Windows NT, and develop products that are compatible with new or
    otherwise emerging operating systems.

We may experience delays in product development
as we have at times in the past. Complex products like ours may
contain undetected errors or version compatibility problems,
particularly when first released, which could delay or harm
market acceptance.

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

We Face Risks Related to Our On-Line
Subscription Services Strategy.

McAfee System Protection Solutions offers on-line
subscription services to multiple user segments including large
enterprises, small-medium businesses and consumers. Our
McAfee.com website is dedicated to selling and delivering
security services over the Internet for consumers and small
businesses (primarily small office and home). Our ASaP web sites
support our selling and delivery of subscription services to
small-medium business and large enterprises. This web-based
model is a relatively new concept and our on-line subscription
services may fail to maintain or increase market acceptance. The
growth and market acceptance and ultimate profitability of our
on-line subscription services are 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, channel development and technical and
    administrative support;
|
| |  | the uninterrupted operability of our websites
    delivering security services over the Internet;                                                                                                            
|
| |  | our ability to attract and retain professionals
    to manage the delivery of services;                                                                                                                      
|
| |  | the introduction of new products by third-party
    competitors; and                                                                                                                                         
|
| |  | our ability to properly price our products and
    services to maximize profitable growth.                                                                                                                   

We also allow intermediaries such as Internet
service providers to sell and host our subscription based
services. The service offerings of these partners may compete
directly with our own subscription service sales efforts. Our
success in making our on-line services available through our
partners depends on several factors, including:



| |   |                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------
| |  | our ability to attract, train and maintain
    qualified and financially stable partners;                        
|
| |  | our ability to develop and maintain mutually
    satisfactory revenue sharing arrangements with our partners; and
|
| |  | our ability to maintain customer satisfaction.                                                                   

18



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Our Managed Service Provider Strategy Exposes
Us to Risks in Addition to Those Generally Experienced with Our
On-Line Subscription Services Strategy.

We also make our technology available to be
integrated with partner offers to be delivered as outsourced
security solutions or managed security solutions. Unlike our
on-line subscription services, Managed Service Provider
(MSP) solutions are customized, monitored and
updated by networking professionals for a specific customer. To
successfully offer MSP services we must:



| |   |                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------
| |  | effectively monitor and customize each
    customers managed services;                                                      
|
| |  | attract and retain qualified networking
    professionals to manage customer accounts; and                                   
|
| |  | effectively price our products and services to
    account for the higher costs associated with selling managed
    services.

We also allow intermediaries, such as
Outsourcers, MSPs and Managed Security Service Providers to sell
and host our products and services in a managed environment.
This partner strategy exposes us to additional risks:



| |   |                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we must select, train and maintain qualified and
    financially stable partners;                                                                                                                                                
|
| |  | it is more difficult for us to ensure customer
    satisfaction as we do not have direct customer contact and we
    rely on our partners to timely and properly customize and
    administer our products, services and support:
|
| |  | we must develop and maintain mutually
    satisfactory revenue sharing arrangements with our partners; and                                                                                                                       
|
| |  | our partners may compete with our own direct
    sales efforts.                                                                                                                                                                  

Our Products Face Manufacturing, Supply,
Inventory, Licensing and Obsolescence Risks.



| |                          
| | -------------------------
| | Third-Party Manufacturing

We rely on a small number of third parties to
manufacture some of our hardware-based network protection and
system protection products. We expect the number of our
hardware-based products and our reliance on third-party
manufacturers to increase as software-only network and system
security solutions become less viable. Reliance on third-party
manufacturers, including software replicators, involves a number
of risks, including the lack of control over the manufacturing
process and the potential absence or unavailability of adequate
capacity. If any of our third party manufacturers cannot or will
not manufacture our products in required volumes on a
cost-effective basis, in a timely manner, or at all, we will
have to secure additional manufacturing capacity. Even if this
additional capacity is available at commercially acceptable
terms, the qualification process could be lengthy and could
cause interruptions in product shipments. The unexpected loss of
any of our manufacturers would be disruptive to our business.



| |         
| | --------
| | Sourcing

Our products contain critical components supplied
by a single or a limited number of third parties. Any
significant shortage of components or the failure of the
third-party supplier to maintain or enhance these products could
lead to cancellations of customer orders or delays in placement
of orders.



| |                     
| | --------------------
| | Third-Party Licenses

Some of our products incorporate licensed
software.We must be able to obtain
reasonably priced licenses and successfully integrate this
software with our hardware. In addition, some of our products
may include open source software. Our ability to
commercialize products or technologies incorporating open source
software may be restricted because, among other reasons, open
source license terms may be ambiguous and may result in
unanticipated obligations regarding our products.

19



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| |             
| | ------------
| | Obsolescence

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

We Rely on the Continued Prominence of
Microsoft Technology.

Although we intend to support other operating
systems, we seek to be the leading supplier of network security
and management products for Windows/ Intel based networks. Sales
of our products would be materially and adversely affected by
market developments that are adverse to the Windows operating
environments, including the failure of users and application
developers to accept Windows. In addition, our ability to
develop products using the Windows operating environments is
dependent on our ability to gain timely access to, and to
develop expertise in, current and future developments by
Microsoft. We may be unable in the future to gain the necessary
access from Microsoft to its product development activities,
particularly in light of Microsofts recent acquisition of
GeCAD Software, an anti-virus software provider.

We May Fail to Support Operating Systems Which
Successfully Compete with Microsofts Technology, Including
Competing Versions of the Unix Operating System.

We are expanding our product support to include
the Unix operating system and the Linux operating system. Sales
of our products could be materially and adversely impacted by
our failure to support those operating systems or competing
operating systems that receive broad market acceptance. The Unix
system encompasses many separate operating systems of which we
only support a few. In recent periods, the Linux operating
system has gained broader market acceptance at the expense of
Unix operating systems. As a result, we placed our anti-virus
products for Sun Microsystems Solaris Unix operating
system into a maintenance only mode. If we fail to adequately
support the Linux operating system or if the Unix versions
supported by us are disproportionately affected by the success
of Linux, our product sales may be adversely impacted.

We Face Risks Related to Customer Outsourcing
to System Integrators.

Some of our customers have outsourced the
management of their information technology departments to large
system integrators. If this trend continues, we face the risk
that our established customer relationships could be disrupted
and our products displaced by alternative system and network
protection solutions offered by system integrators. Significant
product displacements as a result of information technology
department outsourcing could impact our revenue and have a
material adverse effect on our business.

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

We rely on a combination of contractual rights,
trademarks, trade secrets, patents and copyrights to establish
and protect proprietary rights in our software. However, the
steps taken by us to protect our proprietary software may not
deter its misuse or theft. We are aware that a substantial
number of users of our anti-virus products have not paid any
registration or license fees to us. Competitors may also
independently develop technologies or products that are
substantially equivalent or superior to our products. Certain
jurisdictions may not provide adequate legal infrastructure for
effective protection of our intellectual property rights.
Changing legal interpretations of liability for unauthorized use
of our software or lessened sensitivity by corporate, government
or institutional users to avoiding infringement of intellectual
property could also harm our business.

Intellectual Property Litigation in the
Network Security and Management Market is Common and Can Be
Expensive.

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

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



| |   |                                                                           
| | - | --------------------------------------------------------------------------
| |  | result in the loss of our proprietary rights;                             
|
| |  | subject us to significant liabilities, including
    monetary liabilities;
|
| |  | require us to seek licenses from third parties; or                        
|
| |  | prevent us from manufacturing or selling our
    products.                

The litigation process is subject to inherent
uncertainties. We may not prevail in these matters, or we may be
unable to obtain licenses with respect to any patents or other
intellectual property rights that may be held valid or infringed
upon by our products or us.

If we acquire a portion of software included in
our products from third parties, our exposure to infringement
actions may increase because we must rely upon these third
parties as to the origin and ownership of any software being
acquired. Similarly, notwithstanding measures taken by our
competitors or us to protect our competitors intellectual
property, exposure to infringement claims increases if we employ
or hire software engineers previously employed by competitors.
Further, to the extent we utilize open source
software we face risks. For example, the scope and requirements
of the most common open source software license, the GNU General
Public License (GPL), have not been interpreted in a
court of law. Use of GPL software could subject certain portions
of our proprietary software to the GPL requirements. Other forms
of open source software licensing present license
compliance risks, which could result in litigation or loss of
the right to use this software.

Pending or Future Litigation Could Have a
Material Adverse Impact on Our Results of Operation and
Financial Condition.

In addition to intellectual property litigation,
from time to time, we have been subject to litigation. Where we
can make a reasonable estimate of the liability relating to
pending litigation and determine that it is probable, we record
a related liability. As additional information becomes
available, we assess the potential liability and revise
estimates as appropriate. However, because of uncertainties
relating to litigation, the amount of our estimates could be
wrong. In addition to the related cost and use of cash, pending
or future litigation could cause the diversion of
managements attention and resources. In 2000, a putative
securities class action was filed against us, our directors and
our former officers. In 2003, we entered into a memorandum
agreement of settlement resolving the litigation for
$70.0 million, with the settlement approved by the court in
February 2004.

Our Stock Price Has Been Volatile and is
Likely to Remain Volatile.

During the 12-month period ended
December 31, 2003, our stock price was highly volatile
ranging from a per share high of $20.28 to a low of $10.75. On
January 30, 2004, our stocks closing price per share
price was $17.35. Announcements, business developments, such as
a material acquisition or disposition, 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. Certain types of
investors may choose not to invest in stocks with this level of
stock price volatility. Further, we may not discover, or be able
to confirm, revenue or earnings shortfalls until the end of a
quarter. This could result in an immediate drop in our stock
price.

Product Liability and Related Claims May Be
Asserted Against Us.

Our products are used to protect and manage
computer systems and networks that may be critical to
organizations. Because of the complexity of the environments in
which our products operate, an error, failure or bug in our
products could disrupt or cause damage to the networks of our
customers, including disruption of legitimate network traffic by
our intrusion prevention products. Failure of our products to
perform to specifications, disruption of our customers
network traffic or damages to our customers networks
caused by our products could result in product liability damage
claims by our customers. Our license agreements with

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our customers typically contain provisions
designed to limit our exposure to potential product liability
claims. It is possible, however, that the limitation of
liability provisions may not be effective under the laws of
certain jurisdictions, particularly in circumstances involving
unsigned licenses.


Computer Hackers May Damage Our
Products, Services and Systems.

Due to our high profile in the network and system
protection software market, we have been a target of computer
hackers who have, among other things, created viruses to
sabotage or otherwise attack our products and services,
including our various websites. For example, we have recently
seen the spread of viruses, or worms, that intentionally delete
anti-virus and firewall software. Similarly, hackers may attempt
to penetrate our network security and misappropriate proprietary
information or cause interruptions of our internal systems and
services. Also, a number of websites have been subject to denial
of service attacks, where a website is bombarded with
information requests eventually causing the website to overload,
resulting in a delay or disruption of service. If successful,
any of these events could damage users or our computer
systems. In addition, since we do not control diskette
duplication by distributors or our independent agents, diskettes
containing our software may be infected with viruses.

False Detection of Viruses And Actual or
Perceived Security Breaches Could Adversely Affect Our
Business.

Our anti-virus software products have in the past
and may at times in the future falsely detect viruses that do
not actually exist. These false alarms, while typical in the
industry, may impair the perceived reliability of our products
and may therefore adversely impact market acceptance of our
products. In addition, we have in the past been subject to
litigation claiming damages related to a false alarm, and
similar claims may be made in the future. An actual or perceived
breach of network or computer security at one of our customers,
regardless of whether the breach is attributable to our
products, could adversely affect the markets perception of
our security products.

We Face New Risks Related to Our Anti-Spam
Software Products.

Our anti-spam products may falsely identify
e-mails as unwanted spam, reducing the adoption of
these products, or alternatively fail to properly identify
unwanted e-mails, particularly as spam e-mails are often
designed to circumvent anti-spam products. Parties whose e-mails
are blocked by our products may also seek redress against us for
labeling them as spammers or for interfering with their business.

Business Interruptions May Impede Our
Operations and the Operations of Our Customers.

We are implementing a new customer relationship
management information system. Implementation of these types of
computer systems are often disruptive to business and may cause
us to incur higher costs than we anticipate. Failure to manage a
smooth transition to the new system and the ongoing operations
and support of the new system could materially harm our business
operations. In addition, we and our customers face a number of
potential business interruption risks that are beyond our
respective control. Natural disasters or other events could
interrupt our business or the business of our customers, and
each of us is reliant on external infrastructure that may be
antiquated. For example, many parts of the United States and
Canada experienced a widespread power blackout in August 2003,
adversely impacting business in those areas. Also, an outbreak
of SARS, bird flu or other highly contagious illnesses could
have an adverse impact on our operations and the operations of
our customers. Our corporate headquarters are located near a
major earthquake fault. The potential impact of a major
earthquake on our facilities, infrastructure and overall
operations is not known. Despite safety precautions that have
been implemented, there is no guarantee that an earthquake would
not seriously disturb our entire business process. We are
largely uninsured for losses and business disruptions caused by
an earthquake and other natural disasters.

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The U.S. Military Global Presence and
Potential Terrorist Attacks Could Have a Material Adverse Effect
on The U.S. and Global Economies and Could Adversely Impact the
Internet and Our Products and Business.

The U.S. military global presence, coupled with
the possibility of potential terrorist attacks, could have a
continued adverse effect upon an already weakened world economy
and could cause U.S. and foreign businesses to slow spending on
products and services, delay sales cycles and otherwise
negatively impact consumer and business confidence. Terrorists
may also seek to interfere with the operation of the Internet,
the operation of our customers computer systems and
networks, and the operation of our systems and networks,
particularly given our status as an American company providing
security products. Any significant interruption of the Internet
could adversely impact our ability to rapidly and efficiently
provide anti-virus and other product updates to our customers.

We Face Risks Associated With Governmental
Contracting.

Our customers include the U.S. government and a
significant number of other U.S. state and local governments or
agencies. We are also currently engaged in several research and
development contracts with U.S. government agencies.



| |            
| | -----------
| | Procurement

Contracting with public sector customers is
highly competitive and can be expensive and time-consuming,
often requiring that we incur significant upfront time and
expense without any assurance that we will win a contract.
Public sector customers may also change the way they procure new
contracts and may adopt new rules or regulations governing
contract procurement, including required competitive bidding or
use of open source products, where available.



| |           
| | ----------
| | Fee Awards

Minimum fee awards for companies entering into
U.S. government contracts are generally between 3% and 7% of the
costs incurred by them in performing their duties under the
related contract. However, these fees may be as low as 1% of
contract costs.



| |                                     
| | ------------------------------------
| | Budgetary Constraints and
    Cycles

Demand and payment for our products and services
are impacted by public sector budgetary cycles and funding
availability, with funding reductions or delays adversely
impacting public sector demand for our products and services.



| |                                              
| | ---------------------------------------------
| | Modification or Cancellation of
    Contracts

Public sector customers often have contractual or
other legal rights to terminate current contracts for
convenience or due to a default. If a contract is cancelled for
convenience, which can occur if the customers product
needs change, we may only be able to collect for products and
services delivered prior to termination. If a contract is
cancelled because of default, we may only be able to collect for
products and services delivered, and we may be forced to pay any
costs incurred by the customer for procuring alternative
products and services. The U.S. government may also terminate
contracts with us if we come under foreign government control or
influence, require that we disclose our pricing data during the
course of negotiations, ban us from doing business with any
government entity and require us to prevent access to classified
data.



| |                    
| | -------------------
| | Governmental Audits

U.S. government and other state and local
agencies routinely investigate and audit government
contractors administrative processes. They may audit our
performance and pricing and review our compliance with
applicable rules and regulations. If they find that we have
improperly allocated costs, they may require us to refund those
costs or may refuse to pay us for outstanding balances related
to the improper allocation. An

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unfavorable audit could result in a reduction of
revenue, and may result in civil or criminal liability if the
audit uncovers improper or illegal activities.




| |                    
| | -------------------
| | Security Clearances

Some agencies within the U.S. government require
some or all of our personnel to obtain proper security
clearance. If our key personnel are unable to obtain or retain
this clearance, we may be unable to bid for or retain some
government contracts.

We May Not Realize the Anticipated Benefits
from Our Strategic Investments.

We have made a number of venture and minority
investments in private companies with complementary products,
services and technologies. During 2002 and 2001, we recorded
impairment charges of $0.2 million and $20.6 million,
respectively, in connection with these investments. We recorded
no impairment charges in 2003 as all of our investments have no
carrying value. We may make additional strategic investments.
These investments are speculative in value, and we may lose all
or part of the money invested.

Cryptography Contained in Our Technology is
Subject to Export Restrictions.

Some of our computer security solutions,
particularly those incorporating encryption, may be subject to
export restrictions. As a result, some products may not be
exported to international customers without prior U.S.
government approval. The list of products and end users for
which export approval is required, and the regulatory policies
with respect thereto, are subject to revision by the U.S.
government at any time. The cost of compliance with U.S. and
international export laws and changes in existing laws could
affect our ability to sell certain products in certain markets
and could have a material adverse effect on our international
revenues.

Future Sales of Our Common Stock in the Public
Market or Option Exercises and Sales Could Lower Our Stock
Price.

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

Our Charter Documents and Delaware Law and Our
Rights Plan May Impede or Discourage a Takeover, Which Could
Lower Our Stock Price.



| |                                           
| | ------------------------------------------
| | Our Charter Documents and Delaware
    Law

Pursuant to our charter, our board of directors
has the authority to issue up to 5.0 million shares of
preferred stock and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those
shares without any further vote or action by our stockholders.
The issuance of preferred stock could have the effect of making
it more difficult for a third party to acquire a majority of our
outstanding voting stock.

Our classified board and other provisions of
Delaware law and our certificate of incorporation and bylaws,
could also delay or make a merger, tender offer or proxy contest
involving us more difficult. For example, any stockholder
wishing to make a stockholder proposal (including director
nominations) at our 2004 annual meeting, must meet the
qualifications and follow the procedures specified under both
the Exchange Act of 1934 and our bylaws.



| |                
| | ---------------
| | Our Rights Plan

Our board of directors has adopted a
stockholders rights plan. The rights will become
exercisable the tenth day after a person or group announces
acquisition of 15% or more of our common stock or announces

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commencement of a tender or exchange offer the
consummation of which would result in ownership by the person or
group of 15% or more of our common stock. If the rights become
exercisable, the holders of the rights (other than the person
acquiring 15% or more of our common stock) will be entitled to
acquire in exchange for the rights exercise price, shares
of our common stock or shares of any company in which we are
merged with a value equal to twice the rights exercise
price.





Item 2.     Properties

Our headquarters currently occupy approximately
135,000 square feet in facilities located in Santa Clara,
California under leases expiring in 2013. Worldwide, we lease
facilities with approximately 808,000 total square feet, with
leases that expire at various times. Our primary international
facilities are located in, Germany, India, Japan, the
Netherlands and the United Kingdom. Other significant domestic
sites include California, Maryland, Oregon and Texas. We believe
that our existing facilities are adequate for the present and
that additional space will be available as needed.

We own our regional office located in Plano,
Texas. The 170,000 square feet facility, opened in January 2003
and is located on 15.6 acres of owned land. This facility
supports approximately 1,000 employees working in our customer
support, engineering, accounting and finance, information
technology, internal audit, legal and telesales groups.




Item 3.     Legal
Proceedings

Information with respect to this item is
incorporated by reference to note 20 to the notes to
consolidated financial statements included in this Form 10-K.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

1. The election of Messrs. Leslie
Denend and George Samenuk as Class II directors, each for a
three year term:

|                |  |  |             | 
|--------------- |  |  | ----------- | 
|Leslie Denend:  |  |  |             | 
|Shares in Favor |  |  | 135,459,809 | 
|Shares Withheld |  |  | 2,415,052   | 
|George Samenuk: |  |  |             | 
|Shares in Favor |  |  | 134,877,105 | 
|Shares Withheld |  |  | 2,997,756   | 

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

|                 |  |  |            | 
|---------------- |  |  | ---------- | 
|Shares in Favor  |  |  | 38,585,715 | 
|Shares Against   |  |  | 73,307,748 | 
|Shares Abstained |  |  | 362,092    | 

3. The approval of an amendment to the
Companys Stock Option Plan for Outside Directors to
increase the initial stock option grant and subsequent annual
grant to non-employee directors by 5,000 shares to 50,000 and
25,000 shares of common stock, respectively:

|                 |  |  |            | 
|---------------- |  |  | ---------- | 
|Shares in Favor  |  |  | 62,830,924 | 
|Shares Against   |  |  | 49,038,448 | 
|Shares Abstained |  |  | 386,183    | 

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4. The approval of an amendment to the
Companys 2002 Employee Stock Purchase Plan to increase the
number of shares of the Companys common stock reserved for
issuance thereunder by 2,000,000 shares:

|                 |  |  |             | 
|---------------- |  |  | ----------- | 
|Shares in Favor  |  |  | 106,275,748 | 
|Shares Against   |  |  | 5,611,758   | 
|Shares Abstained |  |  | 368,049     | 

5. The ratification of the appointment of
PricewaterhouseCoopers LLP as the independent accountants of the
Company for the fiscal year ending December 31, 2003:

|                 |  |  |             | 
|---------------- |  |  | ----------- | 
|Shares in Favor  |  |  | 131,790,293 | 
|Shares Against   |  |  | 5,727,546   | 
|Shares Abstained |  |  | 357,022     | 

26



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##### Table of Contents






PART II






|        |                                                                              
|------- | -----------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common
    Equity and Related Stockholder Matters

Price Range of Common Stock

From our initial public offering on
October 6, 1992 to February 11, 2002, our common stock
traded on the NASDAQ National Market. After the combination with
Network General Corporation on December 1, 1997, our common
stock traded under the symbol NETA. Prior thereto, our common
stock traded under the symbol MCAF. Effective February 12,
2002, our common stock commenced trading on the New York Stock
Exchange (NYSE) under the symbol NET.

The following table sets forth, for the period
indicated the high and low closing sales prices for our common
stock for the last eight quarters, all as reported by NYSE or
NASDAQ, as applicable. The prices appearing in the table below
do not reflect retail mark-up, mark-down or commission and, for
the periods prior to February 12, 2002, when the stock was
listed on the NYSE, reflect over the counter market quotations
and may not necessarily represent actual transactions.

|                             |  |      |       |     |  |   |       | 
|---------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|                             |  | High |       | Low
|                             |  |      |       |    
|Year Ended December 31, 2003 |  |      |       |     |  |   |       | 
|First Quarter                |  | $    | 20.28 |     |  | $ | 13.72 | 
|Second Quarter               |  |      | 14.40 |     |  |   | 10.80 | 
|Third Quarter                |  |      | 15.50 |     |  |   | 10.75 | 
|Fourth Quarter               |  |      | 15.59 |     |  |   | 12.95 | 
|Year Ended December 31, 2002 |  |      |       |     |  |   |       | 
|First Quarter                |  | $    | 29.99 |     |  | $ | 22.23 | 
|Second Quarter               |  |      | 25.81 |     |  |   | 16.29 | 
|Third Quarter                |  |      | 19.60 |     |  |   | 10.10 | 
|Fourth Quarter               |  |      | 18.83 |     |  |   | 8.45  | 

Dividend Policy

We have not paid any cash dividends since our
reorganization into a corporate form in October 1992. We intend
to retain future earnings for use in our business and do not
anticipate paying cash dividends in the foreseeable future.

Holders of Common Stock

As of January 31, 2004, there were
approximately 915 record owners of our common stock.

Public Filings

Our Internet address is
www.networkassociates.com. We make available free of charge
through our Internet website current and archived press releases
and presentations, our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or
furnished pursuant to Sections 13(a) or 15(d) of the
Securities and Exchange Act, as amended, as soon as reasonably
practicable after we electronically file such material with the
SEC. We also make available through our Internet website our
Corporate Governance Guidelines, the charter for the committees
of our board of directors and our Code of Business Conduct and
Ethics.

The public may read and copy any materials we
file with the SEC at the SECs Public Reference Room at 450
Fifth Street, N.W., Washington, D.C. 20549. Members of the
public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0300. Information
can also be downloaded from the SECs web-site at
www.sec.gov.

27



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|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

You should read the following selected financial
data with the consolidated financial statements and related
notes and Managements Discussion and Analysis of
Financial Conditions and Results of Operations appearing
elsewhere in this Form 10-K. In addition, for a description
of events in connection with the restatement of our 2001, 2000
and 1999 operating results, you should read our 2002 10-K and
Amendment No. 2 to our 2000 10-K, including in each case
note 3 to the consolidated financial statements contained
therein, each of which were filed with the SEC on
October 31, 2003.

|                                                                                                                                                  |                                                                                                  |                                              |         |      |  |      |           |      |  |      |           |      |  |   |          |       |   |   |          |       |  
|------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | -------------------------------------------- | ------- | ---- |  | ---- | --------- | ---- |  | ---- | --------- | ---- |  | - | -------- | ----- | - | - | -------- | ----- | -
|                                                                                                                                                  |                                                                                                  |                                             
|                                                                                                                                                  |                                                                                                  | Years Ended December 31,                    
|                                                                                                                                                  |                                                                                                  |                                             
|                                                                                                                                                  |                                                                                                  | 2003                                         |         | 2002 |  | 2001 |           | 2000 |  | 1999
|                                                                                                                                                  |                                                                                                  |                                              |         |      |  |      |           |      |  |     
|                                                                                                                                                  |                                                                                                  |                                             
|                                                                                                                                                  |                                                                                                  | (In thousands, except for per share amounts)
|Statement of Operations Data                                                                                                                      |                                                                                                  |                                              |         |      |  |      |           |      |  |      |           |      |  |   |          |       |   |   |          |      
|Total net revenue                                                                                                                                 |                                                                                                  | $                                            | 936,336 |      |  | $    | 1,043,044 |      |  | $    | 1,071,660 |      |  | $ | 709,372  |       |   | $ | 660,337  |      
|Income (loss) from operations                                                                                                                     |                                                                                                  |                                              | 65,653  |      |  |      | 114,727   |      |  |      | 153,483   |      |  |   | (127,541 | )     |   |   | (136,725 | )    
|Income (loss) before provision for (benefit
    from) income taxes, minority interest and cumulative effect of
    change in accounting principle |                                                                                                  |                                              | 73,125  |      |  |      | 129,933   |      |  |      | 148,136   |      |  |   | (70,924  | )     |   |   | (127,776 | )    
|Income (loss) before cumulative effect of
    change in accounting principle                                                                      |                                                                                                  |                                              | 59,905  |      |  |      | 128,312   |      |  |      | 83,253    |      |  |   | (108,014 | )     |   |   | (151,964 | )    
|Cumulative effect of change in accounting
    principle, net of taxes                                                                             |                                                                                                  |                                              | 10,337  |      |  |      |          |      |  |      |          |      |  |   |         |       |   |   |         |      
|Net income (loss)                                                                                                                                 |                                                                                                  |                                              | 70,242  |      |  |      | 128,312   |      |  |      | 83,253    |      |  |   | (108,014 | )     |   |   | (151,964 | )    
|                                                                                                                                                  | Income (loss) per share, before cumulative
    effect of change in accounting principle, basic   |                                              | $       | 0.37 |  |      | $         | 0.86 |  |      | $         | 0.60 |  |   | $        | (0.78 | ) |   | $        | (1.10 | )
|                                                                                                                                                  | Income (loss) per share, before cumulative
    effect of change in accounting principle, diluted |                                              | $       | 0.36 |  |      | $         | 0.80 |  |      | $         | 0.53 |  |   | $        | (0.78 | ) |   | $        | (1.10 | )
|Cumulative effect of change in accounting
    principle, basic                                                                                    |                                                                                                  | $                                            | 0.07    |      |  | $    |          |      |  | $    |          |      |  | $ |         |       |   | $ |         |      
|Cumulative effect of change in accounting
    principle, diluted                                                                                  |                                                                                                  | $                                            | 0.07    |      |  | $    |          |      |  | $    |          |      |  | $ |         |       |   | $ |         |      
|Net income (loss) per share, basic                                                                                                                |                                                                                                  | $                                            | 0.44    |      |  | $    | 0.86      |      |  | $    | 0.60      |      |  | $ | (0.78    | )     |   | $ | (1.10    | )    
|Net income (loss) per share, diluted                                                                                                              |                                                                                                  | $                                            | 0.43    |      |  | $    | 0.80      |      |  | $    | 0.53      |      |  | $ | (0.78    | )     |   | $ | (1.10    | )    
|Shares used in per share calculation  basic                                                                                                      |                                                                                                  |                                              | 160,338 |      |  |      | 149,441   |      |  |      | 137,847   |      |  |   | 138,072  |       |   |   | 138,695  |      
|Shares used in per share calculation 
    diluted                                                                                                |                                                                                                  |                                              | 164,489 |      |  |      | 176,249   |      |  |      | 164,363   |      |  |   | 138,072  |       |   |   | 138,695  |      

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|                                               |  |                          |           |      |  |      |           |      |  |      |           |  |  |   |           |  |  |   |           | 
|---------------------------------------------- |  | ------------------------ | --------- | ---- |  | ---- | --------- | ---- |  | ---- | --------- |  |  | - | --------- |  |  | - | --------- | 
|                                               |  |                         
|                                               |  | Years Ended December 31,
|                                               |  |                         
|                                               |  | 2003                     |           | 2002 |  | 2001 |           | 2000 |  | 1999
|                                               |  |                          |           |      |  |      |           |      |  |     
|                                               |  |                         
|                                               |  | (In thousands)          
|Balance Sheet Data                             |  |                          |           |      |  |      |           |      |  |      |           |  |  |   |           |  |  |   |           | 
|Cash and cash equivalents                      |  | $                        | 333,651   |      |  | $    | 674,226   |      |  | $    | 612,832   |  |  | $ | 275,539   |  |  | $ | 329,732   | 
|Working capital                                |  |                          | 415,768   |      |  |      | 475,418   |      |  |      | 443,035   |  |  |   | 79,591    |  |  |   | 64,560    | 
|Total assets                                   |  |                          | 2,120,498 |      |  |      | 2,045,487 |      |  |      | 1,658,093 |  |  |   | 1,465,622 |  |  |   | 1,510,387 | 
|Deferred revenue and taxes                     |  |                          | 459,557   |      |  |      | 329,195   |      |  |      | 404,826   |  |  |   | 531,555   |  |  |   | 446,778   | 
|Long term debt and other long-term liabilities |  |                          | 570,162   |      |  |      | 519,150   |      |  |      | 579,243   |  |  |   | 400,456   |  |  |   | 382,517   | 
|Total equity                                   |  |                          | 888,089   |      |  |      | 770,168   |      |  |      | 341,493   |  |  |   | 222,923   |  |  |   | 355,938   | 






|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operation

Forward-Looking Statements and Factors That
May Affect Future Results

This Managements Discussion and Analysis of
Financial Condition and Results of Operations contains
forward-looking statements that involve known and unknown risks,
uncertainties and other factors that may cause our actual
results, levels of activity, performance or achievements to be
materially different from any future results, levels of
activity, performance or achievements expressed or implied by
such forward-looking statements. Such factors include, among
others things, those risk factors set forth in this section and
elsewhere in this report. We identify forward-looking statements
by words such as may, will,
should, could, expects,
plans, anticipates,
believes, estimates,
predicts, potential or
continue or similar terms that refer to the future.
We cannot guarantee future results, levels of activity,
performance or achievements. Therefore, actual results may
differ materially and adversely from those expressed in any
forward-looking statements. We undertake no obligation to revise
or update publicly any forward-looking statements for any reason.

Overview and Executive Summary

We are a leading supplier of computer security
solutions designed to prevent intrusions on networks and protect
computer systems from the next generation of blended attacks and
threats. We offer two families of products, McAfee System
Protection Solutions and McAfee Network Protection Solutions.
Our computer security solutions are offered primarily to large
enterprises, governments, small and medium sized business and
consumer users.

We derive our revenue and generate cash from
customers from primarily two sources (i) product revenue,
which includes software license, hardware and royalty revenue,
and (ii) services and support revenue, which includes
software license maintenance, training, consulting and on-line
subscription arrangements revenue. For 2003 and 2002, our net
revenue was $936.3 million and $1,043.0 million, and our
net income was $70.2 million and $128.3 million. Our
net revenue is impacted by corporate, government and consumer
spending levels. During the past three years, we have
experienced softness in corporate level spending, with many of
our customers delaying or permanently postponing technology
solution implementations. In addition to total net revenue and
net income, in evaluating our business, management considers,
among many other factors, the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Sales by geography.We operate our business in five geographic regions: North
    America (U.S. and Canada); Europe, Middle East and Africa, or
    EMEA; Japan; Asia-Pacific and Latin America. In 2003, 35% of our
    net revenue was generated outside of North America, with North
    America and EMEA collectively accounting for 90% of our total
    net revenue. Our 2003 sales in EMEA totaling $240.6 million
    were favorably impacted by the strengthening of the Euro and the
    British Pound during the year. North America and EMEA have
    experienced many of the same economic trends.

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| |   |                                        
| | - | ---------------------------------------
| |  | Sales by product and customer category:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | McAfee.Our McAfee
    products include enterprise, small and medium sized businesses
    and consumer products, with enterprise including our Entercept
    host-based intrusion protection products that were acquired in
    connection with the Entercept acquisition in 2003. While sales
    to enterprises and small and medium sized businesses have been
    down, we have experienced significant growth in the consumer
    market. From 2002 to 2003, we experienced 8% growth in our
    consumer anti-virus business and our on-line subscription
    arrangements revenue grew 39%. In 2003, we added
    1.9 million net new subscribers to our McAfee.com on-line
    subscription service and at year-end had a total subscriber base
    of approximately 3.7 million customers. Our McAfee ASaP
    on-line service is targeted at small and medium sized businesses
    and has approximately 2.0 million subscribers at the end of
    2003. Drivers of this subscriber growth include numerous virus
    outbreaks in 2003, including Slammer and Lovesan (Blaster) and
    strategic relationships with OEMs and others, such as AOL, Dell
    and MSN.
|
| |  | IntruShield.Our
    IntruShield network protection products, acquired by us in the
    second quarter of 2003, are sold primarily to enterprises and
    small and medium sized businesses. During 2003, we saw sales
    grow to approximately $9.0 million in the fourth quarter of
    2003, with approximately 100 new customers added to our
    IntruShield customer base in the quarter.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | Sniffer
    Technologies.Our Sniffer business has
    been impacted by the softness in corporate spending in 2002 and
    into 2003. We saw our Sniffer revenues decrease 21% from 2002 to
    2003; however, we did begin to see a rebound in the fourth
    quarter of 2003, with Sniffer revenues up 33% over the prior
    quarter. We saw our newest Sniffer products performing very well
    in the quarter with approximately 22% of Sniffer sales being
    derived from products less than one year old.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Magic.We recently
    sold the assets of our Magic Solutions service desk business to
    BMC Software, Inc. The sale closed on January 30, 2004 and
    we received cash proceeds of approximately $48.0 million,
    subject to final purchase price adjustments. During 2003, 2002
    and 2001, net revenue from the sale of Magic Solutions products
    totaled approximately $63.2 million, $68.4 million and
    $60.7 million respectively. The loss of future Magic
    revenues may increase our operating expenses as a percentage of
    net revenue.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Deferred revenue
    balances.Our deferred revenue balance
    at December 31, 2003 was $481.6 million, of which
    approximately $22.0 million relates to our Magic business.
    We believe that the deferred revenue balance improves
    predictability of future revenues. In the middle of 2003, we
    introduced our perpetual plus licensing program in EMEA and are
    introducing this program in the United States in the first
    quarter of 2004. Under the perpetual plus licensing program more
    revenue is allocated to service and support, therefore
    increasing the deferred revenue balance.            
|
| |  | Cash, cash equivalents and investment
    balances.Cash, cash equivalents and
    investment balances at December 31, 2003 and 2002 totaled
    $766.3 million and $1.0 billion. During 2003, we
    generated approximately $156.3 million in cash from
    operations, used $374.5 million of cash for investing
    activities and used $146.6 million of cash for financing
    activities. Our primary utilization of cash in 2003 was to
    retire zero coupon debentures, make acquisitions and provide for
    settlement of a securities class action lawsuit commenced
    against us in 2000.                             
|
| |  | In 2004, our management is focused, on among
    other things, (i) continuing to build on the current momentum in
    the consumer market and to grow faster than the competition in
    the consumer space; (ii) increasing revenue from the small to
    medium sized business customers by improving our channel
    distribution relationships; (iii) continuing to take the
    steps to make Sniffer more profitable and cash flow positive;
    (iv) implementing cost controls and business streamlining
    measures required to improve operating margins; and
    (v) continuing to grow our intrusion prevention business.

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Critical Accounting Policies and
Estimates

In preparing our consolidated financial
statements, we make estimates, assumptions and judgments that
can have a significant impact on our net revenue, operating
income and net income, as well as on the value of certain assets
and liabilities on our consolidated balance sheet. The
application of our critical accounting policies requires an
evaluation of a number of complex criteria and significant
accounting judgments by us. Management bases its estimates on
historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying
values of assets and liabilities. Senior management has
discussed the development, selection and disclosure of these
estimates with the audit committee of our board of directors.
Actual results may differ, and could be material, from these
estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if
it requires an accounting estimate to be made based on
assumptions about matters that are highly uncertain at the time
the estimate is made, and if different estimates that reasonably
could have been used, or changes in the accounting estimates
that are reasonably likely to occur periodically, could
materially impact the consolidated financial statements.
Management believes the following critical accounting policies
reflect our more significant estimates and assumptions used in
the preparation of the consolidated financial statements. We
have not materially changed our methodology for calculating the
estimates below in the past three years.

Our critical accounting policies are as follows:



| |   |                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | revenue recognition;                                                                                                                                                                                                                                                             
|
| |  | estimating valuation allowances and accrued
    liabilities, specifically sales returns and other allowances,
    the allowance for doubtful accounts, our facility restructuring
    accrual; and the assessment of the probability of the outcome of
    litigation against us;
|
| |  | accounting for income taxes; and                                                                                                                                                                                                                                                 
|
| |  | valuation of goodwill, finite-lived intangibles
    and long-lived assets.                                                                                                                                                                                                       



| |                    
| | -------------------
| | Revenue Recognition

As described below, significant management
judgments and estimates must be made and used in connection with
the revenue recognized in any accounting period. Material
differences may result in the amount and timing of our revenue
for any period if our management made different judgments or
utilized different estimates. These estimates affect the
deferred revenue line item on our consolidated balance sheet and
the net revenue line item on our consolidated statement of
income. Estimates regarding revenue affect all of our operating
geographies.

We apply the provisions of Statement of Position
97-2, Software Revenue Recognition,(SOP 97-2) as amended by Statement of Position
98-9 Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions to all
transactions involving the sale of software products and
hardware transactions where the software is not incidental. For
hardware transactions where software is not incidental, we do
not bifurcate the fee and we do not apply separate accounting
guidance to the hardware and software elements. For hardware
transactions where no software is involved, we apply the
provisions of Staff Accounting Bulletin 104 Revenue
Recognition(SAB 104). In addition, we
apply the provisions of Emerging Issues Task Force Issue
No. 00-03 Application of AICPA Statement of
Position 97-2 to Arrangements that Include the Right to Use
Software Stored on Another Entitys Hardwareto
our on-line software subscription services.

We license our software products on a one and
two-year subscription basis or on a perpetual basis. Our
two-year subscription licenses include the first year of
maintenance and support. Our on-line subscription arrangements
require customers to pay a fixed fee and receive service over a
period of time, generally one or two years. Customers do not pay
setup fees. We recognize revenue from the sale of software
licenses when persuasive evidence of an arrangement exists, the
product has been delivered, the fee is fixed or determinable and
collection of the resulting receivable is reasonably assured.
For all sales, except those completed over the

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Internet, we use either a binding purchase order
or signed license agreement as evidence of an arrangement. For
sales over the Internet, we use a credit card authorization as
evidence of an arrangement. Sales through our distributors are
evidenced by a master agreement governing the relationship
together with binding purchase orders on a transaction by
transaction basis.


Delivery generally occurs when product is
delivered to a common carrier or upon delivery of the license
key which is delivered primarily through e-mail. At the time of
the transaction, we assess whether the fee associated with our
revenue transactions is fixed or determinable and whether or not
collection is reasonably assured. We assess whether the fee is
fixed or determinable based on the payment terms associated with
the transaction. If a significant portion of a fee is due after
our normal payment terms, which are 30 to 90 days from
invoice date, we account for the fee as not being fixed or
determinable. In these cases, we recognize revenue as the fees
become due. We assess collection based on a number of factors,
including past transaction history and credit-worthiness of
direct customers. We do not request collateral from our
customers. If we determine that collection of a fee is not
reasonably assured, we defer the fee and recognize revenue at
the time collection becomes reasonably assured, which is
generally upon receipt of cash. For indirect customers, we
monitor the financial condition and ability to pay for goods
sold. If we do not identify potential collection problems with
our indirect customers on a timely basis, we could incur a
charge for bad debt that could be material to our consolidated
financial statements.

For arrangements with multiple obligations (for
example, undelivered maintenance and support), we allocate
revenue to each component of the arrangement using the residual
value method based on the fair value of the undelivered
elements, which is specific to our company. This means that we
defer revenue from the arrangement fee equivalent to the fair
value of the undelivered elements. Fair values for the ongoing
maintenance and support obligations for both our two-year time
based licenses and perpetual licenses are based upon separate
sales of renewals to other customers or upon renewal rates
quoted in the contracts. This assessment generally includes
analyses of the variability of renewal rates by product and
region and determination of whether a majority of renewals
supports our estimated fair value of the maintenance and support
obligations. In cases where renewal rates are not quoted in the
initial sales contracts, our assessment is critical because if
an estimated fair value cannot be established through separate
sales then the fee for the entire arrangement (e.g. delivered
software and undelivered maintenance and support obligations) is
deferred until delivery occurs which for maintenance would be
ratably over the service period. Fair value of services, such as
training or consulting, is based upon separate sales by us of
these services to other customers. Our arrangements do not
generally include acceptance clauses. However, if an arrangement
includes a specified acceptance provision, recognition occurs
upon the earlier of receipt of a written customer acceptance or
expiration of the acceptance period.

We recognize revenue for maintenance services
ratably over the contract term. Our training and consulting
services are billed based on hourly rates, and we generally
recognize revenue as these services are performed. However, at
the time of entering into a transaction, we assess whether or
not any services included within the arrangement require us to
perform significant work either to alter the underlying software
or to build additional complex interfaces so that the software
performs as the customer requests. If these services are
included as part of an arrangement, we recognize the entire fee
using the percentage of completion method. We estimate the
percentage of completion based on our estimate of the total
costs estimated to complete the project as a percentage of the
costs incurred to date and the estimated costs to complete.

Estimation of Sales Returns and Other
Allowances, Allowance for Doubtful Accounts, Restructuring
Accrual and Litigation

Sales Returns and Other Allowances.In each accounting period, our
management must make judgments and estimates of potential future
product returns related to current period product revenue. We
analyze and monitor current and historical return rates, current
economic trends, and changes in customer demand and acceptance
of our products when evaluating the adequacy of the sales
returns and other allowances. We also budget for our sales
incentives each quarter and determine amounts to be spent and we
monitor amounts spent against our budgets. These estimates
affect our net revenue line item on our statement

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of income and affect our net accounts receivable
line item on our consolidated balance sheet. These estimates
affect all of our operating geographies.


If our sales returns experience were to increase
by an additional 1% of license revenues, our allowance for sales
returns at December 31, 2003 would increase and net revenue
for 2003 would decrease by approximately $3.4 million.

Allowance for Doubtful Accounts.We also make estimates of the
uncollectibility of our accounts receivables. Management
specifically analyzes accounts receivable balances, current and
historical bad debt trends, customer concentrations, customer
credit-worthiness, current economic trends and changes in our
customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. We specifically reserve for any
account receivable for which there are identified collection
issues. Bad debts have historically been approximately 2% of our
average accounts receivable. These estimates affect the
provision for doubtful accounts line item on our statement of
income and the net accounts receivable line item on the
consolidated balance sheet. The estimation of uncollectible
accounts affects all of our operating geographies.

|                                                |  |               |      |              |  |   |      | 
|----------------------------------------------- |  | ------------- | ---- | ------------ |  | - | ---- | 
|                                                |  | December 31,  |      | December 31,
|                                                |  | 2003          |      | 2002        
|                                                |  |               |      |             
|                                                |  |              
|                                                |  | (In millions)
|Allowance for sales return                      |  | $             | 9.1  |              |  | $ | 6.7  | 
|Allowance for sales incentives                  |  |               | 30.5 |              |  |   | 25.6 | 
|                                                |  |               |      |              |  |   |      | 
|Total allowance for sales return and incentives |  |               | 39.6 |              |  |   | 32.3 | 
|                                                |  |               |      |              |  |   |      | 
|Allowance for doubtful accounts                 |  |               | 3.1  |              |  |   | 6.7  | 
|                                                |  |               |      |              |  |   |      | 
|Total allowance                                 |  | $             | 42.7 |              |  | $ | 39.0 | 
|                                                |  |               |      |              |  |   |      | 

At December 31, 2003, our accounts
receivable balance, excluding Magic accounts receivable, was
$170.2 million, net of allowance for doubtful accounts of
$2.9 million. Our total allowance for doubtful accounts,
including allowance related to Magic accounts receivable,
amounts to $3.1 million and our total allowance for sales
return and incentives amounts to $39.6 million. Our
accounts receivable balance was $160.2 million, net of
allowance for doubtful accounts of $6.6 million and
provision for sales returns and other allowances of
$32.3 million as of December 31, 2002. If an
additional 1% of our gross accounts receivable were deemed to be
uncollectible at December 31, 2003, our allowance for
doubtful accounts and provision for bad debt expense would
increase by approximately $2.4 million.

Restructuring Accrual.As part of a consolidation of
activities into our Plano, Texas facility from our headquarters
in Santa Clara, California, we recorded a restructuring charge
of $15.8 million in the first quarter of 2003. We recorded
this facility restructuring charge in accordance with Statement
of Financial Accounting Standard No. 146,
Accounting for Exit Costs Associated With Exit or
Disposal Activities (SFAS 146). In order
to determine our restructuring charge and corresponding
liability, SFAS 146 required us to make a number of assumptions.
These assumptions included estimated sublease income over the
remaining lease period, estimated term of subleases, estimated
utility and real estate broker fees, as well as estimated
discount rates for use in calculating the present value of our
liability. We developed these assumptions based on our
understanding of the current real estate market in Santa Clara
as well as current market interest rates. The assumptions used
are our managements best estimate at the time of the
accrual, and adjustments are made on a periodic basis if better
information is obtained. If, at December 31, 2003, our
estimated sublease income were to decrease 10%, the
restructuring reserve and related expense would have increased
by approximately $0.5 million.

The estimates regarding our restructuring accrual
affect our current liabilities and other long term liabilities
line items in our consolidated balance sheet, since this
liability will be settled each year through 2013. The estimate
affects our statement of income in the restructuring line item.
At December 31, 2003, our North American operating
geography was the only geography affected by this estimate.

Litigation.Managements current estimated
range of liability related to litigation that is brought against
us from time to time is based on claims for which our management
can estimate the amount and range of loss. We recorded the
minimum estimated liability related to those claims, where there
is a range of loss as there is

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no better point of estimate. Because of the
uncertainties related to an unfavorable outcome of litigation,
and the amount and range of loss on pending litigation,
management is often unable to make a reasonable estimate of the
liability that could result from an unfavorable outcome. As
litigation progresses, we continue to assess our potential
liability and revise our estimates. Such revisions in our
estimates could materially impact our results of operations and
financial position. Estimates of litigation liability affect our
accrued liability line item on our consolidated balance sheet
and our general and administrative expense line item on our
statement of income.




| |                            
| | ---------------------------
| | Accounting for Income Taxes

As part of the process of preparing our
consolidated financial statements we are required to estimate
our income taxes in each of the jurisdictions in which we
operate. This process involves estimating our actual current tax
exposure together with assessing temporary differences resulting
from differing treatment of items, such as deferred revenue, for
tax and accounting purposes. These differences result in
deferred tax assets and liabilities, which are included within
our consolidated balance sheet. We must then assess and make
significant estimates regarding the likelihood that our deferred
tax assets will be recovered from future taxable income and to
the extent we believe that recovery is not likely, we must
establish a valuation allowance. To the extent we establish a
valuation allowance or increase this allowance in a period, we
must include an expense within the tax provision in the
statement of income. Estimates related to income taxes affect
the deferred tax asset and liability line items and accrued
liabilities in our consolidated balance sheet and our income tax
(benefit) expense line item in our statement of income. Income
tax estimates affect all of our operating geographies.

The net deferred tax asset as of
December 31, 2003 is $359.7 million, net of a
valuation allowance of $88.3 million due to uncertainties
related to our ability to utilize some of our deferred tax
assets, primarily consisting of certain net operating losses
carried forward and foreign tax credits, before they expire. The
valuation allowance is based on our historical and estimates of
taxable income by jurisdiction in which we operate and the
period over which our deferred tax assets will be recoverable.
In the event that actual results differ from these estimates or
we adjust these estimates in future periods we may need to
establish an additional valuation allowance which could
materially impact our financial position and results of
operations.

Tax returns are subject to audit by various
taxing authorities. Although we believe that adequate accruals
have been made for unsettled issues, additional gains or losses
could occur in future years from resolution of outstanding
matters. We continue to assess our potential tax liability
included in accrued taxes in the consolidated financial
statements, and revise our estimates. Such revisions in our
estimates could materially impact our results of operations and
financial position.



| |                                                              
| | -------------------------------------------------------------
| | Valuation of Goodwill, Intangibles, and
    Long-lived Assets

We account for goodwill and other
indefinite-lived intangible assets in accordance with SFAS 142,
Goodwill and Other Intangible Assets
(SFAS 142). SFAS 142 requires, among other things,
the discontinuance of amortization for goodwill and
indefinite-lived intangibles and at least an annual test for
impairment. An impairment review may be performed more
frequently in the event circumstances indicate that the carrying
value may not be recoverable. The goodwill impairment review
involves a two-step process as described in note 2 to the
consolidated financial statements.

We are required to make estimates regarding the
fair value of our reporting units when testing for potential
impairment. We estimate the fair value of our reporting units
using a combination of the income approach and the market
approach. Under the income approach, we calculate the fair value
of a reporting unit based on the present value of estimated
future cash flows. Under the market approach, we estimate the
fair value based on market multiples of revenues or earnings for
comparable companies. We estimate cash flows for these purposes
using internal budgets based on recent and historical trends. We
base these estimates on assumptions we believe to be reasonable,
but which are unpredictable and inherently uncertain. We also
make certain judgments about the selection of comparable
companies used in the market approach in valuing our reporting
units, as well as certain assumptions to allocate shared assets
and liabilities to calculate the carrying

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value for each of our reporting units. If an
impairment were present, these estimates would affect an
impairment line item on our consolidated statement of income and
would affect the goodwill and/or intangible line items in our
consolidated balance sheet. As goodwill is allocated to all of
our reporting units, any impairment could potentially affect
each operating geography.


Based on our current impairment test, there would
have to be a significant change in assumptions used in such
calculation in order for an impairment to occur as of
December 31, 2003.

We account for finite-lived intangibles and
long-lived assets in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets.Under this standard we will record an
impairment charge on finite-lived intangibles or long-lived
assets to be held and used when we determine that the carrying
value of intangibles and long-lived assets may not be
recoverable.

Based upon the existence of one or more
indicators of impairment, we measure any impairment of
intangibles or long-lived assets based on a projected discounted
cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our
current business model. Our estimates of cash flows require
significant judgment based on our historical results and
anticipated results and are subject to many of the factors,
noted below as triggering factors, which may change in the near
term.

Factors considered important, which could trigger
an impairment review include, but are not limited to:



| |   |                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------
| |  | significant under performance relative to
    expected historical or projected future operating results;         
|
| |  | significant changes in the manner of our use of
    the acquired assets or the strategy for our overall business;
|
| |  | significant negative industry or economic trends;                                                                
|
| |  | significant declines in our stock price for a
    sustained period; and                                          
|
| |  | our market capitalization relative to net book
    value.                                                        

Goodwill amounted to $443.6 million,
excluding $9.8 million related to Magic, and
$273.9 million as of December 31, 2003 and 2002,
respectively. We did not hold any indefinite-lived intangibles
as of December 31, 2003 or 2002. Net finite-lived
intangible assets and long-lived assets amounted to $217.6
million and $182.8 million as of December 31, 2003 and
2002, respectively.

Previous Restatement of Consolidated Financial
Statements

This Managements Discussion and Analysis of
Financial Condition and Results of Operations gives effect to
the restatement of our consolidated financial statements for
1998 through 2001 and should be read in conjunction with the
consolidated financial statements contained in our 2002
Form 10-K (2000 through 2002) and Amendment No. 2 to
our 2000 Form 10-K/ A (1998 through 2000), including in
each case, the related notes and, in particular, note 3
describing the restatement. Among others, the more significant
categories of restatement adjustments were recorded:



| |   |                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to properly reflect sales to our distributors and
    resellers on the sell-through basis for 1998 through 2000, which
    is how we have accounted for these sales since 2001; and  
|
| |  | to correct certain errors previously made in the
    application of the revenue recognition principles under SOP 97-2
    to multi-element revenue transactions in 1998 through 2000.

We have determined that, excluding the effect of
currency-related adjustments, the aggregate amount of net
revenue was not reduced as a result of our change to the
sell-through revenue recognition method for years prior to 2001
or adjustments related to multi-element licensing arrangements
in 1998 through 2000. These adjustments had the effect of
deferring revenue from earlier periods to be recognized in later
periods, with amounts deferred in connection with our
multi-element licensing arrangements generally being recognized
in later periods as service and support revenue. In the
aggregate, for 2003, 2002 and 2001, the restatement adjustments
had the effect of increasing net revenues by $5.7 million,
$101.2 million and $259.2 million, respectively, and
decreasing expenses by $13.6 million in 2003, and
increasing expenses in 2002 and 2001 by

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$63.1 million and $75.3 million,
respectively. In addition, net revenue in 2004 is expected to be
increased by approximately $0.3 million as a result of the
restatement.


Results of Operations



| |                                                  
| | -------------------------------------------------
| | Years Ended December 31, 2003, 2002,
    and 2001



| |            
| | -----------
| | Net Revenue

The following table sets forth for the periods
indicated our product revenue and services and support revenue
as a percent of net revenue (in thousands, except percentages):

|                  |                      |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |    |  
|----------------- | -------------------- | ---------------------------------- | ------- | ------------- |  | ---- | --------- | ------- |  | ---- | --------- | ------- |  |  | --- | -- | - |  | --- | -- | - |  | --- | -- | -
|                  |                      |                                    |         |               |  |      |           |        
|                  |                      |                                    |         | Percentage of
|                  |                      | For the Year Ended December 31,    |         | Net Revenue  
|                  |                      |                                    |         |              
|                  |                      | 2003                               |         | 2002          |  | 2001 |           | 2003    |  | 2002 |           | 2001   
|                  |                      |                                    |         |               |  |      |           |         |  |      |           |        
|                  |                      |                                   
|                  |                      | (In thousands, except percentages)
|Net revenue:      |                      |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |   
|                  | Product              |                                    | $       | 513,610       |  |      | $         | 631,550 |  |      | $         | 611,030 |  |  |     | 55 | % |  |     | 61 | % |  |     | 57 | %
|                  | Services and support |                                    |         | 422,726       |  |      |           | 411,494 |  |      |           | 460,630 |  |  |     | 45 |   |  |     | 39 |   |  |     | 43 |  
|                  |                      |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |   
|Total net revenue |                      | $                                  | 936,336 |               |  | $    | 1,043,044 |         |  | $    | 1,071,660 |         |  |  | 100 | %  |   |  | 100 | %  |   |  | 100 | % 
|                  |                      |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |   

Net revenue decreased 10% or $106.7 million
from 2002 to 2003 and decreased 3% or $28.6 million in 2002
from 2001. The overall decline in each period is due primarily
from weaknesses in the United States and other economies and
continued reductions in corporate spending. Many of our
customers and potential customers have: (i) delayed
initiating the purchase process; (ii) increased the evaluation
time to complete a purchase or postponed, sometimes
indefinitely, full IT deployments; and/or (iii) reduced
their capital expenditure budgets, thereby restricting their
software/services purchases to those believed by them to be
necessary to satisfy an immediate need. Net revenue for 2003
includes approximately $63.2 million of Magic revenue. We
sold our Magic business in January 2004.

In the first quarter of 2004, we will expand our
perpetual plus licensing arrangements to the United
States. Under these arrangements, introduced in Europe and Asia
earlier in 2003, we provide a perpetual license coupled with
additional support, with a higher percentage of the contract
value allocated to support revenues. As a result of these
arrangements, we expect (i) an increase in the amount of
services and support revenue relative to product revenue as a
result of higher renewal rates and (ii) because support
revenues are deferred and recognized over the life of the
arrangement, an increased amount of revenue being deferred to
future periods. Deferred revenue increased 21% to
$481.6 million which includes $22.0 million of
deferred revenue related to Magic, at December 31, 2003
from $397.2 million at September 30, 2003 and has
increased $152.4 million from December 31, 2002.



| |                         
| | ------------------------
| | Net Revenue by Geography

The following table sets forth for the periods
indicated net revenue, in each of the five geographic regions in
which we operate:

|                  |               |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |    |  
|----------------- | ------------- | ---------------------------------- | ------- | ------------- |  | ---- | --------- | ------- |  | ---- | --------- | ------- |  |  | --- | -- | - |  | --- | -- | - |  | --- | -- | -
|                  |               |                                    |         |               |  |      |           |        
|                  |               |                                    |         | Percentage of
|                  |               | For the Year Ended December 31,    |         | Net Revenue  
|                  |               |                                    |         |              
|                  |               | 2003                               |         | 2002          |  | 2001 |           | 2003    |  | 2002 |           | 2001   
|                  |               |                                    |         |               |  |      |           |         |  |      |           |        
|                  |               |                                   
|                  |               | (In thousands, except percentages)
|Net revenue:      |               |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |   
|                  | North America |                                    | $       | 606,685       |  |      | $         | 653,532 |  |      | $         | 696,136 |  |  |     | 65 | % |  |     | 63 | % |  |     | 65 | %
|                  | EMEA          |                                    |         | 240,616       |  |      |           | 298,659 |  |      |           | 292,663 |  |  |     | 26 |   |  |     | 28 |   |  |     | 26 |  
|                  | Japan         |                                    |         | 40,519        |  |      |           | 39,369  |  |      |           | 28,919  |  |  |     | 4  |   |  |     | 4  |   |  |     | 3  |  
|                  | Asia-Pacific  |                                    |         | 29,014        |  |      |           | 33,595  |  |      |           | 37,606  |  |  |     | 3  |   |  |     | 3  |   |  |     | 4  |  
|                  | Latin America |                                    |         | 19,502        |  |      |           | 17,889  |  |      |           | 16,336  |  |  |     | 2  |   |  |     | 2  |   |  |     | 2  |  
|                  |               |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |   
|Total net revenue |               | $                                  | 936,336 |               |  | $    | 1,043,044 |         |  | $    | 1,071,660 |         |  |  | 100 | %  |   |  | 100 | %  |   |  | 100 | % 
|                  |               |                                    |         |               |  |      |           |         |  |      |           |         |  |  |     |    |   |  |     |    |   |  |     |   

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Net revenue outside of North America (United
States and Canada) accounted for approximately 35%, 37% and 35%
of net revenue for 2003, 2002 and 2001. In the previous
three years, net revenue from North America and EMEA has
comprised approximately 90% of our business. In 2003, we saw a
weakening of the U.S. dollar against many currencies, but
most dramatically against the Euro and Great Britain Pound. As a
result of the weakening U.S. dollar, we experienced positive
impacts on our net revenue in EMEA region.

In 2003, total net revenue in North America
decreased 7% or $46.8 million as compared to 2002 and
decreased 6% or $42.6 million from 2001 to 2002. The
decrease in revenue is due to the overall economic downturn that
has been experienced in the past three years in the United
States as well as a softness in corporate spending.

In EMEA, total net revenue decreased 19% or
$58.0 million from 2003 to 2002. In 2002, EMEA net revenue
remained relatively flat, increasing 2% or $6.0 million
from 2001. As in North America, the European economies have been
subject to a prolonged economic downturn resulting in companies
temporarily or permanently delaying technology expenditures.
Also, in the middle of 2003, we introduced our new perpetual
plus licensing model in Europe with a larger portion of total
contract values being deferred into later years.

Our Japan, Latin America and Asia-Pacific
operations combined have historically been approximately 9% of
our total business, and we expect this trend to continue.

Risks inherent in international revenue include
the impact of longer payment cycles, greater difficulty in
accounts receivable collection, unexpected changes in regulatory
requirements, seasonality due to the slowdown in European
business activity during the third quarter, tariffs and other
trade barriers, currency fluctuations and difficulties staffing
and managing foreign operations. These factors may have a
material adverse effect on our future international revenue.



| |                
| | ---------------
| | Product Revenue

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

|                           |                       |                                    |         |                 |  |      |         |         |  |      |         |         |  |  |    |     |   |  |    |     |   |  |    |     |  
|-------------------------- | --------------------- | ---------------------------------- | ------- | --------------- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  |  | -- | --- | - |  | -- | --- | - |  | -- | --- | -
|                           |                       |                                    |         |                 |  |      |         |        
|                           |                       |                                    |         | Percentage of  
|                           |                       | For the Year Ended December 31,    |         | Product Revenue
|                           |                       |                                    |         |                
|                           |                       | 2003                               |         | 2002            |  | 2001 |         | 2003    |  | 2002 |         | 2001   
|                           |                       |                                    |         |                 |  |      |         |         |  |      |         |        
|                           |                       |                                   
|                           |                       | (In thousands, except percentages)
|Term subscription licenses |                       | $                                  | 113,696 |                 |  | $    | 181,825 |         |  | $    | 197,044 |         |  |  | 23 | %   |   |  | 29 | %   |   |  | 32 | %  
|Perpetual licenses         |                       |                                    | 227,492 |                 |  |      | 277,882 |         |  |      | 183,309 |         |  |  | 44 | %   |   |  | 44 | %   |   |  | 30 | %  
|Hardware                   |                       |                                    | 99,502  |                 |  |      | 93,359  |         |  |      | 87,932  |         |  |  | 19 | %   |   |  | 15 | %   |   |  | 14 | %  
|Retail                     |                       |                                    | 45,993  |                 |  |      | 63,236  |         |  |      | 127,453 |         |  |  | 9  | %   |   |  | 10 | %   |   |  | 21 | %  
|Other                      |                       |                                    | 26,927  |                 |  |      | 15,248  |         |  |      | 15,292  |         |  |  | 5  | %   |   |  | 2  | %   |   |  | 3  | %  
|                           |                       |                                    |         |                 |  |      |         |         |  |      |         |         |  |  |    |     |   |  |    |     |   |  |    |    
|                           | Total product revenue |                                    | $       | 513,610         |  |      | $       | 631,550 |  |      | $       | 611,030 |  |  |    | 100 | % |  |    | 100 | % |  |    | 100 | %
|                           |                       |                                    |         |                 |  |      |         |         |  |      |         |         |  |  |    |     |   |  |    |     |   |  |    |    

Product revenue includes revenue from software
licenses, hardware, our retail product and royalties. The
$117.9 million, or 19%, decrease in product revenue from
2002 to 2003 is due to (i) the introduction of our
perpetual plus licensing arrangements in EMEA and Asia-Pacific
resulting in reduced product revenues and increased services and
support revenues, (ii) continued softness in corporate
spending over the past three years and (iii) the shift of
our focus on the retail boxed product to our on-line
subscription model for consumers and small and medium sized
businesses. Product revenue from 2001 to 2002 remained
relatively flat.

Retail revenue in 2001 and 2002 includes
approximately $72 million and $20 million of revenue
deferred from prior years as part of our financial restatement.
During 1998 through 2000 we did not properly establish VSOE on
the sales of certain retail products. We generally expect a
decline in our retail boxed products revenue as we continue to
shift our focus to our on-line subscription services (with the
related revenues categorized in services and support revenue
below).

Our customers license our software on a perpetual
or term subscription basis depending on their preference. We
expect perpetual licenses to become a larger percentage of
product revenue in the future as we

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implement our perpetual plus licensing model. We
expect the remaining mix of product revenue to remain relatively
consistent as a percentage of revenue.




| |                             
| | ----------------------------
| | Services and Support Revenue

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

|                                  |                                    |                                    |         |                        |  |      |         |         |  |      |         |         |  |  |    |     |   |  |    |     |   |  |    |     |  
|--------------------------------- | ---------------------------------- | ---------------------------------- | ------- | ---------------------- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  |  | -- | --- | - |  | -- | --- | - |  | -- | --- | -
|                                  |                                    |                                    |         |                        |  |      |         |        
|                                  |                                    |                                    |         | Percentage of Services
|                                  |                                    | For the Year Ended December 31,    |         | and Support Revenue   
|                                  |                                    |                                    |         |                       
|                                  |                                    | 2003                               |         | 2002                   |  | 2001 |         | 2003    |  | 2002 |         | 2001   
|                                  |                                    |                                    |         |                        |  |      |         |         |  |      |         |        
|                                  |                                    |                                   
|                                  |                                    | (In thousands, except percentages)
|Support and maintenance           |                                    | $                                  | 313,731 |                        |  | $    | 310,473 |         |  | $    | 359,403 |         |  |  | 74 | %   |   |  | 75 | %   |   |  | 78 | %  
|Consulting                        |                                    |                                    | 27,421  |                        |  |      | 36,740  |         |  |      | 41,276  |         |  |  | 7  | %   |   |  | 9  | %   |   |  | 9  | %  
|Training                          |                                    |                                    | 9,486   |                        |  |      | 12,527  |         |  |      | 19,161  |         |  |  | 2  | %   |   |  | 3  | %   |   |  | 4  | %  
|On-line subscription arrangements |                                    |                                    | 72,088  |                        |  |      | 51,754  |         |  |      | 40,790  |         |  |  | 17 | %   |   |  | 13 | %   |   |  | 9  | %  
|                                  |                                    |                                    |         |                        |  |      |         |         |  |      |         |         |  |  |    |     |   |  |    |     |   |  |    |    
|                                  | Total services and support revenue |                                    | $       | 422,726                |  |      | $       | 411,494 |  |      | $       | 460,630 |  |  |    | 100 | % |  |    | 100 | % |  |    | 100 | %
|                                  |                                    |                                    |         |                        |  |      |         |         |  |      |         |         |  |  |    |     |   |  |    |     |   |  |    |    

Services and support revenues include revenues
from software support and maintenance contracts, consulting,
training and on-line subscription arrangements. The
$11.2 million, or 3%, increase in service and support
revenue is due to a $20.3 million increase in our on-line
subscription (McAfee.com and McAfee ASaP) arrangements, offset
by decreases in consulting and training revenues totaling
$12.4 million. The increase in our on-line subscription
arrangements is due to an increase in our customer base to
approximately 3.7 million subscribers at the end of 2003, as
well as an increase in our McAfee ASaP on-line service for
small-to-medium sized businesses. We saw decreases in our
consulting and training revenues in each year because our
customers typically first reduce consulting and training budgets
when reducing overall IT costs and projects.

In 2001, $100.4 million more of service and
support revenue was recognized as compared to 2002 due to our
restatement and the deferral of services and support revenue
from 1998 through 2000 with respect to multi-element revenue
contracts. Excluding this difference, service and support
revenue increased by $51.5 million, reflecting growth of
our installed customer base, an overall increase in maintenance
pricing year over year and an $11.0 million increase in
on-line subscription revenue generated primarily by our
McAfee.com consumer site.

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

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| |                                      
| | -------------------------------------
| | Cost of Net Revenue; Gross
    Margin

|                          |                                      |                                    |         |                       |  |      |         |         |  |      |         |         |  |  |     |    |   |  |     |    |   |  |     |    |  
|------------------------- | ------------------------------------ | ---------------------------------- | ------- | --------------------- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  |  | --- | -- | - |  | --- | -- | - |  | --- | -- | -
|                          |                                      |                                    |         |                       |  |      |         |        
|                          |                                      |                                    |         | Percentage of Cost of
|                          |                                      | For the Year Ended December 31,    |         | Net Revenue          
|                          |                                      |                                    |         |                      
|                          |                                      | 2003                               |         | 2002                  |  | 2001 |         | 2003    |  | 2002 |         | 2001   
|                          |                                      |                                    |         |                       |  |      |         |         |  |      |         |        
|                          |                                      |                                   
|                          |                                      | (In thousands, except percentages)
|Cost of net revenue:      |                                      |                                    |         |                       |  |      |         |         |  |      |         |         |  |  |     |    |   |  |     |    |   |  |     |   
|                          | Product                              |                                    | $       | 86,646                |  |      | $       | 104,039 |  |      | $       | 114,917 |  |  |     | 58 | % |  |     | 63 | % |  |     | 65 | %
|                          | Services and support                 |                                    |         | 51,611                |  |      |         | 57,519  |  |      |         | 56,536  |  |  |     | 34 |   |  |     | 35 |   |  |     | 32 |  
|                          | Amortization of purchased technology |                                    |         | 11,369                |  |      |         | 3,153   |  |      |         | 5,039   |  |  |     | 8  |   |  |     | 2  |   |  |     | 3  |  
|                          |                                      |                                    |         |                       |  |      |         |         |  |      |         |         |  |  |     |    |   |  |     |    |   |  |     |   
|Total cost of net revenue |                                      | $                                  | 149,626 |                       |  | $    | 164,711 |         |  | $    | 176,492 |         |  |  | 100 | %  |   |  | 100 | %  |   |  | 100 | % 
|                          |                                      |                                    |         |                       |  |      |         |         |  |      |         |         |  |  |     |    |   |  |     |    |   |  |     |   
|Gross margin              |                                      | $                                  | 786,710 |                       |  | $    | 878,333 |         |  | $    | 895,168 |         |  |  |     |    |   |  |     |    |   |  |     |   
|                          |                                      |                                    |         |                       |  |      |         |         |  |      |         |         |  |  |     |    |   |  |     |    |   |  |     |   
|Gross margin percentage   |                                      |                                    | 84      | %                     |  |      | 84      | %       |  |      | 84      | %       |  |  |     |    |   |  |     |    |   |  |     |   

Our total cost of net revenue decreased
$15.1 million, or 9% due primarily to our 10% decrease in
net revenue from 2002 to 2003. The decrease of $11.8 million, or
7% from 2001 to 2002 was also as a result of lower revenues in
the same period.

Cost of Product
Revenue.Our cost of product revenue
consists primarily of the cost of media, manuals and packaging
for products distributed through traditional channels;
royalties; and, with respect to hardware-based anti-virus
products and network fault and performance products, computer
platforms and other hardware components. The decrease from 63%
to 58% in the cost of product revenue as a percentage of total
cost of net revenue from 2002 to 2003 is due to lower costs of
computer platforms and other hardware components as at the end
of 2002 we began using a more competitive contract manufacturer
which also utilized a greater number of standardized computer
platforms and hardware components. We also benefited from the
favorable impact of cost control measures. Cost of product
revenue as a percentage of total cost of net revenue remained
relatively flat between 2002 and 2001. We anticipate that cost
of product revenue will continue to fluctuate as a percent of
cost of net revenue.

Cost of Services and Support.Cost of services and support revenue
consists principally of salaries and benefits related to
employees providing customer support and consulting services.
Services and support as a percentage of cost of net revenue
remained relatively flat at 34% to 35% in 2003 and 2002, and
increased to 35% from 32% in 2001. The increase from 2001 to
2002 was due almost exclusively to additional technical support
and customer service personnel hired during 2001 to meet our
customers technical support needs. We anticipate that cost
of service revenue will continue to fluctuate as a percent of
cost of net revenue.

Amortization of Purchased
Technology.Amortization of purchased
technology increased, $8.2 million or 261%, from 2002 to
2003. The increase is due to our acquisitions of Entercept and
IntruVert, in respect of which we recorded purchased technology
of $21.7 million and $18.2 million, respectively. The
purchased technology is being amortized over its estimated
useful life of seven years. Amortization of purchased technology
is expected to be $12.5 million in 2004.

Gross Margins.Our
gross margins were stable at 84% from 2001 to 2003. The increase
of amortization of purchased technology in 2003 as a percentage
of cost of net revenue to 8% offset the improvement we
experienced in our cost of product revenues from 2003 to 2002.



| |                
| | ---------------
| | Operating Costs

Set forth below for the indicated periods are our
operating costs, including and excluding stock-based
compensation. Our management believes that a presentation of
operating costs excluding stock-based compensation provides
investors a meaningful basis of evaluating our underlying cost
and expense levels. The size and amount of our stock based
compensation charges has varied, and in the future will vary,
from period

39



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to period based on movements in our stock price,
making period to period comparisons difficult and, in some
cases, not meaningful. See Stock-Based Compensation
below.


Including Stock-Based Compensation:

|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |         |  |  |    |    |   |  |    |    |   |  |    |    |  
|----------------------------------------------------------- | ---------------------------------------------------------------------------- | ---------------------------------- | ------- | ------------- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  |  | -- | -- | - |  | -- | -- | - |  | -- | -- | -
|                                                            |                                                                              |                                    |         |               |  |      |         |        
|                                                            |                                                                              |                                    |         | Percentage of
|                                                            |                                                                              | For the Year Ended December 31,    |         | Net Revenue  
|                                                            |                                                                              |                                    |         |              
|                                                            |                                                                              | 2003                               |         | 2002          |  | 2001 |         | 2003    |  | 2002 |         | 2001   
|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |        
|                                                            |                                                                              |                                   
|                                                            |                                                                              | (In thousands, except percentages)
|Research and development                                    |                                                                              | $                                  | 184,606 |               |  | $    | 148,801 |         |  | $    | 146,701 |         |  |  | 20 | %  |   |  | 14 | %  |   |  | 14 | % 
|Marketing and sales                                         |                                                                              |                                    | 363,306 |               |  |      | 397,747 |         |  |      | 421,583 |         |  |  | 39 |    |   |  | 38 |    |   |  | 39 |   
|General and administrative                                  |                                                                              |                                    | 129,920 |               |  |      | 119,393 |         |  |      | 111,106 |         |  |  | 14 |    |   |  | 11 |    |   |  | 10 |   
|Provision for (recovery from) doubtful accounts             |                                                                              |                                    | (1,216  | )             |  |      | (219    | )       |  |      | 7,449   |         |  |  |   |    |   |  |   |    |   |  | 1  |   
|Litigation settlement                                       |                                                                              |                                    |        |               |  |      | 70,000  |         |  |      |        |         |  |  |   |    |   |  | 7  |    |   |  |   |   
|Amortization of intangibles                                 |                                                                              |                                    | 15,637  |               |  |      | 10,742  |         |  |      | 51,025  |         |  |  | 2  |    |   |  | 1  |    |   |  | 5  |   
|Acquisition related costs not subject to
    capitalization |                                                                              |                                    |        |               |  |      | 16,026  |         |  |      |        |         |  |  |   |    |   |  | 2  |    |   |  |   |   
|Restructuring charges                                       |                                                                              |                                    | 22,204  |               |  |      | 1,116   |         |  |      | 3,821   |         |  |  | 2  |    |   |  |   |    |   |  |   |   
|In-process research and development                         |                                                                              |                                    | 6,600   |               |  |      |        |         |  |      |        |         |  |  |   |    |   |  |   |    |   |  |   |   
|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |         |  |  |    |    |   |  |    |    |   |  |    |   
|                                                            | Total operating costs, including the effects of
    stock-based compensation |                                    | $       | 721,057       |  |      | $       | 763,606 |  |      | $       | 741,685 |  |  |    | 77 | % |  |    | 73 | % |  |    | 69 | %
|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |         |  |  |    |    |   |  |    |    |   |  |    |   

Excluding Stock-Based Compensation:

|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |         |  |  |    |    |   |  |    |    |   |  |    |    |  
|----------------------------------------------------------- | ---------------------------------------------------------------------------- | ---------------------------------- | ------- | ------------- |  | ---- | ------- | ------- |  | ---- | ------- | ------- |  |  | -- | -- | - |  | -- | -- | - |  | -- | -- | -
|                                                            |                                                                              |                                    |         |               |  |      |         |        
|                                                            |                                                                              |                                    |         | Percentage of
|                                                            |                                                                              | For the Year Ended December 31,    |         | Net Revenue  
|                                                            |                                                                              |                                    |         |              
|                                                            |                                                                              | 2003                               |         | 2002          |  | 2001 |         | 2003    |  | 2002 |         | 2001   
|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |        
|                                                            |                                                                              |                                   
|                                                            |                                                                              | (In thousands, except percentages)
|Research and development(1)                                 |                                                                              | $                                  | 179,449 |               |  | $    | 144,838 |         |  | $    | 142,097 |         |  |  | 19 | %  |   |  | 14 | %  |   |  | 13 | % 
|Marketing and sales(2)                                      |                                                                              |                                    | 358,241 |               |  |      | 395,767 |         |  |      | 411,229 |         |  |  | 39 |    |   |  | 38 |    |   |  | 39 |   
|General and administrative(3)                               |                                                                              |                                    | 127,635 |               |  |      | 102,932 |         |  |      | 101,712 |         |  |  | 14 |    |   |  | 9  |    |   |  | 9  |   
|Provision for (recovery from) doubtful accounts             |                                                                              |                                    | (1,216  | )             |  |      | (219    | )       |  |      | 7,449   |         |  |  |   |    |   |  |   |    |   |  | 1  |   
|Litigation settlement                                       |                                                                              |                                    |        |               |  |      | 70,000  |         |  |      |        |         |  |  |   |    |   |  | 7  |    |   |  |   |   
|Amortization of intangibles                                 |                                                                              |                                    | 15,637  |               |  |      | 10,742  |         |  |      | 51,025  |         |  |  | 2  |    |   |  | 1  |    |   |  | 5  |   
|Acquisition related costs not subject to
    capitalization |                                                                              |                                    |        |               |  |      | 16,026  |         |  |      |        |         |  |  |   |    |   |  | 2  |    |   |  |   |   
|Restructuring charges(4)                                    |                                                                              |                                    | 22,204  |               |  |      | 1,116   |         |  |      | 3,302   |         |  |  | 2  |    |   |  |   |    |   |  |   |   
|In-process research and development                         |                                                                              |                                    | 6,600   |               |  |      |        |         |  |      |        |         |  |  |   |    |   |  |   |    |   |  |   |   
|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |         |  |  |    |    |   |  |    |    |   |  |    |   
|                                                            | Total operating costs, including the effects of
    stock-based compensation |                                    | $       | 708,550       |  |      | $       | 741,202 |  |      | $       | 716,814 |  |  |    | 76 | % |  |    | 71 | % |  |    | 67 | %
|                                                            |                                                                              |                                    |         |               |  |      |         |         |  |      |         |         |  |  |    |    |   |  |    |    |   |  |    |   



---



|    |                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------
|(1) | Excludes stock-based compensation charge of
    $5,157, $3,963 and $4,604 for 2003, 2002 and 2001, respectively. 
|   
|(2) | Excludes stock-based compensation charge of
    $5,065, $1,980 and $10,354 for 2003, 2002 and 2001, respectively.

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|    |                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------
|(3) | Excludes stock-based compensation charge of
    $2,285, $16,461 and $9,394 for 2003, 2002 and 2001, respectively.
|   
|(4) | Excludes stock-based compensation charge of $0,
    $0 and $519 for 2003, 2002 and 2001, respectively.           

Research and Development.Research and development expenses
consist primarily of salary, benefits, and contractors fees for
our development and technical support staff, and other costs
associated with the enhancements of existing products and
services and development of new products and services. Excluding
the effects of stock-based compensation of $5.2 million and
$4.0 million in 2003 and 2002, respectively, research and
development expenses increased $34.6 million to
$179.4 million. Of this increase: $9.7 million and
$3.2 million, respectively, relates to our acquisitions
IntruVert and Entercept, and our acquisitions Deersoft and
Traxess; $4.6 million relate to the 2003 opening of our
research and development facility in Bangalore, India and
$9.0 million relates to increased McAfee research and
development expenditures; and $8.0 million relates to
higher headcount. We plan to increase our research and
development expenditures in Bangalore, India. Excluding the
effects of stock-based compensation of $4.0 million and
$4.6 million in 2002 and 2001, respectively, research and
development expenses remained relatively flat at
$144.8 million in 2002 versus $142.1 million in 2001.

We believe that continued investment in product
development is critical to attaining our strategic objectives
and, as a result, expect product development expenses to
increase in future periods. We anticipate that research and
development expenses will continue to increase in absolute
dollars, but will continue to fluctuate as a percent of net
revenue.

Marketing and Sales.Marketing and sales expenses consist
primarily of salary, commissions and benefits for marketing and
sales personnel and costs associated with advertising and
promotions. Excluding the effects of stock-based compensation of
$5.1 million and $2.0 million in 2003 and 2002,
respectively, marketing and sales expenses decreased
$37.5 million, or 9% from 2002 to 2003 primarily due to a
corresponding 10% decrease in net revenue from 2003 to 2002. We
also experienced lower sales and marketing expense in 2003 of
approximately (i) $10.6 million due to a reduction of
salary, benefit and commission expenses following a decrease in
headcount of approximately 100 sales personnel,
(ii) $5.7 million from our reduced use of outside
services and other cost saving measures and
(iii) $2.1 million related to travel expense cost
savings measures. As a result of the change in the way we
account for sales commissions, we had lower sales and marketing
expense of approximately $5.0 million. Excluding the effects of
stock-based compensation of $2.0 million and
$10.4 million in 2002 and 2001, respectively, marketing and
sales expenses decreased 4% to $395.8 million in 2002 from
$411.2 million in 2001 primarily due to a decrease in
commissions.

We anticipate that marketing and sales expenses
will increase in absolute dollars, but will continue to
fluctuate as a percentage of net revenue.

General and Administrative.General and administrative expenses
consist principally of salary and benefit costs for executive
and administrative personnel, professional services and other
general corporate activities. Excluding the effects of
stock-based compensation of $2.3 million and $16.5 million
for 2003 and 2002, respectively, general and administrative
expenses increased $24.7 million, or 24%, to
$127.6 million in 2003. The increase is due to costs
incurred in connection with our restatement of $8.8 million
and acquisition related bonuses of $4.0 million. The
acquisition related bonuses are being expensed monthly as the
former IntruVert and Entercept employees provide services to us.
We expect these future acquisition related bonuses to be
approximately $3.4 million in 2004 with an additional
$2.3 million being recognized in total through 2007.

In 2003, our legal expenses increased
approximately $4.6 million in 2003 from 2002 due to an
increase in outside legal services due to our on-going SEC and
DOJ investigations. Our information technology department
expenses increased approximately $6.2 million due to
increases in headcount and depreciation and equipment expense.
We also had a full year of internal audit and four-months of
Sarbanes-Oxley expenses in 2003, resulting in an increase of
approximately $0.8 million and $1.4 million,
respectively, as compared to 2002.

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Excluding the effects of stock-based compensation
of $16.5 million and $9.4 million for 2002 and 2001,
respectively, general and administrative expenses remained
relatively flat at $102.9 million and $101.7 million
for 2002 and 2001.

We expect our general and administrative expenses
to remain generally flat as we implement cost control measures.

Provision for (Recovery from) Doubtful
Accounts, Net.Provision for doubtful
accounts consists of our estimates for the uncollectibility of
receivables, net of recoveries of amounts previously written
off. The recovery for doubtful accounts was $1.2 million
and $0.2 million in 2003 and 2002, respectively. The
provision for doubtful accounts was $7.4 million in 2001.

Litigation Settlement.We agreed to settle a securities class
action litigation in September 2003. The $70.0 million
litigation charge was recorded in 2002 because our agreement to
settle, which established the liability to be probable and
estimable, occurred prior to the publication of our 2002
consolidated financial statements in October 2003. We paid the
$70.0 million settlement in October 2003.

Acquisition Related Costs not Subject to
Capitalization.Acquisition costs not
subject to capitalization consist primarily of expenses incurred
by McAfee.com related to our exchange offer for all outstanding
publicly held shares of McAfee.com class A common stock. As of
December 31, 2002, these charges totaled $16.0 million or
2% of net revenue. No additional costs were incurred.

Amortization of Intangibles.We expensed $15.6 million,
$10.7 million, and $51.0 million of amortization
related to intangibles in 2003, 2002, and 2001, respectively.
Intangibles consist of purchased goodwill, purchased technology
and other identifiable intangible assets. The increase in
amortization of $4.9 million in 2003 is the result of the
acquisition of IntruVert and Entercept in 2003.

The decrease in amortization in 2002 was largely
a result of the implementation of SFAS 142 which requires us to
cease amortizing goodwill and, therefore, we realized a decrease
in the annual amortization of $51.2 million.

Restructuring Costs  2003.In January 2003, as part of a
restructuring effort to gain operational efficiencies, we
consolidated operations formerly housed in three leased
facilities in the Dallas, Texas area into our newly constructed
170,000 square-foot regional headquarters facility in Plano,
Texas. The new facility houses approximately 1,000 employees
working in finance, legal, information technology, and the
customer support and telesales groups servicing the McAfee
System Protection Solutions and McAfee Network Protection
Solutions businesses. We also relocated approximately 170
employees from our Santa Clara, California headquarters.

As a result of this consolidation, in March 2003,
we recorded a restructuring charge of $15.8 million which
consisted of a non-cash charge of $2.1 million related to
asset disposals and discontinued use of certain leasehold
improvements, furniture and equipment; non-cash write off of
$(1.9) million deferred rent liability; and a $15.6 million
accrual for estimated lease related costs associated with
permanently vacated facility in Santa Clara, California. The
remaining costs associated with vacating the Santa Clara
facility are primarily comprised of the present value of
remaining lease obligations, net of estimated sublease income,
along with costs associated with subleasing the vacated facility
and will generally be paid over the remaining lease term ending
in 2013.

During the second and third quarters of 2003, we
recorded a restructuring charge of $6.8 million and
$0.6 million, respectively, which consisted of $6.7 million
related to a headcount reduction of 210 employees and
$0.7 million related to other expenses such as legal
expenses incurred in international locations in conjunction with
the headcount reduction. The employees were located in both our
domestic and international locations and were primarily in the
sales, product development and customer support areas. In the
third and fourth quarters of 2003, we reversed a total of
$1.0 million of restructuring accrual in Europe that was no
longer necessary after paying out substantially all accrued
amounts to the former employees.

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The following table summarizes our restructuring
accrual established in 2003 (in thousands):

|                           |  |             |        |           |  |       |        |       |  |   |      |   |  |   |        |  
|-------------------------- |  | ----------- | ------ | --------- |  | ----- | ------ | ----- |  | - | ---- | - |  | - | ------ | -
|                           |  |             |        | Severance |  |       |        |      
|                           |  | Lease       |        | and       |  |       |        |      
|                           |  | Termination |        | Other     |  | Other |        |      
|                           |  | Costs       |        | Benefits  |  | Costs |        | Total
|                           |  |             |        |           |  |       |        |      
|Balance, January 1, 2003   |  | $           |       |           |  | $     |       |       |  | $ |     |   |  | $ |       |  
|Restructuring accrual      |  |             | 15,734 |           |  |       | 6,692  |       |  |   | 739  |   |  |   | 23,165 |  
|Cash payments              |  |             | (1,707 | )         |  |       | (6,259 | )     |  |   | (167 | ) |  |   | (8,133 | )
|Adjustment to liability    |  |             | (273   | )         |  |       | (116   | )     |  |   | (572 | ) |  |   | (961   | )
|Accretion                  |  |             | 463    |           |  |       |       |       |  |   |     |   |  |   | 463    |  
|                           |  |             |        |           |  |       |        |       |  |   |      |   |  |   |        |  
|Balance, December 31, 2003 |  | $           | 14,217 |           |  | $     | 317    |       |  | $ |     |   |  | $ | 14,534 |  
|                           |  |             |        |           |  |       |        |       |  |   |      |   |  |   |        |  

Our managements estimates of the excess
facilities charge may vary significantly depending, in part, on
factors which may be beyond our control, such as our success in
negotiating with our lessor, the time periods required to locate
and contract suitable subleases and the market rates at the time
of such subleases. Adjustments to the facilities accrual will be
made if further consolidations are required or if actual lease
exit costs or sublease income differ from amounts currently
expected. The facility restructuring charge was not allocated to
our reporting segments. However, the restructuring charge
related to headcount reductions was $0.9 million in North
America and $5.8 million in EMEA.

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

The following table sets forth our restructuring
accrual established in February 2002 and the activity against
the accrual during 2002 (in thousands):

|                           |  |       |      |           |  |       |      |   |  |   |        |  
|-------------------------- |  | ----- | ---- | --------- |  | ----- | ---- | - |  | - | ------ | -
|                           |  |       |      | Severance |  |      
|                           |  | Other |      | and       |  |      
|                           |  | Costs |      | Benefits  |  | Total
|                           |  |       |      |           |  |      
|Balance, February 2002     |  | $     | 190  |           |  | $     | 926  |   |  | $ | 1,116  |  
|Cash payments              |  |       | (190 | )         |  |       | (926 | ) |  |   | (1,116 | )
|                           |  |       |      |           |  |       |      |   |  |   |        |  
|Balance, December 31, 2002 |  | $     |     |           |  | $     |     |   |  | $ |       |  
|                           |  |       |      |           |  |       |      |   |  |   |        |  

In-Process Research and Development.The ongoing project at IntruVert at
the time of the purchase in 2003 included the development of the
Infinity model of IntruShield sensor. Infinity is a lower end
model of the IntruShield sensor product family that is targeted
towards remote offices and branch offices of large enterprises
as well as small/medium businesses. At the date we acquired
IntruVert, we recognized $5.7 million of in-process
research and development, and we estimated that, on average, 86%
of the development effort had been completed and that the
remaining 14% of the development effort would take approximately
2 1/2 months to complete and would cost
$0.3 million. The efforts required to complete the
development of these projects principally relate to finalization
of coding, and completion of prototyping, verification, and
testing activities required to establish that products
associated with the technologies can be successfully introduced.
The product was completed in the third quarter of 2003 and is
being shipped to customers. The value of the in-process
technologies was determined by estimating the projected net cash
flows related to products, including costs to complete the
development of the technologies or products, and the future net
revenues that may be earned from the products, excluding the
value attributed to integration with our products or that may
have been achieved due to efficiencies resulting from the
combined sales force or the use of our more effective
distribution channel. These cash flows were discounted back to
their net present value using a discount rate of 20% (which
represents a premium of approximately 4% over our weighted
average cost of capital) and excluding the value attributable to
the use of the in-process technologies in future products.

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The ongoing project at Entercept at the time of
the purchase in 2003 comprised a Linux version of their current
product. At the date we acquired Entercept, we recognized
$0.9 million of in-process research and development, and we
estimated that, on average, 31% of the development effort had
been completed and that the remaining 69% of the development
effort would take approximately eight months to complete and
would cost $0.3 million. The efforts required to complete
the development of these projects principally relate to
additional design efforts, finalization of coding, and
completion of prototyping, verification, and testing activities
required to establish that products associated with the
technologies can be successfully introduced. The project has
been delayed and product availability is expected in July 2004.
The value of the in-process technologies was determined by
estimating the projected net cash flows related to products,
including costs to complete the development of the technologies
or products, and the future net revenues that may be earned from
the products, excluding the value attributed to integration with
our products or that may have been achieved due to efficiencies
resulting from the combined sales force or the use of the our
more effective distribution channel. These cash flows were
discounted back to their net present value using a discount rate
of 35% (which represents a premium of approximately 19% over our
weighted average cost of capital) and excluding the value
attributable to the use of the in-process technologies in future
products.

Interest and Other Income.Interest and other income was
$15.5 million in 2003, $27.3 million in 2002 and
$28.0 million in 2001. Interest and other income decreased
from 2003 to 2002 primarily due to a decrease of cash and
investments of $247.5 million from 2002 to 2003 and an
overall decrease in average yields on our marketable securities.
In 2003, we used cash of approximately $217.1 million to
purchase Entercept and IntruVert and $177.3 million to
redeem the remaining portion of our outstanding zero coupon
debentures. Interest and other income increased slightly from
2001 to 2002 primarily due to an increased cash and investment
balances of approximately $70.8 million, offset by an
overall decrease in average yields.

Interest and Other Expenses.Interest and other expense decreased
to $7.5 million in 2003 from $25.1 million in 2002.
Interest and other expense decreased by $8.8 million due to
a reduction in interest and expense due to the repurchase in
2003 of the remaining zero coupon debentures during 2003.
Additionally, in 2003, we realized a full year of effect of the
interest rate swap we entered into in July 2002 resulting in
interest and expense savings of $9.2 million compared to
2002. We also recorded $0.3 million of capitalized interest
in 2003. The reduction in our interest expense due to positive
effects from our swap is dependent on interest rates. As
interest rates remain low, we will continue to receive positive
impact from our swap, however, if interest rates begin to rise,
the positive effects of the swap will begin to diminish.

Interest and other expense increased slightly to
$25.1 million in 2002 from $24.7 million in 2001.
Interest and other expense during 2002 increased
$12.7 million due to the recognition of a full twelve
months of interest and expense on the 5.25% convertible
subordinated notes issued in August 2001. This was offset by a
$7.3 million reduction in interest and expense due to the
partial repurchase of $140.0 million face value of zero
coupon debentures during 2002. Additionally, we entered into an
interest rate swap in July 2002 related to the 5.25% convertible
subordinated notes resulting in interest and expense savings
during 2002 of $4.2 million over the stated rate. In
addition, we recorded $0.8 million of capitalized interest
in 2002 related to the construction of the Plano, Texas office
facility.

Gain on Sale of Assets and Business.We recognized a $6.7 million and
$2.6 million gain on the sale of the PGP Gauntlet
businesses in February 2002, and the PGP Desktop/ Encryption
assets and technology in August 2002, respectively.

Gain (loss) on repurchase of zero coupon
convertible debentures.We recognized
a loss of $2.7 million on the repurchase of zero coupon
debentures in 2003, and recognized gains on the repurchase of
zero coupon debentures of approximately $26,000 and
$1.7 million in 2002 and 2001, respectively. The zero
coupon debentures have been fully repurchased, therefore no
future gains or losses are expected.

Gain on Investments, Net.In 2003 and 2002, we recognized a
$3.1 million and $3.8 million gain on the sale of
equity and debt securities, respectively. In 2001, we recognized
a $10.2 million gain on the sale of equity and debt
securities. Our investments are classified as available for sale
and we may sell securities from time to time to move funds into
investments with more lucrative investment yields, thus
resulting in gains and losses on sale.

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Impairment of Strategic and Other Investments.For the years ended December 31,
2002 and 2001, we recorded impairment charges of
$0.2 million and $20.6 million, respectively, related
to an other than temporary decline in the value of our venture
and strategic investments. No such impairment charges were
incurred in 2003 as all of our investments have no carrying
value.

Provision for (benefit from) Income Taxes.The provision for (benefit from)
income taxes was $16.8 million (including $3.6 million
included in the cumulative effect of change in accounting
principle), $(0.3) million and $66.0 million in 2003, 2002 and
2001, respectively. Tax expense was 19.3% and 0% of earnings
before income taxes and minority interest for 2003 and 2002,
respectively. Tax expense for 2001 was 45%. The increase in the
effective tax rate from 2002 to 2003 was primarily attributable
to the generation of fewer tax credits along with less income
being derived in lower tax jurisdictions. The decrease in the
effective tax rate from 2001 to 2002 was primarily due to
foreign tax credit benefits in 2002, the elimination of the
goodwill write-off, increased benefit from foreign earnings
taxed at a lower rate, and a reduction of non-deductible and
other costs. Each year, our tax expense is mainly influenced by
the mix of income between geographic jurisdictions, including
taxable income in certain foreign countries.

Stock-Based Compensation

We recognized stock-based compensation expense of
$12.5 million, $22.4 million and $24.9 million in
2003, 2002 and 2001, respectively. Our stock-based compensation
charges comprised of the following for the years presented (in
thousands):

|                                                                    |                                |                          |       |        |  |      |        |        |  |   |        |        | 
|------------------------------------------------------------------- | ------------------------------ | ------------------------ | ----- | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                                                                    |                                |                         
|                                                                    |                                | Years Ended December 31,
|                                                                    |                                |                         
|                                                                    |                                | 2003                     |       | 2002   |  | 2001
|                                                                    |                                |                          |       |        |  |     
|Exchange of McAfee.com options                                      |                                | $                        | 3,369 |        |  | $    | 16,101 |        |  | $ |       |       
|Former employees                                                    |                                |                          | 1,125 |        |  |      | 10,118 |        |  |   | 2,668  |       
|New and existing executives                                         |                                |                          | 424   |        |  |      | 1,478  |        |  |   | 3,230  |       
|Extended life of vested options of terminated
    employees         |                                |                          | 3,720 |        |  |      |       |        |  |   |       |       
|Extended vesting term of options                                    |                                |                          |      |        |  |      | 193    |        |  |   |       |       
|Extended period of Employee Stock Purchase Plan                     |                                |                          | 3,869 |        |  |      |       |        |  |   |       |       
|Shares purchased outside Employee Stock Purchase
    Plan and other |                                |                          |      |        |  |      | 62     |        |  |   | 9      |       
|Repriced options                                                    |                                |                          |      |        |  |      | (5,548 | )      |  |   | 17,396 |       
|Warrants to outside consultants                                     |                                |                          |      |        |  |      |       |        |  |   | 1,049  |       
|PGP restructuring                                                   |                                |                          |      |        |  |      |       |        |  |   | 519    |       
|                                                                    |                                |                          |       |        |  |      |        |        |  |   |        |       
|                                                                    | Total stock-based compensation |                          | $     | 12,507 |  |      | $      | 22,404 |  |   | $      | 24,871 | 
|                                                                    |                                |                          |       |        |  |      |        |        |  |   |        |       

Described below are the events giving rise to the
more significant stock-based compensation charges in 2003. These
and the other stock-based compensation charges are described in
greater detail in note 16 to our consolidated financial
statements. We expect significant future stock-based
compensation charges related to the exchange of McAfee.com
options and repriced employee stock options, with the amount of
these charges being impacted by fluctuations in our stock price.
The stock-based compensation charges in 2002 and 2001 with
respect to (i) former employees, relate primarily to
charges taken in connection with the former executive officers
of McAfee.com, the minority shares of which we acquired in 2002,
and our former executive officers which left the company in late
2002 or early 2001 and (ii) new and existing executives,
relate primarily to charges taken in connection our retention of
new executive officers in 2001.

Exchange of McAfee.com
Options.On September 13, 2002,
we acquired the minority interest in McAfee.com. In exchange for
each McAfee.com option, holders received options for 0.675 of a
share of our common stock plus $8.00 in cash, which will be paid
to the option holder only upon exercise of the option and
without interest. McAfee.com options to purchase
4.1 million shares were converted into options to purchase
2.8 million shares of our common stock. Because McAfee.com
was our consolidated subsidiary and these options were repriced
in conjunction with the acquisition of the minority interest,
these options were

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accounted for under the variable method of
accounting which requires that a compensation charge be
remeasured at the end of every reporting period using fair
market value.


During 2003 and 2002, we recorded a charge of
approximately $3.4 million and $16.1 million,
respectively, related to exchanged options subject to variable
accounting. Our stock-based compensation charge related to
exchanged options subject to variable accounting was based on
our closing share price of $15.04 and $16.09 on
December 31, 2003 and 2002, respectively. As of December
31, 2003, we had outstanding exchanged options to acquire
approximately 0.8 million of our shares subject to this variable
accounting.

Extended life of vested options held by
terminated employees.During a
significant portion of 2003, we suspended exercises of stock
options until our required public company reports were filed
with the SEC. The period during which stock option exercises
were suspended is known as the black-out period. Due to the
blackout period, we have extended the exercisability of any
options that would otherwise terminate during the blackout
period for a period of time equal to a specified period after
termination of the blackout period. Accordingly, we have
recorded a stock-based compensation charge on the date the
options should have terminated based on the intrinsic value of
the option on the modification date and the option price. During
2003, we recorded a stock-based compensation charge of
approximately $3.7 million for the extension of life of
vested options held by terminated employees.

Extended period of Employee Stock Purchase
Plan.During the blackout period in
2003, we suspended all stock purchases under our 2002 Employee
Stock Purchase Plan (2002 Purchase Plan). Due to the
blackout period, we extended the purchase period of the 2002
Purchase Plan that would otherwise had been purchased on
July 31, 2003. Accordingly, during 2003, we have recorded a
stock-based compensation charge of approximately
$3.9 million for the extended period of the 2002 Purchase
Plan.

Repriced Options.On
April 22, 1999, we offered to substantially all of our
employees, excluding executive officers, the right to cancel
certain outstanding stock options and receive new options with
an exercise price equivalent to the fair market value of our
stock at the time of grant. Options to purchase a total of
10.3 million shares were cancelled and the same number of
new options were granted. These new options vest at the same
rate that they would have vested under previous option plans and
are subject to variable accounting. Accordingly, we have and
will continue to remeasure compensation cost for these repriced
options until these options are exercised, cancelled or
forfeited without replacement. The first valuation period began
on July 1, 2000. At December 31, 2002, these options
were substantially fully vested. Depending upon movements in the
market value of our common stock, this accounting treatment may
result in additional stock-based compensation charges in future
periods.

During 2002 and 2001, we incurred charges
(credits) to earnings of approximately ($6.5) million and
$15.6 million, respectively, related to options subject to
variable plan accounting. As of December 31, 2003, options
to purchase 0.7 million shares of the company were
outstanding and subject to variable accounting.

We also incurred an initial stock-based
compensation charge in connection with the initial issuance of
the repriced options. Approximately $1.0 million and
$1.8 million was expensed during 2002 and 2001,
respectively.

Acquisitions



| |                         
| | ------------------------
| | IntruVert Networks, Inc.

On May 14, 2003, we acquired 100% of the
outstanding capital shares of IntruVert Networks, Inc.,
(IntruVert) a provider of network-based intrusion
prevention solutions designed to proactively detect and stop
system and network security attacks before they occur, for
$103.3 million in cash. We acquired IntruVert to enhance
our intrusion detection product line. The results of operations
of IntruVert have been included in our consolidated financial
statements since the date of acquisition.

Under the transaction, we recorded approximately
$18.2 million for developed technology, $1.9 million
for acquired product rights, including revenue related order
backlog and contracts, $71.8 million for goodwill

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(none of which is deductible for tax purposes),
$11.0 million in cash, $7.4 million for net deferred
tax liabilities and $2.2 million for tangible assets, net
of liabilities. We also recorded approximately $5.7 million
for acquired in-process research and development which was fully
expensed upon purchase because technological feasibility had not
been established and there was no alternative use for the
projects under development. The intangibles acquired in the
acquisition, excluding goodwill, are being amortized over their
estimated useful lives of two to five years or a weighted
average period of 4.5 years. We also accrued approximately
$0.3 million in duplicative site costs for lease space no
longer being utilized and permanently vacated related to the
IntruVert acquisition of which less than $0.1 million
remains as an accrual as of December 31, 2003.




| |                                          
| | -----------------------------------------
| | Entercept Security Technologies,
    Inc.

On April 30, 2003, We acquired 100% of the
outstanding capital shares of Entercept Security Technologies,
Inc. (Entercept), a provider of host-based intrusion
prevention solutions designed to proactively detect and stop
system and network security attacks before they occur, for
$125.8 million in cash. We acquired Entercept to enhance
our intrusion detection product line. The results of operations
of Entercept have been included in our consolidated financial
statements since the date of acquisition.

Under the transaction, we recorded approximately
$21.7 million for developed technology, $2.8 million
for acquired product rights, including revenue related order
backlog and contracts, $99.7 million for goodwill (none of
which is deductible for tax purposes), $9.6 million for net
deferred tax liabilities, $10.6 million of deferred tax
assets, $1.0 million in cash and $1.5 million in
liabilities, net of tangible assets. We also recorded
approximately $0.9 million for acquired in-process research
and development which was fully expensed upon purchase because
technological feasibility had not been established and there was
no alternative use for the projects under development. The
intangibles acquired in the acquisition, excluding goodwill, are
being amortized over their estimated useful lives of two to six
years or a weighted average period of 5.6 years.

As a result of the acquisition, we accrued
$2.8 million in duplicative sites costs for permanently
vacated facilities at the acquisition date. The accrual will be
fully utilized by 2006, the end of the original lease term. In
the fourth quarter of 2003, we entered into a sublease for the
vacated facility, and therefore, adjusted the accrual by the
value of the sublease. The following is a summary of activity in
the restructuring accrual related to Entercept in 2003 (in
thousands):

|                           |  |   |        |  
|-------------------------- |  | - | ------ | -
|Original accrual           |  | $ | 2,837  |  
|Cash payments              |  |   | (684   | )
|Adjustments                |  |   | (1,137 | )
|                           |  |   |        |  
|Balance, December 31, 2003 |  | $ | 1,016  |  
|                           |  |   |        |  

Liquidity and Capital Resources

|                                                        |  |                |          |      |  |      |           |   |  |   |         | 
|------------------------------------------------------- |  | -------------- | -------- | ---- |  | ---- | --------- | - |  | - | ------- | 
|                                                        |  | 2003           |          | 2002 |  | 2001
|                                                        |  |                |          |      |  |     
|                                                        |  |               
|                                                        |  | (In thousands)
|Cash, cash equivalents and investments                  |  | $              | 766,257  |      |  | $    | 1,013,709 |   |  | $ | 942,950 | 
|Net cash provided by operating activities               |  | $              | 156,304  |      |  | $    | 195,093   |   |  | $ | 145,989 | 
|Net cash (used in) provided by investing
    activities |  | $              | (374,480 | )    |  | $    | (183,646  | ) |  | $ | 20,775  | 
|Net cash provided by (used in) financing
    activities |  | $              | (146,579 | )    |  | $    | 43,736    |   |  | $ | 158,599 | 



| |         
| | --------
| | Overview

We ended 2003 with cash, cash equivalents and
investments totaling $766.3 million, as compared to
$1,013.7 million at the end of 2002. The decrease was due
primarily to our purchase of Entercept and IntruVert in 2003 for
$217.1 million; our payment of $70.0 million to settle a
pending securities class action lawsuit; and our use of
$177.3 million of cash to repurchase the remaining balance
of zero coupon convertible debentures. The uses of cash were
offset by the receipt of approximately $35.4 million in
proceeds from stock

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issued under employee stock purchase plans and
options, as well as cash collections from our customers and the
timing of payment of our liabilities. A more detailed discussion
of changes in our liquidity follows.




| |                      
| | ---------------------
| | Operating Activities.

Net cash provided by operating activities in
2003, 2002 and 2001 was primarily the result of our net income
of $70.2 million, $128.3 million and
$83.3 million, respectively, which is adjusted for non-cash
items such as depreciation and amortization, non-cash
restructuring charges, acquired in-process research and
development, stock-based compensation and changes in various
assets and liabilities such as accounts payable, accounts
receivable and other current assets.

Our historical and primary source of operating
cash flow is the collection of accounts receivable from our
customers and the timing of payments to our vendors and service
providers. One measure of the effectiveness of our collection
efforts is average accounts receivable days sales outstanding
(DSO). DSOs were 92 days, 69 days, and
68 days at December 31, 2003, 2002 and 2001. We
calculate accounts receivable DSO on a gross basis
by dividing the accounts receivable balance at the end of the
quarter by the amount of revenue recognized for the quarter
multiplied by 90 days. We expect DSOs to vary from
period to period because of changes in quarterly revenue and the
effectiveness of our collection efforts. In 2003, 2002 and 2001,
we have not made any significant changes to our payment terms
for our customers, which are generally net 30.

Our balances in accounts payable and accrued
liabilities decreased $78.5 million causing a use of cash in
operating activities. A primary cause of the decrease in accrued
liabilities from 2002 to 2003 was our cash payment of $70.0
million related to our class action litigation settlement. We
are pursuing the collection of insurance proceeds of up to
$25.0 million from our insurance carriers in regards to
this litigation settlement. We will record the proceeds when
received. Our operating cash flows will be impacted in the
future based on the timing of payments to our vendors for
accounts payable. We typically pay our vendors and service
providers in accordance with invoice terms and conditions, and
take advantage of invoice discounts when available. The timing
of future cash payments in future periods will be impacted by
the nature of accounts payable arrangements and
managements assessment of our cash inflows. In 2003, 2002
and 2001, we have not made any significant changes to our
payment timing to our vendors.

Our cash balances are held in numerous locations
throughout the world, including substantial amounts held outside
the United States. As of December 31, 2003, approximately
$271 million was held outside the United States. Most
amounts held outside the United States could be repatriated to
the United States, but, under current law, would be subject to
United States federal income taxes, less applicable foreign tax
credits. Repatriation of some foreign balances is restricted by
local laws. We have provided for United States federal tax
liability on these amounts for consolidated financial statement
purposes except for foreign earnings that are considered
indefinitely reinvested outside the United States. Repatriation
could result in additional United States federal income tax
payments in future years. Where local restrictions prevent an
efficient intercompany transfer of funds, our intent is that
cash balances would remain in the foreign country and we would
meet United States liquidity needs through ongoing cash flows.
We utilize a variety of tax planning and financing strategies in
an effort to ensure that our worldwide cash is available in the
locations in which it is needed.

Our working capital, defined as current assets
minus current liabilities, was $415.8 million and
$475.4 million at December 31, 2003 and
December 31, 2002, respectively. The cause of the decrease
in working capital of approximately $59.6 million is the
use of cash discussed above in the Overview section, offset in
part by the decrease in current liabilities of
$173.8 million from 2002 to 2003. Current liabilities
decreased due to the repurchase of the remaining balance of our
zero coupon convertible debentures in 2003, offset by an
increase of $50.5 million in the current portion of
deferred revenue. Our new perpetual plus licensing model,
results in less revenue recognition up-front, therefore causing
increases in our deferred revenue.

We are currently under an SEC and DOJ
investigation. As a result of these investigations, we may be
exposed to penalties that may be material to our consolidated
financial statements.

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We expect to meet our obligations as they become
due through available cash and internally generated funds. We
expect to continue generating positive working capital through
our operations. However, we cannot predict whether current
trends and conditions will continue or what the effect on our
business might be from the competitive environment in which we
operate. We believe the working capital available to us will be
sufficient to meet our cash requirements for at least the next
12 months.



| |                      
| | ---------------------
| | Investing Activities.

A summary of our investing activities at
December 31, 2003, 2002 and 2001 is as follows (in
thousands). The detail of these line items can be seen in our
consolidated statement of cash flows.

|                                                                     |  |      |          |      |  |      |          |   |  |   |         |  
|-------------------------------------------------------------------- |  | ---- | -------- | ---- |  | ---- | -------- | - |  | - | ------- | -
|Activity                                                             |  | 2003 |          | 2002 |  | 2001
|                                                                     |  |      |          |      |  |     
|Cash payments for acquisitions                                       |  | $    | (217,256 | )    |  | $    | (118,308 | ) |  | $ | (23,821 | )
|Cash payments for property and equipment                             |  |      | (60,027  | )    |  |      | (59,427  | ) |  |   | (31,493 | )
|Net proceeds (purchases) of investments in
    marketable securities |  |      | (97,861  | )    |  |      | 8,668    |   |  |   | 76,089  |  
|Cash payments for restricted cash                                    |  |      | 664      |      |  |      | (21,734  | ) |  |   | 0       |  
|Sales of common stock investments                                    |  |      | 0        |      |  |      | 7,155    |   |  |   | 0       |  
|                                                                     |  |      |          |      |  |      |          |   |  |   |         |  
|Net cash used in (provided by) investing
    activities              |  | $    | (374,480 | )    |  | $    | (183,646 | ) |  | $ | 20,775  |  
|                                                                     |  |      |          |      |  |      |          |   |  |   |         |  



| |             
| | ------------
| | Acquisitions

In 2003, we paid cash for our acquisitions of
Entercept and IntruVert in the amount of $124.8 million and
$92.3 million, respectively. We purchased IntruVert and
Entercept to enhance our network intrusion prevention products.
In September 2002, to among other things, reduce customer and
brand confusion, we acquired the outstanding minority interest
in McAfee.com for a combination of shares our common stock and
$98.4 million total cash payments. In 2002, we also
purchased several smaller entities for cash in the amount of
$19.1 million in order to enhance our products and improve
distribution in Latin America. In 2001, we repurchased the
shares of Networks Associate Japan for $10.7 million due to
a change in our business strategy and paid $12.3 million
for acquired technology.

We may buy or make investments in complementary
companies, products and technologies. Our available cash and
equity and debt securities may be used to acquire or invest in
companies or products, possibly resulting in significant
acquisition-related charges to earnings and dilution to our
stockholders.

We have also made divestures previously. For
example, in January 2004, we completed the sale of our Magic
service desk business as part of our continued focus on security
and security related products. In 2004, we received cash
proceeds of approximately $48.0 million, subject to final
purchase price adjustments.



| |                       
| | ----------------------
| | Property and Equipment

We added $60.0 million of equipment during
2003 to update hardware for our employees and enhance various
back office systems, including our new customer relationship
management system which we are deploying in early 2004. In 2002,
we added $59.4 million of property and equipment, including
approximately $17.0 million related to the construction of our
regional office in Plano, Texas. We added $31.5 million of
property and equipment in 2001. Our property and equipment
additions have been funded from operations.

We anticipate that we will continue to purchase
property and equipment necessary in the normal course of our
business. The amount and timing of these purchases and the
related cash outflows in future periods is difficult to predict
and is dependent on a number of factors including our hiring of
employees, the rate of change in computer hardware/software used
in our business and our business outlook.

49



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| |            
| | -----------
| | Investments

We received net proceeds from (and made net
purchases of) and sales/maturities of our marketable securities
of $(97.9 million), $8.7 million, and
$76.1 million in 2003, 2002 and 2001. We have classified
our investment portfolio as available for sale, and
our investments are made with a policy of capital preservation
and liquidity as the primary objectives. We generally hold
investments in corporate bonds and U. S. government agency
securities to maturity; however, we may sell an investment at
any time if the quality rating of the investment declines, the
yield on the investment is no longer attractive or we are in
need of cash. Because we invest only in investment securities
that are highly liquid with a ready market, we believe that the
purchase, maturity of sale of our investments has no material
impact on our overall liquidity.



| |                
| | ---------------
| | Restricted Cash

At December 31, 2003, we had on deposit
approximately $20.2 million as collateral for our interest
rate swap arrangements we entered into related to our
$345.0 million of 5.25% subordinated convertible debt. The
arrangements require we keep a minimum amount of
$20.0 million on deposit with the swap counterparties,
subject to increase based on the fair value of the swap.

Financing Activities.A primary use of financing activities
in 2003 was the use of $177.3 million of cash to repurchase
the remaining balance of our zero coupon convertible debt. As a
result of this redemption, we recorded a total loss on
repurchase of approximately $2.7 million. In 2002 and 2001,
we also repurchased portions of this debt using
$66.2 million and $173.7 million of cash.

Historically, our recurring cash flows provided
by financing activities have been from the receipt of cash from
the issuance of common stock under stock option and employee
stock purchase plans. We received cash proceeds from these plans
in the amount of $35.4 million, $109.9 million and
$51.1 million in 2003, 2002 and 2001, respectively. While
we expect to continue to receive these proceeds in future
periods, the timing and amount of such proceeds are difficult to
predict and is contingent on a number of factors including the
price of our common stock, the number of employees participating
in the plans and general market conditions.

As our stock price rises, more participants are
in the money in their options, and thus, more likely
to exercise their options, which results in cash to us. As our
stock price decreases, more of our employees are out of
the money or under water in regards to their
options, and therefore, are not able to exercise options and
results in no cash received by us. The decrease in cash proceeds
from the exercise of stock options and employee stock purchase
plans from 2002 to 2003 was primarily the result of the blackout
period in most of 2003 due to our restatement. From March 2003
through November 2003, all purchases under our stock option
plans and employee stock purchase plan were suspended pending
the filing with the SEC of our public company reports, including
our restated financial results. Following the October 31,
2003 filing of these reports, activity under our plans was
resumed.

In 2001, we received net proceeds from the
issuance of our 5.25% convertible subordinated notes in the
amount of $335.1 million. We used the proceeds from this
offering for working capital purposes.

Contractual Obligations

A summary of our contractual obligations at
December 31, 2003 is as follows (in thousands):

|                        |  |                        |         |                  |  |           |        |           |  |                   |         |  |  |   |        |  |  |   |        | 
|----------------------- |  | ---------------------- | ------- | ---------------- |  | --------- | ------ | --------- |  | ----------------- | ------- |  |  | - | ------ |  |  | - | ------ | 
|                        |  |                       
|                        |  | Payments Due by Period
|                        |  |                       
|Contractual Obligations |  | Total                  |         | Less Than 1 Year |  | 1-3 Years |        | 3-5 Years |  | More Than 5 Years
|                        |  |                        |         |                  |  |           |        |           |  |                  
|Long-term debt(1)       |  | $                      | 392,496 |                  |  | $         | 18,113 |           |  | $                 | 374,383 |  |  | $ |       |  |  | $ |       | 
|Operating leases(2)     |  |                        | 107,277 |                  |  |           | 18,535 |           |  |                   | 29,601  |  |  |   | 19,141 |  |  |   | 40,000 | 
|Purchase obligations(3) |  |                        | 1,846   |                  |  |           | 1,846  |           |  |                   |        |  |  |   |       |  |  |   |       | 
|                        |  |                        |         |                  |  |           |        |           |  |                   |         |  |  |   |        |  |  |   |        | 
|Total                   |  | $                      | 501,619 |                  |  | $         | 38,494 |           |  | $                 | 403,984 |  |  | $ | 19,141 |  |  | $ | 40,000 | 
|                        |  |                        |         |                  |  |           |        |           |  |                   |         |  |  |   |        |  |  |   |        | 

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---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Under the terms of the 5.25% convertible
    subordinated notes in a total principal amount of
    $345.0 million, in 2004, 2005 and 2006, we will make
    interest payments of $18.1 million to the note holders.
    Pursuant to a related interest rate swap, the swap counter
    parties are obligated to make regular payments to us with
    respect to these interest obligations based on the 5.25%
    interest rate and, subject to quarterly resets, we are required
    to make regular payments to the counter parties based on a
    floating rate of LIBOR plus 1.66%.                                                                                                                                                                                                                                                                                                                        
|   
|(2) | Operating leases are primarily for leased office
    space and for leased office equipment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   
|(3) | We generally issue purchase orders to our
    contract manufacturers with delivery dates from four to six
    weeks from the purchase order date. In addition, we regularly
    provide such contract manufacturers with rolling six-month
    forecasts of product requirements for planning and long-lead
    time parts procurement purposes only. We are committed to accept
    delivery of materials pursuant to our purchase orders subject to
    various contract provisions which allow us to delay receipt of
    such order or allow us to cancel orders beyond certain agreed
    lead times. Such cancellations may or may not include
    cancellation costs payable by us. If we are unable to adequately
    manage our contract manufacturers and adjust such commitments
    for changes in demand, we may incur additional inventory
    expenses related to excess and obsolete inventory.

Off-Balance Sheet Arrangements

As part of our ongoing business, we do not
participate in transactions that generate relationships with
unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance or special
purpose entities, often established for the purpose of
facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. All of our
subsidiaries are 100% owned by us and are fully consolidated
into our consolidated financial statements.

Convertible Debt

On August 17, 2001, we issued 5.25%
convertible subordinated notes due 2006 with an aggregate
principal amount of $345.0 million. The issuance generated
net proceeds to us of approximately $335.1 million (after
deducting fees and expenses). The notes mature on August 15,
2006, unless earlier redeemed by us at our option or converted
at the holders option. Interest is payable semi-annually
in cash in arrears on February 15 and August 15 of
each year, commencing February 15, 2002. At the option of
the holder, the notes may be converted into our common stock at
any time, unless previously redeemed, at a conversion price of
$18.07 per share. At any time between August 20, 2004 and
August 14, 2005, we may redeem all or a portion of the
notes for cash at a repurchase price of 101.3125% of the
principal amount. After August 14, 2005, the repurchase
price is 100.0% of the principal amount. The notes are unsecured
and are subordinated to all of our existing and future Senior
Indebtedness (as defined in the related Indenture). We have no
financial covenants related to these convertible subordinated
notes.

In February 1998, we issued zero coupon
convertible subordinated debentures due 2018 with an aggregate
face amount at maturity of $885.5 million and generating
net proceeds to us of approximately $337.6 million. Prior
to December 31, 2002, we repurchased zero coupon debentures
with an aggregate face amount of approximately
$527.0 million, at a total price of $239.9 million. On
February 13, 2003, we paid approximately
$177.1 million in cash to redeem approximately
$358.0 million in face amount of the zero coupon
debentures. On June 9, 2003, we redeemed the remaining zero
coupon debentures with an aggregate face amount at maturity of
$0.5 million for a net price of $0.2 million.

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Stock Repurchases

The table below sets forth all repurchases by us
of our common stock during the quarter ended December 31,
2003 whether or not pursuant to a publicly announced plan or
program (in thousands, except price per share):

|              |       |                  |     |               |  |                     |       |                      |  |  |     |     |  |   |         |  | 
|------------- | ----- | ---------------- | --- | ------------- |  | ------------------- | ----- | -------------------- |  |  | --- | --- |  | - | ------- |  | 
|              |       |                  |     |               |  | Total Number of     |       | Approximate Dollar  
|              |       |                  |     |               |  | Shares Purchased as |       | Value of Shares That
|              |       |                  |     |               |  | Part of Publicly    |       | May Yet Be          
|              |       |                  |     | Average Price |  | Announced Plan or   |       | Purchased Under Our 
|              |       | Total Number of  |     | Paid Per      |  | Repurchase          |       | Stock Repurchase    
|Period        |       | Shares Purchased |     | Share         |  | Program(1)          |       | Program(1)          
|              |       |                  |     |               |  |                     |       |                     
|October 2003  |       |                  |    |               |  | $                   |      |                      |  |  |    |     |  |   | NA      | 
|November 2003 |       |                  |    |               |  |                     |      |                      |  |  |    |     |  | $ | 150,000 | 
|December 2003 |       |                  | 350 |               |  | $                   | 13.45 |                      |  |  | 350 |     |  |   | 145,293 | 
|              |       |                  |     |               |  |                     |       |                      |  |  |     |     |  |   |         | 
|              | Total |                  |     | 350           |  |                     | $     | 13.45                |  |  |     | 350 |  |   |         |  | 
|              |       |                  |     |               |  |                     |       |                      |  |  |     |     |  |   |         | 



---



|    |                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In November 2003, our board of directors
    authorized the repurchase of up to $150.0 million of our
    common stock in the open market from time to time over the next
    two years, depending upon market conditions, share price and
    other factors. We purchased 350,000 shares for a total of
    $4.7 million in 2003.

In conjunction with a previous stock repurchase
program, prior to 2001, we sold European style put
options for 3.0 million shares of our common stock as part
of our stock repurchase plan. In February 2001, we settled the
remaining put options, which resulted in the purchase of
2.0 million shares of our stock for approximately
$53.8 million.

In 1998, we deposited approximately
1.6 million shares of our common stock with a trustee for
the benefit of the employees of Dr. Solomon in respect of
their stock options assumed in our acquisition of the company.
These shares are included in our total outstanding share
balance. We believe our obligations with respect to these
assumed stock options have been terminated or satisfied, and we
are attempting to obtain the return of these shares.

Financial Risk Management

The following discussion about our risk
management activities includes forward-looking
statements that involve risks and uncertainties. Actual
results could differ materially from those projected in the
forward-looking statements.



| |                      
| | ---------------------
| | Foreign Currency Risk

As a global concern, we face exposure to
movements in foreign currency exchange rates. These exposures
may change over time as business practices evolve and could have
a material adverse impact on our financial results. Our primary
exposures related to non U.S. dollar-denominated sales and
operating expenses in Japan, Canada, Australia, Europe, Latin
America, and Asia. At the present time, we hedge only those
currency exposures associated with certain assets and
liabilities denominated in nonfunctional currencies and do not
generally hedge anticipated foreign currency cash flows. Our
hedging activity is intended to offset the impact of currency
fluctuations on certain nonfunctional currency assets and
liabilities. The success of this activity depends upon estimates
of transaction activity denominated in various currencies,
primarily the Japanese Yen, Canadian dollar, Australian dollar,
the Euro, and the British Pound. To the extent that these
estimates are overstated or understated during periods of
currency volatility, we could experience unanticipated currency
gains or losses.

To reduce exposures associated with nonfunctional
net monetary asset positions in various currencies, we enter
into spot, forward and swap foreign exchange contracts. Our
foreign exchange contracts range from one to three months in
original maturity. In general, we have not hedged anticipated
foreign currency cash flows nor do we enter into forward
contracts for trading purposes. We do not use any derivatives
for speculative purposes. Our existing forward contracts do not
qualify for hedge accounting and accordingly are marked to

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market at the end of each reporting period with
any unrealized gain or loss being recognized in the consolidated
statements of income. Net realized gains and losses arising from
settlement of our forward foreign exchange contracts were not
significant in 2003, 2002, and 2001.


The forward contracts outstanding and their fair
values are presented below as of December 31 (in thousands):

|                       |  |          |     |       |  |          |     |       |  |   |       |  |  |   |       | 
|---------------------- |  | -------- | --- | ----- |  | -------- | --- | ----- |  | - | ----- |  |  | - | ----- | 
|                       |  |          |     |      
|                       |  | 2003     |     | 2002 
|                       |  |          |     |      
|                       |  | Carrying |     | Fair  |  | Carrying |     | Fair 
|                       |  | Value    |     | Value |  | Value    |     | Value
|                       |  |          |     |       |  |          |     |      
|Euro                   |  | $        | 490 |       |  | $        | 490 |       |  | $ | 488   |  |  | $ | 488   | 
|British Pound Sterling |  |          | 54  |       |  |          | 54  |       |  |   | 774   |  |  |   | 774   | 
|Singapore Dollar       |  |          | (16 | )     |  |          | (16 | )     |  |   | 15    |  |  |   | 15    | 
|Australian Dollar      |  |          | 75  |       |  |          | 75  |       |  |   | 155   |  |  |   | 155   | 
|Canadian Dollar        |  |          | 255 |       |  |          | 255 |       |  |   | 354   |  |  |   | 354   | 
|                       |  |          |     |       |  |          |     |       |  |   |       |  |  |   |       | 
|                       |  | $        | 858 |       |  | $        | 858 |       |  | $ | 1,786 |  |  | $ | 1,786 | 
|                       |  |          |     |       |  |          |     |       |  |   |       |  |  |   |       | 



| |                   
| | ------------------
| | Interest Rate Risk

In July 2002, we entered into interest rate swap
transactions (the Transactions) with two investment
banks (the Banks), to hedge the interest rate risk
of its outstanding 5.25% Convertible Subordinated Note due 2006
(the Notes) (See note 7 to the consolidated
financial statements).

The notional amount of the Transactions was
$345.0 million to match the entire principal amount of the
Notes. We receive from the Banks fixed payments equal to 5.25%
percent of the notional amount, payable on February 15 and
August 15 which started on August 15, 2002. In
exchange, we pay to the Banks floating rate payments based upon
the London InterBank Offered Rate (LIBOR) plus 1.66%
multiplied by the notional amount of the Transactions with the
LIBOR resetting every three months which began on
August 15, 2002.

The Transactions terminate on August 15,
2006 (Termination Date), subject to certain early
termination provisions if on or after August 20, 2004 and
prior to August 15, 2006 the twenty-day average closing
price of our common stock equals or exceeds $22.59.

The Transactions qualified and were designated as
a fair value hedge under SFAS 133, Accounting for
Derivative Instruments and Hedging Activities to hedge
against movements in the fair value of the Notes due to changes
in the benchmark interest rate. Under the fair value hedge
model, the derivative is recognized at fair value on the
consolidated balance sheet with an offsetting entry to the
consolidated income statement. In addition, changes in fair
value of the Notes due to changes in the benchmark interest rate
are recognized as a basis adjustment to the carrying amount of
the Notes with an offsetting entry to the consolidated income
statement. The gain or loss from the change in fair value of the
Transaction and the offsetting change in the fair value of the
Notes are recognized as interest and other expense. The net gain
recorded as of December 31, 2003 and 2002 was approximately
$5.6 million and $1.4 million, respectively.

To test effectiveness of the hedges, regression
analysis is performed at least quarterly comparing the change in
fair value of the Transactions and the Notes. The fair values of
the Transactions and the Notes are calculated at least quarterly
as the present value of the contractual cash flows to the
expected maturity date, where the expected maturity date is
based on probability-weighted analysis of interest rates
relating to the five-year LIBOR curve and our stock prices. For
the year ended December 31, 2003, the hedge was highly
effective and therefore, the ineffective portion did not have a
material impact on earnings.

In support of our obligation under the
Transactions, we are required to maintain with the Banks a
minimum level of cash and investment collateral of
$20.0 million and periodically adjust the overall level of
collateral depending on the fair market value of the
Transactions. This minimum amount of collateral is presented as
restricted cash in our consolidated financial statements.

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The following table presents the hypothetical
changes in fair values of the interest rate swaps held at
December 31, 2003 assuming the following shifts in the
yield curve at December 31, 2003. Beginning fair values
represent the fair value of the swaps at December 31, 2003
(in millions).

|                |       |                                 |       |           |  |                                 |       |       |  |        |      |         |  |         |      |       |  |   |      |       |  |   |      |      |  |   |      |      | 
|--------------- | ----- | ------------------------------- | ----- | --------- |  | ------------------------------- | ----- | ----- |  | ------ | ---- | ------- |  | ------- | ---- | ----- |  | - | ---- | ----- |  | - | ---- | ---- |  | - | ---- | ---- | 
|                |       |                                 |       |           |  |                                
|                |       | Valuation of Interest Rate Swap |       |           |  | Valuation of Interest Rate Swap
|                |       | Given an Interest Rate Decrease |       | No        |  | Given an Interest Rate Increase
|                |       | of X Basis Points               |       | Change in |  | of X Basis Points              
|                |       |                                 |       | Interest  |  |                                
|Issuer          |       | 150 BPS                         |       | 100 BPS   |  | 50 BPS                          |       | Rate  |  | 50 BPS |      | 100 BPS |  | 150 BPS
|                |       |                                 |       |           |  |                                 |       |       |  |        |      |         |  |        
|JP Morgan       |       | $                               | 11.27 |           |  | $                               | 9.77  |       |  | $      | 8.37 |         |  | $       | 7.00 |       |  | $ | 5.57 |       |  | $ | 4.27 |      |  | $ | 2.97 |     
|Lehman Brothers |       |                                 | 13.03 |           |  |                                 | 11.30 |       |  |        | 9.68 |         |  |         | 8.10 |       |  |   | 6.44 |       |  |   | 4.94 |      |  |   | 3.43 |     
|                |       |                                 |       |           |  |                                 |       |       |  |        |      |         |  |         |      |       |  |   |      |       |  |   |      |      |  |   |      |     
|                | Total |                                 | $     | 24.30     |  |                                 | $     | 21.07 |  |        | $    | 18.05   |  |         | $    | 15.10 |  |   | $    | 12.01 |  |   | $    | 9.21 |  |   | $    | 6.40 | 
|                |       |                                 |       |           |  |                                 |       |       |  |        |      |         |  |         |      |       |  |   |      |       |  |   |      |      |  |   |      |     

The following table presents the hypothetical
changes in the value of our 5.25% Convertible debt as of
December 31, 2003 assuming the following shifts in the
yield curve at December 31, 2003 and does not take into
consideration the embedded equity conversion option of the bond.
The beginning value represents the value of the debt at
December 31, 2003 (in millions).

|                                              |  |                               |        |           |  |                               |        |      |  |        |        |         |  |         |        |  |  |   |        |  |  |   |        |  |  |   |        | 
|--------------------------------------------- |  | ----------------------------- | ------ | --------- |  | ----------------------------- | ------ | ---- |  | ------ | ------ | ------- |  | ------- | ------ |  |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|                                              |  |                               |        |           |  |                              
|                                              |  | Valuation of 5.25% Debt Given |        |           |  | Valuation of 5.25% Debt Given
|                                              |  | an Interest Rate Decrease of  |        | No        |  | an Interest Rate Increase of 
|                                              |  | X Basis Points                |        | Change in |  | X Basis Points               
|                                              |  |                               |        | Interest  |  |                              
|                                              |  | 150 BPS                       |        | 100 BPS   |  | 50 BPS                        |        | Rate |  | 50 BPS |        | 100 BPS |  | 150 BPS
|                                              |  |                               |        |           |  |                               |        |      |  |        |        |         |  |        
|5.25% Convertible Subordinated Notes due 2006 |  | $                             | 379.68 |           |  | $                             | 378.81 |      |  | $      | 377.89 |         |  | $       | 373.14 |  |  | $ | 374.63 |  |  | $ | 372.58 |  |  | $ | 374.75 | 
|                                              |  |                               |        |           |  |                               |        |      |  |        |        |         |  |         |        |  |  |   |        |  |  |   |        |  |  |   |        | 



| |                     
| | --------------------
| | Cash Management Risk

We maintain balances in cash, cash equivalents
and investment securities. We maintain our investment securities
in portfolio holdings of various issuers, types and maturities
including money market, government, agency and corporate bonds.
These securities are classified as available-for-sale, and
consequently are recorded on the consolidated balance sheet at
fair value with unrealized gains and losses reported as a
separate component of accumulated other comprehensive income.
These securities are not leveraged and are held for purposes
other than trading.

We also maintain a minority investment in a
publicly traded company and historically have had investments in
private companies. These investments are reviewed for other than
temporary declines in value on a quarterly basis. Reasons for
other than temporary declines in value include whether the
related company would have insufficient cash flow to operate for
the next twelve months, significant changes in the operating
performance or operating model and changes in market conditions.
During 2002, we disposed of our shares in a majority of these
investments. As of December 31, 2003, the minority
investments we continue to hold totaled $0.4 million at
estimated fair value. These investments were in a public company.

The following tables present the hypothetical
changes in fair values in the securities held at
December 31, 2003 that are sensitive to the changes in
interest rates. The modeling technique used measures the change
in fair values arising from hypothetical parallel shifts in the
yield curve of plus or minus 50 basis points (BPS),
100 BPS and 150 BPS over six and twelve-month time horizons.
Beginning fair values represent the market principal plus
accrued interest and dividends at December 31, 2003. Ending
fair values are the market principal plus accrued interest,
dividends and reinvestment income at six and twelve month time
horizons.

54



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The following table estimates the fair value of
the portfolio at a six-month time horizon (in millions):

|                                      |       |                  |       |           |  |                               |       |        |  |         |       |         |  |   |       |       |  |   |       |       |  |   |       |       | 
|------------------------------------- | ----- | ---------------- | ----- | --------- |  | ----------------------------- | ----- | ------ |  | ------- | ----- | ------- |  | - | ----- | ----- |  | - | ----- | ----- |  | - | ----- | ----- | 
|                                      |       |                  |       |           |  |                               |       |        |  |        
|                                      |       | Valuation of     |       |           |  |                               |       |        |  |        
|                                      |       | Securities Given |       |           |  |                              
|                                      |       | an Interest Rate |       |           |  | Valuation of Securities Given
|                                      |       | Decrease of      |       | No        |  | an Interest Rate Increase of 
|                                      |       | X Basis Points   |       | Change in |  | X Basis Points               
|                                      |       |                  |       | Interest  |  |                              
|Issuer                                |       | 100 BPS          |       | 50 BPS    |  | Rate                          |       | 50 BPS |  | 100 BPS |       | 150 BPS
|                                      |       |                  |       |           |  |                               |       |        |  |         |       |        
|U.S. Government notes and bonds       |       | $                | 243.7 |           |  | $                             | 242.7 |        |  | $       | 241.7 |         |  | $ | 240.7 |       |  | $ | 239.7 |       |  | $ | 238.8 |      
|Corporate notes, bonds and preferreds |       |                  | 234.5 |           |  |                               | 233.6 |        |  |         | 232.7 |         |  |   | 231.9 |       |  |   | 231.1 |       |  |   | 230.2 |      
|                                      |       |                  |       |           |  |                               |       |        |  |         |       |         |  |   |       |       |  |   |       |       |  |   |       |      
|                                      | Total |                  | $     | 478.2     |  |                               | $     | 476.3  |  |         | $     | 474.4   |  |   | $     | 472.6 |  |   | $     | 470.8 |  |   | $     | 469.0 | 
|                                      |       |                  |       |           |  |                               |       |        |  |         |       |         |  |   |       |       |  |   |       |       |  |   |       |      

The following table estimates the fair value of
the portfolio at a twelve-month time horizon (in millions):

|                                      |       |                  |       |           |  |                               |       |        |  |         |       |         |  |   |       |       |  |   |       |       |  |   |       |       | 
|------------------------------------- | ----- | ---------------- | ----- | --------- |  | ----------------------------- | ----- | ------ |  | ------- | ----- | ------- |  | - | ----- | ----- |  | - | ----- | ----- |  | - | ----- | ----- | 
|                                      |       |                  |       |           |  |                               |       |        |  |        
|                                      |       | Valuation of     |       |           |  |                               |       |        |  |        
|                                      |       | Securities Given |       |           |  |                              
|                                      |       | an Interest Rate |       |           |  | Valuation of Securities Given
|                                      |       | Decrease of      |       | No        |  | an Interest Rate Increase of 
|                                      |       | X Basis Points   |       | Change in |  | X Basis Points               
|                                      |       |                  |       | Interest  |  |                              
|Issuer                                |       | 100 BPS          |       | 50 BPS    |  | Rate                          |       | 50 BPS |  | 100 BPS |       | 150 BPS
|                                      |       |                  |       |           |  |                               |       |        |  |         |       |        
|U.S. Government notes and bonds       |       | $                | 245.9 |           |  | $                             | 245.0 |        |  | $       | 244.1 |         |  | $ | 243.1 |       |  | $ | 242.4 |       |  | $ | 241.7 |      
|Corporate notes, bonds and preferreds |       |                  | 235.0 |           |  |                               | 234.6 |        |  |         | 234.3 |         |  |   | 233.9 |       |  |   | 233.6 |       |  |   | 233.2 |      
|                                      |       |                  |       |           |  |                               |       |        |  |         |       |         |  |   |       |       |  |   |       |       |  |   |       |      
|                                      | Total |                  | $     | 480.9     |  |                               | $     | 479.6  |  |         | $     | 478.4   |  |   | $     | 477.0 |  |   | $     | 476.0 |  |   | $     | 474.9 | 
|                                      |       |                  |       |           |  |                               |       |        |  |         |       |         |  |   |       |       |  |   |       |       |  |   |       |      

Recent Accounting Pronouncements
Update

See Note 2 of the consolidated financial
statements for a full description of recent accounting
pronouncements, including the expected dates of adoption and
effects on financial condition, results of operations and cash
flows.






|         |                                                              
|-------- | -------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosure
    About Market Risk

Quantitative and qualitative disclosure about
market risk is set forth at Managements Discussion
and Analysis of Financial Condition and Results of
Operations under Item 7.

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

Quarterly Operating Results
(Unaudited)

|                                                                                                                                   |  |                                       |         |               |  |           |         |           |  |              |         |               |  |          |         |           |  |   |         |   |  |   |         |  |  |   |         |  |  |   |         | 
|---------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------- | ------------- |  | --------- | ------- | --------- |  | ------------ | ------- | ------------- |  | -------- | ------- | --------- |  | - | ------- | - |  | - | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                                                                                                                   |  |                                      
|                                                                                                                                   |  | Three Months Ended                   
|                                                                                                                                   |  |                                      
|                                                                                                                                   |  | December 31,                          |         | September 30, |  | June 30,  |         | March 31, |  | December 31, |         | September 30, |  | June 30, |         | March 31,
|                                                                                                                                   |  | 2003                                  |         | 2003          |  | 2003      |         | 2003      |  | 2002         |         | 2002          |  | 2002     |         | 2002     
|                                                                                                                                   |  |                                       |         |               |  |           |         |           |  |              |         |               |  |          |         |          
|                                                                                                                                   |  |                                      
|                                                                                                                                   |  | (In thousands, except per share data)
|                                                                                                                                   |  |                                       |         | (1)(As        |  | (1)(As    |         | (1)(As    |  |             
|                                                                                                                                   |  |                                       |         | Restated)     |  | Restated) |         | Restated) |  |             
|                                                                                                                                   |  |                                       |         |               |  |           |         |           |  |              |         |               |  |          |         |          
|Statement of Operations and Other
    Data:                                                                                        |  |                                       |         |               |  |           |         |           |  |              |         |               |  |          |         |           |  |   |         |   |  |   |         |  |  |   |         |  |  |   |         | 
|Net revenues                                                                                                                       |  | $                                     | 272,222 |               |  | $         | 227,775 |           |  | $            | 217,025 |               |  | $        | 219,314 |           |  | $ | 269,525 |   |  | $ | 254,430 |  |  | $ | 263,441 |  |  | $ | 255,648 | 
|Gross margin                                                                                                                       |  |                                       | 230,335 |               |  |           | 189,840 |           |  |              | 180,882 |               |  |          | 185,653 |           |  |   | 229,437 |   |  |   | 214,133 |  |  |   | 221,869 |  |  |   | 212,894 | 
|Income (loss) from operations                                                                                                      |  |                                       | 52,946  |               |  |           | 10,093  |           |  |              | 1,009   |               |  |          | 1,605   |           |  |   | (15,680 | ) |  |   | 26,863  |  |  |   | 55,675  |  |  |   | 47,869  | 
|Income (loss) before provision for income
    taxes, minority interest and cumulative effect of change in
    accounting principle |  |                                       | 55,478  |               |  |           | 13,268  |           |  |              | 2,903   |               |  |          | 1,476   |           |  |   | (11,163 | ) |  |   | 31,442  |  |  |   | 56,096  |  |  |   | 53,558  | 
|Income (loss) before cumulative effect of
    change in accounting principle                                                       |  |                                       | 45,308  |               |  |           | 10,774  |           |  |              | 2,491   |               |  |          | 1,332   |           |  |   | (11,197 | ) |  |   | 34,124  |  |  |   | 53,746  |  |  |   | 51,639  | 
|Cumulative effect of, change in accounting
    principle, net of taxes                                                             |  |                                       | (805    | )             |  |           |        |           |  |              |        |               |  |          | 11,142  |           |  |   |        |   |  |   |        |  |  |   |        |  |  |   |        | 
|Net income (loss)                                                                                                                  |  |                                       | 44,503  |               |  |           | 10,774  |           |  |              | 2,491   |               |  |          | 12,474  |           |  |   | (11,197 | ) |  |   | 34,124  |  |  |   | 53,746  |  |  |   | 51,639  | 
|Cumulative effect of change in accounting
    principle, per share                                                                 |  | $                                     |        |               |  | $         |        |           |  | $            |        |               |  | $        | 0.07    |           |  | $ |        |   |  | $ |        |  |  | $ |        |  |  | $ |        | 
|Basic income (loss) per share                                                                                                      |  | $                                     | 0.28    |               |  | $         | 0.07    |           |  | $            | 0.02    |               |  | $        | 0.08    |           |  | $ | (0.07   | ) |  | $ | 0.23    |  |  | $ | 0.37    |  |  | $ | 0.36    | 
|Diluted income (loss)per share                                                                                                     |  | $                                     | 0.26    |               |  | $         | 0.07    |           |  | $            | 0.02    |               |  | $        | 0.08    |           |  | $ | (0.07   | ) |  | $ | 0.21    |  |  | $ | 0.33    |  |  | $ | 0.31    | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | During analysis of our international
    subsidiaries 2003 deferred revenue balances we detected
    that our accounting system was recognizing deferred revenue
    using fluctuating foreign currency exchange rates (the current
    rate). The subsidiaries deferred revenue should be
    recognized using the exchange rate applied when the deferred
    revenue was initially recorded (the historical rate). As a
    result, we have (i) recorded adjustments to previously
    reported or announced 2003 quarterly revenue resulting in a
    cumulative $3.8 million or 0.4%, revenue increase to
    $936.3 million from the previously announced 2003 revenue
    of $932.5 million and (ii) increased previously
    announced 2003 earnings per share, or EPS, by $0.03 per share to
    $0.44 (basic) and $0.43 (diluted). Further, in adjusting
    2003 quarterly interim revenue we also reclassified two
    previously recorded correcting adjustments in the third and
    fourth quarters to appropriately reflect these adjustments in
    the second and third quarters of 2003. These quarterly
    adjustments had no net impact on cumulative 2003 revenue. As a
    result of these adjustments, for the first, second, third and
    fourth quarters of 2003, previously reported or announced
    revenue of $218.4 million, $218.3 million,
    $226.9 million and $268.9 million is increased
    (decreased) by $0.9 million, $(1.3) million,
    $0.9 million and $3.3 million, respectively. Also, as
    a result of all adjustments for the first, second, third and
    fourth quarters of 2003, previously reported or announced net
    income of $11.6 million, $3.7 million,
    $9.9 million and $41.3 million is increased
    (decreased) by $0.9 million, $(1.2) million,
    $0.9 million and $3.2 million, respectively.
    Previously reported 2003 net income of $66.5 million was
    increased by $3.7 million to $70.2 million. EPS (basic and
    diluted) for the first and third quarters is increased by $0.01
    each quarter from $0.07 to $0.08 per share, and $0.06 to $0.07
    per share, respectively, with no adjustment to the second
    quarter EPS (basic or diluted). EPS for the fourth quarter
    increased $0.02 from $0.26 to $0.28 per share (basic) and
    from $0.24 to $0.26 per share (diluted). As a result of these
    adjustments, our previously announced deferred revenue and
    currency translation adjustment balance at December 31,
    2003 is reduced (increased) by $4.5 million and $(0.7)
    million to $481.6 million and $33.3 million, respectively.

We believe that period-to-period comparisons of
our financial results should not be relied upon as an indication
of future performance.

Our revenues and results of operations have been
subject to significant fluctuations, particularly on a quarterly
basis, and our revenues and results of operations could
fluctuate significantly quarter to quarter and year to year.
Causes of such fluctuations may include the volume and timing of
new orders and renewals, the sales cycle for our products, the
introduction of new products, return rates, inventory levels,
product upgrades or updates by us or our competitors, changes in
product mix, changes in product prices and pricing models, the

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portion of our licensing fees deferred and
recognized as support and maintenance revenue, seasonality,
trends in the computer industry, general economic conditions,
extraordinary events such as acquisitions or litigation and the
occurrence of unexpected events. For example, net income for the
quarter ended December 31, 2002, reflects a
$70.0 million charge related to our recently settled class
action suit which. Significant quarterly fluctuations in
revenues will cause significant fluctuations in our cash flows
and the cash and cash equivalents, accounts receivable and
deferred revenue accounts on our consolidated balance sheet. In
addition, the operating results of many software companies
reflect seasonal trends, and our business, financial condition
and results of operations may be affected by such trends in the
future. These trends may include higher net revenue in the
fourth quarter as many customers complete annual budgetary
cycles, and lower net revenue in the summer months when many
businesses experience lower sales, particularly in the European
market.


Our financial statements and supplementary data
required by this item are set forth at the pages indicated at
Item 15(a).






|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes In and Disagreements With
    Accountants on Accounting and Financial Disclosure

Nothing to report.






|         |                         
|-------- | ------------------------
|Item 9A. | Controls and Procedures.

Our management evaluated, with the participation
of our Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended) as of the
end of the period covered by this annual report on
Form 10-K. Based on this evaluation, our CEO and CFO have
concluded that, except as described below, our disclosure
controls and procedures are effective to ensure that information
we are required to disclose in reports that we file or submit
under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.
There has been no change in our internal control over financial
reporting that occurred during the quarter ended
December 31, 2003 which materially affected, or is
reasonably likely to affect, our internal control over financial
reporting. Described below are internal control over financial
reporting changes made after the period covered by this
Form 10-K made as a result of events discovered subsequent
to, but impacting results for, the quarter and year ended
December 31, 2003.

As more fully described in footnote (1) to
Item 8, during our preparation and analysis of our 2003
consolidated financial statements, we identified and reported to
our external auditors and audit committee required corrections
to our previously reported or announced financial information
relating to our booking of international deferred revenue and
the making of manual journal entries. These corrections required
restatement of previously reported first, second and third
quarter 2003 quarterly information and adjustment of previously
announced fourth quarter 2003 and full year 2003 information. In
evaluating our corrections, our external auditor determined and
reported to our audit committee in a letter that the underlying
control issues should be considered a material weakness under
standards established by the Public Company Accounting Oversight
Board. In conjunction with making the required corrections, we
have bolstered internal controls around the recognition of
international revenues as part of our quarterly financial
closing process and the manual journal entry process. We are
also in the process of initiating additional internal control
procedures to address the identified weaknesses, including the
hiring of additional personnel, determining how to automate
revenue recognition calculations so as to limit the number of
manual adjustments, and engaging in additional testing of our
control processes and procedures.

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##### Table of Contents






PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our annual meeting of stockholders to be held
on May 27, 2004. We have adopted a code of ethics that
applies to our Chief Executive Officer, Chief Financial Officer,
Corporate Controller and other finance organization employees
that establishes minimum standards of professional
responsibility and ethical conduct. The finance code of ethics
is publicly available on our website at
www.networkassociates.com. If we make any substantive amendments
to the finance code of ethics or grant any waiver, including any
implicit waiver, from a provision of the code to our Chief
Executive Officer, Chief Financial Officer or Corporate
Controller, we will disclose the nature of such amendment or
waiver on that website or in a report on Form 8-K.

Compliance with Section 16(a) of the
Securities Exchange Act of 1934

Section 16(a) of the Securities Exchange Act
of 1934, as amended (the Exchange Act), requires the
Companys officers and directors, and persons who own more
than ten percent of a registered class of the Companys
equity securities, to file certain reports of ownership with the
SEC. Such officers, directors and stockholders are also required
by SEC rules to furnish us with copies of all Section 16(a)
forms they file. All reports required to be filed during fiscal
year 2003 pursuant to Section 16(a) of the exchange act by
directors, executive officers and 10% beneficial owners were
filed on timely basis, except as follows: Mr. Leslie
Denends option grant of 20,000 shares in May 2003 was not
reported in a timely manner to the SEC, Mr. Robert
Dutkowskys option grant of 20,000 shares in April 2003 was
not reported to the SEC in a timely manner, Mr. Robert
Pangias option grant of 20,000 shares in April 2003 was
not reported to the SEC in a timely manner and Ms. Liane
Wilsons option grant of 20,000 shares in April 2003 was
not reported to the SEC in a timely manner.

10b5-1 Trading Plans

Our Insider Trading Policy allows directors,
officers and other employees covered under the policy to
establish, under limited circumstances contemplated by
Rule 10b5-1 under the Securities Exchange Act of 1934,
written programs that permit automatic trading of our stock or
trading of our stock by an independent person (such as an
investment bank) who is not aware of material inside information
at the time of the trade. As of the filing date of this report,
a number of our executive officers, including George Samenuk,
our Chairman and Chief Executive Officer, Stephen C. Richards,
our Chief Operating Officer and Chief Financial Officer, Vernon
Gene Hodges, our President, Kent H. Roberts, our Executive Vice
President and General Counsel, each a Section 16 officer,
have adopted or intend to adopt a Rule 10b5-1 trading plan.
In addition, Amanda Hodges, the wife of our President, intends
to adopt a 10b5-1 trading plan. We believe that additional
directors, officers and employees have established or may
establish such programs. As a result of our March 2003 announced
restatement of certain prior period financial statements and the
delay in the filing of our 2002 Form 10-K, all trades in
our stock by our Section 16 officers, including trades
pursuant to Rule 10b5-1 trading plans, were suspended from
March 2003 until November 2003. All trades in our
common stock made during the fourth quarter and following the
termination of such suspension by officers who have adopted Rule
10b5-1 trading plans were made pursuant to the terms of such
plans.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our annual meeting of stockholders to be held
on May 27, 2004.

58



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##### Table of Contents








|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our annual meeting of stockholders to be held
on May 27, 2004.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our annual meeting of stockholders to be held
on May 27, 2004.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our annual meeting of stockholders to be held
on May 27, 2004.

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PART IV




Item 15. Exhibits, Financial Statement
Schedules and Reports on Form 8-K

(a)(1) Financial Statements:

|                                                                |                                               |        |    |    | 
|--------------------------------------------------------------- | --------------------------------------------- | ------ | -- | -- | 
|                                                                |                                               | Page  
|                                                                |                                               | Number
|                                                                |                                               |       
|Report of Independent Auditors                                  |                                               |        | 61 |   
|Consolidated Balance Sheets:                                    |                                               |        |    |   
|                                                                | December 31, 2003 and 2002                    |        |    | 62 | 
|Consolidated Statements of Income and
    Comprehensive Income: |                                               |        |    |   
|                                                                | Years ended December 31, 2003, 2002 and 2001  |        |    | 63 | 
|Consolidated Statements of Stockholders
    Equity:            |                                               |        |    |   
|                                                                | Years ended December 31, 2003, 2002 and 2001  |        |    | 65 | 
|Consolidated Statements of Cash Flows:                          |                                               |        |    |   
|                                                                | Years ended December 31, 2003, 2002, and 2001 |        |    | 67 | 
|Notes to Consolidated Financial Statements                      |                                               |        | 69 |   

(a)(2) Financial Statement Schedule

The following financial statement schedule of
Networks Associates, Inc. for the years ended December 31,
2003, 2002, and 2001 is filed as part of this Form 10-K and
should be read in conjunction with Networks Associates,
Inc.s Consolidated Financial Statements.

Schedule II  Valuation and Qualifying
Accounts on Page 123

Schedules not listed above have been omitted
because they are not applicable or are not required or because
the required information is included in the Consolidated
Financial Statements or Notes thereto.

(a)(3) Exhibits:See Index to Exhibits on
Page 124. The Exhibits listed on the accompanying Index of
Exhibits are filed or incorporated by reference as part of this
report.

(b) Reports on Form 8-K:

On October 23, 2003, we furnished a report
on Form 8-K to announce our third quarter 2003 financial
results.

On November 1, 2003, we filed a report on
Form 8-K in connection with the completion of our financial
statement restatement and the filing of our Form 2002 10-K,
Amendment No. 2 to our 2000 Form 10-K and our Q1 and
Q2 2003 Form 10-Qs.

On November 13, 2003, we filed a
Form 8-K filing and furnished certain financial information.

On November 21, 2003, we filed a
Form 8-K filing and furnished certain financial information.

On November 24, 2003, we filed a
Form 8-K in connection with our program to repurchase up to
$150 million of our common stock.

On December 1, 2003, we filed a
Form 8-K to file certain information in respect of
historical segment data and to furnish certain
Regulation FD disclosure in connection with our anticipated
operating results for 2004.

On December 15, 2003, we filed a
Form 8-K announcing the signing of an agreement to sell our
Magic Solutions assets to BMC Software, Inc.

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REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders

of Networks Associates, Inc.:


In our opinion, the consolidated financial
statements listed in the index appearing under
Item 15(a)(1) present fairly, in all material respects, the
financial position of Networks Associates, Inc. and its
subsidiaries at December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the three
years in the period ended December 31, 2003 in conformity
with accounting principles generally accepted in the United
States of America. In addition, in our opinion, the financial
statement schedule listed in the index appearing under
Item 15(a)(2) presents fairly, in all material respects,
the information set forth therein when read in conjunction with
the related consolidated financial statements. These financial
statements and financial statement schedule are the
responsibility of the Companys management; our
responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits.
We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.

As discussed in Notes 2 and 9 to the
consolidated financial statements, the Company changed its
method of accounting for exit and disposal activities effective
January 1, 2003.

As discussed in Note 3 to the consolidated
financial statements, the Company changed its method of
accounting for sales commissions effective January 1, 2003.

As discussed in Notes 2 and 10 to the
consolidated financial statements, the Company changed its
method of accounting for goodwill effective January 1, 2002.

PRICEWATERHOUSECOOPERS LLP

Dallas, Texas

February 26, 2004


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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |         |           | 
|-------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | --------- | ------- | --------- |  | --------- | ------- | --------- | 
|                                                                     |                                                                                                                                                                                                  |                                           
|                                                                     |                                                                                                                                                                                                  | December 31,                              
|                                                                     |                                                                                                                                                                                                  |                                           
|                                                                     |                                                                                                                                                                                                  | 2003                                       |           | 2002   
|                                                                     |                                                                                                                                                                                                  |                                            |           |        
|                                                                     |                                                                                                                                                                                                  |                                           
|                                                                     |                                                                                                                                                                                                  | (In thousands,                            
|                                                                     |                                                                                                                                                                                                  | except share data)                        
|ASSETS                                                              
|Current assets:                                                      |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     | Cash and cash equivalents                                                                                                                                                                        |                                            | $         | 333,651 |           |  | $         | 674,226 |          
|                                                                     | Short-term marketable securities                                                                                                                                                                 |                                            |           | 174,499 |           |  |           | 133,577 |          
|                                                                     | Accounts receivable, net of allowance for
    doubtful accounts of $2,863 and $6,638, respectively                                                                                               |                                            |           | 170,218 |           |  |           | 160,159 |          
|                                                                     | Prepaid expenses, income taxes and other current
    assets                                                                                                                                      |                                            |           | 97,616  |           |  |           | 52,238  |          
|                                                                     | Deferred taxes                                                                                                                                                                                   |                                            |           | 160,550 |           |  |           | 174,469 |          
|                                                                     | Assets held for sale                                                                                                                                                                             |                                            |           | 24,719  |           |  |           |        |          
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     |                                                                                                                                                                                                  | Total current assets                       |           |         | 961,253   |  |           |         | 1,194,669 | 
|Long-term marketable securities                                      |                                                                                                                                                                                                  |                                            | 258,107   |         |           |  | 205,906   |        
|Restricted cash                                                      |                                                                                                                                                                                                  |                                            | 20,547    |         |           |  | 21,211    |        
|Property and equipment, net                                          |                                                                                                                                                                                                  |                                            | 111,672   |         |           |  | 89,277    |        
|Deferred taxes                                                       |                                                                                                                                                                                                  |                                            | 199,196   |         |           |  | 139,091   |        
|Intangible assets, excluding goodwill, net                           |                                                                                                                                                                                                  |                                            | 105,952   |         |           |  | 93,551    |        
|Goodwill                                                             |                                                                                                                                                                                                  |                                            | 443,593   |         |           |  | 273,934   |        
|Other assets                                                         |                                                                                                                                                                                                  |                                            | 20,178    |         |           |  | 27,848    |        
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     |                                                                                                                                                                                                  | Total assets                               |           | $       | 2,120,498 |  |           | $       | 2,045,487 | 
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|LIABILITIES                                                         
|Current liabilities:                                                 |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     | Accounts payable                                                                                                                                                                                 |                                            | $         | 32,099  |           |  | $         | 29,948  |          
|                                                                     | Accrued liabilities                                                                                                                                                                              |                                            |           | 147,281 |           |  |           | 220,766 |          
|                                                                     | Deferred revenue                                                                                                                                                                                 |                                            |           | 342,795 |           |  |           | 292,277 |          
|                                                                     | Current portion of convertible debt                                                                                                                                                              |                                            |           |        |           |  |           | 176,260 |          
|                                                                     | Liabilities related to assets held for sale                                                                                                                                                      |                                            |           | 23,310  |           |  |           |        |          
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     |                                                                                                                                                                                                  | Total current liabilities                  |           |         | 545,485   |  |           |         | 719,251   | 
|Deferred revenue, less current portion                               |                                                                                                                                                                                                  |                                            | 116,762   |         |           |  | 36,918    |        
|Convertible debt, less current portion                               |                                                                                                                                                                                                  |                                            | 347,397   |         |           |  | 356,013   |        
|Other long term liabilities                                          |                                                                                                                                                                                                  |                                            | 222,765   |         |           |  | 163,137   |        
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     |                                                                                                                                                                                                  | Total liabilities                          |           |         | 1,232,409 |  |           |         | 1,275,319 | 
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|Commitments and contingencies (Notes 11, 12 and
    20)              |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|STOCKHOLDERS EQUITY                                                
|Preferred stock, $0.01 par value:                                    |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     | Authorized: 5,000,000 shares; Issued and
    outstanding: none in 2003 and 2002                                                                                                                  |                                            |           |        |           |  |           |        |          
|Common stock, $0.01 par value:                                       |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     | Authorized: 300,000,000 shares; Issued:
    162,071,798 shares and 157,926,732 shares for 2003 and 2002;
    Outstanding: 161,721,798 shares and 157,926,732 for 2003 and
    2002, respectively |                                            |           | 1,621   |           |  |           | 1,579   |          
|Additional paid-in capital                                           |                                                                                                                                                                                                  |                                            | 1,087,625 |         |           |  | 1,050,288 |        
|Deferred stock-based compensation                                    |                                                                                                                                                                                                  |                                            | (598      | )       |           |  | (5,736    | )      
|Accumulated other comprehensive income                               |                                                                                                                                                                                                  |                                            | 34,027    |         |           |  | 24,158    |        
|Accumulated deficit                                                  |                                                                                                                                                                                                  |                                            | (229,879  | )       |           |  | (300,121  | )      
|Treasury stock, at cost: 350,000 shares in 2003
    and none in 2002 |                                                                                                                                                                                                  |                                            | (4,707    | )       |           |  |          |        
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     |                                                                                                                                                                                                  | Total stockholders equity                 |           |         | 888,089   |  |           |         | 770,168   | 
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        
|                                                                     |                                                                                                                                                                                                  | Total liabilities and stockholders equity |           | $       | 2,120,498 |  |           | $       | 2,045,487 | 
|                                                                     |                                                                                                                                                                                                  |                                            |           |         |           |  |           |        

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

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME


|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |         |           | 
|------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------- | ------ | ------- | ------- | ---- | ------- | ------- | --------- |  | ------- | ------- | --------- | 
|                                                                    |                                                                                                                                            |                                      
|                                                                    |                                                                                                                                            | Years Ended December 31,             
|                                                                    |                                                                                                                                            |                                      
|                                                                    |                                                                                                                                            | 2003                                  |        | 2002    |         | 2001
|                                                                    |                                                                                                                                            |                                       |        |         |         |     
|                                                                    |                                                                                                                                            |                                      
|                                                                    |                                                                                                                                            | (In thousands, except per share data)
|Net revenue:                                                        |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    | Product                                                                                                                                    |                                       | $      | 513,610 |         |      | $       | 631,550 |           |  | $       | 611,030 |          
|                                                                    | Services and support                                                                                                                       |                                       |        | 422,726 |         |      |         | 411,494 |           |  |         | 460,630 |          
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    |                                                                                                                                            | Total net revenue                     |        |         | 936,336 |      |         |         | 1,043,044 |  |         |         | 1,071,660 | 
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|Cost of net revenue:                                                |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    | Product                                                                                                                                    |                                       |        | 86,646  |         |      |         | 104,039 |           |  |         | 114,917 |          
|                                                                    | Services and support                                                                                                                       |                                       |        | 51,611  |         |      |         | 57,519  |           |  |         | 56,536  |          
|                                                                    | Amortization of purchased technology                                                                                                       |                                       |        | 11,369  |         |      |         | 3,153   |           |  |         | 5,039   |          
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    |                                                                                                                                            | Total cost of net revenue             |        |         | 149,626 |      |         |         | 164,711   |  |         |         | 176,492   | 
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|Operating costs:                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    | Research and development(1)                                                                                                                |                                       |        | 184,606 |         |      |         | 148,801 |           |  |         | 146,701 |          
|                                                                    | Marketing and sales(2)                                                                                                                     |                                       |        | 363,306 |         |      |         | 397,747 |           |  |         | 421,583 |          
|                                                                    | General and administrative(3)                                                                                                              |                                       |        | 129,920 |         |      |         | 119,393 |           |  |         | 111,106 |          
|                                                                    | Amortization of intangibles                                                                                                                |                                       |        | 15,637  |         |      |         | 10,742  |           |  |         | 51,025  |          
|                                                                    | Litigation settlement                                                                                                                      |                                       |        |        |         |      |         | 70,000  |           |  |         |        |          
|                                                                    | Provision for (recovery of) doubtful accounts, net                                                                                         |                                       |        | (1,216  | )       |      |         | (219    | )         |  |         | 7,449   |          
|                                                                    | Acquisition and other related costs                                                                                                        |                                       |        |        |         |      |         | 16,026  |           |  |         |        |          
|                                                                    | Restructuring costs(4)                                                                                                                     |                                       |        | 22,204  |         |      |         | 1,116   |           |  |         | 3,821   |          
|                                                                    | In-process research and development                                                                                                        |                                       |        | 6,600   |         |      |         |        |           |  |         |        |          
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    |                                                                                                                                            | Total operating costs                 |        |         | 721,057 |      |         |         | 763,606   |  |         |         | 741,685   | 
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    | Income from operations                                                                                                                     |                                       |        | 65,653  |         |      |         | 114,727 |           |  |         | 153,483 |          
|Interest and other income                                           |                                                                                                                                            |                                       | 15,454 |         |         |      | 27,324  |         |           |  | 27,993  |        
|Interest and other expenses                                         |                                                                                                                                            |                                       | (7,543 | )       |         |      | (25,085 | )       |           |  | (24,682 | )      
|Gain (loss) on sale of businesses                                   |                                                                                                                                            |                                       | (788   | )       |         |      | 9,301   |         |           |  |        |        
|Gain (loss) on repurchase of zero coupon
    convertible debentures |                                                                                                                                            |                                       | (2,727 | )       |         |      | 26      |         |           |  | 1,731   |        
|Gain on investments, net                                            |                                                                                                                                            |                                       | 3,076  |         |         |      | 3,838   |         |           |  | 10,242  |        
|Impairment of strategic and other investments                       |                                                                                                                                            |                                       |       |         |         |      | (198    | )       |           |  | (20,631 | )      
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    | Income before provision for (benefit from) income
    taxes, minority interest and cumulative effect of change in
    accounting principle |                                       |        | 73,125  |         |      |         | 129,933 |           |  |         | 148,136 |          
|Provision for (benefit from) income taxes                           |                                                                                                                                            |                                       | 13,220 |         |         |      | (274    | )       |           |  | 66,020  |        
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    | Income before minority interest and cumulative
    effect of change in accounting principle                                                |                                       |        | 59,905  |         |      |         | 130,207 |           |  |         | 82,116  |          
|Minority interest in loss (income) of
    consolidated subsidiaries |                                                                                                                                            |                                       |       |         |         |      | (1,895  | )       |           |  | 1,137   |        
|                                                                    |                                                                                                                                            |                                       |        |         |         |      |         |         |           |  |         |        
|                                                                    | Income before cumulative effect of change in
    accounting principle                                                                      |                                       |        | 59,905  |         |      |         | 128,312 |           |  |         | 83,253  |          

63



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##### Table of Contents



NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME 
(Continued)


|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |         | 
|------------------------------------------------------------------------------- | --------------------------------------------------------------------- | ------------------------------------- | ------ | ------- | - | ---- | ------- | ------- | - | - | ------ | ------- | 
|                                                                                |                                                                       |                                      
|                                                                                |                                                                       | Years Ended December 31,             
|                                                                                |                                                                       |                                      
|                                                                                |                                                                       | 2003                                  |        | 2002    |   | 2001
|                                                                                |                                                                       |                                       |        |         |   |     
|                                                                                |                                                                       |                                      
|                                                                                |                                                                       | (In thousands, except per share data)
|Cumulative effect of change in accounting
    principle, net of taxes of $3,590 |                                                                       |                                       | 10,337 |         |   |      |        |         |   |   |       |        
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|Net income                                                                      |                                                                       | $                                     | 70,242 |         |   | $    | 128,312 |         |   | $ | 83,253 |        
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|Other comprehensive income (loss):                                              |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|                                                                                | Unrealized gain (loss) on marketable
    securities net               |                                       | $      | (709    | ) |      | $       | (2,667  | ) |   | $      | 3,332   | 
|                                                                                | Foreign currency translation gain                                     |                                       |        | 10,578  |   |      |         | 10,744  |   |   |        | 5,961   | 
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|Comprehensive income                                                            |                                                                       | $                                     | 80,111 |         |   | $    | 136,389 |         |   | $ | 92,546 |        
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|Basic net income per share:                                                     |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|                                                                                | Income before cumulative effect of change in
    accounting principle |                                       | $      | 0.37    |   |      | $       | 0.86    |   |   | $      | 0.60    | 
|                                                                                | Cumulative effect of change in accounting
    principle, net of taxes |                                       |        | 0.07    |   |      |         |        |   |   |        |        | 
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|                                                                                | Net income per share  basic                                          |                                       | $      | 0.44    |   |      | $       | 0.86    |   |   | $      | 0.60    | 
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|                                                                                | Shares used in per share calculation 
    basic                      |                                       |        | 160,338 |   |      |         | 149,441 |   |   |        | 137,847 | 
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|Diluted net income per share:                                                   |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|                                                                                | Income before cumulative effect of change in
    accounting principle |                                       | $      | 0.36    |   |      | $       | 0.80    |   |   | $      | 0.53    | 
|                                                                                | Cumulative effect of change in accounting
    principle, net of taxes |                                       |        | 0.07    |   |      |         |        |   |   |        |        | 
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|                                                                                | Net income per share  diluted                                        |                                       | $      | 0.43    |   |      | $       | 0.80    |   |   | $      | 0.53    | 
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        
|                                                                                | Shares used in per share calculation 
    diluted                    |                                       |        | 164,489 |   |      |         | 176,249 |   |   |        | 164,363 | 
|                                                                                |                                                                       |                                       |        |         |   |      |         |         |   |   |        |        



---



|    |                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------
|(1) | Includes stock-based compensation charge of
    $5,157, $3,963 and $4,604 in 2003, 2002 and 2001, respectively. 
|   
|(2) | Includes stock-based compensation charge of
    $5,065, $1,980 and $10,354 in 2003, 2002 and 2001, respectively.
|   
|(3) | Includes stock-based compensation charge of
    $2,285, $16,461 and $9,394 in 2003, 2002 and 2001, respectively.
|   
|(4) | Includes stock-based compensation charge of $0,
    $0 and $519 in 2003, 2002 and 2001, respectively.           

|                                                                                            |                          |                   |   |                   |  |  |   |        | 
|------------------------------------------------------------------------------------------- | ------------------------ | ----------------- | - | ----------------- |  |  | - | ------ | 
|                                                                                            |                          | Year Ended        |   | Year Ended       
|                                                                                            |                          | December 31, 2002 |   | December 31, 2001
|                                                                                            |                          |                   |   |                  
|Pro forma amounts assuming the change in
    accounting principle is applied retroactively: |                          |                   |   |                   |  |  |   |       
|                                                                                            | Net income               |                   | $ | 121,513           |  |  | $ | 74,150 | 
|                                                                                            | Basic income per share   |                   | $ | 0.81              |  |  | $ | 0.54   | 
|                                                                                            | Diluted income per share |                   | $ | 0.76              |  |  | $ | 0.48   | 

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

64



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##### Table of Contents



NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                            |                                                                                                            |                |         |          |   |            |       |             |   |               |         |             |   |               |         |         |   |   |   |         |   |   |        |       |  |   |          |         |   |   |         |         |  
|--------------------------- | ---------------------------------------------------------------------------------------------------------- | -------------- | ------- | -------- | - | ---------- | ----- | ----------- | - | ------------- | ------- | ----------- | - | ------------- | ------- | ------- | - | - | - | ------- | - | - | ------ | ----- |  | - | -------- | ------- | - | - | ------- | ------- | -
|                            |                                                                                                            |                |         |          |   |            |       |             |   |               |         | Accumulated |   |               |         |        
|                            |                                                                                                            |                |         |          |   |            |       |             |   | Other         |         |             |   |              
|                            |                                                                                                            | Common Stock   |         |          |   | Additional |       | Deferred    |   | Comprehensive |         |             |   | Total        
|                            |                                                                                                            |                |         | Treasury |   | Paid-In    |       | Stock-based |   | Income        |         | Accumulated |   | Stockholders
|                            |                                                                                                            | Shares         |         | Amount   |   | Stock      |       | Capital     |   | Compensation  |         | (Loss)      |   | Deficit       |         | Equity 
|                            |                                                                                                            |                |         |          |   |            |       |             |   |               |         |             |   |               |         |        
|                            |                                                                                                            |               
|                            |                                                                                                            | (In thousands)
|Balances, December 31, 2000 |                                                                                                            |                | 138,072 |          |   | $          | 1,381 |             |   | $             | (23,186 | )           |   | $             | 695,388 |         |   | $ |  |         |   | $ | 6,788  |       |  | $ | (457,448 | )       |   | $ | 222,923 |        
|                            | Issuance of common stock upon exercise of stock
    options                                                |                |         | 3,233    |   |            |       | 13          |   |               |         | 41,575      |   |               |         | 15,482  |   |   |   |        |   |   |        |      |  |   |          | (27,626 | ) |   |         | 29,444  |  
|                            | Issuance of common stock upon exercise of stock
    options by McAfee.com                                  |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 12,107  |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 12,107  |  
|                            | Issuance of common stock from Employee Stock
    Purchase Plans                                            |                |         | 1,376    |   |            |       | 14          |   |               |         | 35,411      |   |               |         | 705     |   |   |   |        |   |   |        |      |  |   |          | (26,612 | ) |   |         | 9,518   |  
|                            | Repurchase of common stock                                                                                 |                |         | (2,000   | ) |            |       | (2          | ) |               |         | (53,800     | ) |               |         |        |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | (53,802 | )
|                            | Compensation charge due to repricing of stock
    options                                                  |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 24,871  |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 24,871  |  
|                            | Tax benefit from exercise of nonqualified stock
    options                                                |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 5,389   |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 5,389   |  
|                            | Issuance of stock by consolidated subsidiary                                                               |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 5,523   |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 5,523   |  
|                            | Minority interest attributed to McAfee.com                                                                 |                |         |         |   |            |       |            |   |               |         |            |   |               |         | (7,026  | ) |   |   |        |   |   |        |      |  |   |          |        |   |   |         | (7,026  | )
|                            | Foreign currency translation                                                                               |                |         |         |   |            |       |            |   |               |         |            |   |               |         |        |   |   |   |        |   |   |        | 5,961 |  |   |          |        |   |   |         | 5,961   |  
|                            | Net increase (decrease) in unrealized gains
    on investments                                             |                |         |         |   |            |       |            |   |               |         |            |   |               |         |        |   |   |   |        |   |   |        | 3,332 |  |   |          |        |   |   |         | 3,332   |  
|                            | Net income                                                                                                 |                |         |         |   |            |       |            |   |               |         |            |   |               |         |        |   |   |   |        |   |   |        |      |  |   |          | 83,253  |   |   |         | 83,253  |  
|                            |                                                                                                            |                |         |          |   |            |       |             |   |               |         |             |   |               |         |         |   |   |   |         |   |   |        |       |  |   |          |         |   |   |         |        
|Balances, December 31, 2001 |                                                                                                            |                | 140,681 |          |   |            | 1,406 |             |   |               |        |             |   |               | 752,439 |         |   |   |  |         |   |   | 16,081 |       |  |   | (428,433 | )       |   |   | 341,493 |        
|                            | Issuance of common stock upon exercise of stock
    options                                                |                |         | 8,197    |   |            |       | 82          |   |               |         |            |   |               |         | 99,664  |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 99,746  |  
|                            | Issuance of common stock upon exercise of stock
    options by McAfee.com                                  |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 3,633   |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 3,633   |  
|                            | Issuance of common stock from Employee Stock
    Purchase Plans                                            |                |         | 743      |   |            |       | 8           |   |               |         |            |   |               |         | 6,524   |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 6,532   |  
|                            | Issuance of common stock for acquisition of
    minority interest in McAfee.com, net of cost of $1,956     |                |         | 8,307    |   |            |       | 83          |   |               |         |            |   |               |         | 119,397 |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 119,480 |  
|                            | Deferred stock-based compensation                                                                          |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 31,955  |   |   |   | (31,955 | ) |   |        |      |  |   |          |        |   |   |         |        |  
|                            | Amortization of deferred stock-based compensation
    and other compensation charge                        |                |         |         |   |            |       |            |   |               |         |            |   |               |         | (3,815  | ) |   |   | 26,219  |   |   |        |      |  |   |          |        |   |   |         | 22,404  |  
|                            | Reclassification of cash payable in excess of
    exercise price related to exchange of McAfee.com options |                |         |         |   |            |       |            |   |               |         |            |   |               |         | (4,190  | ) |   |   |        |   |   |        |      |  |   |          |        |   |   |         | (4,190  | )
|                            | Tax benefits from exercise of non-qualified stock
    options                                              |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 45,962  |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 45,962  |  
|                            | Stock options issued in connection with
    acquisition                                                    |                |         |         |   |            |       |            |   |               |         |            |   |               |         | 357     |   |   |   |        |   |   |        |      |  |   |          |        |   |   |         | 357     |  

65



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##### Table of Contents



|                            |                                                                                                            |                |         |          |   |            |       |             |  |               |        |             |   |               |           |        |   |   |        |       |  |   |        |        |   |   |          |         |  |   |         |         |  
|--------------------------- | ---------------------------------------------------------------------------------------------------------- | -------------- | ------- | -------- | - | ---------- | ----- | ----------- |  | ------------- | ------ | ----------- | - | ------------- | --------- | ------ | - | - | ------ | ----- |  | - | ------ | ------ | - | - | -------- | ------- |  | - | ------- | ------- | -
|                            |                                                                                                            |                |         |          |   |            |       |             |  |               |        | Accumulated |   |               |           |       
|                            |                                                                                                            |                |         |          |   |            |       |             |  | Other         |        |             |   |              
|                            |                                                                                                            | Common Stock   |         |          |   | Additional |       | Deferred    |  | Comprehensive |        |             |   | Total        
|                            |                                                                                                            |                |         | Treasury |   | Paid-In    |       | Stock-based |  | Income        |        | Accumulated |   | Stockholders
|                            |                                                                                                            | Shares         |         | Amount   |   | Stock      |       | Capital     |  | Compensation  |        | (Loss)      |   | Deficit       |           | Equity
|                            |                                                                                                            |                |         |          |   |            |       |             |  |               |        |             |   |               |           |       
|                            |                                                                                                            |               
|                            |                                                                                                            | (In thousands)
|                            | Minority interest attributed to McAfee.com                                                                 |                |         |         |   |            |       |            |  |               |        |            |   |               |           | (1,638 | ) |   |        |      |  |   |        |       |   |   |          |        |  |   |         | (1,638  | )
|                            | Foreign currency translation                                                                               |                |         |         |   |            |       |            |  |               |        |            |   |               |           |       |   |   |        |      |  |   |        | 10,744 |   |   |          |        |  |   |         | 10,744  |  
|                            | Net increase (decrease) in unrealized gains
    on investments                                             |                |         |         |   |            |       |            |  |               |        |            |   |               |           |       |   |   |        |      |  |   |        | (2,667 | ) |   |          |        |  |   |         | (2,667  | )
|                            | Net income                                                                                                 |                |         |         |   |            |       |            |  |               |        |            |   |               |           |       |   |   |        |      |  |   |        |       |   |   |          | 128,312 |  |   |         | 128,312 |  
|                            |                                                                                                            |                |         |          |   |            |       |             |  |               |        |             |   |               |           |        |   |   |        |       |  |   |        |        |   |   |          |         |  |   |         |        
|Balances, December 31, 2002 |                                                                                                            |                | 157,928 |          |   |            | 1,579 |             |  |               |       |             |   |               | 1,050,288 |        |   |   | (5,736 | )     |  |   | 24,158 |        |   |   | (300,121 | )       |  |   | 770,168 |        
|                            | Issuance of common stock upon exercise of stock
    options                                                |                |         | 2,548    |   |            |       | 26          |  |               |        |            |   |               |           | 19,610 |   |   |        |      |  |   |        |       |   |   |          |        |  |   |         | 19,636  |  
|                            | Issuance of common stock from Employee Stock
    Purchase Plans                                            |                |         | 1,596    |   |            |       | 16          |  |               |        |            |   |               |           | 15,765 |   |   |        |      |  |   |        |       |   |   |          |        |  |   |         | 15,781  |  
|                            | Repurchase of common stock                                                                                 |                |         | (350     | ) |            |       |            |  |               |        | (4,707      | ) |               |           |       |   |   |        |      |  |   |        |       |   |   |          |        |  |   |         | (4,707  | )
|                            | Deferred stock-based compensation                                                                          |                |         |         |   |            |       |            |  |               |        |            |   |               |           | (643   | ) |   |        | 643   |  |   |        |       |   |   |          |        |  |   |         |        |  
|                            | Amortization of deferred stock-based Compensation
    and other stock-based compensation charge            |                |         |         |   |            |       |            |  |               |        |            |   |               |           | 8,012  |   |   |        | 4,495 |  |   |        |       |   |   |          |        |  |   |         | 12,507  |  
|                            | Reclassification of cash payable in excess of
    exercise price related to exchange of McAfee.com options |                |         |         |   |            |       |            |  |               |        |            |   |               |           | (5,407 | ) |   |        |      |  |   |        |       |   |   |          |        |  |   |         | (5,407  | )
|                            | Foreign currency translation                                                                               |                |         |         |   |            |       |            |  |               |        |            |   |               |           |       |   |   |        |      |  |   |        | 10,578 |   |   |          |        |  |   |         | 10,578  |  
|                            | Net increase (decrease) in unrealized gains
    on investments                                             |                |         |         |   |            |       |            |  |               |        |            |   |               |           |       |   |   |        |      |  |   |        | (709   | ) |   |          |        |  |   |         | (709    | )
|                            | Net income                                                                                                 |                |         |         |   |            |       |            |  |               |        |            |   |               |           |       |   |   |        |      |  |   |        |       |   |   |          | 70,242  |  |   |         | 70,242  |  
|                            |                                                                                                            |                |         |          |   |            |       |             |  |               |        |             |   |               |           |        |   |   |        |       |  |   |        |        |   |   |          |         |  |   |         |        
|Balances, December 31, 2003 |                                                                                                            |                | 161,722 |          |   | $          | 1,621 |             |  | $             | (4,707 | )           |   | $             | 1,087,625 |        |   | $ | (598   | )     |  | $ | 34,027 |        |   | $ | (229,879 | )       |  | $ | 888,089 |        
|                            |                                                                                                            |                |         |          |   |            |       |             |  |               |        |             |   |               |           |        |   |   |        |       |  |   |        |        |   |   |          |         |  |   |         |        

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

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                      |                                                                                       |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |          |         |          |         | 
|------------------------------------- | ------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------- | ----------------------------------------------- | ------------------------------------------------------- | ------- | ------- | -------- | -------- | ------- | ------- | -------- | -------- | ------- | -------- | ------- | 
|                                      |                                                                                       |                                                                                            
|                                      |                                                                                       | Years Ended December 31,                                                                   
|                                      |                                                                                       |                                                                                            
|                                      |                                                                                       | 2003                                                                                        |                                                 | 2002                                                    |         | 2001   
|                                      |                                                                                       |                                                                                             |                                                 |                                                         |         |        
|                                      |                                                                                       |                                                                                            
|                                      |                                                                                       | (In thousands)                                                                             
|Cash flows from operating activities: |                                                                                       |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |         
|                                      | Net income                                                                            |                                                                                             | $                                               | 70,242                                                  |         |         | $        | 128,312  |         |         | $        | 83,253   |        
|                                      | Adjustments to reconcile net income to net cash
    provided by operating activities: |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |          |        
|                                      |                                                                                       | Cumulative effect of change in accounting
    principle                                     |                                                 |                                                         | (10,337 | )       |          |          |        |         |          |          |        |         
|                                      |                                                                                       | Depreciation and amortization                                                               |                                                 |                                                         | 51,461  |         |          |          | 50,531  |         |          |          | 94,969  |         
|                                      |                                                                                       | Amortization of purchased technology to cost of
    revenue                                 |                                                 |                                                         | 11,369  |         |          |          | 3,153   |         |          |          | 5,039   |         
|                                      |                                                                                       | Non-cash restructuring charge                                                               |                                                 |                                                         | 14,534  |         |          |          |        |         |          |          |        |         
|                                      |                                                                                       | Acquired in-process research and development                                                |                                                 |                                                         | 6,600   |         |          |          |        |         |          |          |        |         
|                                      |                                                                                       | Premium amortization of marketable securities                                               |                                                 |                                                         | 7,114   |         |          |          |        |         |          |          |        |         
|                                      |                                                                                       | Provision for (recovery of) doubtful accounts                                               |                                                 |                                                         | (1,216  | )       |          |          | (219    | )       |          |          | 7,449   |         
|                                      |                                                                                       | Non-cash interest and other expense on
    convertible Notes                                |                                                 |                                                         | 3,162   |         |          |          | 12,025  |         |          |          | 24,697  |         
|                                      |                                                                                       | Stock-based compensation                                                                    |                                                 |                                                         | 12,507  |         |          |          | 22,404  |         |          |          | 24,871  |         
|                                      |                                                                                       | Deferred taxes                                                                              |                                                 |                                                         | (25,368 | )       |          |          | (65,208 | )       |          |          | 47,286  |         
|                                      |                                                                                       | Gain on sale of investments                                                                 |                                                 |                                                         | (3,076  | )       |          |          | (3,838  | )       |          |          | (10,242 | )       
|                                      |                                                                                       | Impairment of strategic and other investments                                               |                                                 |                                                         |        |         |          |          | 198     |         |          |          | 20,631  |         
|                                      |                                                                                       | Minority interest                                                                           |                                                 |                                                         |        |         |          |          | 1,895   |         |          |          | (1,137  | )       
|                                      |                                                                                       | (Gain) loss on repurchase of zero coupon
    convertible debenture                          |                                                 |                                                         | 2,727   |         |          |          | (26     | )       |          |          | (1,731  | )       
|                                      |                                                                                       | Loss (gain) on the sale of assets and
    businesses                                        |                                                 |                                                         | 788     |         |          |          | (9,301  | )       |          |          |        |         
|                                      |                                                                                       | Tax benefit from exercise of nonqualified stock
    options                                 |                                                 |                                                         |        |         |          |          | 45,962  |         |          |          | 5,389   |         
|                                      |                                                                                       | Change in fair value of interest rate swap, net
    of change in the fair value of the debt |                                                 |                                                         | (5,646  | )       |          |          | (1,402  | )       |          |          |        |         
|                                      |                                                                                       | Changes in assets and liabilities, net of
    acquisitions:                                 |                                                 |                                                         |         |         |          |          |         |         |          |          |         |         
|                                      |                                                                                       |                                                                                             | Accounts receivable                             |                                                         |         | (6,676  | )        |          |         | (15,805 | )        |          |         | (33,003  | )      
|                                      |                                                                                       |                                                                                             | Prepaid expenses, income taxes and other assets |                                                         |         | (17,624 | )        |          |         | 9,699   |          |          |         | 35,239   |        
|                                      |                                                                                       |                                                                                             | Accounts payable and accrued liabilities        |                                                         |         | (78,452 | )        |          |         | 77,993  |          |          |         | (12,497  | )      
|                                      |                                                                                       |                                                                                             | Deferred revenue                                |                                                         |         | 124,195 |          |          |         | (61,280 | )        |          |         | (144,224 | )      
|                                      |                                                                                       |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |         
|                                      |                                                                                       |                                                                                             |                                                 | Net cash provided by operating activities               |         |         | 156,304  |          |         |         | 195,093  |          |         |          | 145,989 | 
|                                      |                                                                                       |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |         
|Cash flows from investing activities: |                                                                                       |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |         
|                                      | Purchase of marketable securities                                                     |                                                                                             |                                                 | (1,120,561                                              | )       |         |          | (773,093 | )       |         |          | (678,093 | )      
|                                      | Proceeds from sale and maturity of marketable
    securities                          |                                                                                             |                                                 | 1,022,700                                               |         |         |          | 781,761  |         |         |          | 754,182  |        
|                                      | (Increase) decrease in restricted cash                                                |                                                                                             |                                                 | 664                                                     |         |         |          | (21,734  | )       |         |          |         |        
|                                      | Purchase of minority interest in McAfee.com                                           |                                                                                             |                                                 |                                                        |         |         |          | (98,447  | )       |         |          |         |        
|                                      | Purchases of acquired technology                                                      |                                                                                             |                                                 | (178                                                    | )       |         |          | (807     | )       |         |          | (12,250  | )      
|                                      | Acquisitions, net of cash acquired                                                    |                                                                                             |                                                 | (217,078                                                | )       |         |          | (19,054  | )       |         |          | (916     | )      
|                                      | Purchase of property and equipment and leasehold
    improvements, net                |                                                                                             |                                                 | (60,027                                                 | )       |         |          | (59,427  | )       |         |          | (31,493  | )      
|                                      | Sale of Secure Computing shares and collar                                            |                                                                                             |                                                 |                                                        |         |         |          | 5,105    |         |         |          |         |        
|                                      | Sale of assets and technology                                                         |                                                                                             |                                                 |                                                        |         |         |          | 2,050    |         |         |          |         |        
|                                      | Purchase of shares of Networks Associates Japan                                       |                                                                                             |                                                 |                                                        |         |         |          |         |         |         |          | (10,655  | )      
|                                      |                                                                                       |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |         
|                                      |                                                                                       |                                                                                             |                                                 | Net cash provided by (used in) investing
    activities |         |         | (374,480 | )        |         |         | (183,646 | )        |         |          | 20,775  | 
|                                      |                                                                                       |                                                                                             |                                                 |                                                         |         |         |          |          |         |         |          |         

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|                                      |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |          |         | 
|------------------------------------- | ------------------------------------------------------------------------------------------------------- | ------------------------------------------------------- | - | -------- | -------- | ---- | - | ------- | ------ |  | - | -------- | ------- | 
|                                      |                                                                                                         |                                                        
|                                      |                                                                                                         | Years Ended December 31,                               
|                                      |                                                                                                         |                                                        
|                                      |                                                                                                         | 2003                                                    |   | 2002     |          | 2001
|                                      |                                                                                                         |                                                         |   |          |          |     
|                                      |                                                                                                         |                                                        
|                                      |                                                                                                         | (In thousands)                                         
|Cash flows from financing activities: |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |         
|                                      | Repayment of short-term financing                                                                       |                                                         |   |         |          |      |   |        |        |  |   | (41      | )      
|                                      | Proceeds from issuance of common stock under
    stock option plan and stock purchase plans             |                                                         |   | 35,417   |          |      |   | 109,911 |        |  |   | 51,069   |        
|                                      | Repurchase of common stock                                                                              |                                                         |   | (4,707   | )        |      |   |        |        |  |   | (53,802  | )      
|                                      | Repurchase of convertible debentures                                                                    |                                                         |   | (177,289 | )        |      |   | (66,175 | )      |  |   | (173,708 | )      
|                                      | Issuance of convertible debentures, net of
    issuance costs                                           |                                                         |   |         |          |      |   |        |        |  |   | 335,081  |        
|                                      |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |         
|                                      |                                                                                                         | Net cash provided by (used in) financing
    activities |   |          | (146,579 | )    |   |         | 43,736 |  |   |          | 158,599 | 
|                                      |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |         
|                                      | Effect of exchange rate fluctuations                                                                    |                                                         |   | 24,180   |          |      |   | 6,211   |        |  |   | 11,930   |        
|                                      |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |         
|                                      | Net increase (decrease) in cash and cash
    equivalents                                                |                                                         |   | (340,575 | )        |      |   | 61,394  |        |  |   | 337,293  |        
|                                      | Cash and cash equivalents at beginning of period                                                        |                                                         |   | 674,226  |          |      |   | 612,832 |        |  |   | 275,539  |        
|                                      |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |         
|                                      | Cash and cash equivalents at end of period                                                              |                                                         | $ | 333,651  |          |      | $ | 674,226 |        |  | $ | 612,832  |        
|                                      |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |         
|Non cash investing activities:        |                                                                                                         |                                                         |   |          |          |      |   |         |        |  |   |         
|                                      | Unrealized gains (losses) on marketable
    investments, net                                            |                                                         | $ | (709     | )        |      | $ | (2,667  | )      |  | $ | 3,332    |        
|                                      | Issuance of common stock for acquisition of
    minority interest in McAfee.com, net of costs of $1,956 |                                                         | $ |         |          |      | $ | 119,480 |        |  |   |         |        
|                                      | Fair value of assets acquired in business
    combinations                                              |                                                         | $ | 247,958  |          |      |   |        |        |  |   |         |        
|                                      | Liabilities assumed in business combinations                                                            |                                                         | $ | 25,465   |          |      | $ |        |        |  | $ |         |        
|                                      | McAfee.com stock issued in acquisitions                                                                 |                                                         | $ |         |          |      | $ |        |        |  | $ | 5,523    |        
|                                      | Supplemental disclosure of cash flow information:                                                       |                                                         |   |          |          |      |   |         |        |  |   |          |        
|                                      | Cash paid during the year for interest                                                                  |                                                         | $ | 10,434   |          |      | $ | 20,666  |        |  | $ |         |        
|                                      | Cash paid during the year for income taxes                                                              |                                                         | $ | 20,864   |          |      | $ | 18,547  |        |  | $ | 8,844    |        

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

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##### Table of Contents



NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

1.     Organization
and Business

Networks Associates, Inc. and its wholly owned
subsidiaries (the Company) are a leading supplier of
computer security solutions designed to prevent intrusions on
networks and protect computer systems from the next generation
of blended attacks and threats. The Company offers two families
of products, McAfee System Protection Solutions and McAfee
Network Protection Solutions. The Companys computer
security solutions are offered primarily to large enterprises,
governments, small and medium sized businesses and consumers.
The Company operates its business in five geographic regions:
North America; Europe, Middle East and Africa
(EMEA); Japan; Asia-Pacific and Latin America.

2.     Summary of
Significant Accounting Policies



| |                      
| | ---------------------
| | Basis of Presentation

The accompanying consolidated financial
statements include the accounts of the Company and its wholly
owned subsidiaries. On September 13, 2002, the Company
repurchased the 25% minority interest in its McAfee.com
subsidiary. Therefore, since the date of acquisition, no
minority interest exists in McAfee.com and accordingly the
Companys consolidated net income for 2002 includes the
full amount of McAfee.com results from this date. All
intercompany accounts and transactions have been eliminated.

Certain reclassifications have been made to the
prior years consolidated financial statements to conform
to the current years presentation. These reclassifications
had no effect on the prior years stockholders equity
or results of operations.



| |                  
| | -----------------
| | Minority Interest

Minority interest in (income) loss of
consolidated subsidiaries in the statements of income for 2002
and 2001 represents the minority stockholders share of the
income or loss of various consolidated subsidiaries. As of
December 31, 2002, the Companys consolidated
subsidiaries were all wholly owned and there were no minority
interests.



| |                 
| | ----------------
| | Use of Estimates

The preparation of consolidated financial
statements in conformity with generally accepted accounting
principles in the United States of America requires management
to make estimates and assumptions that affect the reported
amount of assets and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements
and the reported amounts of revenues and expenses during the
reported period. Significant estimates include those required in
the valuation of intangible assets acquired in purchase
combinations, impairment analysis of goodwill and intangibles,
property and equipment, allowances for doubtful accounts, sales
returns and allowances, vendor specific objective evidence of
the fair value of the various elements of the Companys
multiple element software transactions, valuation allowances for
deferred tax assets, tax accruals, and warranty obligation
accrual. Although the Company believes that adequate accruals
have been made for unsettled issues, additional gains or losses
could occur in future years from resolutions of outstanding
matters. Actual results could differ materially from original
estimates.



| |                                     
| | ------------------------------------
| | Certain Risks and
    Concentrations

The Company has historically derived a majority
of its net revenue from its McAfee anti-virus software products
and its Sniffer network fault identification and application
performance management products. These products are expected to
continue to account for a significant portion of the
Companys net revenues. The markets in which the Company
operates are highly competitive and rapidly changing.
Significant technological changes, changes in customer
requirements, or the emergence of competitive products with new
capabilities or technologies could adversely affect operating
results. The Company has historically derived a

69



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

majority of its net revenues from anti-virus
software products and network fault and performance management
products. These products are expected to continue to account for
a significant portion of net revenue for the foreseeable future.
As a result of this revenue concentration, the Companys
business could be harmed by a decline in demand for, or in the
prices of, these products as a result of, among other factors,
any change in pricing model, a maturation in the markets for
these products, increased price competition or a failure by the
Company to keep up with technological change.

The Company sells a significant amount of its
products through intermediaries such as distributors, resellers
and others. The Companys top ten distributors typically
represent approximately 46% to 62% of net sales in any quarter.
The Companys two largest distributors accounted for
approximately 33% to 35% of net revenue during 2003, 2002 and
2001. The Companys distributor agreements may be
terminated by either party without cause. If one of the
Companys significant distributors terminates its
distribution agreement, the Company could experience a
significant interruption in the sale and distribution of its
products. The distributors may sell other vendors products
that are complementary to, or compete with, its products. While
the Company encourages its distributors to focus on the
Companys products through market and support programs,
these distributors may give greater priority to products of
other suppliers, including competitors.

Some of the Companys distributors may
experience financial difficulties, which could adversely impact
collection of accounts receivable. The Company regularly reviews
the collectibility and credit-worthiness of its distributors to
determine an appropriate allowance for doubtful accounts. The
Companys bad debt allowance was $2.9 million at
December 31, 2003 and $6.6 million at
December 31, 2002. The Companys uncollectible
accounts could exceed its current or future allowances. The
Company determines its allowance for doubtful accounts by
assessing the collectibility of individual accounts receivable
over a specified aging and amount and provides an amount equal
to the historical percentage of write-off experience of the
remaining accounts receivable. Accounts receivable are written
off on a case by case basis, including probability that any
amounts can be collected.

Some of our products incorporate licensed
software and the Company must be able to obtain reasonably
priced licenses and successfully integrate this software with
its hardware. In addition, some of the Companys products
may include open source software. The Companys
ability to commercialize products or technologies incorporating
open source software may be restricted because, among other
reasons, open source license terms may be ambiguous and may
result in unanticipated obligations regarding its products.

The Company has credit risk exposure from the
potential that the counterparties to its interest rate swaps and
foreign forward exchange contracts may not perform according to
the terms of these derivative agreements. The Company limits the
risk that counterparties to these contracts may be unable to
perform by transacting only with major U.S. and European banks.
Failure of a counterparty to perform under the agreements with
respect to these transactions could have a material effect on
the Companys results of operations and cash flows.

The Company maintains the majority of cash
balances and all of its short-term investments with seven
financial institutions. The Company invests with financial
institutions with high quality credit and, by policy, limits the
amount of credit exposure to any one financial institution.

The Company receives certain of its critical
components from sole suppliers. Additionally, the Company relies
on a limited number of contract manufacturers and suppliers to
provide manufacturing services for its products. The inability
of any contract manufacturer or supplier to fulfill supply
requirements of the Company could materially impact future
operating results.



| |                             
| | ----------------------------
| | Foreign Currency Translation

The Company considers the local currency to be
the functional currency for its international subsidiaries.
Assets and liabilities denominated in foreign currencies are
translated using the exchange rate on the consolidated balance
sheet date. Revenues and expenses are translated at average
exchange rates prevailing

70



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

during the year. Translation adjustments
resulting from this process are charged or credited to
accumulated other comprehensive income. Where the United States
Dollar is the functional currency of the subsidiary, all
remeasurement adjustments are recorded in the consolidated
statement of income.

Foreign currency transaction gains and losses,
which to date have not been material, are included in the
consolidated statements of income.



| |            
| | -----------
| | Derivatives

The Company follows the guidance in Statement of
Financial Accounting Standard (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging
Activities, as amended, in accounting for derivatives.
The standard requires the Company to recognize all derivatives
on the consolidated balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through the
consolidated statement of income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value
of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities or firm commitments
through earnings, or recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective
portion of a derivatives change in fair value is
immediately recognized in earnings. The Companys use of
derivative financial instruments is discussed in Note 7 to these
Notes to the Consolidated Financial Statements.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

Cash equivalents are comprised of highly liquid
debt instruments with original maturities or remaining
maturities at date of purchase of 90 days or less.



| |                      
| | ---------------------
| | Marketable Securities

All marketable securities are classified as
available-for-sale securities. Available-for-sale securities are
carried at fair value with resulting unrealized gains and
losses, net of related taxes, reported as a component of
accumulated other comprehensive income. Premium and discount on
debt securities recorded at the date of purchase are amortized
and accreted, respectively, to interest income using the
effective interest method. Short-term marketable securities are
those with remaining maturities at the consolidated balance
sheet date of one year or less. Long-term marketable securities
have remaining maturities at the consolidated balance sheet date
of greater than one year. Realized gains and losses on sales of
all such investments are reported in earnings and computed using
the specific identification cost method.

The Company assesses the value of its
available-for-sale marketable securities on a regular basis to
assess whether an other-than-temporary decline in the fair value
has occurred. Factors which the Company uses to assess whether
an other than temporary decline has occurred include, but are
not limited to, the period of time which the fair value is below
original cost, significant changes in the operating performance,
financial condition or business model, and changes in market
conditions. Any other than temporary decline in
value is reported in earnings and a new cost basis for the
marketable security established.



| |          
| | ---------
| | Inventory

Inventory, which consists primarily of finished
goods, is stated at lower of cost or market and is included in
other current assets. Cost is computed using standard cost,
which approximates cost on a first in, first out basis. The
Company provides an inventory allowance based upon excess and
obsolete inventory determined primarily by future demand
forecasts.

71



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are presented at cost less
accumulated depreciation and amortization (See Note 8 of
these Notes to Consolidated Financial Statements). Depreciation
and amortization of property and equipment are computed using
the straight-line method over the estimated useful lives as
follows:



| |   |                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------
| |  | building  interior  seven
    years; exterior  twenty years;                                      
|
| |  | computer hardware and software  three
    to five years;                                            
|
| |  | office furniture and equipment  three
    to seven years; and                                       
|
| |  | leasehold improvements  the shorter of the
    lease term or the estimated useful life of the asset.

The costs associated with projects eligible for
capitalization are accumulated on the consolidated balance sheet
until the project is substantially complete and is placed into
service. Capitalized interest is calculated on all eligible
projects in progress. Interest capitalization begins when three
conditions have been met (1) expenditures have occurred,
(2) activities necessary to prepare the asset have begun, and
(3) interest cost has been incurred. For 2003 and 2002, the
Company recorded $0.3 million and $0.8 million of
capitalized interest, respectively.

When assets are disposed, the Company removes the
asset and accumulated depreciation from its records and
recognizes the related gain or loss in results of operations.
The cost and related accumulated depreciation applicable to
property and equipment sold or no longer in service are
eliminated from the accounts and any gain or loss is included in
operations.

Repairs and maintenance expenditures, which are
not considered improvements and do not extend the useful life of
property and equipment, are expensed as incurred.



| |         
| | --------
| | Goodwill

The Company follows the guidance of SFAS
No. 142, Goodwill and Other Intangible
Assets (SFAS 142) in accounting for
its goodwill and intangible assets. The Company adopted
SFAS 142 as of January 1, 2002, and as required,
ceased amortizing goodwill. In lieu of amortization, an
impairment review of goodwill is performed on at least an annual
basis and on an interim basis if an event occurs or
circumstances change that would more likely than not reduce the
fair value of the Companys reporting units below their
carrying value. Our reporting units are consistent with the
operating geographies discussed in Note 19. This impairment
review involves a two-step process as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Step 1  The Company compares the fair
    value of its reporting units to the carrying value, including
    goodwill of each of those units. For each reporting unit where
    the carrying value, including goodwill, exceeds the units
    fair value, the Company moves on to Step 2. If a units
    fair value exceeds the carrying value, no further work is
    performed and no impairment charge is necessary.                                                                                                                                                                           
|
| |  | Step 2  The Company performs an
    allocation of the fair value of the reporting unit to its
    identifiable tangible and non-goodwill intangible assets and
    liabilities. This derives an implied fair value for the
    reporting units goodwill. The Company then compares the
    implied fair value of the reporting units goodwill with
    the carrying amount of the reporting units goodwill. If
    the carrying amount of the reporting units goodwill is
    greater than the implied fair value of its goodwill, an
    impairment charge would be recognized for the excess.



| |                                                                         
| | ------------------------------------------------------------------------
| | Finite-Lived Intangibles, Long-Lived Assets
    and Assets Held for Sale

Purchased technology and other identifiable
intangible assets are carried at cost less accumulated
amortization. The Company amortizes other identifiable
intangibles on a straight-line basis over their estimated useful
lives. The range of estimated useful lives of the Companys
identifiable intangibles is one to seven years (see Note 10 to
these Notes to Consolidated Financial Statements).

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Company accounts for finite-lived intangibles
and long-lived assets in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets. Under this standard, the Company reviews
finite-lived intangibles or long-lived assets to be held and
used for impairment whenever events or changes in circumstances
indicate that the carrying value such assets may not be
recoverable.

Based upon the existence of one or more potential
indicators of impairment, recoverability is assessed based upon
an estimate of undiscounted cash flows resulting from the use of
the assets and its eventual disposition. Measurement of an
impairment loss is based on a projected discounted cash flow
method using a discount rate determined by management to be
commensurate with the risk inherent in our current business
model. Finite-lived intangibles and long-lived assets to be
disposed of are reported at the lower of carrying amount of fair
value less the costs to sell.

The Company announced plans to sell its Magic
Solutions assets (Magic) in December 2003. The
disposal group met the criteria stated in SFAS 144 to be held
for sale in December 2003, and consequently, depreciation on
equipment related to Magic was ceased. All assets and
liabilities related to Magic have been presented as held for
sale on the consolidated balance sheet at December 31, 2003.



| |                      
| | ---------------------
| | Internal Use Software

The Company follows the guidance in Statement of
Position 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use.
Software development costs, including costs incurred to purchase
third party software, are capitalized beginning when the Company
has determined factors are present, including among others, that
technology exists to achieve the performance requirements, buy
versus internal development decisions have been made and the
Companys management has authorized the funding for the
project. Capitalization of software costs ceases when the
software is substantially complete and is ready for its intended
use and is amortized over its estimated useful life of three
years using the straight-line method.

When events or circumstances indicate the
carrying value of internal use software might not be
recoverable, the Company assesses the recoverability of these
assets by determining whether the amortization of the asset
balance over its remaining life can be recovered through
undiscounted future operating cash flows. The amount of
impairment, if any, is recognized to the extent that the
carrying value exceeds the projected discounted future operating
cash flows and is recognized as a write down of the asset. In
addition, when it is no longer probable that computer software
being developed will be placed in service, the asset will be
recorded at the lower of its carrying value or fair value, if
any, less direct selling costs.



| |            
| | -----------
| | Investments

Investments consist of minority investments in
non-publicly and publicly traded companies in which the Company
holds less than a 20% interest and does not exercise significant
influence. The private investments with no concurrent revenue
arrangements are included in other assets on the Companys
consolidated balance sheet and are carried at original cost,
less reductions related to other-than-temporary declines in
value. In accordance with APB Opinion No. 29, investments
with concurrent revenue arrangements, are carried at cost, less
the amounts received under the revenue arrangement when fair
value cannot be readily determined. The public investments are
included in short-term marketable securities and are carried at
fair value with resulting unrealized gains, net of related
taxes, included on the Companys consolidated balance sheet
as a component of accumulated other comprehensive income.

The Company assesses the recoverability of its
investments on a regular basis. Factors that the Company
considers which could trigger an other than temporary decline in
the value of such investments include, but are not limited to,
the likelihood that the related company would have insufficient
cash flows to operate for the next twelve months, significant
changes in the operating performance or business model, and
changes in market conditions. For public investments, the
Company also considers the period of time the fair value of the

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

investment has been less than its carrying value.
The Company recorded charges related to other than temporary
declines in the value of certain strategic investments of
$0.2 million and $20.6 million in 2002 and 2001,
respectively. As a result, all of the Companys investments
in non-publicly traded companies have no carrying value. No
charges were recorded in 2003.



| |                                        
| | ---------------------------------------
| | Fair Value of Financial
    Instruments

Carrying amounts of the Companys financial
instruments including accounts receivable, accounts payable and
accrued liabilities approximate fair value due to their short
maturities. The fair values of the Companys investments in
marketable securities are disclosed in Note 6 to the Notes to
these Consolidated Financial Statements. The fair value of the
Companys derivative instruments is disclosed in
Note 7 to the Notes to these Consolidated Financial
Statements. The fair value of the Companys convertible
debt instruments is disclosed in Note 13 to the Notes to these
Consolidated Financial Statements.



| |                    
| | -------------------
| | Revenue Recognition

The Companys revenue is derived from
primarily two sources (i) product revenue, which includes
software license, hardware, retail and royalty revenue and
(ii) services and support revenue which includes software
license maintenance and support, training, consulting, and
on-line subscription revenue.

The Company licenses its software products under
one and two-year term or perpetual licenses. The two-year
licenses include the first year of maintenance and support. The
Company sells its products and services via its direct sales
force, through domestic and foreign distributors and via the
Internet. Under the Companys on-line subscription
arrangements, which do not include any upfront setup fees,
customers pay a fixed fee and receive service over a period of
time, generally one year.

The Company applies the provisions of Statement
of Position 97-2, Software Revenue
Recognition, (SOP 97-2) as amended by
Statement of Position 98-9 Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain
Transactions to all transactions involving the sale of
software products and hardware transactions where the software
is not incidental. For hardware transactions where software is
not incidental, the Company does not bifurcate the fee and apply
separate accounting guidance to the hardware and software
elements. For hardware transactions where no software is
involved, the Company applies the provisions of Staff Accounting
Bulletin 104 Revenue Recognition. In
addition, the Company applies the provisions of Emerging Issues
Task Force Issue No. 00-03 Application of AICPA
Statement of Position 97-2 to Arrangements that Include the
Right to Use Software Stored on Another Entitys
Hardware to its on-line subscription software
transactions.

Product revenue from the license of the
Companys software products and sale of hardware products
where the software is and is not incidental is recognized when
persuasive evidence of an arrangement exists, the product has
been delivered, the fee is fixed or determinable, and collection
of the resulting receivable is reasonably assured, and, if
applicable, upon acceptance when acceptance criteria are
specified or upon expiration of the acceptance period.
Maintenance and support revenue for providing product updates
and customer support is deferred and recognized ratably over the
service period. On-line subscription revenue is recognized
ratably over the service period, which is generally one year.
Training and consulting revenue is recognized as services are
performed and billable according to the terms of the service
arrangement. Revenue on one-year time-based subscription
licenses is recognized ratably over the contract term. Royalty
revenue is generally recognized upon receipt of periodic royalty
reports received from customers, which generally coincides with
receipt of cash.

For all sales except those completed via the
Internet, the Company uses either a binding purchase order or
signed license agreement as evidence of an arrangement. For
sales over the Internet, the Company uses a credit card
authorization as evidence of an arrangement. Sales through
distributors are evidenced by a master

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

agreement governing the relationship together
with binding purchase orders on a transaction by transaction
basis.

Fees due under an arrangement are generally
deemed not to be fixed or determinable if a significant portion
of the fee is due beyond the Companys normal payment terms
that are 30 to 90 days from the date of invoice. Fees due
under an arrangement with distributors and resellers are
generally deemed not to be fixed or determinable if a
significant portion of the fee is due beyond the date when the
products have been sold by the distributor or reseller to the
customers. In these cases, revenue is not recognized until the
fees become due. The Company assesses collection based on a
number of factors, including past transaction history with the
customer and the credit-worthiness of the customer. The Company
does not request collateral from its customers. If the Company
determines that collection of a fee is not reasonably assured,
the fee is deferred and revenue recognized at the time
collection becomes reasonably assured, which is generally upon
receipt of cash.

The Companys distributors are permitted 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, the distributors have an unlimited right of return
up until the point of sale. After sale, the Company must approve
any returns from end-users. As a result, the Company recognizes
revenue from sales to distributors and resellers when products
have been sold by the distributors or resellers to their
customers (sell-through or sell-out method). In addition, the
Company makes an estimate of returns from end users and amounts
for promotional and rebate programs based on its historical
experience. The provisions are recorded as a reduction of
revenue.

For arrangements with multiple obligations (e.g.
undelivered maintenance and support bundled with term and
perpetual licenses), the Company allocates revenue to each
component of the arrangement using the residual value method
based on evidence of the fair value of the undelivered elements,
which is specific to the Company. The vendor specific objective
evidence of fair values for the ongoing maintenance and support
obligations for both term and perpetual licenses are based upon
the prices paid for the separate renewal of these services by
the customer or upon substantive renewal rates stated in the
contractual arrangements. Vendor specific objective evidence of
the fair value of other services, primarily consulting and
training services, is based upon separate sales of these
services.



| |                     
| | --------------------
| | Government Contracts

The Company enters into research and development
contracts with government agencies under various pricing
arrangements. Government contracting revenue is classified as
services and support revenue in the accompanying consolidated
statements of income and comprehensive income. Under government
contracts, the Company is subject to audit by the Defense
Contract Audit Agency (DCAA) which could result in
the renegotiation of amounts previously billed.

Revenue from cost-plus-fixed-fee
contracts is recognized on the basis of reimbursable contract
costs incurred during the period, plus a percentage of the fixed
fee. Revenue from time and material contracts is
recognized on the basis of hours utilized, plus other
reimbursable contract costs incurred during the period. Revenue
from firm-fixed-price contracts is recognized on the
percentage of completion method. Under this method, individual
contract revenues are recorded based on the percentage
relationship that contract costs incurred bear to costs incurred
plus managements estimate of costs to complete. Losses, if
any, are accrued when their occurrence becomes known and the
amount of the loss is reasonably determinable. During 2003,
2002, and 2001, the Company recognized revenue of approximately
$11.0 million, $17.3 million, and $16.6 million,
respectively, associated with government contracts.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                         
| | ------------------------
| | Research and Development

Costs incurred in the research and development of
new software products are expensed as incurred until
technological feasibility is established. Research and
development costs include salaries and benefits of researchers,
supplies, and other expenses incurred with research and
development efforts. Development costs are capitalized beginning
when a products technological feasibility has been
established and ending when the product is available for general
release to customers. Technological feasibility is reached when
the product reaches the working model stage. To date, products
and enhancements have generally reached technological
feasibility and have been released for sale at substantially the
same time and all research and development costs have been
expensed.



| |                  
| | -----------------
| | Advertising Costs

Advertising production costs are expensed as
incurred. Media (television and print) placement costs are
expensed in the period the advertising first appears. Total
advertising and promotional expenses were $7.9 million,
$13.6 million, and $25.1 million for 2003, 2002, and 2001,
respectively.



| |                         
| | ------------------------
| | Stock-based Compensation

As permitted by SFAS No. 123,
Accounting for Stock-Based
Compensation(SFAS 123), the Company
accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25 (APB
25), Accounting for Stock Issued to
Employees, and FASB Interpretation No. 44
(FIN 44), Accounting for Certain
Transactions Involving Stock-Based Compensation, an
interpretation of APB Opinion No. 25 and related
interpretations in accounting for its stock-based compensation
plans. Accordingly, with respect to fixed-plan awards, the
Company measures the excess, if any, of the market value of its
common stock on the date of the award over the exercise price of
options granted as deferred compensation expense (intrinsic
method) and recognizes any such excess over the vesting period
using the straight-line method. With respect to variable-plan
awards resulting from award modifications or award terms where
the amount of shares and the exercise price are not fixed at the
date of grant, the Company records stock-based deferred
compensation for the excess, if any, of the market value of its
common stock at the end of each reporting period (or date of
exercise, forfeiture or cancellation without replacement, if
earlier) over the fair value of its common stock on the date of
the award or modification. The resulting deferred compensation
charge to earnings will be recorded over the remaining vesting
term using the accelerated method of amortization. When variable
plan options become fully vested, any remaining deferred
compensation is recognized.

The Company accounts for options awarded to
non-employees (consultants) at fair value using the
Black-Scholes option pricing model. The resulting fair value is
recognized in expense upon performance.

The following table illustrates the effect on net
income and earnings per share if the Company had applied the
fair value recognition provisions of SFAS 123 to stock-based
employee compensation.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

For pro forma purposes, the compensation costs
for the 1997 Plan, the Stock Option Plan for Outside Directors,
the 2000 Nonstatutory Stock Option Plan and the 2002 and 1994
ESPPs has been determined based on fair value at the grant date
for awards from 1998 through 2003 consistent with the provisions
of SFAS 123, the Companys net income (loss) and net
income (loss) per share would have been as follows (in
thousands):

|                             |                                                                                                                                     |                         |        |         |   |      |         |         |   |   |        |          |  
|---------------------------- | ----------------------------------------------------------------------------------------------------------------------------------- | ----------------------- | ------ | ------- | - | ---- | ------- | ------- | - | - | ------ | -------- | -
|                             |                                                                                                                                     |                        
|                             |                                                                                                                                     | Year Ended December 31,
|                             |                                                                                                                                     |                        
|                             |                                                                                                                                     | 2003                    |        | 2002    |   | 2001
|                             |                                                                                                                                     |                         |        |         |   |     
|Net income, as reported      |                                                                                                                                     | $                       | 70,242 |         |   | $    | 128,312 |         |   | $ | 83,253 |         
|                             | Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards,
    net of tax |                         |        | (55,848 | ) |      |         | (76,721 | ) |   |        | (138,302 | )
|                             | Add back: stock-based compensation expense, net
    of tax; included in reported net income                                         |                         |        | 7,504   |   |      |         | 13,442  |   |   |        | 14,923   |  
|                             |                                                                                                                                     |                         |        |         |   |      |         |         |   |   |        |         
|                             | Pro forma net income (loss)                                                                                                         |                         | $      | 21,898  |   |      | $       | 65,033  |   |   | $      | (40,126  | )
|                             |                                                                                                                                     |                         |        |         |   |      |         |         |   |   |        |         
|Net income (loss) per share: |                                                                                                                                     |                         |        |         |   |      |         |         |   |   |        |         
|                             | Basic  as reported                                                                                                                 |                         | $      | 0.44    |   |      | $       | 0.86    |   |   | $      | 0.60     |  
|                             | Basic  pro forma                                                                                                                   |                         | $      | 0.14    |   |      | $       | 0.44    |   |   | $      | (0.29    | )
|                             | Diluted  as reported                                                                                                               |                         | $      | 0.43    |   |      | $       | 0.80    |   |   | $      | 0.53     |  
|                             | Diluted  pro forma                                                                                                                 |                         | $      | 0.13    |   |      | $       | 0.41    |   |   | $      | (0.29    | )

The impact on pro forma income (loss) per
share and net income (loss) in the table above may not be
indicative of the effect in future years as options vest over
several years and the Company continues to grant stock options
to new employees.



| |             
| | ------------
| | Income Taxes

The Company accounts for income taxes in
accordance with the liability method of accounting for income
taxes. Under the liability method, deferred assets and
liabilities are recognized based upon anticipated future tax
consequences attributable to differences between financial
statement carrying amounts of assets and liabilities and their
respective tax bases. The provision for income taxes is
comprised of the current tax liability and the change in
deferred tax assets and liabilities. The Company establishes a
valuation allowance to the extent that it is more likely than
not that deferred tax assets will not be recoverable against
future taxable income.



| |                     
| | --------------------
| | Net Income Per Share

Basic net income per share is computed using the
weighted-average common shares outstanding during the period.
Diluted net income per share is computed using the weighted
average common shares and potentially dilutive shares
outstanding during the period. Potentially dilutive common
shares include incremental common shares issuable upon exercise
of stock options, stock purchase warrants, restricted stock, and
potential dilution upon conversion of the convertible debt.
Diluted loss per share is computed using the weighted average
number of common shares and excludes potentially dilutive shares
outstanding, as their effect is anti-dilutive.



| |         
| | --------
| | Warranty

The Company offers warranty on its software and
hardware products and records a liability for the estimated
future costs associated with warranty claims, which is based
upon historical experience and the Companys estimate of
the level of future costs.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                            
| | ---------------------------
| | Comprehensive Income (Loss)

Unrealized gains (losses) on available-for-sale
securities and foreign currency translation adjustments are
included in the Companys components of comprehensive
income (loss), which are excluded from net income.

For 2003, 2002 and 2001 other comprehensive
income (loss) is comprised of the following items (in thousands):

|                                                                   |                                  |            |         |            |  |            |        |        |   |   |         |       | 
|------------------------------------------------------------------ | -------------------------------- | ---------- | ------- | ---------- |  | ---------- | ------ | ------ | - | - | ------- | ----- | 
|                                                                   |                                  | Before     |         |            |  | Net of    
|                                                                   |                                  | Income Tax |         | Income Tax |  | Income Tax
|                                                                   |                                  |            |         |            |  |           
|2003                                                               |                                  |            |         |            |  |            |        |        |   |   |         |      
|Unrealized loss on marketable securities and
    investments, net  |                                  | $          | (4,258  | )          |  | $          | 1,703  |        |   | $ | (2,555  | )    
|Net realized gain on marketable securities and
    investments     |                                  |            | 3,076   |            |  |            | (1,230 | )      |   |   | 1,846   |      
|Foreign currency translation gain                                  |                                  |            | 10,578  |            |  |            |       |        |   |   | 10,578  |      
|                                                                   |                                  |            |         |            |  |            |        |        |   |   |         |      
|                                                                   | Total other comprehensive income |            | $       | 9,396      |  |            | $      | 473    |   |   | $       | 9,869 | 
|                                                                   |                                  |            |         |            |  |            |        |        |   |   |         |      
|2002                                                               |                                  |            |         |            |  |            |        |        |   |   |         |      
|Unrealized loss on marketable securities and
    investments, net  |                                  | $          | (8,084  | )          |  | $          | 3,233  |        |   | $ | (4,851  | )    
|Net realized gain on marketable securities and
    investments     |                                  |            | 3,838   |            |  |            | (1,535 | )      |   |   | 2,303   |      
|Impairment recognized                                              |                                  |            | (198    | )          |  |            | 79     |        |   |   | (119    | )    
|Foreign currency translation gain                                  |                                  |            | 10,744  |            |  |            |       |        |   |   | 10,744  |      
|                                                                   |                                  |            |         |            |  |            |        |        |   |   |         |      
|                                                                   | Total other comprehensive income |            | $       | 6,300      |  |            | $      | 1,777  |   |   | $       | 8,077 | 
|                                                                   |                                  |            |         |            |  |            |        |        |   |   |         |      
|2001                                                               |                                  |            |         |            |  |            |        |        |   |   |         |      
|Unrealized gains on marketable securities and
    investments, net |                                  | $          | 15,943  |            |  | $          | (6,377 | )      |   | $ | 9,566   |      
|Net realized gain on marketable securities and
    investments     |                                  |            | 10,242  |            |  |            | (4,096 | )      |   |   | 6,146   |      
|Impairment recognized                                              |                                  |            | (20,631 | )          |  |            | 8,251  |        |   |   | (12,380 | )    
|Foreign currency translation gain                                  |                                  |            | 5,961   |            |  |            |       |        |   |   | 5,961   |      
|                                                                   |                                  |            |         |            |  |            |        |        |   |   |         |      
|                                                                   | Total other comprehensive income |            | $       | 11,515     |  |            | $      | (2,222 | ) |   | $       | 9,293 | 
|                                                                   |                                  |            |         |            |  |            |        |        |   |   |         |      

Accumulated other comprehensive income is
comprised of the following (in thousands):

|                                                 |       |      |        |        |  |      |        |        |  |   |        |        | 
|------------------------------------------------ | ----- | ---- | ------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                                                 |       | 2003 |        | 2002   |  | 2001
|                                                 |       |      |        |        |  |     
|Unrealized gain on available-for-sale securities |       | $    | 745    |        |  | $    | 1,454  |        |  | $ | 4,121  |       
|Cumulative translation adjustment                |       |      | 33,282 |        |  |      | 22,704 |        |  |   | 11,960 |       
|                                                 |       |      |        |        |  |      |        |        |  |   |        |       
|                                                 | Total |      | $      | 34,027 |  |      | $      | 24,158 |  |   | $      | 16,081 | 
|                                                 |       |      |        |        |  |      |        |        |  |   |        |       



| |                                                  
| | -------------------------------------------------
| | Recent Accounting Pronouncements and
    Guidance



| |                    
| | -------------------
| | Revenue Recognition

In December 2003, the Securities and Exchange
Commission (SEC) published Staff Accounting Bulletin
(SAB) No. 104, Revenue
Recognition (SAB 104). SAB 104
updates portions of the SEC staffs interpretive guidance
provided in SAB 101 and included in Topic 13 of the
Codification of Staff Accounting Bulletins. SAB 104 deletes
interpretative material no longer necessary, and conforms the
interpretive material retained, because of pronouncements issued
by the FASBs EITF on various revenue

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

recognition topics. SAB 104 also incorporates
into the SAB Codification certain sections of the SEC
staffs Revenue Recognition in Financial
Statements  Frequently Asked Questions and
Answers. The adoption of SAB 104 had no material
impact on the Companys consolidated financial condition,
results of its operations or its cash flows.



| |                                                
| | -----------------------------------------------
| | Accounting for Asset Retirement
    Obligations

In June 2001, the Financial Accounting Standards
Board (FASB) issued SFAS No. 143
Accounting for Asset Retirement Obligations
(SFAS 143). SFAS 143 addresses the financial
accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated
asset retirement costs. SFAS 143 applies to legal obligations
associated with the retirement of long-lived assets that result
from the acquisition, construction, development and/or normal
use of the assets, including lease restoration obligations. SFAS
143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is
incurred if a reasonable estimate of the fair value can be made.
The fair value of the liability is added to the carrying amount
of the associated asset, and this additional carrying amount is
expensed over the life of the asset. The Company adopted SFAS
143 effective January 1, 2003. The adoption of SFAS 143 did
not have a material impact on the Companys consolidated
financial condition, results of operations or cash flows.



| |                                                                   
| | ------------------------------------------------------------------
| | Accounting for Extraordinary Items and
    Discontinued Operations

In May 2002, the FASB issued SFAS No. 145,
Rescission of SFAS Nos. 4, 44, and 64, Amendment of
SFAS No. 13, and Technical Corrections
(SFAS 145). Among other things, SFAS 145 rescinds
various pronouncements regarding early extinguishment of debt
and allows extraordinary accounting treatment for early
extinguishment only when the provisions of Accounting Principles
Board Opinion No. 30, Reporting the Results of
Operations  Reporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactionsare met. SFAS 145
provisions regarding early extinguishment of debt are generally
effective for fiscal years beginning after May 15, 2002 and
require retroactive application. Upon adoption of this Standard,
the Company did not classify the losses related to the
repurchases of its outstanding debt in 2003 as extraordinary and
reclassified gains on the extinguishment of debt that were
presented in prior periods as extraordinary items to components
of operating income.



| |                                               
| | ----------------------------------------------
| | Accounting for Exit or Disposal
    Activities

In July 2002, the FASB issued SFAS No. 146
Accounting for Exit Costs Associated With Exit or
Disposal Activities (SFAS 146). SFAS 146
addresses the recognition, measurement and reporting of costs
associated with exit and disposal activities (i.e.,
restructuring activities), including costs related to
terminating a contract that is not a capital lease and
termination benefits due to employees who are involuntarily
terminated under the terms of a one-time benefit arrangement.

SFAS 146 supersedes the Emerging Issues Task
Force (EITF) Issue No. 94-3 Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring) (EITF 94-3) and EITF Issue
No. 88-10 Costs Associated with Lease Modification
or Termination (EITF 88-10). Accordingly,
SFAS 146 prohibits recognition of a liability based solely on an
entitys commitment to a plan to exit an activity. SFAS 146
requires that: (i) liabilities associated with exit and
disposal activities be measured at fair value and changes in the
fair value of the liability at each reporting period be measured
using an interest allocation approach; (ii) one-time
termination benefits be expensed at the date the entity notifies
the employee, unless the employee must provide future service,
in which case the benefits are expensed ratably over the future
service period; (iii) liabilities to terminate a contract
be recorded at fair value when the contract is terminated;
(iv) liabilities related to an existing operating
lease/contract, unless terminated, be recorded at fair value,
less estimated sublease income,

79



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

and measured when the contract does not have any
future economic benefit to the entity (i.e., the entity ceases
to utilize the rights conveyed by the contract); and
(v) all other costs related to an exit or disposal activity
be expensed as incurred.

SFAS 146 is effective for exit or disposal
activities initiated after December 31, 2002. The Company
adopted SFAS 146 during the fourth quarter of 2002. The adoption
of SFAS 146 did not impact the Companys restructuring
obligations recognized in 2002 as these obligations must
continue to be accounted for in accordance with EITF 94-3 and
other applicable pre-existing guidance.



| |                                                                 
| | ----------------------------------------------------------------
| | Accounting for Derivative Instruments and
    Hedging Activities

In April 2003, the FASB issued SFAS No. 149,
Amendment of Statement 133 on Derivative Instruments
and Hedging Activities (SFAS 149). SFAS
149 (i) clarifies under what circumstances a contract with an
initial net investment meets the characteristics of a derivative
discussed in SFAS 133, (ii) clarifies when a derivative
contains a financing component and (iii) amends the
definition of an underlying to conform it to language in FIN 45.
SFAS 149 is generally effective for contract entered into or
modified after June 30, 2003. The Company has adopted the
provisions of SFAS 149, which did not have a material impact on
the Companys consolidated financial position, results of
operations or cash flows.



| |                                                                                                     
| | ----------------------------------------------------------------------------------------------------
| | Accounting for Certain Financial Instruments
    with Characteristics of both Liabilities and Equity

In May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and
Equity(SFAS 150). SFAS 150 establishes
standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities
and equity. It requires companies classify a financial
instrument that is within its scope as a liability (or an asset
in some circumstances) as defined in SFAS 150.

In November 2003, FASB issued FASB Staff Position
No. 150-3 (FSS 150-3) which deferred the
effective dates for applying certain provisions of SFAS 150
related to mandatorily redeemable financial instruments of
certain non-public entities and certain mandatorily redeemable
non-controlling interests for public and non-public companies.
For public entities, SFAS 150 is effective for mandatorily
redeemable financial instruments entered into or modified after
May 31, 2003 and is effective for all other financial
instruments as of the first interim period beginning after
June 15, 2003. The measurement provisions of SFAS 150 are
deferred indefinitely for other mandatorily redeemable
non-controlling interests that were issued before
November 5, 2003. For those instruments, the measurement
guidance for redeemable shares and non-controlling interests in
other literature shall apply during the deferral period.

The Company has adopted the provisions of SFAS
150, which did not have a material impact on the Companys
consolidated financial position, results of operations or cash
flows based on the types of financial instruments the Company
currently has issued.



| |                                                             
| | ------------------------------------------------------------
| | Accounting for Multiple Deliverable Revenue
    Arrangements

In November 2002, the EITF reached a consensus on
Issue No. 00-21, Multiple Deliverable Revenue
Arrangement(EITF 00-21). EITF 00-21
addresses certain aspects of the accounting by a vendor for
arrangements under which it will perform multiple
revenue-generating activities. It also addresses when and how an
arrangement involving multiple deliverables should be divided
into separate units of accounting. The guidance in EITF 00-21 is
effective for revenue arrangements entered into in fiscal
periods beginning after June 15, 2003, with early
application permitted. Companies may elect to report the change
in accounting as a cumulative effect of a change in accounting
principle in accordance with APB Opinion 20, Accounting
Changes and SFAS No. 3, Reporting
Accounting Changes in Interim Financial Statements (an amendment
of APB Opinion No. 28). The Company adopted the
provisions of EITF 00-21 for transactions to which SOP

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

97-2 does not apply, such as sales of hardware
without software and on-line subscription software applications
in the quarter ended September 30, 2003. The adoption of
EITF 00-21 did not have a significant impact on the
Companys consolidated financial position, results of
operations or cash flows.



| |                                                   
| | --------------------------------------------------
| | Accounting for Retroactive Insurance
    Contracts

In May 2003, the EITF reached a consensus on
Issue No. 03-03, Accounting for Retroactive
Insurance Contracts Purchased by Entities Other Than Insurance
Enterprises to Claims-Made Insurance Policies
(EITF 03-03). The consensus requires the insured
company to determine if their claims-made policy is retroactive,
prospective, or both and account for the policy accordingly. A
policy has a retroactive provision if it covers a specific known
claim(s) that was reportable before the policys effective
date. The continued applicability of FASB Interpretation
No. 39, Offsetting of Amounts Related to Certain
Contracts, (FIN 39) to the recording of
liabilities and the related insurance recoverables is also
addressed. Since FIN 39 does not allow for offsetting the
insurance liability with the recoverable, regardless of whether
the company is recording the insurance policy as prospective or
retroactive, there will likely be a balance sheet gross-up for
all covered losses. EITF 03-03 is applicable to all claims-made
insurance arrangements entered after June 30, 2003 for the
Company. The adoption of EITF 03-03 did not have a significant
impact on the Companys consolidated financial position,
results of operations or cash flows.



| |                                                
| | -----------------------------------------------
| | Accounting for and Disclosure of
    Guarantees

In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN
45). FIN 45 requires that a liability (at fair value) be
recorded in the guarantors balance sheet upon issuance of
a guarantee or indemnification. In addition, FIN 45 requires
disclosures about the guarantees and indemnifications that an
entity has issued, including a reconciliation of changes in the
entitys product warranty liabilities. The initial
recognition and initial measurement provisions of FIN 45 are
applicable on a prospective basis to guarantees and
indemnifications issued or modified after December 31,
2002, irrespective of the guarantors fiscal year-end. The
Company has adopted FIN 45, which did not have a material impact
on its consolidated financial position, results of operations,
or cash flows.



| |                                                               
| | --------------------------------------------------------------
| | Accounting for Consolidation of Variable
    Interest Entities

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities(FIN 46). FIN 46 applied
immediately to variable interest entities (VIEs)
created after January 31, 2003. The adoption of FIN 46
had no impact as the Company has no special purpose entities.
The Company is continuing to evaluate the provisions of
FIN 46R which updates FIN 46 and is effective for
periods ending after March 15, 2004, related to VIEs,
created prior to February 2003, and their effects on the Company.

3.     Cumulative
Effect of Change in Accounting Principle

Effective January 1, 2003, the Company
changed its method for recognizing commission expenses to sales
personnel. Prior to January 1, 2003, the Companys
policy has been to expense the commissions as incurred, however,
the Company believes that expensing the commissions as incurred
does not provide a fair representation of the income from
operations where part or all of the revenue related to these
sales transactions is deferred and recognized over time.
Commission expense directly related to sales transactions is now
deferred and recognized ratably over the same period as the
related revenue is recognized and recorded, which the Company
believes will provide greater transparency into its performance.

81



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The cumulative effect of the change in accounting
principle resulted in a one-time credit of $13.9 million
($10.3 million after tax). The following table illustrates
2002 and 2001 after considering the retroactive application of
the adopted principle and 2003 prior consideration of the change:

|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |      | 
|--------------------------------------------------------------------- | -------------------------- | ----------------- | ------- | ----------------- |  | ----------------- | ------- | ------------- |  | ------ | ------- | ------------- |  | - | ------- | ---- |  | - | ------- | ---- |  | - | ------- | ---- | 
|                                                                      |                            |                   |         |                   |  |                  
|                                                                      |                            | December 31, 2003 |         | December 31, 2002 |  | December 31, 2001
|                                                                      |                            |                   |         |                   |  |                  
|                                                                      |                            |                   |         | Pro Forma for     |  |                   |         | Pro Forma for |  |        |         | Pro Forma for
|                                                                      |                            |                   |         | Commission        |  |                   |         | Commission    |  |        |         | Commission   
|                                                                      |                            | Actual            |         | Change            |  | Actual            |         | Change        |  | Actual |         | Change       
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |              
|Operating expenses                                                    |                            | $                 | 721,057 |                   |  | $                 | 726,091 |               |  | $      | 763,606 |               |  | $ | 774,938 |      |  | $ | 741,685 |      |  | $ | 756,856 |     
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |     
|Income before cumulative effect of change in
    accounting principle |                            | $                 | 59,905  |                   |  | $                 | 56,885  |               |  | $      | 128,312 |               |  | $ | 121,513 |      |  | $ | 83,253  |      |  | $ | 74,150  |     
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |     
|                                                                      | Per common share  basic   |                   | $       | 0.37              |  |                   | $       | 0.35          |  |        | $       | 0.86          |  |   | $       | 0.81 |  |   | $       | 0.60 |  |   | $       | 0.54 | 
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |     
|                                                                      | Per common share  diluted |                   | $       | 0.36              |  |                   | $       | 0.35          |  |        | $       | 0.80          |  |   | $       | 0.76 |  |   | $       | 0.53 |  |   | $       | 0.48 | 
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |     
|Net income                                                            |                            | $                 | 70,242  |                   |  | $                 | 56,885  |               |  | $      | 128,312 |               |  | $ | 121,513 |      |  | $ | 83,253  |      |  | $ | 74,150  |     
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |     
|                                                                      | Per common share  basic   |                   | $       | 0.44              |  |                   | $       | 0.35          |  |        | $       | 0.86          |  |   | $       | 0.81 |  |   | $       | 0.60 |  |   | $       | 0.54 | 
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |     
|                                                                      | Per common share  diluted |                   | $       | 0.43              |  |                   | $       | 0.35          |  |        | $       | 0.80          |  |   | $       | 0.76 |  |   | $       | 0.53 |  |   | $       | 0.48 | 
|                                                                      |                            |                   |         |                   |  |                   |         |               |  |        |         |               |  |   |         |      |  |   |         |      |  |   |         |     

4.     Business
Combinations and Other



| |                         
| | ------------------------
| | IntruVert Networks, Inc.

On May 14, 2003, the Company acquired 100%
of the outstanding capital shares of IntruVert Networks, Inc.,
(IntruVert) a provider of network-based intrusion
prevention solutions designed to proactively detect and stop
system and network security attacks before they occur, for
$98.1 million in cash and $5.2 million of direct
expenses, totaling $103.3 million. The Company acquired
IntruVert to enhance its intrusion detection product line,
achieve a leading position in the emerging intrusion prevention
marketplace, embed the acquired technologies in the
Companys current product offering, and sell IntruVert
products to its existing customer base. The results of
operations of IntruVert have been included in these consolidated
financial statements since the date of acquisition.

Under the transaction, the Company recorded
approximately $18.2 million for developed technology,
$1.9 million for acquired product rights, including revenue
related order backlog and contracts, $71.8 million for
goodwill (none of which is deductible for tax purposes),
$11.0 million in cash, $7.4 million for net deferred
tax liabilities and $2.2 million for tangible assets, net
of liabilities. The Company also recorded approximately
$5.7 million for acquired in-process research and
development which was fully expensed upon purchase because
technological feasibility had not been established and there was
no alternative use for the projects under development. The
intangibles acquired in the acquisition, excluding goodwill, are
being amortized over their estimated useful lives of two to five
years or a weighted average period of 4.5 years. The
Company also accrued approximately $0.3 million in
duplicative site costs for lease space no longer being utilized
and permanently vacated related to the IntruVert acquisition of
which less than $0.1 million remains as an accrual as of
December 31, 2003.

82



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

As part of the IntruVert acquisition, the Company
cancelled all outstanding IntruVert restricted stock and
outstanding stock options and agreed to make cash payments to
former IntruVert employees contingent upon their continued
employment with the Company based on the same vesting terms of
their restricted stock or stock option agreements. The payments
to former IntruVert employees are recorded ratably over the
vesting period as salary expense as the employees are currently
providing services to the Company. Payments under the restricted
stock plan are paid monthly from an escrow account and will
total approximately $3.0 million from the purchase date
through the fourth quarter of 2006. Payments under the stock
option plan are being paid monthly through the Companys
payroll and will total approximately $4.1 million from the
purchase date through the second quarter of 2007. Cash payments
that were fully vested at the date of acquisition were included
in the purchase price. If a former IntruVert employee ceases
employment with the Company, unvested payment amounts will be
returned to the Company.



| |                                          
| | -----------------------------------------
| | Entercept Security Technologies,
    Inc.

On April 30, 2003, the Company acquired 100%
of the outstanding capital shares of Entercept Security
Technologies, Inc. (Entercept), a provider of
host-based intrusion prevention solutions designed to
proactively detect and stop system and network security attacks
before they occur, for $121.9 million in cash and
$3.9 million of direct expenses, totaling
$125.8 million. The Company acquired Entercept to enhance
its intrusion detection product line, achieve a leading position
in the emerging intrusion prevention marketplace, embed the
acquired technologies in the Companys current product
offering, and sell Entercept products to its existing customer
base. The results of operations of Entercept have been included
in these consolidated financial statements since the date of
acquisition.

Under the transaction, the Company recorded
approximately $21.7 million for developed technology,
$2.8 million for acquired product rights, including revenue
related order backlog and contracts, $99.7 million for
goodwill (none of which is deductible for tax purposes),
$9.6 million for deferred tax liabilities,
$10.6 million of deferred tax assets, $1.0 million in
cash and $1.5 million in liabilities, net of tangible
assets. The Company also recorded approximately
$0.9 million for acquired in-process research and
development which was fully expensed upon purchase because
technological feasibility had not been established and there was
no alternative use for the projects under development. The
intangibles acquired in the acquisition, excluding goodwill, are
being amortized over their estimated useful lives of two to six
years or a weighted average period of 5.6 years.

The Company accrued $2.8 million in
duplicative sites costs for permanently vacated facilities at
the acquisition date The accrual will be fully utilized by 2006,
the end of the original lease term. In the fourth quarter of
2003, the Company entered into a sublease for the vacated
facility, and therefore, adjusted the accrual by the value of
the sublease. The following is a summary of activity in the
restructuring accrual related to Entercept in 2003 (in
thousands):

|                           |  |   |        |  
|-------------------------- |  | - | ------ | -
|Original accrual           |  | $ | 2,837  |  
|Cash payments              |  |   | (684   | )
|Adjustments                |  |   | (1,137 | )
|                           |  |   |        |  
|Balance, December 31, 2003 |  | $ | 1,016  |  
|                           |  |   |        |  

As part of the Entercept acquisition, the Company
assumed all outstanding unvested Entercept cash bonus units and
agreed to make specified per unit cash payments to former
Entercept employees contingent upon their continued employment
with the Company for one year based on the vesting terms of such
units, generally one year. The payments to former Entercept
employees are expensed monthly as salary expense as the
employees are currently providing services to the Company. Total
payments subject to remaining vesting are estimated to be
$2.4 million as of December 31, 2003. Amounts to be
paid under the cash bonus plan are

83



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

held in escrow and will be paid generally at the
end of one year from the Entercept purchase date. Employees that
are no longer with the Company at the payment date will not
receive any payment, and any forfeited amounts will be allocated
to the former Entercept stockholders.

Management determined the purchase price
allocation based on estimates of the fair values of the tangible
and intangible assets acquired and liabilities assumed. These
estimates were arrived at utilizing recognized valuation
techniques and the assistance of valuation consultants. The
following is a summary of the assets acquired and liabilities
assumed in the acquisitions:

|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |         | 
|---------------------------------------------- | ------------------------- | -------------- | ------- | ------------------ |  | ------------------- | ------- | ------- |  | - | ------- | ------- | 
|                                               |                           |                |         |                    |  | Total Assets       
|                                               |                           | IntruVert      |         | Entercept Security |  | Acquired and       
|                                               |                           | Networks, Inc. |         | Technologies, Inc. |  | Liabilities Assumed
|                                               |                           |                |         |                    |  |                    
|                                               |                           |               
|                                               |                           | (In thousands)
|Deferred tax assets                            |                           | $              | 436     |                    |  | $                   | 10,560  |         |  | $ | 10,996  |        
|Technology                                     |                           |                | 18,200  |                    |  |                     | 21,700  |         |  |   | 39,900  |        
|Other intangible assets                        |                           |                | 1,900   |                    |  |                     | 2,800   |         |  |   | 4,700   |        
|Cash                                           |                           |                | 10,986  |                    |  |                     | 1,028   |         |  |   | 12,014  |        
|Goodwill                                       |                           |                | 71,763  |                    |  |                     | 99,747  |         |  |   | 171,510 |        
|Other assets                                   |                           |                | 5,321   |                    |  |                     | 3,517   |         |  |   | 8,838   |        
|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |        
|                                               | Total assets acquired     |                |         | 108,606            |  |                     |         | 139,352 |  |   |         | 247,958 | 
|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |        
|Current liabilities                            |                           |                | 3,151   |                    |  |                     | 4,920   |         |  |   | 8,071   |        
|Deferred tax liabilities                       |                           |                | 7,839   |                    |  |                     | 9,555   |         |  |   | 17,394  |        
|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |        
|                                               | Total liabilities assumed |                |         | 10,990             |  |                     |         | 14,475  |  |   |         | 25,465  | 
|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |        
|Net assets acquired                            |                           | $              | 97,616  |                    |  | $                   | 124,877 |         |  | $ | 222,493 |        
|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |        
|In-process research and development (expensed) |                           | $              | 5,700   |                    |  | $                   | 900     |         |  | $ | 6,600   |        
|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |        
|Total acquisition cost                         |                           | $              | 103,316 |                    |  | $                   | 125,777 |         |  | $ | 229,093 |        
|                                               |                           |                |         |                    |  |                     |         |         |  |   |         |        

The following unaudited pro forma financial
information presents the combined results of the Company,
IntruVert and Entercept as if the acquisitions had occurred at
the beginning of 2003 and 2002 (in thousands except per share
amounts):

|                                                   |  |                         |         |      |  |   |           | 
|-------------------------------------------------- |  | ----------------------- | ------- | ---- |  | - | --------- | 
|                                                   |  |                        
|                                                   |  | Year Ended December 31,
|                                                   |  |                        
|                                                   |  | 2003                    |         | 2002
|                                                   |  |                         |         |     
|                                                   |  |                        
|                                                   |  | (Unaudited)            
|Net revenue                                        |  | $                       | 939,953 |      |  | $ | 1,052,474 | 
|                                                   |  |                         |         |      |  |   |           | 
|Net income                                         |  | $                       | 60,058  |      |  | $ | 93,367    | 
|                                                   |  |                         |         |      |  |   |           | 
|Basic net income per share                         |  | $                       | 0.38    |      |  | $ | 0.62      | 
|                                                   |  |                         |         |      |  |   |           | 
|Shares used in per share calculation  basic       |  |                         | 160,338 |      |  |   | 149,441   | 
|                                                   |  |                         |         |      |  |   |           | 
|Diluted net income per share                       |  | $                       | 0.37    |      |  | $ | 0.59      | 
|                                                   |  |                         |         |      |  |   |           | 
|Shares used in per share calculation 
    diluted |  |                         | 164,489 |      |  |   | 157,156   | 
|                                                   |  |                         |         |      |  |   |           | 

The above unaudited pro forma financial
information includes adjustments for interest income on cash
disbursed for the acquisitions, amortization of identifiable
intangible assets and adjustments for expenses incurred in
conjunction with the acquisitions. The pro forma financial
information excludes the effects of the in-process research and
development totaling $6.6 million that was expensed
immediately.

84



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |           
| | ----------
| | McAfee.com

In September 2002, the Company repurchased the
25% minority interest in its McAfee.com subsidiary for
$219.9 million in cash and stock. The Company issued
8.3 million shares of its common stock valued at $14.62 per
share, which corresponds to the average market price of the
Companys common stock two days before and after the date
the terms of the acquisition were agreed and announced. The
acquisition was an effort to reduce or eliminate customer,
market and brand confusion due to the similarity in its
products, names and web addresses and to reduce or eliminate
actual and potential conflicts between the companies and their
sales forces, and related senior management distraction, due to
confusion over market boundaries. This acquisition increased the
Companys ownership of McAfee.com to 100% and was accounted
for using the purchase method of accounting. As part of the
acquisition, McAfee.com was merged with and into the Company.
The results of operations of McAfee.com have always been
included in the consolidated income (loss) before minority
interest of the Company. Prior to the acquisition, the minority
interest in the McAfee.com income (loss) was excluded from
the Companys consolidated net income (loss).

Since the date of acquisition on
September 13, 2002, no minority interest exists in
McAfee.com and accordingly the consolidated net income includes
the full amount of McAfee.com results from this date. The
aggregate purchase price was allocated to tangible and
identified intangible assets acquired and liabilities assumed
based on estimates of fair value. Identifiable intangible assets
totaled $50.7 million and are amortized using an estimated
useful life identified for each type of intangible ranging from
two to seven years, or a weighted average period of
6.7 years. The excess of the aggregate purchase price over
the fair value of the identifiable net assets acquired of
approximately $145.8 million has been recognized as
goodwill of which none is deductible for tax purposes.

The following table summarizes the final fair
values of the assets acquired and liabilities assumed.

|                         |                           |                |         |         | 
|------------------------ | ------------------------- | -------------- | ------- | ------- | 
|                         |                           | (In thousands)
|Deferred tax assets      |                           | $              | 25,767  |        
|Technology               |                           |                | 1,401   |        
|Other intangible assets  |                           |                | 49,335  |        
|Goodwill                 |                           |                | 145,756 |        
|Minority interest        |                           |                | 21,044  |        
|                         |                           |                |         |        
|                         | Total assets acquired     |                |         | 243,303 | 
|                         |                           |                |         |        
|Current liabilities      |                           |                | 2,065   |        
|Deferred tax liabilities |                           |                | 21,345  |        
|                         |                           |                |         |        
|                         | Total liabilities assumed |                |         | 23,410  | 
|                         |                           |                |         |        
|Net assets acquired      |                           | $              | 219,893 |        
|                         |                           |                |         |        

85



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following unaudited pro forma financial
information presents the combined results of the Company and
McAfee.com as if the acquisition had occurred at the beginning
of 2002 and 2001, after giving effect to certain adjustments,
including amortization of identifiable intangible assets (in
thousands except per share amounts):

|                                                   |  |                         |           |      |  |   |           | 
|-------------------------------------------------- |  | ----------------------- | --------- | ---- |  | - | --------- | 
|                                                   |  |                        
|                                                   |  | Year Ended December 31,
|                                                   |  |                        
|                                                   |  | 2002                    |           | 2001
|                                                   |  |                         |           |     
|                                                   |  |                        
|                                                   |  | (Unaudited)            
|Net revenue                                        |  | $                       | 1,043,044 |      |  | $ | 1,071,660 | 
|                                                   |  |                         |           |      |  |   |           | 
|Net income                                         |  | $                       | 141,334   |      |  | $ | 74,902    | 
|                                                   |  |                         |           |      |  |   |           | 
|Basic net income per share                         |  | $                       | 0.91      |      |  | $ | 0.51      | 
|                                                   |  |                         |           |      |  |   |           | 
|Shares used in per share calculation  basic       |  |                         | 155,245   |      |  |   | 146,154   | 
|                                                   |  |                         |           |      |  |   |           | 
|Diluted net income per share                       |  | $                       | 0.84      |      |  | $ | 0.46      | 
|                                                   |  |                         |           |      |  |   |           | 
|Shares used in per share calculation 
    diluted |  |                         | 183,150   |      |  |   | 172,670   | 
|                                                   |  |                         |           |      |  |   |           | 

The above unaudited pro forma financial
information includes adjustments for interest income on cash
disbursed for the acquisition, amortization of identifiable
intangible assets and adjustments for the expenses incurred by
McAfee.com related to the Companys exchange offer for all
McAfee.com outstanding publicly held shares.



| |                   
| | ------------------
| | Other Acquisitions

In 2002, the Company acquired four entities for a
total cost of $19.1 million, which was paid in cash:



| |   |                                                               
| | - | --------------------------------------------------------------
| |  | Traxess, Inc., a provider of forensic software,               
|
| |  | BySupport, S.A., one of our South America
    reseller,       
|
| |  | BySecure, S.A., one of our Central American
    resellers, and
|
| |  | Deersoft, Inc., a provider of anti-spam software.             

Liabilities assumed in conjunction with the
acquisitions totaled $2.0 million. Intangible assets consisting
primarily of acquired technology of $22.3 million and
$6.2 million of goodwill, none of which is deductible for
tax purposes. These acquisitions were not material to the
Companys results of operations.



| |                     
| | --------------------
| | Capital Transactions

In February 2000, the Company sold less than 5%
of its interest of its Japanese subsidiary, Network Associates
Company Limited (NAI Japan) to several unrelated
parties generating proceeds of approximately $11.9 million.
Due to a change in business strategy, the Company repurchased
this minority interest in NAI Japan in June 2001 for
approximately $10.7 million. The Company accounted for this
repurchase using the purchase method of accounting and
accordingly performed an allocation of the purchase price paid
for this minority interest. As a result, approximately
$10.3 million of the purchase price was allocated to
goodwill. The full results of operations of NAI Japan have been
included with those of the Company since the date of acquisition
of the minority interest.

86



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

5.     Sale of
Business



| |                
| | ---------------
| | Magic Solutions

In December 2003, the Company announced the sale
of its Magic Solutions business (Magic) to BMC
Software for $47.0 million in cash plus final purchase
price adjustments. The Company completed the transaction on
January 30, 2004. At December 31, 2003, the carrying
values of assets and liabilities related to Magic sale are
presented as held for sale on the consolidated balance sheet.
The following are the components of the Magic disposal group (in
thousands):

|                                            |                                                                         |   |        |        | 
|------------------------------------------- | ----------------------------------------------------------------------- | - | ------ | ------ | 
|Assets:                                     |                                                                         |   |        |       
|                                            | Accounts receivable, net of allowance for
    doubtful accounts of $215 |   | $      | 12,991 | 
|                                            | Prepaid expenses                                                        |   |        | 888    | 
|                                            | Inventory                                                               |   |        | 20     | 
|                                            | Equipment, net                                                          |   |        | 1,023  | 
|                                            | Goodwill                                                                |   |        | 9,797  | 
|                                            |                                                                         |   |        |       
|Assets held for sale                        |                                                                         | $ | 24,719 |       
|                                            |                                                                         |   |        |       
|Liabilities:                                |                                                                         |   |        |       
|                                            | Accounts payable                                                        |   | $      | 215    | 
|                                            | Accrued liabilities                                                     |   |        | 1,050  | 
|                                            | Deferred revenue                                                        |   |        | 22,045 | 
|                                            |                                                                         |   |        |       
|Liabilities related to assets held for sale |                                                                         | $ | 23,310 |       
|                                            |                                                                         |   |        |       

The assets and liabilities of Magic are present
primarily in the Companys North American and EMEA
operating regions. Magic assets and liabilities in the
Companys other operating regions are not material.
Depreciation on equipment held for sale was ceased in December
2003. Revenues related to Magic were approximately
$63.2 million, $68.4 million and $60.7 million in
2003, 2002 and 2001, respectively.



| |                  
| | -----------------
| | PGP Product Group

In October 2001, the Board of Directors of the
Company approved a plan to integrate the activities of the
Companys PGP product group into its other product groups.
In addition to the integration plan, the Company began to look
for a buyer for the PGP desktop encryption and Gauntlet firewall
product. In February 2002, the Company announced the sale of
Gauntlet firewall/ VPN business to Secure Computing. As a result
of the transaction, the Company received common shares of Secure
Computing in exchange for the Gauntlet business. The Company
recorded a gain on sale of the business of $6.7 million. In
August 2002, the Company announced the sale of PGP business to
PGP Corporation, a new venture funded company unrelated to the
Company, for $2.0 million in cash and assumed liabilities.
As a result of the transaction, the Company recorded a gain on
sale of the business of $2.6 million.

87



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

6.     Marketable
Securities and Cash and Cash Equivalents

Marketable securities, which are classified as
available-for-sale, are summarized as follows as of
December 31 (in thousands):

|                                                 |  |           |         |            |  |            |       |            |  |   |      |   |  |   |         | 
|------------------------------------------------ |  | --------- | ------- | ---------- |  | ---------- | ----- | ---------- |  | - | ---- | - |  | - | ------- | 
|                                                 |  |          
|                                                 |  | 2003     
|                                                 |  |          
|                                                 |  | Purchase/ |         | Gross      |  | Gross      |       |           
|                                                 |  | Amortized |         | Unrealized |  | Unrealized |       | Aggregate 
|                                                 |  | Cost      |         | Gains      |  | Losses     |       | Fair Value
|                                                 |  |           |         |            |  |            |       |           
|U.S. Government debt securities                  |  | $         | 190,567 |            |  | $          | 401   |            |  | $ | (76  | ) |  | $ | 190,892 | 
|Corporate debt securities and money market funds |  |           | 484,156 |            |  |            | 607   |            |  |   | (180 | ) |  |   | 484,583 | 
|Equity securities                                |  |           | 118     |            |  |            | 293   |            |  |   |     |   |  |   | 411     | 
|                                                 |  |           |         |            |  |            |       |            |  |   |      |   |  |   |         | 
|                                                 |  | $         | 674,841 |            |  | $          | 1,301 |            |  | $ | (256 | ) |  | $ | 675,886 | 
|                                                 |  |           |         |            |  |            |       |            |  |   |      |   |  |   |         | 

|                                |  |           |         |            |  |            |       |            |  |   |      |   |  |   |         | 
|------------------------------- |  | --------- | ------- | ---------- |  | ---------- | ----- | ---------- |  | - | ---- | - |  | - | ------- | 
|                                |  |          
|                                |  | 2002     
|                                |  |          
|                                |  | Purchase/ |         | Gross      |  | Gross      |       |           
|                                |  | Amortized |         | Unrealized |  | Unrealized |       | Aggregate 
|                                |  | Cost      |         | Gains      |  | Losses     |       | Fair Value
|                                |  |           |         |            |  |            |       |           
|U.S. Government debt securities |  | $         | 214,337 |            |  | $          | 1,634 |            |  | $ | (16  | ) |  | $ | 215,955 | 
|Municipal debt securities       |  |           | 10,035  |            |  |            | 121   |            |  |   |     |   |  |   | 10,156  | 
|Corporate debt securities       |  |           | 644,410 |            |  |            | 785   |            |  |   | (105 | ) |  |   | 645,090 | 
|Equity securities               |  |           | 1,500   |            |  |            | 148   |            |  |   |     |   |  |   | 1,648   | 
|                                |  |           |         |            |  |            |       |            |  |   |      |   |  |   |         | 
|                                |  | $         | 870,282 |            |  | $          | 2,688 |            |  | $ | (121 | ) |  | $ | 872,849 | 
|                                |  |           |         |            |  |            |       |            |  |   |      |   |  |   |         | 

At December 31, 2003, $427.0 million of
marketable debt securities had scheduled maturities of less than
three years, and $5.2 million of marketable debt securities
had scheduled maturities of more than three years. At
December 31, 2002, $338.0 million of marketable debt
securities had scheduled maturities of less than three years,
and $10.6 million of marketable debt securities had
scheduled maturities of more than three years. Money market
funds totaling $243.3 million in 2003, and
$533.3 million in 2002, have maturities of less than three
months and are therefore classified as cash equivalents. As of
December 31, 2003, there has been no material unrealized
loss existing for more than one year.

The following table summarizes the components of
the cash and cash equivalents balance at December 31 (in
thousands):

|                                                                       |                                 |      |         |         |  |   |         |         | 
|---------------------------------------------------------------------- | ------------------------------- | ---- | ------- | ------- |  | - | ------- | ------- | 
|                                                                       |                                 | 2003 |         | 2002   
|                                                                       |                                 |      |         |        
|Cash and money market funds, at cost which
    approximates fair value |                                 | $    | 325,360 |         |  | $ | 660,901 |        
|Corporate debt securities, primarily commercial
    paper              |                                 |      | 8,291   |         |  |   | 13,325  |        
|                                                                       |                                 |      |         |         |  |   |         |        
|                                                                       | Total cash and cash equivalents |      | $       | 333,651 |  |   | $       | 674,226 | 
|                                                                       |                                 |      |         |         |  |   |         |        

The following table summarizes the gross realized
gains (losses) for the years ending December 31 (in
thousands):

|                |                   |      |       |       |  |      |       |       |  |   |        |        | 
|--------------- | ----------------- | ---- | ----- | ----- |  | ---- | ----- | ----- |  | - | ------ | ------ | 
|                |                   | 2003 |       | 2002  |  | 2001
|                |                   |      |       |       |  |     
|Realized gains  |                   | $    | 3,753 |       |  | $    | 4,670 |       |  | $ | 11,172 |       
|Realized losses |                   |      | (677  | )     |  |      | (832  | )     |  |   | (930   | )     
|                |                   |      |       |       |  |      |       |       |  |   |        |       
|                | Net realized gain |      | $     | 3,076 |  |      | $     | 3,838 |  |   | $      | 10,242 | 
|                |                   |      |       |       |  |      |       |       |  |   |        |       

88



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

7.     Derivatives



| |                           
| | --------------------------
| | Forward Exchange Contracts

The Company conducts business globally. As a
result, it is exposed to movements in foreign currency exchange
rates. The Company enters into forward exchange contracts to
reduce exposures associated with nonfunctional currency monetary
assets and liabilities such as accounts receivable and accounts
payable denominated in Euros, British Pound Sterling, Singapore,
Japanese Yen, Canadian and Australian dollars. The forward
contracts range from one to three months in original maturity.
In general, the Company does not hedge anticipated foreign
currency cash flows nor does the Company enter into forward
contracts for trading purposes. The Company does not use any
derivatives for trading or speculative purposes.

The forward contracts do not qualify for hedge
accounting and accordingly are marked to market at the end of
each reporting period with any unrealized gain or loss being
recognized in the statement of income as interest and other
income.

The forward contracts outstanding and their fair
values are presented below as of December 31 (in thousands):

|                       |  |          |     |       |  |          |     |       |  |   |       |  |  |   |       | 
|---------------------- |  | -------- | --- | ----- |  | -------- | --- | ----- |  | - | ----- |  |  | - | ----- | 
|                       |  |          |     |      
|                       |  | 2003     |     | 2002 
|                       |  |          |     |      
|                       |  | Carrying |     | Fair  |  | Carrying |     | Fair 
|                       |  | Value    |     | Value |  | Value    |     | Value
|                       |  |          |     |       |  |          |     |      
|Euro                   |  | $        | 490 |       |  | $        | 490 |       |  | $ | 488   |  |  | $ | 488   | 
|British Pound Sterling |  |          | 54  |       |  |          | 54  |       |  |   | 774   |  |  |   | 774   | 
|Singapore Dollar       |  |          | (16 | )     |  |          | (16 | )     |  |   | 15    |  |  |   | 15    | 
|Australian Dollar      |  |          | 75  |       |  |          | 75  |       |  |   | 155   |  |  |   | 155   | 
|Canadian Dollar        |  |          | 255 |       |  |          | 255 |       |  |   | 354   |  |  |   | 354   | 
|                       |  |          |     |       |  |          |     |       |  |   |       |  |  |   |       | 
|                       |  | $        | 858 |       |  | $        | 858 |       |  | $ | 1,786 |  |  | $ | 1,786 | 
|                       |  |          |     |       |  |          |     |       |  |   |       |  |  |   |       | 



| |                    
| | -------------------
| | Interest Rate Swaps

In July 2002, the Company entered into interest
rate swap transactions (the Transactions) with two
investment banks (the Banks), to hedge the interest
rate risk of its outstanding 5.25% Convertible Subordinated
Notes due 2006 (the Notes) (See Note 13 of Notes to
these consolidated financial statements).

The notional amount of the Transactions was
$345.0 million to match the entire principal amount of the
Notes. The Company will receive from the Banks fixed payments
equal to 5.25% percent of the notional amount, payable on
February 15 and August 15 which started on
August 15, 2002. In exchange, the Company will pay to the
Banks floating rate payments based upon the London InterBank
Offered Rate (LIBOR) plus 1.66% multiplied by the
notional amount of the Transactions with the LIBOR resetting
every three months which began on August 15, 2002.

The Transactions will terminate on
August 15, 2006 (Termination Date), subject to
certain early termination provisions if on or after
August 20, 2004 and prior to August 15, 2006 the
twenty-day average closing price of the Companys common
stock equals or exceeds $22.59 per share. Depending on the
timing of the early termination event, the Banks would be
obligated to pay the Company an amount equal to the repurchase
premium called for under the terms of the Notes.

The Transactions qualified and were designated as
a fair value hedge against movements in the fair value of the
Notes due to changes in the benchmark interest rate. Under the
fair value hedge model, the derivative is recognized at fair
value on the balance sheet with an offsetting entry to the
income statement. In addition, changes in fair value of the
Notes due to changes in the benchmark interest rate are
recognized as a basis

89



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

adjustment to the carrying amount of the Notes
with an offsetting entry to the income statement. The gain or
loss from the change in fair value of the Transaction and the
offsetting change in the fair value of the Notes are recognized
as interest and other expense. The net unrealized gain recorded
as of December 31, 2003 and 2002 was approximately
$5.6 million and $1.4 million, respectively. The
estimated fair value of the Transactions was $9.4 million
and $12.4 million at December 31, 2003 and 2002,
respectively.

To test effectiveness of the hedge, regression
analysis is performed at least quarterly comparing the change in
fair value of the Transactions and the Notes. The fair values of
the Transactions and the Notes are calculated at least quarterly
as the present value of the contractual cash flows to the
expected maturity date, where the expected maturity date is
based on probability-weighted analysis of interest rates
relating to the five-year LIBOR curve and the Companys
stock prices. For 2003 and 2002, the hedge was highly effective
and therefore, the ineffective portion did not have a material
impact on earnings.

In support of the Companys obligation under
the Transactions, the Company is required to maintain with the
Banks a minimum level of cash and investment collateral of
$20.0 million and periodically adjust the overall level of
collateral depending on the fair market value of the
Transactions. This minimum amount of collateral is presented as
restricted cash in the on the consolidated balance sheets.



| |       
| | ------
| | Collar

In March 2002, the Company purchased a one-year
collar consisting of 300,354 purchased put options with a strike
price of $17.31 and the same number of written call options with
a strike price of $22.04. Underlying both the put and call
options were the Secure Computing shares. The Company designated
the purchased collar as a fair value hedge of the Secure
Computing available-for-sale securities received in the sales of
Gauntlet assets (described in Note 5 to these Notes to
Consolidated Financial Statements) in accordance with SFAS 133.
At the inception of the hedge, the Company assessed that the
collar was highly effective based upon expected changes in the
collars intrinsic value. In July 2002, the Company sold
its shares in Secure Computing and closed its collar. As a
result the Company recorded a net gain of $0.3 million,
which is recorded as a gain of $0.4 million from the sale
of the collar offset by a loss of $0.1 million from the
sale of Secure Computing securities.

90



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

8.     Consolidated
Balance Sheet Detail (in thousands):

|                                  |                                                  |              |          |          |   |   |          |          |  
|--------------------------------- | ------------------------------------------------ | ------------ | -------- | -------- | - | - | -------- | -------- | -
|                                  |                                                  |             
|                                  |                                                  | December 31,
|                                  |                                                  |             
|                                  |                                                  | 2003         |          | 2002    
|                                  |                                                  |              |          |         
|Property and equipment:           |                                                  |              |          |          |   |   |          |         
|                                  | Building                                         |              | $        | 19,822   |   |   | $        |         |  
|                                  | Furniture and fixtures                           |              |          | 27,469   |   |   |          | 23,235   |  
|                                  | Computers and equipment                          |              |          | 198,737  |   |   |          | 170,557  |  
|                                  | Leasehold improvements                           |              |          | 26,179   |   |   |          | 23,528   |  
|                                  | Construction in progress                         |              |          | 23,505   |   |   |          | 23,418   |  
|                                  |                                                  |              |          |          |   |   |          |         
|                                  |                                                  |              | 295,712  |          |   |   | 240,738  |         
|                                  |                                                  |              |          |          |   |   |          |         
|                                  | Accumulated depreciation building                |              |          | (1,500   | ) |   |          |         |  
|                                  | Accumulated depreciation furniture and fixtures  |              |          | (19,608  | ) |   |          | (16,762  | )
|                                  | Accumulated depreciation computers and equipment |              |          | (152,001 | ) |   |          | (126,241 | )
|                                  | Accumulated depreciation leasehold improvements  |              |          | (15,993  | ) |   |          | (12,872  | )
|                                  |                                                  |              |          |          |   |   |          |         
|                                  |                                                  |              | (189,102 | )        |   |   | (155,875 | )       
|                                  |                                                  |              |          |          |   |   |          |         
|                                  |                                                  | $            | 106,610  |          |   | $ | 84,863   |         
|                                  |                                                  |              |          |          |   |   |          |         
|Land                              |                                                  | $            | 5,062    |          |   | $ | 4,414    |         
|                                  |                                                  |              |          |          |   |   |          |         
|Total property and equipment, net |                                                  | $            | 111,672  |          |   | $ | 89,277   |         
|                                  |                                                  |              |          |          |   |   |          |         

Depreciation expense for 2003, 2002, and 2001 was
$35.8 million, $39.8 million, and $43.2 million,
respectively.

|                     |                                   |              |         |        |  |   |         |        | 
|-------------------- | --------------------------------- | ------------ | ------- | ------ |  | - | ------- | ------ | 
|                     |                                   |             
|                     |                                   | December 31,
|                     |                                   |             
|                     |                                   | 2003         |         | 2002  
|                     |                                   |              |         |       
|Accrued liabilities: |                                   |              |         |        |  |   |         |       
|                     | Accrued taxes, short term         |              | $       | 10,123 |  |   | $       | 11,288 | 
|                     | Accrued compensation              |              |         | 51,183 |  |   |         | 65,138 | 
|                     | Accrued marketing costs           |              |         | 3,622  |  |   |         | 6,568  | 
|                     | Accrued legal and accounting fees |              |         | 6,946  |  |   |         | 76,424 | 
|                     | Accrued interest                  |              |         | 6,843  |  |   |         | 6,843  | 
|                     | Other accrued expenses            |              |         | 68,564 |  |   |         | 54,505 | 
|                     |                                   |              |         |        |  |   |         |       
|                     |                                   | $            | 147,281 |        |  | $ | 220,766 |       
|                     |                                   |              |         |        |  |   |         |       

|                             |                          |              |         |         |  |   |         |         | 
|---------------------------- | ------------------------ | ------------ | ------- | ------- |  | - | ------- | ------- | 
|                             |                          |             
|                             |                          | December 31,
|                             |                          |             
|                             |                          | 2003         |         | 2002   
|                             |                          |              |         |        
|Other long-term liabilities: |                          |              |         |         |  |   |         |        
|                             | Accrued taxes, long term |              | $       | 209,287 |  |   | $       | 162,692 | 
|                             | Other                    |              |         | 13,478  |  |   |         | 445     | 
|                             |                          |              |         |         |  |   |         |        
|                             |                          | $            | 222,765 |         |  | $ | 163,137 |        
|                             |                          |              |         |         |  |   |         |        

91



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

9.     Restructuring

In January 2003, as part of a restructuring
effort to gain operational efficiencies, the Company
consolidated operations formerly housed in three leased
facilities in the Dallas, Texas area into its newly constructed
regional headquarters facility in Plano, Texas. The new facility
houses employees working in finance, legal, information
technology, and the customer support and telesales groups
servicing the McAfee System Protection Solutions and McAfee
Network Protection Solutions businesses.

As part of the consolidation of activities into
the Plano facility, the Company relocated employees from its
Santa Clara, California headquarters site. As a result of this
consolidation, in March 2003, the Company recorded a
restructuring charge of $15.8 million which consisted of a
non-cash charge of $2.1 million related to asset disposals
and discontinued use of certain leasehold improvements,
furniture and equipment; non-cash write off of $(1.9) million
deferred rent liability; and a $15.6 million accrual for
estimated lease related costs associated with the permanently
vacated facilities in Santa Clara, California. The remaining
costs associated with vacating the facility are primarily
comprised of the present value of remaining lease obligations,
net of estimated sublease income, along with costs associated
with subleasing the vacated facility. The remaining costs will
generally be paid over the remaining lease term ending in 2013.
The total restructuring charge and related cash outlay are based
on managements current estimates. As of December 31,
2003, amounts to be paid, relative to the restructuring accrual,
within 12 months ($2.0 million) have been included in
accrued liabilities, while amounts to be paid beyond
12 months ($12.2 million) have been included in other
long term liabilities in these consolidated financial statements.

During the second and third quarter of 2003, the
Company recorded a restructuring charge of $6.8 million and
$0.6 million, respectively, which consisted of
$6.7 million related to a headcount reduction of 210
employees and $0.7 million related to other expenses such
as legal expenses incurred in international locations in
conjunction with the headcount reduction. The employees were
located in the Companys domestic and international
locations and were primarily in the sales, product development
and customer support areas. In the third and fourth quarters of
2003, the Company reversed a total of $1.0 million of
restructuring reserve in Europe that was no longer necessary
after paying out substantially all accrued amounts to the former
employees.

The following table summarizes the Companys
restructuring accrual established in 2003 (in thousands):

|                           |  |             |        |           |  |       |        |       |  |   |      |   |  |   |        |  
|-------------------------- |  | ----------- | ------ | --------- |  | ----- | ------ | ----- |  | - | ---- | - |  | - | ------ | -
|                           |  |             |        | Severance |  |       |        |      
|                           |  | Lease       |        | and       |  |       |        |      
|                           |  | Termination |        | Other     |  | Other |        |      
|                           |  | Costs       |        | Benefits  |  | Costs |        | Total
|                           |  |             |        |           |  |       |        |      
|Balance, January, 1, 2003  |  | $           |       |           |  | $     |       |       |  | $ |     |   |  | $ |       |  
|Restructuring accrual      |  |             | 15,734 |           |  |       | 6,692  |       |  |   | 739  |   |  |   | 23,165 |  
|Cash payments              |  |             | (1,707 | )         |  |       | (6,259 | )     |  |   | (167 | ) |  |   | (8,133 | )
|Adjustment to liability    |  |             | (273   | )         |  |       | (116   | )     |  |   | (572 | ) |  |   | (961   | )
|Accretion                  |  |             | 463    |           |  |       |       |       |  |   |     |   |  |   | 463    |  
|                           |  |             |        |           |  |       |        |       |  |   |      |   |  |   |        |  
|Balance, December 31, 2003 |  | $           | 14,217 |           |  | $     | 317    |       |  | $ |     |   |  | $ | 14,534 |  
|                           |  |             |        |           |  |       |        |       |  |   |      |   |  |   |        |  

The Companys estimates of the excess
facilities charge may vary significantly depending, in part, on
factors which may be beyond the Companys control, such as
the Companys success in negotiating with its lessor, the
time periods required to locate and contract suitable subleases
and the market rates at the time of such subleases. Adjustments
to the facilities accrual will be made if further consolidations
are required or if actual lease exit costs or sublease income
differ from amounts currently expected. The facility
restructuring charge was not allocated to reporting segments.
The restructuring charge related to headcount reductions was
$0.9 million in the Companys North American segment
and $5.8 million in the Companys EMEA segment.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

The following table sets forth the Companys
restructuring accrual established in February 2002 and the
activity against the accrual during 2002 (in thousands):

|                           |  |       |      |           |  |       |      |   |  |   |        |  
|-------------------------- |  | ----- | ---- | --------- |  | ----- | ---- | - |  | - | ------ | -
|                           |  |       |      | Severance |  |      
|                           |  | Other |      | and       |  |      
|                           |  | Costs |      | Benefits  |  | Total
|                           |  |       |      |           |  |      
|Balance, February 2002     |  | $     | 190  |           |  | $     | 926  |   |  | $ | 1,116  |  
|Paid out                   |  |       | (190 | )         |  |       | (926 | ) |  |   | (1,116 | )
|                           |  |       |      |           |  |       |      |   |  |   |        |  
|Balance, December 31, 2002 |  | $     |     |           |  | $     |     |   |  | $ |       |  
|                           |  |       |      |           |  |       |      |   |  |   |        |  

10.     Goodwill and
Other Intangible Assets

The Company accounts for goodwill and other
intangible assets in accordance with SFAS No. 142,
Goodwill and Other Intangible Assets. In lieu
of amortization, the Company performs an impairment review of
its goodwill on at least an annual basis. The impairment review
requires a two-step process. The Company performed Step 1 of the
initial goodwill impairment analysis as of January 1, 2002,
as described in Note 2 of the Consolidated Financial Statements
and concluded that goodwill was not impaired, as the fair value
of each reporting unit exceeded its carrying value, including
goodwill. Accordingly, Step 2 was not required to be performed.

The Company completed its annual goodwill
impairment review as of October 1, 2003, during the fourth
quarter of 2003 and concluded that goodwill was not impaired.
The fair value of the reporting units was estimated using the
average of the expected present value of future cash flows and
of the market multiple value. Furthermore, as a result of the
sale of Magic, the Company also tested its reporting units
excluding Magic as required by SFAS 142 and no impairment was
present. The Company will continue to test for impairment on an
annual basis and on an interim basis if an event occurs or
circumstances change that would more likely than not reduce the
fair value of the Companys reporting units below their
carrying amounts.

Goodwill information is as follows (in thousands):

|                               |  |            |         |          |  |             |         |          |  |              |        |   |  |   |       |  |  |   |         | 
|------------------------------ |  | ---------- | ------- | -------- |  | ----------- | ------- | -------- |  | ------------ | ------ | - |  | - | ----- |  |  | - | ------- | 
|                               |  |            |         |          |  |             |         | Effects  |  |             
|                               |  |            |         |          |  |             |         | of       |  |             
|                               |  |            |         |          |  |             |         | Foreign  |  |             
|                               |  | January 1, |         | Goodwill |  |             |         | Currency |  | December 31,
|                               |  | 2003       |         | Acquired |  | Adjustments |         | Exchange |  | 2003        
|                               |  |            |         |          |  |             |         |          |  |             
|North America                  |  | $          | 232,122 |          |  | $           | 137,636 |          |  | $            | (6,671 | ) |  | $ | 1,238 |  |  | $ | 364,325 | 
|EMEA                           |  | $          | 25,424  |          |  | $           | 21,477  |          |  | $            | (2,830 | ) |  | $ | 289   |  |  | $ | 44,360  | 
|Japan                          |  | $          | 12,071  |          |  | $           | 4,678   |          |  | $            | (1     | ) |  | $ |      |  |  | $ | 16,748  | 
|Asia-Pacific (excluding Japan) |  | $          | 2,301   |          |  | $           | 3,814   |          |  | $            | (28    | ) |  | $ |      |  |  | $ | 6,087   | 
|Latin America                  |  | $          | 2,016   |          |  | $           | 3,905   |          |  | $            | 5,454  |   |  | $ | 698   |  |  | $ | 12,073  | 
|                               |  |            |         |          |  |             |         |          |  |              |        |   |  |   |       |  |  |   |         | 
|Total                          |  | $          | 273,934 |          |  | $           | 171,510 |          |  | $            | (4,076 | ) |  | $ | 2,225 |  |  | $ | 443,593 | 
|                               |  |            |         |          |  |             |         |          |  |              |        |   |  |   |       |  |  |   |         | 

Goodwill was acquired during 2003 as a result of
the Companys purchases of Entercept and IntruVert (See
Note 4 of these Notes to the Consolidated Financial Statements).

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The adjustments column reflects the final
purchase price adjustment related to BySupport which was
acquired by the Company in the fourth quarter of 2002. Based on
a final review of the purchase price allocation, the
acquisitions goodwill allocation was increased by
$6.2 million from amortizable intangibles. The adjustment
column also reflects the reclassification of $9.8 million
of goodwill related to Magic that was removed from the
Companys operating segments and presented as held for sale
at December 31, 2003. The goodwill related to Magic was
calculated based on the relative percentage of Magics
estimated fair value to the Companys fair value by
reporting unit.

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

|                                                |                                          |      |         |        | 
|----------------------------------------------- | ---------------------------------------- | ---- | ------- | ------ | 
|                                                |                                          | 2001
|                                                |                                          |     
|Net income, as reported                         |                                          | $    | 83,253  |       
|                                                | Add: Goodwill amortization, net of taxes |      |         | 43,895 | 
|                                                |                                          |      |         |       
|Adjusted net income                             |                                          | $    | 127,148 |       
|                                                |                                          |      |         |       
|Net income per share, as reported 
    basic   |                                          | $    | 0.60    |       
|Effect of goodwill amortization                 |                                          |      | 0.32    |       
|                                                |                                          |      |         |       
|Adjusted net income per share  basic           |                                          | $    | 0.92    |       
|                                                |                                          |      |         |       
|Net income per share, as reported 
    diluted |                                          | $    | 0.53    |       
|Effect of goodwill amortization                 |                                          |      | 0.26    |       
|                                                |                                          |      |         |       
|Adjusted net income per share  diluted         |                                          | $    | 0.79    |       
|                                                |                                          |      |         |       

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

|                         |                                                              |                   |         |                    |  |          |          |          |   |                    |         |          |  |   |         |         |  |   |         |         |   |   |        |        | 
|------------------------ | ------------------------------------------------------------ | ----------------- | ------- | ------------------ |  | -------- | -------- | -------- | - | ------------------ | ------- | -------- |  | - | ------- | ------- |  | - | ------- | ------- | - | - | ------ | ------ | 
|                         |                                                              |                   |         |                   
|                         |                                                              | December 31, 2003 |         | December 31, 2002 
|                         |                                                              |                   |         |                   
|                         |                                                              |                   |         | Accumulated        |  |          |          |          |   | Accumulated        |         |         
|                         |                                                              |                   |         | Amortization       |  |          |          |          |   | Amortization       |         |         
|                         |                                                              |                   |         | (Including Effects |  |          |          |          |   | (Including Effects |         |         
|                         |                                                              | Gross             |         | of Foreign         |  | Net      |          | Gross    |   | of Foreign         |         | Net     
|                         |                                                              | Carrying          |         | Currency           |  | Carrying |          | Carrying |   | Currency           |         | Carrying
|                         |                                                              | Amount            |         | Exchange)          |  | Amount   |          | Amount   |   | Exchange)          |         | Amount  
|                         |                                                              |                   |         |                    |  |          |          |          |   |                    |         |         
|Other Intangible assets: |                                                              |                   |         |                    |  |          |          |          |   |                    |         |          |  |   |         |         |  |   |         |         |   |   |        |       
|                         | Purchased technologies                                       |                   | $       | 116,037            |  |          | $        | (64,439  | ) |                    | $       | 51,598   |  |   | $       | 72,715  |  |   | $       | (49,424 | ) |   | $      | 23,291 | 
|                         | Trademarks, patents customer base, and other
    intangibles |                   |         | 103,431            |  |          |          | (49,077  | ) |                    |         | 54,354   |  |   |         | 104,540 |  |   |         | (34,280 | ) |   |        | 70,260 | 
|                         |                                                              |                   |         |                    |  |          |          |          |   |                    |         |          |  |   |         |         |  |   |         |         |   |   |        |       
|                         |                                                              | $                 | 219,468 |                    |  | $        | (113,516 | )        |   | $                  | 105,952 |          |  | $ | 177,255 |         |  | $ | (83,704 | )       |   | $ | 93,551 |       
|                         |                                                              |                   |         |                    |  |          |          |          |   |                    |         |          |  |   |         |         |  |   |         |         |   |   |        |       

The aggregate amortization expenses for the
intangible assets listed above totaled $27.0 million,
$13.9 million, and $12.9 million for 2003, 2002, and
2001 respectively.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                     |           |                                                                     |                                     |         |        |       |         |         |        |        | 
|------------------------------------ | --------- | ------------------------------------------------------------------- | ----------------------------------- | ------- | ------ | ----- | ------- | ------- | ------ | ------ | 
|                                     |           | 2003                                                                |                                     | 2002   
|                                     |           |                                                                     |                                     |        
|                                     |           |                                                                    
|                                     |           | (In thousands)                                                     
|Intangible assets, beginning of year |           | $                                                                   | 177,255                             |         |        | $     | 95,734  |        
|                                     |           | Add: Purchased technologies (amortized over one
    to seven years) |                                     |         | 40,523 |       |         |         | 23,028 |       
|                                     |           | Add: Trademarks, patents and other intangibles                      |                                     |         |        |       |         |         |        |       
|                                     |           |                                                                     | (amortized over one to seven years) |         |        | 4,704 |         |         |        | 56,770 | 
|                                     |           | Add: Change in value due to foreign exchange                        |                                     |         | 2,738  |       |         |         | 1,823  |       
|                                     |           |                                                                     |                                     |         |        |       |         |        
|                                     | Sub-total |                                                                     | $                                   | 225,220 |        |       | $       | 177,355 |       
|                                     |           | Less: Transfers to goodwill and write-offs                          |                                     |         | (5,752 | )     |         |         | (100   | )     
|                                     |           |                                                                     |                                     |         |        |       |         |        
|Intangible Assets, end of year       |           | $                                                                   | 219,468                             |         |        | $     | 177,255 |        
|                                     |           |                                                                     |                                     |         |        |       |         |        

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

|              |            |   |         |        | 
|------------- | ---------- | - | ------- | ------ | 
|Fiscal Years: |            |   |         |       
|              | 2004       |   | $       | 25,951 | 
|              | 2005       |   |         | 23,270 | 
|              | 2006       |   |         | 20,401 | 
|              | 2007       |   |         | 17,646 | 
|              | 2008       |   |         | 12,277 | 
|              | Thereafter |   |         | 6,407  | 
|              |            |   |         |       
|              |            | $ | 105,952 |       
|              |            |   |         |       

11.     Commitments



| |       
| | ------
| | Leases

The Company leases most of its operating
facilities under non-cancelable operating leases, which expire
at various times ranging from the year 2004 through 2017. The
Company owns its regional office in Plano, Texas. A description
of the Companys significant operating leases is as follows:

|                                                  |                 |                                     |               |                 |               
|------------------------------------------------- | --------------- | ----------------------------------- | ------------- | --------------- | --------------
|                                                  |                 | Lease Expiration                    |               | Renewal Option 
|                                                  |                 |                                     |               |                
|Corporate Headquarters, Santa Clara, California   |                 | March 2013                          |               | None           
|                                                  | Slough, England |                                     | December 2017 |                 | None          
|European Headquarters, Amsterdam, The Netherlands |                 | Various dates
    through June 2008 |               | Various Options
|                                                  | Paris, France   |                                     | April 2012    |                 | None          
|                                                  | Tokyo, Japan    |                                     | February 2004 |                 | 2 year renewal

In addition, the Company has leased certain
office equipment with various lease expiration dates through
2007.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Future minimum payments and sublease rental
income under non-cancelable operating leases are as follows as
of December 31 (in thousands):

|           |       |          |        |          |  |   |     |     | 
|---------- | ----- | -------- | ------ | -------- |  | - | --- | --- | 
|           |       |          |        | Sublease
|           |       | Payments |        | Income  
|           |       |          |        |         
|2004       |       | $        | 18,535 |          |  | $ | 395 |    
|2005       |       |          | 16,560 |          |  |   | 352 |    
|2006       |       |          | 13,041 |          |  |   | 78  |    
|2007       |       |          | 10,167 |          |  |   |    |    
|2008       |       |          | 8,974  |          |  |   |    |    
|Thereafter |       |          | 40,000 |          |  |   |    |    
|           |       |          |        |          |  |   |     |    
|           | Total |          | $      | 107,277  |  |   | $   | 825 | 
|           |       |          |        |          |  |   |     |    

Rent expense for 2003, 2002, and 2001 amounted to
$21.3 million, $25.2 million, and $25.5 million,
respectively. Sublease rental income under non-cancelable
subleases amounted to $0.4 million, $0.1 million, and
$1.5 million for 2003, 2002, and 2001, respectively.

12.     Warranty
Provision and Guarantees

The Company offers warranty on its hardware and
software products and records a liability for the estimated
future costs associated with warranty claims, which is based
upon historical experience and the Companys estimate of
the level of future costs. A reconciliation of the change in the
Companys warranty obligation at December 31, follows
(in thousands):

|                                      |  |      |        |      |  |   |        |  
|------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | -
|                                      |  | 2003 |        | 2002
|                                      |  |      |        |     
|Warranty provision, beginning of year |  | $    | 1,153  |      |  | $ | 982    |  
|Additional accruals                   |  |      | 3,881  |      |  |   | 4,624  |  
|Expenses incurred during the period   |  |      | (3,931 | )    |  |   | (4,453 | )
|                                      |  |      |        |      |  |   |        |  
|Warranty provision, end of year       |  | $    | 1,103  |      |  | $ | 1,153  |  
|                                      |  |      |        |      |  |   |        |  

In November 2002, the FASB issued Interpretation
No. 45 (FIN 45), Guarantors
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45
requires that a guarantor recognize, at the inception of a
guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee or indemnification. FIN 45
also requires additional disclosure by a guarantor in its
interim and annual consolidated financial statements about its
obligations under certain guarantees and indemnifications. The
initial recognition and measurement provisions of FIN 45 are
applicable for guarantees issued or modified after
December 31, 2002. The disclosure requirements of FIN 45
are effective for consolidated financial statements of interim
or annual periods ending after December 15, 2002. The
following is a summary of the agreements that the Company has
determined are within the scope of FIN 45:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Under the terms of the Companys software
    license agreements with its customers, the Company agrees that
    in the event the software sold infringes upon any patent,
    copyright, trademark, or any other proprietary right of a third
    party, it will indemnify its customer licensees, against any
    loss, expense, or liability from any damages that may be awarded
    against its customer. The Company includes this infringement
    indemnification in all of its software license agreements and
    selected managed service arrangements. In the event the customer
    cannot use the software or service due to infringement and the
    Company can not obtain the right to use, replace or modify the
    license or service in a commercially feasible manner so that it
    no longer infringes then the Company may terminate the license
    and provide

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SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | the customer a pro-rata refund of the fees paid
    by the customer for the infringing license or service. The
    Company has recorded no liability associated with this
    indemnification, as it is not aware of any pending or threatened
    infringement actions that are probable losses. The Company
    believes the estimated fair value of these intellectual property
    indemnification clauses is minimal.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Under the terms of certain vendor agreements, in
    particular, vendors used as part of the Companys managed
    services, the Company has agreed that in the event the service
    provided to the customer by the vendor on behalf of the Company
    infringes upon any patent, copyright, trademark, or any other
    proprietary right of a third party, it will indemnify its
    vendor, against any loss, expense, or liability from any damages
    that may be awarded against its customer. No maximum liability
    is stipulated in these vendor agreements. The Company has
    recorded no liability associated with this indemnification, as
    it is not aware of any pending or threatened infringement
    actions or claims that are probable losses. The Company believes
    the estimated fair value of these indemnification clauses is
    minimal.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | The Company has agreed to indemnify members of
    the board of directors, as well as officers of the Company, if
    they are made a party or are threatened to be made a party to
    any proceeding (other than an action by or in the right of the
    Company) by reason of the fact that they are an agent of the
    Company, or by reason of anything done or not done by them in
    any such capacity. The indemnity is for any and all expenses and
    liabilities of any type whatsoever (including but not limited
    to, judgments, fines and amounts paid in settlement) actually
    and reasonably incurred by the directors or officers in
    connection with the investigation, defense, settlement or appeal
    of such proceeding, provided they acted in good faith. The
    Company maintains insurance coverage for directors and officers
    liability (D&O insurance). No maximum liability
    is stipulated in these agreements that include indemnifications
    of members of the board of directors and officers of the
    Company. The Company has recorded no liability associated with
    these indemnifications as it is not aware of any pending or
    threatened actions or claims against it members of board of
    directors or officers that are probable losses in excess of
    amounts covered by its D&O insurance. As a result of the
    insurance policy coverage, the Company believes the estimated
    fair value of these indemnification agreements is minimal.
|
| |  | Under the terms of the Companys agreements
    to sell the PGP and Gauntlet assets, the Company agreed to
    indemnify the purchasers for any breach of representations or
    warranties in the agreement as well as for any liabilities
    related to the assets prior to sale that are not included in the
    purchaser assumed liabilities (undiscovered liabilities). The
    maximum potential loss related to the indemnification for breach
    of representations or warranties is $2.4 million. No
    maximum liability is stipulated in the agreement related to any
    undiscovered liabilities. To date, the Company has paid
    $0.4 million under the representations and warranties
    indemnification.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

If the Company believes a liability associated
with any of the aforementioned indemnifications becomes probable
and the amount of the liability is reasonably estimable or the
maximum amount of a range of loss is reasonably estimable, then
an appropriate liability will be established.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

13.     Convertible
Debt

Convertible debt is comprised of the following
amounts at December 31 (in thousands):

|                                                             |                                                                                                                                                            |                        |   |         |         |  |         |          |         | 
|------------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------- | - | ------- | ------- |  | ------- | -------- | ------- | 
|                                                             |                                                                                                                                                            | 2003                   |   | 2002   
|                                                             |                                                                                                                                                            |                        |   |        
|Zero Coupon Convertible Subordinated Debentures
    due 2018 |                                                                                                                                                            |                        |   |         |         |  |         |         
|                                                             | Face Value                                                                                                                                                 |                        | $ |        |         |  | $       | 358,500  |        
|                                                             | Unamortized Discount                                                                                                                                       |                        |   |        |         |  |         | (182,240 | )      
|                                                             |                                                                                                                                                            |                        |   |         |         |  |         |         
|                                                             |                                                                                                                                                            |                        |  |         |         |  | 176,260 |         
|                                                             |                                                                                                                                                            |                        |   |         |         |  |         |         
|5.25% Convertible Subordinated Notes due 2006                |                                                                                                                                                            |                        |   |         |         |  |         |         
|                                                             | Face Value (net of accumulated fair value
    adjustment of $2,397 and $11,012 at December 31, 2003 and
    2002, respectively, See Note 7 on Derivatives) |                        |   | 347,397 |         |  |         | 356,013  |        
|                                                             |                                                                                                                                                            |                        |   |         |         |  |         |         
|                                                             |                                                                                                                                                            | Total convertible debt |   | $       | 347,397 |  |         | $        | 532,273 | 
|                                                             |                                                                                                                                                            |                        |   |         |         |  |         |         



| |                                                
| | -----------------------------------------------
| | Zero Coupon Convertible Debentures Due
    2018

In February 1998, the Company completed a private
placement of zero coupon convertible subordinated debentures due
in 2018 (the Debentures). The Debentures, with an
aggregate face amount at maturity of $885.5 million,
generated net proceeds to the Company of approximately
$337.6 million. The initial price to the public for the
debentures was $391.06 per $1,000 of face amount at maturity,
which equates to a yield to maturity over the term of the
Debentures of 4.75% (on a semi-annual Debentures equivalent
basis). The Debentures were convertible into common stock at the
rate of 8.538 shares per $1,000 of face amount at maturity,
which equated to an initial conversion price of $45.80 per
share. The Debentures were subordinated in right of payment to
all existing and future Senior Indebtedness (as defined in the
related indenture) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the
Companys subsidiaries.

In accordance with the indenture, in 2002 and
2001, the Company redeemed Debentures, which had an aggregate
face amount at maturity of $140.0 million and
$387.0 million, respectively, at a net price of
$66.2 million and $173.7 million, which was financed from
the Companys investment portfolio. In connection with
these repurchases, the Company recognized net gains of
approximately $26,000 and $1.7 million in 2002 and 2001,
respectively. The gain was calculated as the difference between
the accreted value of the debt, net of unamortized issuance
costs and the cost of repurchase.

In February 2003, outstanding Debentures, with an
aggregate face amount at maturity of $358.5 million, became
redeemable for cash at the option of the holders thereof, at
which time the Company repurchased Debentures which had an
aggregate face amount at maturity of $358.0 million for a
net price of $177.1 million. In June 2003, the Company
repurchased the remaining Debentures with an aggregate face
amount at maturity of $0.5 million for a net price of $0.2
million. The Company recognized a loss of $2.7 million on
the repurchase of Debentures during 2003. The loss was
calculated as the difference between the accreted value of the
debt, net of unamortized issuance costs and the cost of
repurchase.



| |                                                 
| | ------------------------------------------------
| | 5.25% Convertible Subordinated Note Due
    2006

In August 2001, the Company issued 5.25%
convertible subordinated notes (Notes) due 2006 with
an aggregate principal amount of $345.0 million. The
issuance generated net proceeds (after deducting fees and
expenses) of $335.1 million. The amortization of the issuance
costs related to the Notes is calculated using the effective
interest method and recorded as additional interest expense in
the statements of income. The Notes

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

are unsecured and are subordinated to all
existing and future Senior Indebtedness (as defined in the
related indenture). The Notes have no restrictive financial
covenants.

The Notes mature on August 15, 2006, unless
earlier redeemed by the Company at its option or converted at
the holders option. At the option of the holder, the Notes
may be converted into the Companys common stock at any
time, unless previously redeemed, at a conversion price of
$18.07 per share. The Notes may also be redeemed at the option
of the holder in the event of a Change of Control (as defined in
the related indenture). At any time between August 20, 2004
and August 14, 2005, the Company may redeem all or a
portion of the Notes for cash at a repurchase price of 101.3125%
of the principal amount. After August 14, 2005, the
repurchase price is 100.0% of the principal amount.

Interest is payable in cash semi-annually in
arrears on February 15 and August 15 of each year, and
started on February 15, 2002. In 2004, 2005, and 2006,
without giving effect to the related floating rate interest rate
swap (See Note 7 of these Notes to Consolidated Financial
Statements), the Company will make interest payments of $18.1
million. In the event the Notes are redeemed after
August 20, 2004, the annual interest payments will be
reduced.

The value of the long-term debt outstanding at
December 31, 2003 of $345.0 million fully matures in 2006.

In July 2002, the Company entered into an
interest rate swap transaction with two investment banks, which
results in the convertible notes being carried at fair value.
(See Note 7 of these Notes to the Consolidated Financial
Statements).

The estimated fair value of the Companys
long-term debt outstanding is as follows (in thousands):

|                                              |  |                    |         |      |  |   |         | 
|--------------------------------------------- |  | ------------------ | ------- | ---- |  | - | ------- | 
|                                              |  |                   
|                                              |  | As of December 31,
|                                              |  |                   
|                                              |  | 2003               |         | 2002
|                                              |  |                    |         |     
|Zero Coupon Convertible Debentures due 2018   |  | $                  |        |      |  | $ | 174,360 | 
|5.25% Convertible Subordinated Notes due 2006 |  |                    | 373,134 |      |  |   | 425,364 | 
|                                              |  |                    |         |      |  |   |         | 
|                                              |  | $                  | 373,134 |      |  | $ | 599,724 | 
|                                              |  |                    |         |      |  |   |         | 

14.     Employee
Benefit Plans



| |                                           
| | ------------------------------------------
| | Company 401(k) and Profit Sharing
    Plan

The Companys 401(k) and Profit Sharing Plan
cover substantially all full-time employees. Employees can elect
to defer the lesser of 40% of their compensation or $13,000 per
year. The board of directors, at its discretion, can match
employee contributions in an amount not to exceed a maximum of
$4,000 per year. Annual amounts contributed by the Company under
the plan were $4.7 million, $4.3 million, and
$4.5 million in 2003, 2002, and 2001, respectively.



| |                                         
| | ----------------------------------------
| | Company Employee Stock Purchase
    Plan

In April 2002, the Companys board of
directors adopted Networks Associates 2002 Employee Stock
Purchase Plan (2002 Purchase Plan) and an initial
2.0 million shares of the Companys common stock were
reserved for issuance. In December 2003, the Companys
stockholders approved an additional 2.0 million shares for
issuance under the 2002 Purchase Plan for a total of
4.0 million shares. All employees are eligible to
participate in the 2002 Purchase Plan. The 2002 Purchase Plan is
comprised of two year offering periods with four six-month
purchase periods. Purchase periods occur twice yearly and each
offering effectively contains a six, twelve, eighteen and
twenty-four month option. Shares are purchased through
employees contributions at exercise prices equal to 85% of
the lesser of the fair market value of the Companys common
stock at either the first day of an offering period or the last
day of the purchase period. No participant may purchase more

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

than $25,000 of common stock in any one calendar
year and the maximum number of shares a participant may purchase
during a single offering period is 10,000 shares. In 2003,
approximately 1.6 million shares were issued under the 2002
Purchase Plan at a weighted average purchase price of $9.89.

Under the 1994 Employee Qualified Stock Purchase
Plan (1994 Purchase Plan), the Company could grant
stock purchase rights to all eligible employees during one year
offering periods with exercise dates approximately every six
months (beginning each August and February). The Company had
reserved 3.8 million shares of common stock for issuance under
the plan. Shares were purchased through employees payroll
deductions at exercise prices equal to 85% of the lesser of the
fair value of the Companys common stock at either the
first day of an offering period or the last day of such offering
period. No participant could purchase more than $25,000 of
common stock in any one calendar year. After the purchase on
January 31, 2002, the 1994 Purchase Plan was terminated. In
2002, approximately 0.7 million shares were issued under
the 1994 Purchase Plan at a weighted average purchase price of
$7.24.



| |                                            
| | -------------------------------------------
| | McAfee.com Employee Stock Purchase
    Plan

In September 1999, McAfee.coms board of
directors adopted McAfee.coms Employee Stock Purchase Plan
(the 1999 Purchase Plan). A total of
0.5 million shares of McAfee.com Class A common stock
were initially reserved for issuance under the 1999 Purchase
Plan. All McAfee.com full-time employees were eligible to
participate in the 1999 Purchase Plan. The 1999 Purchase Plan
was comprised of two-year offering periods with exercise dates
approximately every six months (beginning each August and
February), with the exception of the first offering period,
which commenced on December 2, 1999, with the first
exercise date on January 31, 2000. Shares were purchased
through McAfee.com employees payroll deductions at
exercise prices equal to 85% of the lesser of the fair market
value of McAfee.coms Class A common stock at either
the first day of an offering period or the last day of such
offering period. No participant could purchase more than $25,000
worth of Class A common stock in any one calendar year and
the maximum number of shares a participant could purchase during
a single purchase period was 2,500 shares. Purchase periods
occurred twice yearly and each offering effectively contained a
six, twelve, eighteen and twenty-four month option. On
September 13, 2002, the Company acquired the minority
interest in McAfee.com and therefore the McAfee.com employee
stock purchase plan was terminated. In 2002, approximately
0.2 million of McAfee.com shares were issued under the 1999
Purchase Plan at weighted average purchase price of $6.66

15.     Stockholders
Equity



| |                
| | ---------------
| | Preferred Stock

The Company has authorized 5.0 million
shares of preferred stock, par value $0.01 per share. The
Companys board of directors has authority to provide for
the issuance of the shares of preferred stock in series, to
establish from time to time the number of shares to be included
in each such series and to fix the designation, powers,
preferences and rights of the shares of each such series and the
qualifications, limitations or restrictions thereof, without any
further vote or action by the shareholders.



| |                           
| | --------------------------
| | Company Stock Option Plans

Under the amended 1997 Plan, the Company has
reserved 32.5 million shares for issuance to employees,
officers, directors, third party contractors and consultants.
The plan provides for an option price no less than 100% of the
fair value of the Companys common stock on the date of
grant for incentive stock options granted to employees and
officers (including directors who are also employees) or 85% of
the fair value on the date of grant for all others. The options
may be exercisable immediately, or over time, but generally
become exercisable 25% one year after commencing employment or
from date of grant and thereafter in monthly increments over
three years. All options under the option plan expire ten years
after grant.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Under the Stock Option Plan for Outside
Directors, the Company has reserved 1.1 million shares of
its common stock for issuance to certain members of its board of
directors who are not employees of the Company or any affiliated
corporation. The plan provides for an option price at fair value
of the Companys common stock on the date of grant. The
initial grant to each outside director generally vests ratably
over a three-year period. Subsequent option grants will become
exercisable after three years from the date of grant. All
options under the option plan expire ten years after grant.

In May 1999, the board of directors approved the
1999 Nonstatutory Stock Option Plan. Under the plan, as amended
in January 2003, the Company reserved 1.0 million shares of
its common stock for issuance to employees and officers. The
plan provides for an option price at fair value of the
Companys common stock on the date of grant. The options
become exercisable over a period of four years: 25% become
exercisable one year from the date of grant and the remaining
become exercisable ratably in monthly increments over three
years. All options under the option plan expire ten years after
grant. In April 2003, the 1999 Nonstatutory Stock Option Plan
was retired and no new options were granted from this plan.

In December 1999, the board of directors approved
the 2000 Nonstatutory Stock Option Plan. Under the plan, as
amended in January 2001, the Company has reserved
11.5 million shares of its common stock for issuance to
employees, officers, directors, third party contracts and
consultants. The plan provides for an option price at fair value
of the Companys common stock on the date of grant. The
options become exercisable over a period of four years: 25%
become exercisable one year from the date of grant and the
remaining become exercisable ratably in monthly increments over
three years. All options under the option plan expire ten years
after grant. In April 2003, the 2000 Nonstatutory Stock Option
Plan was retired and no new options were granted from this plan.

Aggregate activity under the Companys stock
option plans is as follows (in thousands, except per share data):

|                                                                       |  |           |         |                     |  |                 |        |           |  |          |             |  |  |  |          |   |  |   |       | 
|---------------------------------------------------------------------- |  | --------- | ------- | ------------------- |  | --------------- | ------ | --------- |  | -------- | ----------- |  |  |  | -------- | - |  | - | ----- | 
|                                                                       |  |           |         |                    
|                                                                       |  |           |         | Outstanding Options
|                                                                       |  |           |         |                    
|                                                                       |  |           |         |                     |  | Weighted       
|                                                                       |  | Shares    |         |                     |  | Average        
|                                                                       |  | Available |         | Number of           |  |                 |        | Aggregate |  | Exercise
|                                                                       |  | for Grant |         | Shares              |  | Price Per Share |        | Price     |  | Price   
|                                                                       |  |           |         |                     |  |                 |        |           |  |         
|Balances, December 31, 2000                                            |  |           | 10,509  |                     |  |                 | 20,254 |           |  | $        | 0.23-$44.58 |  |  |  | 378,442  |   |  | $ | 18.68 | 
|Additional options reserved                                            |  |           | 13,500  |                     |  |                 |       |           |  |          |             |  |  |  |         |   |  |   |      | 
|Option plan expirations                                                |  |           | (155    | )                   |  |                 |       |           |  |          |             |  |  |  |         |   |  |   |      | 
|Options granted                                                        |  |           | (18,487 | )                   |  |                 | 18,487 |           |  | $        | 0.01-$27.20 |  |  |  | 127,401  |   |  | $ | 6.89  | 
|Options exercised                                                      |  |           |        |                     |  |                 | (3,233 | )         |  | $        | 0.01-$24.50 |  |  |  | (29,444  | ) |  | $ | 9.11  | 
|Options canceled                                                       |  |           | 3,737   |                     |  |                 | (3,737 | )         |  | $        | 4.19-$44.50 |  |  |  | (54,906  | ) |  | $ | 14.69 | 
|                                                                       |  |           |         |                     |  |                 |        |           |  |          |             |  |  |  |          |   |  |   |       | 
|Balances, December 31, 2001                                            |  |           | 9,104   |                     |  |                 | 31,771 |           |  | $        | 0.23-$48.72 |  |  |  | 421,493  |   |  | $ | 13.27 | 
|Additional options reserved                                            |  |           | 5,000   |                     |  |                 |       |           |  |          |             |  |  |  |         |   |  |   |      | 
|Option plan expirations                                                |  |           | (984    | )                   |  |                 |       |           |  |          |             |  |  |  |         |   |  |   |      | 
|Options granted                                                        |  |           | (8,302  | )                   |  |                 | 8,302  |           |  | $        | 0.01-$30.26 |  |  |  | 190,401  |   |  | $ | 22.93 | 
|Options issued in exchange of McAfee.com
    outstanding stock options |  |           |        |                     |  |                 | 2,761  |           |  | $        | 4.63-$71.26 |  |  |  | 46,748   |   |  | $ | 16.93 | 
|Options exercised                                                      |  |           |        |                     |  |                 | (8,197 | )         |  | $        | 0.01-$28.50 |  |  |  | (107,454 | ) |  | $ | 13.11 | 
|Options canceled                                                       |  |           | 6,335   |                     |  |                 | (6,335 | )         |  | $        | 4.19-$34.69 |  |  |  | (124,025 | ) |  | $ | 19.58 | 
|                                                                       |  |           |         |                     |  |                 |        |           |  |          |             |  |  |  |          |   |  |   |       | 

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                            |  |           |        |                     |  |                 |        |           |  |          |              |  |  |   |         |   |  |   |       | 
|--------------------------- |  | --------- | ------ | ------------------- |  | --------------- | ------ | --------- |  | -------- | ------------ |  |  | - | ------- | - |  | - | ----- | 
|                            |  |           |        |                    
|                            |  |           |        | Outstanding Options
|                            |  |           |        |                    
|                            |  |           |        |                     |  | Weighted       
|                            |  | Shares    |        |                     |  | Average        
|                            |  | Available |        | Number of           |  |                 |        | Aggregate |  | Exercise
|                            |  | for Grant |        | Shares              |  | Price Per Share |        | Price     |  | Price   
|                            |  |           |        |                     |  |                 |        |           |  |         
|Balances, December 31, 2002 |  |           | 11,153 |                     |  |                 | 28,302 |           |  | $        | 0.01-$71.26  |  |  | $ | 427,163 |   |  | $ | 15.09 | 
|Option plan expirations     |  |           | (1,326 | )                   |  |                 |       |           |  |          |              |  |  |   |        |   |  |   |      | 
|Options granted             |  |           | (7,807 | )                   |  |                 | 7,807  |           |  | $        | 10.80-$20.28 |  |  |   | 118,364 |   |  | $ | 15.16 | 
|Options exercised           |  |           |       |                     |  |                 | (2,548 | )         |  | $        | 1.78-$29.82  |  |  |   | (20,532 | ) |  | $ | 8.06  | 
|Options canceled            |  |           | 3,821  |                     |  |                 | (3,821 | )         |  | $        | 4.19-$65.38  |  |  |   | (69,982 | ) |  | $ | 18.32 | 
|                            |  |           |        |                     |  |                 |        |           |  |          |              |  |  |   |         |   |  |   |       | 
|Balances, December 31, 2003 |  |           | 5,841  |                     |  |                 | 29,740 |           |  | $        | 0.01-$71.26  |  |  |   | 455,013 |   |  | $ | 15.30 | 
|                            |  |           |        |                     |  |                 |        |           |  |          |              |  |  |   |         |   |  |   |       | 

At December 31, 2003, approximately
14.1 million options to purchase common stock of the
Company were exercisable at an average exercise price of $15.33.
For 2003, net proceeds from exercise of stock options was
$19.6 million, which is net of a reduction in stock option
exercise proceeds of $0.9 million. This reduction is for
the payment of the Companys cash obligation, not exceeding
the full exercise price, which is triggered upon exercise of the
Company stock options that were granted in exchange for the
McAfee options (see Note 16 to the notes to these consolidated
financial statements).

At December 31, 2002, approximately
10.0 million options to purchase common stock of the
Company were exercisable at an average exercise price of $14.27.
Net proceeds from exercise of stock options was
$99.7 million, which is net of a reduction in stock option
exercise proceeds of $7.8 million. This reduction is for
the payment of the Companys cash obligation, not exceeding
the full exercise price, which is triggered upon exercise of the
Company stock options that were granted in exchange for the
McAfee options.

At December 31, 2001, approximately
10.9 million outstanding options to purchase common stock
of the Company were exercisable at an average exercise price of
$20.01. During 2001, the Company used approximately
3.2 million shares of treasury stock to fulfill employee
option exercises and shares issued under the employee stock
purchase plan. Net proceeds from exercises of Company stock
options was approximately $29.4 million in 2001.

For various price ranges, weighted average
characteristics of outstanding stock options of the Company at
December 31, 2003 were as follows (in thousands, except per
share data):

|                         |  |                     |        |                     |  |          |      |             |  |          |       |  |  |  |        |  |  |   |       | 
|------------------------ |  | ------------------- | ------ | ------------------- |  | -------- | ---- | ----------- |  | -------- | ----- |  |  |  | ------ |  |  | - | ----- | 
|                         |  |                     |        |                    
|                         |  | Options Outstanding |        | Options Exercisable
|                         |  |                     |        |                    
|                         |  |                     |        | Weighted            |  |          |      |            
|                         |  |                     |        | Average             |  | Weighted |      |             |  | Weighted
|                         |  |                     |        | Remaining           |  | Average  |      |             |  | Average 
|                         |  | Number              |        | Contractual         |  | Exercise |      | Number      |  | Exercise
|Range of Exercise Prices |  | Outstanding         |        | Life (Yrs)          |  | Price    |      | Exercisable |  | Price   
|                         |  |                     |        |                     |  |          |      |             |  |         
|$0.01-$1.98              |  |                     | 59     |                     |  |          | 2.6  |             |  | $        | 0.25  |  |  |  | 12     |  |  | $ | 1.20  | 
|$4.13-$6.19              |  |                     | 5,609  |                     |  |          | 5.5  |             |  | $        | 4.49  |  |  |  | 3,547  |  |  | $ | 4.50  | 
|$6.20-$9.30              |  |                     | 1,448  |                     |  |          | 5.7  |             |  | $        | 7.73  |  |  |  | 743    |  |  | $ | 7.62  | 
|$9.31-$13.97             |  |                     | 5,837  |                     |  |          | 5.5  |             |  | $        | 12.04 |  |  |  | 2,447  |  |  | $ | 11.56 | 
|$13.98-$20.97            |  |                     | 9,103  |                     |  |          | 7.1  |             |  | $        | 16.96 |  |  |  | 2,450  |  |  | $ | 17.51 | 
|$20.98-$31.47            |  |                     | 7,461  |                     |  |          | 5.3  |             |  | $        | 24.86 |  |  |  | 4,713  |  |  | $ | 24.74 | 
|$31.48-$47.22            |  |                     | 193    |                     |  |          | 5.2  |             |  | $        | 34.98 |  |  |  | 139    |  |  | $ | 35.17 | 
|$47.23-$59.45            |  |                     | 29     |                     |  |          | 4.1  |             |  | $        | 57.08 |  |  |  | 26     |  |  | $ | 57.33 | 
|$71.26                   |  |                     | 1      |                     |  |          | 6.0  |             |  | $        | 71.26 |  |  |  | 1      |  |  | $ | 71.26 | 
|                         |  |                     |        |                     |  |          |      |             |  |          |       |  |  |  |        |  |  |   |       | 
|                         |  |                     | 29,740 |                     |  |          | 5.98 |             |  | $        | 15.30 |  |  |  | 14,078 |  |  | $ | 15.33 | 
|                         |  |                     |        |                     |  |          |      |             |  |          |       |  |  |  |        |  |  |   |       | 

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                              
| | -----------------------------
| | McAfee.com Stock Option Plans

In January 1999, the McAfee.coms board of
directors approved the 1999 Stock Plan (the McAfee
Plan), as amended June 19, 1999. Under the McAfee
Plan, McAfee.com reserved 10.9 million shares of its
Class A common stock for issuance to employees, officers,
directors and consultants. The McAfee Plan also provided for
automatic annual increases to be added at the annual
stockholders meeting, equal to the lower of:
(a) 2.5 million shares of Class A common stock,
(b) 5% of the outstanding shares of all Class A common
stock on that date, or (c) an amount determined by the
McAfee.coms board of directors. The McAfee Plan provided
for an option price no less than 100% of the fair market value
of McAfee.coms common stock on the date of grant for
incentive stock options granted to employees and officers
(including directors who are also employees) or 85% of the fair
market value on the date of grant for all others. The options
were exercisable immediately, or became exercisable over time,
generally 25% one year after commencing employment or from date
of grants and thereafter in monthly increments over three years.
All options under the McAfee Plan expired ten years after grant.
Unvested options on termination of employment were canceled and
returned to the McAfee Plan.

In September 1999, McAfee.com adopted the 1999
Director Option Plan. McAfee.com had reserved 150,000 shares of
its Class A common stock for issuance under the plan to
certain members of its board of directors who were not employees
of McAfee.com or any affiliated corporation. Under this plan the
number of shares reserved automatically increased at the date of
the McAfee.com Annual Stockholders Meeting by the number
of shares required to restore the reserve available for new
options to 150,000 shares. Each outside director was
automatically granted an option to purchase 40,000 shares of
McAfee.coms Class A common stock on the date at which they
become a director. Each anniversary thereafter, each outside
director was automatically granted an option to purchase 10,000
shares of McAfee.coms Class A common stock. Both the
initial and subsequent grants became exercisable at a rate of
25% after one year and  1/48 each month thereafter. All
options under grant expire ten years after grant. Unvested
options on termination of employment were canceled and returned
to the Director Option Plan.

In September 2002, the Company acquired the
minority interest in McAfee.com. At that time, all outstanding
options were converted and transferred into the Companys
option plans and the McAfee.com stock option plans were
terminated. The following is the aggregate activity under the
McAfee.com stock option plans through the date of acquisition
(in thousands, except per share data):

|                                                   |           |                     |       |           |   |                 |        |           |  |          |             |             |  |  |        |        |  |   |      |      | 
|-------------------------------------------------- | --------- | ------------------- | ----- | --------- | - | --------------- | ------ | --------- |  | -------- | ----------- | ----------- |  |  | ------ | ------ |  | - | ---- | ---- | 
|                                                   |           |                    
|                                                   |           | Outstanding Options
|                                                   |           |                    
|                                                   |           | Shares              |       |           |   | Weighted       
|                                                   |           | Available           |       |           |   | Average        
|                                                   |           | for                 |       | Number of |   |                 |        | Aggregate |  | Exercise
|                                                   |           | Grant               |       | Shares    |   | Price Per Share |        | Price     |  | Price   
|                                                   |           |                     |       |           |   |                 |        |           |  |         
|Balances, December 31, 2000                        |           |                     | 5,047 |           |   |                 | 5,102  |           |  | $        | 3.13-$50.38 |             |  |  | 36,733 |        |  | $ | 7.20 |     
|Additional options reserved                        |           |                     | 2,110 |           |   |                 |       |           |  |          |             |             |  |  |       |        |  |   |      |     
|Options granted  company                          |           |                     |       |           |   |                 |        |           |  |          |             |             |  |  |        |        |  |   |      |     
|                                                   | employees |                     |       | (1,968    | ) |                 |        | 1,968     |  |          | $           | 4.75-$35.13 |  |  |        | 16,593 |  |   | $    | 8.43 | 
|Options exercised  company employees              |           |                     |      |           |   |                 | (833   | )         |  | $        | 3.67-$28.81 |             |  |  | (5,744 | )      |  | $ | 6.90 |     
|Options exercised  NAI officers and
    employees |           |                     |      |           |   |                 | (1,615 | )         |  | $        | 3.67-$12.00 |             |  |  | (6,363 | )      |  | $ | 3.94 |     
|Options canceled  company employees               |           |                     | 769   |           |   |                 | (769   | )         |  | $        | 3.13-$49.06 |             |  |  | (6,408 | )      |  | $ | 8.33 |     
|Options canceled  NAI officers and
    employees  |           |                     | 33    |           |   |                 | (33    | )         |  | $        | 6.55-$12.00 |             |  |  | (234   | )      |  | $ | 7.09 |     
|                                                   |           |                     |       |           |   |                 |        |           |  |          |             |             |  |  |        |        |  |   |      |     

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                                        |           |                     |        |           |   |                 |        |           |  |          |             |              |  |   |         |        |  |   |      |       | 
|----------------------------------------------------------------------- | --------- | ------------------- | ------ | --------- | - | --------------- | ------ | --------- |  | -------- | ----------- | ------------ |  | - | ------- | ------ |  | - | ---- | ----- | 
|                                                                        |           |                    
|                                                                        |           | Outstanding Options
|                                                                        |           |                    
|                                                                        |           | Shares              |        |           |   | Weighted       
|                                                                        |           | Available           |        |           |   | Average        
|                                                                        |           | for                 |        | Number of |   |                 |        | Aggregate |  | Exercise
|                                                                        |           | Grant               |        | Shares    |   | Price Per Share |        | Price     |  | Price   
|                                                                        |           |                     |        |           |   |                 |        |           |  |         
|Balances, December 31, 2001                                             |           |                     | 5,991  |           |   |                 | 3,820  |           |  | $        | 3.13-$49.06 |              |  |   | 34,577  |        |  | $ | 9.05 |      
|Additional options reserved                                             |           |                     |        |           |   |                 |        |           |  |          |             |              |  |   |        |        |  |   |     |      
|Options granted  company                                               |           |                     |        |           |   |                 |        |           |  |          |             |              |  |   |         |        |  |   |      |      
|                                                                        | employees |                     |        | (1,444    | ) |                 |        | 1,444     |  |          | $           | 10.94-$34.31 |  |   |         | 20,148 |  |   | $    | 13.95 | 
|Options exercised  company employees                                   |           |                     |       |           |   |                 | (633   | )         |  | $        | 3.13-$16.66 |              |  |   | (3,491  | )      |  | $ | 5.52 |      
|Options exercised  NAI officers and
    employees                      |           |                     |       |           |   |                 | (20    | )         |  | $        | 6.55-$12.00 |              |  |   | (142    | )      |  | $ | 7.10 |      
|Options canceled  company employees                                    |           |                     | 519    |           |   |                 | (519   | )         |  | $        | 3.13-$43.13 |              |  |   | (4,712  | )      |  | $ | 9.08 |      
|Options available for grant terminated due to
    acquisition           |           |                     | (5,066 | )         |   |                 |       |           |  | $        | 3.13-$43.13 |              |  |   | (14,825 | )      |  | $ | 2.93 |      
|Options converted into the Companys options
    at date of acquisition |           |                     |       |           |   |                 | (4,092 | )         |  | $        | 3.13-$48.10 |              |  |   | (31,555 | )      |  | $ | 7.71 |      
|                                                                        |           |                     |        |           |   |                 |        |           |  |          |             |              |  |   |         |        |  |   |      |      
|Balances, September 13, 2002                                            |           |                     |       |           |   |                 |       |           |  |          |             |              |  | $ |        |        |  |   |      |      
|                                                                        |           |                     |        |           |   |                 |        |           |  |          |             |              |  |   |         |        |  |   |      |      



| |                                           
| | ------------------------------------------
| | Proforma Stock Compensation
    Disclosure

The fair value of options granted by the Company
and McAfee.com has been calculated using the Black-Scholes
option-pricing model using the multiple option approach. A
typical option grant vests over a four-year period. Parameters
for the option analysis are listed below.

|             |                         |      |  |      |   |      |  |      |   |  |  |      |  
|------------ | ----------------------- | ---- |  | ---- | - | ---- |  | ---- | - |  |  | ---- | -
|             |                         | 2003 |  | 2002 |   | 2001
|             |                         |      |  |      |   |     
|The Company: |                         |      |  |      |   |      |  |      |   |  |  |     
|             | Risk free interest rate |      |  | 2.44 | % |      |  | 3.46 | % |  |  | 4.24 | %
|             | Expected life (years)   |      |  | 4    |   |      |  | 4    |   |  |  | 4    |  
|             | Volatility              |      |  | 96   | % |      |  | 84   | % |  |  | 84   | %
|             | Dividend yield          |      |  |     |   |      |  |     |   |  |  |     |  

The weighted average grant date fair value of
options granted by the Company in 2003, 2002 and 2001 was
$10.38, $10.07 and $4.86, respectively.

The weighted average fair value of restricted
stock granted by the Company in 2002 and 2001 was $27.19 and
$7.67, respectively.

No options were granted to employees below or
above fair value during 2003 or 2001. During 2002, the Company
exchanged approximately 2.3 million options in the
McAfee.com acquisition at exercise prices below fair value as of
the acquisition date (see Note 16 to these Notes to these
Consolidated Financial Statements).

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |            
| | -----------
| | McAfee.com:

|                        |  |            |      |            |  |      |      |      |  |  |      |   |  |  |      |  
|----------------------- |  | ---------- | ---- | ---------- |  | ---- | ---- | ---- |  |  | ---- | - |  |  | ---- | -
|                        |  |            |      |            |  |     
|                        |  |            |      | Options   
|                        |  | Options    |      | Granted to
|                        |  | Granted to |      | Non-      
|                        |  | Employees  |      | Employees 
|                        |  |            |      |           
|                        |  | 2002       |      | 2001       |  | 2002 |      | 2001
|                        |  |            |      |            |  |      |      |     
|Risk free interest rate |  |            | 3.82 | %          |  |      | 4.49 | %    |  |  | 3.82 | % |  |  | 5.25 | %
|Expected life (years)   |  |            | 5    |            |  |      | 5    |      |  |  | 10   |   |  |  | 10   |  
|Volatility              |  |            | 110  | %          |  |      | 167  | %    |  |  | 110  | % |  |  | 167  | %
|Dividend yield          |  |            |     |            |  |      |     |      |  |  |     |   |  |  |     |  

The weighted average expected life of the option
grants was estimated based on historical exercise patterns.

The weighted average grant date fair value of
options granted by McAfee.com to employees in 2002 and 2001 was
$7.76 and $8.44, respectively.

The Company and McAfee.com have also estimated
the fair value of purchase rights issued under their employee
stock purchase plans. Rights under these plans were also valued
using the Black-Scholes option pricing model. Parameters for the
purchase rights analysis are listed below:



| |             
| | ------------
| | The Company:

|                        |  |      |            |      |  |      |          |   |  |  |          |  
|----------------------- |  | ---- | ---------- | ---- |  | ---- | -------- | - |  |  | -------- | -
|                        |  | 2003 |            | 2002 |  | 2001
|                        |  |      |            |      |  |     
|Risk free interest rate |  |      | 1.43       | %    |  |      | 2.05     | % |  |  | 3.08     | %
|Expected life           |  |      | 1.25 years |      |  |      | 6 months |   |  |  | 6 months |  
|Volatility              |  |      | 72         | %    |  |      | 84       | % |  |  | 84       | %
|Dividend yield          |  |      |           |      |  |      |         |   |  |  |         |  

The weighted average fair value of rights issued
pursuant to the Companys employee stock purchase plans in
2003, 2002, and 2001, was $13.75, $14.62, and $7.75,
respectively.



| |            
| | -----------
| | McAfee.com:

|                        |  |      |          |      |  |  |          |  
|----------------------- |  | ---- | -------- | ---- |  |  | -------- | -
|                        |  | 2002 |          | 2001
|                        |  |      |          |     
|Risk free interest rate |  |      | 1.72     | %    |  |  | 3.27     | %
|Expected life           |  |      | 6 months |      |  |  | 6 months |  
|Volatility              |  |      | 110      | %    |  |  | 145      | %
|Dividend yield          |  |      |         |      |  |  |         |  

The weighted average fair value of rights issued
by McAfee.com pursuant to its employee stock purchase plan until
September 13, 2002 and in 2001 was $39.60 and $5.30,
respectively.



| |                                          
| | -----------------------------------------
| | Stock Repurchase Plan and Put
    Options

In December 2003, the board of directors
authorized the Company to repurchase up to $150.0 million
of its common stock in the open market over the next two years.
Through December 31, 2003, the Company repurchased
0.4 million shares of its common stock for
$4.7 million. The timing and size of any future stock
repurchases are subject to market conditions, stock prices, the
Companys cash position and other cash requirements. At the
time the repurchase program was commenced, the Company
determined that stock was undervalued.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In 1999 and 2000, the Company sold European
style put options for three million shares of the
Companys common stock as part of its stock repurchase plan
in effect during those periods. On August 3, 2000, put
options sold on August 2, 1999 for one million shares were
exercised in the Companys stock. In February 2001, the
Company settled the remaining put options, which resulted in the
purchase of two million shares of the Companys stock for
$53.8 million.



| |                                  
| | ---------------------------------
| | Preferred Shares Rights Agreement

On October 19, 1998, pursuant to a Preferred
Shares Rights Agreement between the Company and BankBoston, N.A.
as Rights Agent, the board of directors of the Company announced
that it had declared a dividend distribution of one preferred
share purchase right (a Right) on each outstanding
share of the Companys common stock. Each Right will
entitle stockholders to buy one one-thousandth of a share of the
Companys Series B Participating Preferred Stock at an
exercise price of $200.00. The Rights will become exercisable
following the tenth day after a person or group announces the
acquisition of 15% or more of the Companys common stock or
announces commencement of a tender or exchange offer, the
consummation of which would result in ownership by the person or
group of 15% or more of the common stock of the Company. The
Company will be entitled to redeem the Rights at $0.01 per Right
at any time on or before the tenth day following acquisition by
a person or group of 15% or more of the Companys common
stock. The dividend distribution was made on November 3, 1998,
payable to the stockholders of record on November 3, 1998.
The Rights expire on October 20, 2008.



| |                           
| | --------------------------
| | Summary of Reserved Shares

At December 31, 2003, the following shares
of the Companys common stock were reserved for potential
future issuances (in millions):

|                                             |  |  |      | 
|-------------------------------------------- |  |  | ---- | 
|1997 Stock Incentive Plan                    |  |  | 32.5 | 
|Stock Option Plan for Outside Directors      |  |  | 1.1  | 
|2000 Nonstatutory Stock Option Plan          |  |  | 11.5 | 
|2002 Employee Stock Purchase Plan            |  |  | 4.0  | 
|5.25% convertible subordinated note due 2006 |  |  | 19.1 | 
|                                             |  |  |      | 
|Total                                        |  |  | 68.2 | 
|                                             |  |  |      | 

16.     Stock-Based
Compensation

The Company recorded $12.5 million,
$22.4 million and $24.9 million in 2003, 2002 and
2001, respectively, of stock-based compensation. Stock-based
compensation charges relate primarily to the exchange of
McAfee.com options in connection with the Companys
acquisition of the publicly traded minority interest in
McAfee.com, non-recurring stock compensation charges related to
executive compensation and the repricing of employee stock
options. The Company expects significant future stock-based
compensation charges related to the exchange of McAfee.com
options and repriced employee stock options.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following is a summary of the Companys
compensation charges are for the years presented (in thousands):

|                                                                    |                                |                          |       |        |  |      |        |        |  |   |        |        | 
|------------------------------------------------------------------- | ------------------------------ | ------------------------ | ----- | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                                                                    |                                |                         
|                                                                    |                                | Years Ended December 31,
|                                                                    |                                |                         
|                                                                    |                                | 2003                     |       | 2002   |  | 2001
|                                                                    |                                |                          |       |        |  |     
|Exchange of McAfee.com options                                      |                                | $                        | 3,369 |        |  | $    | 16,101 |        |  | $ |       |       
|Former employees                                                    |                                |                          | 1,125 |        |  |      | 10,118 |        |  |   | 2,668  |       
|New and existing executives                                         |                                |                          | 424   |        |  |      | 1,478  |        |  |   | 3,230  |       
|Extended life of vested options of terminated
    employees         |                                |                          | 3,720 |        |  |      |       |        |  |   |       |       
|Extended vesting term of options                                    |                                |                          |      |        |  |      | 193    |        |  |   |       |       
|Extended period of Employee Stock Purchase Plan                     |                                |                          | 3,869 |        |  |      |       |        |  |   |       |       
|Shares purchased outside Employee Stock Purchase
    Plan and other |                                |                          |      |        |  |      | 62     |        |  |   | 9      |       
|Repriced options                                                    |                                |                          |      |        |  |      | (5,548 | )      |  |   | 17,396 |       
|Warrants to outside consultants                                     |                                |                          |      |        |  |      |       |        |  |   | 1,049  |       
|PGP restructuring                                                   |                                |                          |      |        |  |      |       |        |  |   | 519    |       
|                                                                    |                                |                          |       |        |  |      |        |        |  |   |        |       
|                                                                    | Total stock-based compensation |                          | $     | 12,507 |  |      | $      | 22,404 |  |   | $      | 24,871 | 
|                                                                    |                                |                          |       |        |  |      |        |        |  |   |        |       

Exchange of McAfee.com
options.On September 13, 2002,
the Company acquired the minority interest in McAfee.com.
McAfee.com option holders received options for 0.675 of a share
of our common stock plus $8.00 in cash for each option of
McAfee.com, which will be paid to the option holder only upon
exercise of the option and without interest, in exchange for
each McAfee.com option. McAfee.com options to purchase
4.1 million shares were converted into options to purchase
2.8 million shares of the Companys common stock. The
assumed options have been accounted for under the guidance in
EITF No. 00-23 Issues Related to the Accounting
for Stock Compensation under APB Opinion No. 25
and Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation  an
Interpretation of APB Opinion No. 25.
Accordingly, these options are subject to variable accounting
treatment, which means that a compensation charge has been
measured initially at the date of the closing of the merger and
then remeasured at the end of each reporting period.

The initial charge was based on the excess of the
closing price of the Companys stock over the exercise
price of the options plus the $11.85 per share of the
Companys options payable in cash, which will be paid upon
exercise of the option. The charge has been and will be
remeasured, using the same methodology, until the earlier of the
date of exercise, forfeiture or cancellation without
replacement. This compensation charge is recorded as an expense
over the remaining vesting period of the options, using the
accelerated method of amortization under FASB Interpretation
No. 28 Accounting for Stock Appreciation Rights
and Other Variable Stock Option or Award Plans
(FIN 28). To the extent that the options issued were
fully vested at the date of the closing of the McAfee.com
acquisition, the Company immediately recorded a compensation
expense of $10.5 million. Charges related to unvested
options are recorded in deferred compensation in
stockholders equity. Depending upon movements in the
market value of the Companys common stock, variable
accounting treatment can result in significant additional
stock-based compensation charges in future periods.

During 2003 and 2002, the Company recorded a
charge of approximately $3.4 million and $16.1 million,
respectively, including the $10.5 million described above,
related to exchanged options subject to variable accounting. The
Companys stock-based compensation charge related to
exchanged options subject to variable accounting was based on
its closing common stock price of $15.04 and $16.09 on
December 31, 2003 and 2002, respectively. As of
December 31, 2003, the Company had outstanding exchanged
options of approximately 0.8 million shares subject to variable
accounting.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Former Executives.Effective January 2001, William
Larson, former chief executive officer, Prabhat Goyal, former
chief financial officer, and Peter Watkins, former president and
chief operating officer, became special advisors. Options held
by Mr. Larson, Mr. Goyal and Mr. Watkins
continued to vest during 2001 while they each served during
their one-year terms as special advisors. As a result, the
Company recorded a one-time stock compensation charge of
approximately $0.6 million during 2001.

In December 2001, the Company terminated the
employment of three executives. Upon termination, the options
held by these executives were modified. As a result, it recorded
a one-time stock compensation charge of approximately
$2.1 million during 2001.

In July 2002, one of the Companys employees
became a non-employee, but continued to provide services to the
Company. As he was allowed to continue to vest his options, the
Company recorded a stock-based compensation charge corresponding
to the fair market value of his vested options. The unvested
options have been and will be remeasured periodically using the
Black Scholes option valuation model and recognized over the
remaining vesting period using the accelerated method of
amortization discussed in FIN 28. Stock-based compensation of
$0.2 million was expensed during 2002.

In October 2002, the Company terminated the
employment of four former McAfee.com executives. These
executives held McAfee.com exchanged options, which are subject
to variable accounting as discussed above. Upon termination, the
options were modified in accordance with a change in control
agreement. As a result, the Company recorded a stock
compensation charge of approximately $1.1 million and
$9.9 million during 2003 and 2002, respectively.

New Executives.On
January 3, 2001, the Company entered into an employment
agreement with George Samenuk to become its chief executive
officer. In accordance with the terms of the agreement, the
Company issued 400,000 shares of restricted stock to
Mr. Samenuk. The price of the underlying shares was $0.01
per share. The shares will vest and the Companys right to
repurchase such shares will lapse as follows: 12.5% on the first
four quarterly anniversaries of Mr. Samenuks
employment and the remaining 50% on the second year anniversary
of Mr. Samenuks employment. The fair value of the
restricted stock was determined to be approximately
$2.0 million and was estimated based on the difference
between the exercise price of the restricted stock and the fair
value of the Companys common stock on
Mr. Samenuks employment commencement date. During
2002 and 2001, the Company recorded approximately
$1.0 million in each year related to stock compensation
associated with Mr. Samenuks 2001 restricted stock
grant.

On April 3, 2001, the Company entered into
an employment agreement with Stephen C. Richards to become its
executive vice president and chief financial officer. In
accordance with the terms of the agreement, the Company issued
50,000 shares of stock to Mr. Richards for $0.01 per share.
During 2001, the Company recorded approximately
$0.3 million related to stock compensation associated with
Mr. Richards stock.

On October 30, 2001, the Company entered
into an employment agreement with Arthur R. Matin to become the
president of its McAfee product group. In accordance with the
terms of the agreement, the Company issued 100,000 shares of
restricted stock to Mr. Matin for $0.01 per share. During
2001, the Company recorded approximately $1.9 million
related to stock compensation associated with
Mr. Matins stock.

On January 15, 2002, the Companys
board of directors approved a grant of 50,000 shares of
restricted stock to Mr. Samenuk. The price of the
underlying shares is $0.01 per share. The shares will vest and
the Companys right to repurchase such shares will lapse as
follows: 3,000 vested as of the grant date and 47,000 are
restricted until January 15, 2005 and have not been issued
as of December 31, 2003. The fair value of the restricted
stock was determined to be approximately $1.4 million and
was estimated based on the difference between the exercise price
of the restricted stock and the fair value of its common stock
on January 15, 2002. During 2003 and 2002, the Company
recorded approximately $0.4 million and $0.5 million
related to stock-based compensation associated with
Mr. Samenuks 2002 restricted stock grant.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Extended life of vested options held by
terminated employees.In March 2003,
the Company announced that the filing of its Form 10-K for
2002 would be postponed in order to restate prior financial
results for 2000, 1999 and 1998. As a result, effective
April 9, 2003, the Company suspended all exercises of stock
options until the 2002 Form 10-K and all required quarterly
reports on Form 10-Q were filed with the SEC, as these
reports are incorporated by reference into the securities
registration statements for each of the stock option plans. The
period during which all stock option exercises were suspended
was known as the blackout period. Due to the blackout period,
the Company extended the exercisability of any options that
would otherwise terminate during the blackout period for a
period of time equal to a specified period after termination of
the blackout period. Accordingly, the Company recorded a
stock-based compensation charge on the date the options should
have terminated based on the intrinsic value of the option on
the modification date and the option price. During 2003, the
Company recorded a stock-based compensation charge of
approximately $3.7 million for the extension of life of
vested options held by terminated employees.

Extended Vesting Term of Options.In the second quarter of 2002, the
Company recorded a one-time stock-based compensation charge of
approximately $0.2 million as a result of the modification
of the terms of the options previously granted to certain
employees.

Extended period of Employee Stock Purchase
Plan.In March 2003, the Company
announced that the filing of its Form 10-K for 2002 would
be postponed in order to restate prior financial results for
2000, 1999 and 1998. As a result, effective April 9, 2003,
the Company suspended all stock purchases until the 2002
Form 10-K and all required quarterly reports on
Form 10-Q were filed with the SEC, as these reports are
incorporated by reference into the securities registration
statements for the 2002 Employee Stock Purchase Plan (2002
Purchase Plan). The period during which all stock
purchases were suspended was known as the blackout period. Due
to the blackout period, the Company extended the purchase period
of the 2002 Purchase Plan that would otherwise had been
purchased on July 31, 2003. Accordingly, during 2003, the
Company recorded a stock-based compensation charge of
approximately $3.9 million for the extended period of the 2002
Purchase Plan. The blackout period ended in November 2003, and
therefore no additional stock-based compensation will be
recorded.

Shares Purchased Outside Employee Stock
Purchase Plan.On January 31,
2002, the Company experienced a shortfall in the number of
shares available under the 1994 Employee Qualified Stock
Purchase Plan to meet the requirements of the open purchase
period. Although the Company reduced the number of shares plan
participants could purchase by a pro rata amount, additional
shares were required to be purchased outside of the plan in
order to meet this shortfall. As a result, the Company recorded
a one-time stock-based compensation charge of approximately
$0.1 million in the first quarter of 2002. The charge was
based on the difference between the fair value of the shares
purchased outside of the plan and the price the shares were sold
to plan participants.

Repriced Options.On
April 22, 1999, the Company offered to substantially all of
its employees, excluding executive officers, the right to cancel
certain outstanding stock options and receive new options with
an exercise price of $11.063, the then current fair value of the
stock. Options to purchase a total of 10.3 million shares
were cancelled and the same number of new options were granted.
These new options vest at the same rate that they would have
vested under previous option plans and are subject to variable
accounting. Accordingly, the Company has and will continue to
remeasure compensation cost for these repriced options until
these options are exercised, cancelled, or forfeited without
replacement. The first valuation period began July 1, 2000.

The amount of stock-based compensation recorded
was and will be based on any excess of the closing stock price
at the end of the reporting period or date of exercise,
forfeiture or cancellation without replacement, if earlier, over
the fair value of the Companys common stock on
July 1, 2000, which was $20.375. The resulting compensation
charge to earnings is recorded over the remaining vesting
period, using the accelerated method of amortization required by
FIN 28. When options are fully vested, the charge will be

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

recorded to earnings immediately. At
December 31, 2003, these options were substantially 100%
vested. Depending upon movements in the market value of the
Companys common stock, this variable accounting treatment
can result in additional stock-based compensation charges in
future periods until the options are exercised or forfeited.

During 2002 and 2001, the Company incurred
charges (credits) to earnings of approximately
$(6.5) million and $15.6 million, respectively,
related to options subject to variable plan accounting. For 2002
and 2001, the Companys stock compensation charges related
to options subject to variable plan accounting were based on a
year end per share price of its stock of $16.09 and $25.85,
respectively. As of December 31, 2003, the Company had
options to purchase 0.7 million shares, which were
outstanding and subject to variable accounting. The Company
recorded no charges in 2003.

The Company also incurred an initial stock-based
compensation charge in connection with the initial issuance of
the repriced options. This charge was calculated based on the
difference between the exercise price of the new options and
their market value on the date of acceptance by employees.
Approximately $1.0 million and $1.8 million was
expensed during 2002 and 2001, respectively.

Warrants to Outside Consultants.In January 2001, upon completion of
the search for the Companys chief executive officer, the
Company issued warrants to the executive search firm for
services performed. The warrants, if exercised, can be exchanged
for 166,667 shares of the Companys common stock. The
weighted-average exercise price of the underlying shares is
$2.97 per share. The warrants were immediately exercisable and
scheduled to expire in January 2004. The combined fair value of
the warrants was determined to be $0.5 million. The fair
value of the warrants was included as stock compensation during
2001 and included in general and administrative expenses in the
accompanying statements of income. The warrants were exercised
in January 2004, and as a result 133,705 shares of the
Companys common stock were issued. The warrants issued
included a net exercise feature which allowed the holder of the
warrants to use a portion of the shares acquired upon exercise
of the warrants in lieu of making a cash payment to exercise the
warrants. The executive search firm chose to exercise this
feature and forfeited 32,962 shares in lieu of making a cash
payment to acquire the shares.

In April 2001, upon completion of the search for
its chief financial officer, the Company issued warrants to an
executive search firm for services performed. The warrants, if
exercised, can be exchanged for 66,667 shares of the
Companys common stock. The weighted-average exercise price
of the underlying shares is $4.50 per share. The warrants
are immediately exercisable and expire in April 2004. The
combined fair value of the warrants was determined to be
$0.3 million. The fair value of the warrants was included
as a stock compensation charge during 2001 and included in
general and administrative expenses in the accompanying
statements of income.

In November 2001, upon completion of the search
for two executives for international operations, the Company
issued warrants to an executive search firm for services
performed. The warrants, if exercised, can be exchanged for
20,833 shares of the Companys common stock. The
weighted-average exercise price of the underlying shares is
$19.64 per share. The warrants are immediately exercisable and
expire in 2004. The combined fair value of the warrants was
determined to be approximately $0.2 million. The fair value
of the warrants was included as a stock compensation charge
during 2001 and included in general and administrative expenses
in the accompanying statements of income.

PGP Restructuring.In connection with the integration of
the PGP product group, the Company accelerated the vesting of
45,600 options held by the 100 employees terminated during 2001.
As a result of this modification, it recorded a stock based
compensation charge of approximately $0.5 million with
restructuring expense in the Companys statement of income.
The charge was calculated based on the intrinsic value of the
modified options on the date the acceleration was approved by
the Companys board of directors.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

17.     Provision for
Income Taxes

The domestic and foreign components of our income
before provision for income taxes were as follows (in thousands):

|         |  |      |        |      |  |      |         |  |  |   |         | 
|-------- |  | ---- | ------ | ---- |  | ---- | ------- |  |  | - | ------- | 
|         |  | 2003 |        | 2002 |  | 2001
|         |  |      |        |      |  |     
|Domestic |  | $    | 17,303 |      |  | $    | 278     |  |  | $ | 22,742  | 
|Foreign  |  |      | 69,752 |      |  |      | 129,655 |  |  |   | 125,394 | 
|         |  |      |        |      |  |      |         |  |  |   |         | 
|         |  | $    | 87,055 |      |  | $    | 129,933 |  |  | $ | 148,136 | 
|         |  |      |        |      |  |      |         |  |  |   |         | 

Significant components of the provision
(benefit) for income taxes attributable to continuing
operations are as follows (in thousands):

|                                          |          |                          |        |         |        |      |      |         |         |   |        |        |        | 
|----------------------------------------- | -------- | ------------------------ | ------ | ------- | ------ | ---- | ---- | ------- | ------- | - | ------ | ------ | ------ | 
|                                          |          |                         
|                                          |          | Years Ended December 31,
|                                          |          |                         
|                                          |          | 2003                     |        | 2002    |        | 2001
|                                          |          |                          |        |         |        |     
|Federal:                                  |          |                          |        |         |        |      |      |         |         |   |        |       
|                                          | Current  |                          | $      | 18,148  |        |      | $    | 39,916  |         |   | $      | (453   | )     
|                                          | Deferred |                          |        | (23,332 | )      |      |      | (61,674 | )       |   |        | 38,640 |       
|                                          |          |                          |        |         |        |      |      |         |         |   |        |       
|                                          |          | Total Federal            |        |         | (5,184 | )    |      |         | (21,758 | ) |        |        | 38,187 | 
|State:                                    |          |                          |        |         |        |      |      |         |         |   |        |       
|                                          | Current  |                          |        | 5,863   |        |      |      | 5,189   |         |   |        | (59    | )     
|                                          | Deferred |                          |        | (4,802  | )      |      |      | (2,362  | )       |   |        | 2,773  |       
|                                          |          |                          |        |         |        |      |      |         |         |   |        |       
|                                          |          | Total State              |        |         | 1,061  |      |      |         | 2,827   |   |        |        | 2,714  | 
|Foreign:                                  |          |                          |        |         |        |      |      |         |         |   |        |       
|                                          | Current  |                          |        | 18,167  |        |      |      | 19,829  |         |   |        | 19,246 |       
|                                          | Deferred |                          |        | 2,766   |        |      |      | (1,172  | )       |   |        | 5,873  |       
|                                          |          |                          |        |         |        |      |      |         |         |   |        |       
|                                          |          | Total Foreign            |        |         | 20,933 |      |      |         | 18,657  |   |        |        | 25,119 | 
|                                          |          |                          |        |         |        |      |      |         |         |   |        |       
|Provision for (benefit from) income taxes |          | $                        | 16,810 |         |        | $    | (274 | )       |         | $ | 66,020 |       
|                                          |          |                          |        |         |        |      |      |         |         |   |        |       

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Significant components of net deferred tax assets
are as follows (in thousands):

|                                             |  |              |         |      |  |   |         |  
|-------------------------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                                             |  |             
|                                             |  | Years Ended 
|                                             |  | December 31,
|                                             |  |             
|                                             |  | 2003         |         | 2002
|                                             |  |              |         |     
|ASSETS                                      
|Deferred revenue                             |  | $            | 124,932 |      |  | $ | 91,811  |  
|Accrued liabilities and allowances           |  |              | 61,802  |      |  |   | 92,975  |  
|Depreciation and amortization                |  |              | 137,554 |      |  |   | 92,905  |  
|Tax credits                                  |  |              | 117,998 |      |  |   | 101,239 |  
|Deferred stock compensation                  |  |              | 4,116   |      |  |   | 5,465   |  
|Net operating loss carryover                 |  |              | 51,332  |      |  |   | 42,299  |  
|                                             |  |              |         |      |  |   |         |  
|                                             |  |              | 497,734 |      |  |   | 426,694 |  
|Valuation allowance                          |  |              | (88,283 | )    |  |   | (75,731 | )
|                                             |  |              |         |      |  |   |         |  
|Total deferred tax assets                    |  |              | 409,451 |      |  |   | 350,963 |  
|                                             |  |              |         |      |  |   |         |  
|LIABILITIES                                 
|Intangibles not amortizable for tax purposes |  |              | 40,178  |      |  |   | 29,791  |  
|Accrued liabilities and allowances           |  |              | 9,527   |      |  |   | 7,612   |  
|                                             |  |              |         |      |  |   |         |  
|Total deferred tax liability                 |  |              | 49,705  |      |  |   | 37,403  |  
|                                             |  |              |         |      |  |   |         |  
|Net deferred tax asset                       |  | $            | 359,746 |      |  | $ | 313,560 |  
|                                             |  |              |         |      |  |   |         |  
|Current portion                              |  | $            | 160,550 |      |  | $ | 174,469 |  
|Noncurrent portion                           |  |              | 199,196 |      |  |   | 139,091 |  
|                                             |  |              |         |      |  |   |         |  
|                                             |  | $            | 359,746 |      |  | $ | 313,560 |  
|                                             |  |              |         |      |  |   |         |  

At December 31, 2003, the Company has net
operating loss carryovers for federal income tax purposes of
approximately $142.9 million. These net operating loss
carryovers have expiration dates ranging from 2008 to 2023. The
net increase in the valuation allowance primarily relates to the
uncertainty of future utilization of certain foreign deferred
tax assets and tax attributes and net operating loss
carryforwards from acquisitions made during 2003.

U.S. income taxes were not provided for on a
cumulative total of approximately $155.7 million of
retained earnings of certain non-U.S. subsidiaries. The Company
intends to reinvest these earnings indefinitely in operations
outside the United States.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Companys effective tax rate on income
before income taxes differs from the U.S. Federal statutory tax
rate as follows (in thousands):

|                                                                 |  |                          |         |      |  |      |         |   |  |   |         |  
|---------------------------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                                 |  |                         
|                                                                 |  | Years Ended December 31,
|                                                                 |  |                         
|                                                                 |  | 2003                     |         | 2002 |  | 2001
|                                                                 |  |                          |         |      |  |     
|U.S. Federal income tax provision at statutory
    rate          |  | $                        | 30,470  |      |  | $    | 45,469  |   |  | $ | 51,240  |  
|State provision                                                  |  |                          | 1,258   |      |  |      | 2,725   |   |  |   | 2,402   |  
|Non deductible acquisition and other costs                       |  |                          | 2,310   |      |  |      | 5,343   |   |  |   | 22,017  |  
|Foreign earnings taxed at rates different than
    the U.S. rate |  |                          | (3,480  | )    |  |      | (26,724 | ) |  |   | (18,767 | )
|Goodwill and other permanent differences                         |  |                          | 867     |      |  |      | (957    | ) |  |   | 14,812  |  
|Tax credits                                                      |  |                          | (2,532  | )    |  |      | (26,096 | ) |  |   | (5,316  | )
|Benefit from change in accruals for tax exposures                |  |                          | (12,083 | )    |  |      |        |   |  |   |        |  
|Other                                                            |  |                          |        |      |  |      | (34     | ) |  |   | (368    | )
|                                                                 |  |                          |         |      |  |      |         |   |  |   |         |  
|                                                                 |  | $                        | 16,810  |      |  | $    | (274    | ) |  | $ | 66,020  |  
|                                                                 |  |                          |         |      |  |      |         |   |  |   |         |  

18.     Net Income
Per Share

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

|                                                                    |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |         |        |         | 
|------------------------------------------------------------------- | ----------------------------------------------------------------------- | --------------------------------------------------------------------- | ------------------------------------------------ | ------- | ------ | ------- | - | ------- | ------- | ------- | - | ------- | ------ | ------- | 
|                                                                    |                                                                         |                                                                      
|                                                                    |                                                                         | Years Ended December 31,                                             
|                                                                    |                                                                         |                                                                      
|                                                                    |                                                                         | 2003                                                                  |                                                  | 2002    |        | 2001   
|                                                                    |                                                                         |                                                                       |                                                  |         |        |        
|Numerator  Basic                                                   |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|                                                                    |                                                                         | Income before cumulative effect of change in
    accounting principle |                                                  | $       | 59,905 |         |   | $       | 128,312 |         |   | $       | 83,253 |        
|Cumulative effect of change in accounting
    principle, net of tax |                                                                         |                                                                       | 10,337                                           |         |        |         |  |         |         |         |  |        
|                                                                    |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|                                                                    |                                                                         | Net income                                                            |                                                  | $       | 70,242 |         |   | $       | 128,312 |         |   | $       | 83,253 |        
|                                                                    |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|Numerator  Diluted                                                 |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|                                                                    | Income before cumulative effect of change in
    accounting principle   |                                                                       | $                                                | 59,905  |        |         | $ | 128,312 |         |         | $ | 83,253  |       
|                                                                    | Cumulative effect of change in accounting
    principle, net of tax     |                                                                       |                                                  | 10,337  |        |         |   |        |         |         |   |        |       
|                                                                    | Interest on convertible debentures(1)                                   |                                                                       |                                                  |        |        |         |   | 12,042  |         |         |   | 4,358   |       
|                                                                    |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|                                                                    |                                                                         |                                                                       | Net income, adjusted                             |         | $      | 70,242  |   |         | $       | 140,354 |   |         | $      | 87,611  | 
|                                                                    |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|Denominator  Basic                                                 |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|                                                                    | Weighted average shares of common stock
    outstanding                 |                                                                       |                                                  | 160,338 |        |         |   | 149,641 |         |         |   | 138,172 |       
|                                                                    | Less: weighted average shares of common stock
    subject to repurchase |                                                                       |                                                  |        |        |         |   | (200    | )       |         |   | (325    | )     
|                                                                    |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        
|                                                                    |                                                                         |                                                                       | Basic weighted average common shares outstanding |         |        | 160,338 |   |         |         | 149,441 |   |         |        | 137,847 | 
|                                                                    |                                                                         |                                                                       |                                                  |         |        |         |   |         |         |         |   |        

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                              |                                                                       |                                 |   |         |         |      |   |         |         |  |   |         |         | 
|----------------------------- | --------------------------------------------------------------------- | ------------------------------- | - | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- | 
|                              |                                                                       |                                
|                              |                                                                       | Years Ended December 31,       
|                              |                                                                       |                                
|                              |                                                                       | 2003                            |   | 2002    |         | 2001
|                              |                                                                       |                                 |   |         |         |     
|Denominator  Diluted         |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|                              | Basic weighted average common shares outstanding                      |                                 |   | 160,338 |         |      |   | 149,641 |         |  |   | 138,172 |        
|                              | Effective of dilutive securities:                                     |                                 |   |         |         |      |   |         |         |  |   |         |        
|                              |                                                                       | Convertible debentures(1)       |   |         |        |      |   |         | 19,092  |  |   |         | 19,092  | 
|                              |                                                                       | Common stock options(2)         |   |         | 3,992   |      |   |         | 7,333   |  |   |         | 6,774   | 
|                              |                                                                       | Put options                     |   |         |        |      |   |         |        |  |   |         | 163     | 
|                              |                                                                       | Warrants                        |   |         | 159     |      |   |         | 183     |  |   |         | 162     | 
|                              |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|                              |                                                                       | Diluted weighted average shares |   |         | 164,489 |      |   |         | 176,249 |  |   |         | 164,363 | 
|                              |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|Basic net income per share:   |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|                              | Income before cumulative effect of change in
    accounting principle |                                 | $ | 0.37    |         |      | $ | 0.86    |         |  | $ | 0.60    |        
|                              | Cumulative effect of change in accounting
    principle, net of tax   |                                 |   | 0.07    |         |      |   |        |         |  |   |        |        
|                              |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|                              |                                                                       | Net income per share  Basic    |   | $       | 0.44    |      |   | $       | 0.86    |  |   | $       | 0.60    | 
|                              |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|Diluted net income per share: |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|                              | Income before cumulative effect of change in
    accounting principle |                                 | $ | 0.36    |         |      | $ | 0.80    |         |  | $ | 0.53    |        
|                              | Cumulative effect of change in accounting
    principle, net of tax   |                                 |   | 0.07    |         |      |   |        |         |  |   |        |        
|                              |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        
|                              |                                                                       | Net income per share  Diluted  |   | $       | 0.43    |      |   | $       | 0.80    |  |   | $       | 0.53    | 
|                              |                                                                       |                                 |   |         |         |      |   |         |         |  |   |        



---



|    |                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Convertible debt interest and related
    19.1 million as-if converted shares were excluded from the
    calculation since the effect was anti-dilutive in 2003. The
    total number of shares excluded from the calculation related to
    as-if converted shares was 3.1 million and 4.3 million
    for 2002 and 2001, respectively.
|   
|(2) | At December 31, 2003, 2002 and 2001,
    15.6 million, 9.9 million and 31.8 million
    options to purchase common stock, respectively, were excluded
    from the calculation since the effect was anti-dilutive.                                                                                                                      

19.     Business
Segment and Major Customer Information

The Company has concluded that it has one
business and operates in one industry, developing, marketing,
distributing and supporting computer security solutions for
large enterprises, governments, small and medium sized business
and consumer users, as well as resellers and distributors.
Management measures profitability based on the Companys
five geographic regions: North America; Europe, Middle East and
Africa (EMEA); Japan; Asia-Pacific (excluding Japan)
and Latin America. The regions are evidence of the operating
structure of the Companys internal organization.

The Company markets and sells, through its
geographic regions, anti-virus and security software, hardware
and services; network management software, hardware and
services; and help desk software and services. These products
and services are marketed and sold worldwide primarily through
resellers, distributors, systems integrators retailers, and
directly by the Company. In addition, the Company offers web
sites, which provide suites of on-line products and services
personalized for the user based on the users PC
configuration, attached peripherals and resident software. The
Company also offers managed security and availability
applications to corporations and governments on the Internet.

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Following is the summary of the Companys
net revenue from external customers and income from operations
by geographic region. The accounting policies of the businesses
and geographic segments are the same as disclosed in Note 2 to
these Notes to Consolidated Financial Statements. To reconcile
to the consolidated financial statements, where applicable,
Corporate represents costs and expenses associated
with corporate activities. Corporate activities include general
and administrative expenses and corporate marketing expenses of
$61.9 million, $37.3 million and $48.6 million in
2003, 2002 and 2001, respectively; stock-based compensation
charges; and acquisition, restructuring and other related costs.
These corporate expenses are not considered attributable to any
specific geographic region. The $70.0 million litigation
charge incurred in 2002 was recorded in North America.
Summarized financial information concerning the Companys
net revenue and operating income by business and geographic
region is as follows (in thousands):

|                                       |                  |                          |          |         |  |      |          |           |  |   |          |           | 
|-------------------------------------- | ---------------- | ------------------------ | -------- | ------- |  | ---- | -------- | --------- |  | - | -------- | --------- | 
|                                       |                  |                         
|                                       |                  | Years Ended December 31,
|                                       |                  |                         
|                                       |                  | 2003                     |          | 2002    |  | 2001
|                                       |                  |                          |          |         |  |     
|Net revenue by region:                 |                  |                          |          |         |  |      |          |           |  |   |          |          
|North America                          |                  | $                        | 606,685  |         |  | $    | 653,532  |           |  | $ | 696,136  |          
|EMEA                                   |                  |                          | 240,616  |         |  |      | 298,659  |           |  |   | 292,663  |          
|Japan                                  |                  |                          | 40,519   |         |  |      | 39,369   |           |  |   | 28,919   |          
|Asia-Pacific (excluding Japan)         |                  |                          | 29,014   |         |  |      | 33,595   |           |  |   | 37,606   |          
|Latin America                          |                  |                          | 19,502   |         |  |      | 17,889   |           |  |   | 16,336   |          
|                                       |                  |                          |          |         |  |      |          |           |  |   |          |          
|                                       | Net revenue      |                          | $        | 936,336 |  |      | $        | 1,043,044 |  |   | $        | 1,071,660 | 
|                                       |                  |                          |          |         |  |      |          |           |  |   |          |          
|Operating income (loss) by
    region: |                  |                          |          |         |  |      |          |           |  |   |          |          
|North America                          |                  | $                        | 215,027  |         |  | $    | 156,080  |           |  | $ | 231,479  |          
|EMEA                                   |                  |                          | 88,884   |         |  |      | 135,629  |           |  |   | 134,674  |          
|Japan                                  |                  |                          | 11,061   |         |  |      | 8,710    |           |  |   | (2,404   | )        
|Asia-Pacific (excluding Japan)         |                  |                          | 5,962    |         |  |      | 6,682    |           |  |   | 16,727   |          
|Latin America                          |                  |                          | 1,338    |         |  |      | 2,436    |           |  |   | 4,777    |          
|Corporate                              |                  |                          | (256,619 | )       |  |      | (194,810 | )         |  |   | (231,770 | )        
|                                       |                  |                          |          |         |  |      |          |           |  |   |          |          
|                                       | Operating income |                          | $        | 65,653  |  |      | $        | 114,727   |  |   | $        | 153,483   | 
|                                       |                  |                          |          |         |  |      |          |           |  |   |          |          

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Following is a summary of the Companys
long-lived assets, including property and equipment and
amortizable intangibles, and total assets by business and by
geographic region. Long-lived assets are capital expenditures,
including land purchases. Assets purchased to support
infrastructure general and administrative activities, including
land purchases, are included in Corporate in the
Long-lived assets table below. Assets purchased to
support infrastructure general and administrative activities,
including land purchases, are included in Corporate
in the Total assets table, below. These corporate
assets are not assigned to any specific geographic region.
Summarized financial information concerning the Companys
long-lived assets and total assets by business and geographic
region is as follows (in thousands):

|                                   |                         |              |           |         |           |   |           |         |           | 
|---------------------------------- | ----------------------- | ------------ | --------- | ------- | --------- | - | --------- | ------- | --------- | 
|                                   |                         |             
|                                   |                         | December 31,
|                                   |                         |             
|                                   |                         | 2003         |           | 2002   
|                                   |                         |              |           |        
|Total long-lived assets by region: |                         |              |           |         |           |   |           |        
|North America                      |                         | $            | 84,091    |         |           | $ | 63,767    |        
|EMEA                               |                         |              | 27,361    |         |           |   | 32,028    |        
|Japan                              |                         |              | 9,040     |         |           |   | 8,073     |        
|Asia-Pacific (excluding Japan)     |                         |              | 6,178     |         |           |   | 5,766     |        
|Latin America                      |                         |              | 3,125     |         |           |   | 8,072     |        
|Corporate                          |                         |              | 87,829    |         |           |   | 65,122    |        
|                                   |                         |              |           |         |           |   |           |        
|                                   | Total long-lived assets |              | $         | 217,624 |           |   | $         | 182,828 |          
|                                   |                         |              |           |         |           |   |           |        
|Total assets by region:            |                         |              |           |         |           |   |           |        
|North America                      |                         | $            | 1,452,407 |         |           | $ | 1,571,529 |        
|EMEA                               |                         |              | 485,613   |         |           |   | 334,540   |        
|Japan                              |                         |              | 51,331    |         |           |   | 45,190    |        
|Asia-Pacific (excluding Japan)     |                         |              | 25,479    |         |           |   | 11,763    |        
|Latin America                      |                         |              | 17,839    |         |           |   | 17,344    |        
|Corporate                          |                         |              | 87,829    |         |           |   | 65,121    |        
|                                   |                         |              |           |         |           |   |           |        
|                                   |                         | Total assets |           | $       | 2,120,498 |   |           | $       | 2,045,487 | 
|                                   |                         |              |           |         |           |   |           |        

Property and equipment based on the physical
location of the assets is as follows (in thousands):

|                |  |      |         |      |  |   |        | 
|--------------- |  | ---- | ------- | ---- |  | - | ------ | 
|                |  | 2003 |         | 2002
|                |  |      |         |     
|United States   |  | $    | 89,857  |      |  | $ | 73,990 | 
|Japan           |  |      | 5,484   |      |  |   | 4,560  | 
|India           |  |      | 4,261   |      |  |   | 1,506  | 
|The Netherlands |  |      | 3,991   |      |  |   | 1,835  | 
|Other countries |  |      | 8,079   |      |  |   | 7,386  | 
|                |  |      |         |      |  |   |        | 
|Total           |  | $    | 111,672 |      |  | $ | 89,277 | 
|                |  |      |         |      |  |   |        | 

116



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Net revenues attributed to countries based on the
location of the customer for the years ended December 31 is
as follows (in thousands):

|                |  |      |         |      |  |   |           | 
|--------------- |  | ---- | ------- | ---- |  | - | --------- | 
|                |  | 2003 |         | 2002
|                |  |      |         |     
|United States   |  | $    | 573,263 |      |  | $ | 618,936   | 
|United Kingdom  |  |      | 67,229  |      |  |   | 87,010    | 
|Germany         |  |      | 43,717  |      |  |   | 50,533    | 
|Japan           |  |      | 40,519  |      |  |   | 39,369    | 
|Other countries |  |      | 211,608 |      |  |   | 247,196   | 
|                |  |      |         |      |  |   |           | 
|Total           |  | $    | 936,336 |      |  | $ | 1,043,044 | 
|                |  |      |         |      |  |   |           | 

Net revenue by location of the customer in 2001
is impracticable to obtain.

Net revenue information on a business unit basis
is as follows for the year ended December 31 (in thousands):

|                  |  |      |         | 
|----------------- |  | ---- | ------- | 
|                  |  | 2003
|                  |  |     
|McAfee            |  | $    | 634,812 | 
|Sniffer           |  |      | 210,176 | 
|Magic             |  |      | 63,164  | 
|IntruShield       |  |      | 15,510  | 
|NAI Labs          |  |      | 11,023  | 
|PGP               |  |      | 1,651   | 
|                  |  |      |         | 
|Total net revenue |  | $    | 936,336 | 
|                  |  |      |         | 

Net revenue information on a product and service
basis is as follows for the years ended December 31 (in
thousands):

|                                  |       |      |         |         |  |      |         |           |  |   |         |           | 
|--------------------------------- | ----- | ---- | ------- | ------- |  | ---- | ------- | --------- |  | - | ------- | --------- | 
|                                  |       | 2003 |         | 2002    |  | 2001
|                                  |       |      |         |         |  |     
|Software licenses                 |       | $    | 341,188 |         |  | $    | 459,707 |           |  | $ | 380,353 |          
|Support and maintenance           |       |      | 313,731 |         |  |      | 310,473 |           |  |   | 359,403 |          
|Hardware                          |       |      | 99,502  |         |  |      | 93,359  |           |  |   | 87,932  |          
|Retail                            |       |      | 45,993  |         |  |      | 63,236  |           |  |   | 127,453 |          
|Consulting                        |       |      | 27,421  |         |  |      | 36,740  |           |  |   | 41,276  |          
|Training                          |       |      | 9,486   |         |  |      | 12,527  |           |  |   | 19,161  |          
|On-line subscription arrangements |       |      | 72,088  |         |  |      | 51,754  |           |  |   | 40,790  |          
|Other                             |       |      | 26,927  |         |  |      | 15,248  |           |  |   | 15,292  |          
|                                  |       |      |         |         |  |      |         |           |  |   |         |          
|                                  | Total |      | $       | 936,336 |  |      | $       | 1,043,044 |  |   | $       | 1,071,660 | 
|                                  |       |      |         |         |  |      |         |           |  |   |         |          

At December 31, 2003 and 2002, one customer
had an accounts receivable balance greater than 10% of the
Companys total accounts receivable balance. During 2003,
2002 and 2001, one customer accounted for 24%, 25% and 24%,
respectively, of the total net revenue for each year. During
2002, another customer accounted for 10% of the net revenue, but
accounted for less than 10% for 2001. The net revenue derived
from these customers is reported primarily in the Companys
North American and EMEA geographic segments.

117



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

20.     Litigation



| |        
| | -------
| | General

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

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



| |                 
| | ----------------
| | Securities Cases

Between December 29, 2000 and
February 7, 2001, the Company and certain of its current
and former officers and directors were named in securities class
action lawsuits filed in the United States District Court for
the Northern District of California. On September 24, 2001,
a consolidated class action complaint, styled In re Network
Associates, Inc. II Securities Litigation,was filed which
asserts claims against the Company, William Larson, Prabhat
Goyal and Peter Watkins on behalf of a putative class of persons
who purchased the Companys stock between July 19 and
December 26, 2000. The complaint asserts causes of action
(and seeks unspecified damages) for alleged violations of
Exchange Act Section 10(b)/ SEC Rule 10b-5 and
Exchange Act Section 20(a). In particular, the complaint
alleges that defendants engaged in improper practices designed
to increase the Companys revenues and earnings and that,
as a result of those practices, the Companys class period
financial statements were false and misleading and failed to
comply with Generally Accepted Accounting Principles (GAAP).
After a hearing on defendants motion to dismiss was held
on April 16, 2002, the Court entered an order approving a
jointly stipulated withdrawal of defendants motion to
dismiss. On September 30, 2002, plaintiffs filed a first
amended and consolidated complaint. The amended and consolidated
complaint asserts claims on behalf of an expanded class of
plaintiffs, i.e., persons who purchased the
Companys stock between April 15, 1999 and December
26, 2000, and, in addition to reasserting the allegations
contained in the consolidated complaints, adds allegations
regarding the Companys restatement of its 1998, 1999, and
2000 consolidated financial statements, which restatement
resulted from the Companys discovery of certain accounting
inaccuracies impacting those consolidated financial statements.
The FAC also adds Terry Davis, the Companys former
Controller as a party defendant. On November 11, 2002, the
Company and the individual defendants each moved to dismiss
certain claims asserted on the first amended and consolidated
complaint. Prior to the hearing on Defendants motions,
which took place on February 11, 2003, plaintiff
voluntarily dismissed Peter Watkins as a party defendant in the
lawsuit. A decision on the remaining motions to dismiss was
issued on March 25, 2003, where the Court granted, in part,
defendants motion to dismiss. On September 23, 2003,
the Company and the plaintiffs entered into a memorandum of
agreement of settlement settling the matter for
$70.0 million. The settlement was approved by the court on
February 11, 2004, and the case was dismissed with
prejudice as to all parties and claims.

On February 5, 2001, the Company was
nominally sued in a derivative lawsuit filed in the Superior
Court in Santa Clara County. The lawsuit, captioned Mead Ann
Krim v. William L. Larson, et al., Case No. CV795734,
asserts claims against William Larson, Peter Watkins, Prabhat
Goyal, Leslie Denend, Virginia Gemmell, Edwin Harper, Enzo
Torresi (collectively the individual defendants), and

118



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

PricewaterhouseCoopers LLP for breach of
fiduciary duty, unjust enrichment and professional negligence
against the accountants. In particular, the complaint alleges
that the defendants engaged in a course of conduct by which they
improperly accounted for revenue from software license sales,
and that, as a result of their actions, certain of the
Companys financial statements were false and misleading
and not in compliance with GAAP. The complaint seeks an
unspecified amount of damages. Nominal defendant Network
Associates, Inc. filed a demurrer to the complaint on
May 21, 2001. A hearing on the demurrer was held on
June 29, 2001. On July 24, 2001, the Court sustained
the demurrer with leave to amend. By Order dated August 21,
2001, the Court granted plaintiff limited discovery for purposes
of amending the complaint to meet the demand futility test
imposed by Delaware law. Plaintiff filed an amended complaint on
December 26, 2001. Nominal defendant Network Associates,
Inc. filed a demurrer, which was joined by the individual
defendants, to the amended complaint on January 30, 2002. A
hearing on the demurrer was held on March 8, 2002. The
Court entered an order on March 28, 2002 sustaining the demurrer
without leave to amend and dismissing the amended complaint with
prejudice. Plaintiff filed a Notice of Appeal in the California
Court of Appeals, Sixth Appellate District on June 24,
2002. On December 19, 2002, plaintiff filed a motion
seeking the Courts approval of the parties
settlement stipulation and dismissal of the case with prejudice.
By order dated January 7, 2003, the Court entered the
parties stipulation and dismissed the case with prejudice
as to all parties and all claims.

In March 2002, several putative securities class
action lawsuits were filed in the Court of Chancery in the State
of Delaware, County of New Castle, and the Superior Court of the
State of California, County of Santa Clara, arising out of the
Companys proposed acquisition of McAfee.com Corporation
(McAfee.com). The lawsuits named as defendants
Network Associates and certain of McAfee.coms officers and
directors, and with respect to the Delaware Court of Chancery
actions, McAfee.com. The lawsuit filed in Santa Clara County is
encaptioned Peyton v. Richards, et al., No. CV
806199. The lawsuits filed in the Delaware Court of Chancery,
which were encaptioned Bank v. McAfee.com Corp., et al.,
Civil Action No. 19481; Birnbaum v. Sampath, et al.,
Civil Action No. 19482 NC; Brown v. Sampath, et al.,
Civil Action No. 19483 NC; Chin v. McAfee.com Corp., et
al.,Civil Action No. 19484 NC; Monastero v.
Sampath, et al., Civil Action No. 19485; and Ebner
v. Sampath, et al., Civil Action No. 19487, were
consolidated into a single case (the Consolidated
Action) by Court order dated April 9, 2002.
Plaintiffs amended the complaint in the Consolidated Action on
July 8, 2002. The second amended complaint asserts claims
against defendants for breach of fiduciary duty on the grounds
that (i) the price at which Network Associates proposed to
consummate the current exchange offer purportedly was unfair and
inadequate, and (ii) defendants purportedly failed to
disclose information material to assessing the propriety of the
exchange offer. The plaintiffs seek, among other things, to
recover unspecified damages and costs and to enjoin or rescind
the transaction contemplated by the offer. On September 19,
2002 the parties entered into a memorandum of understanding. On
July 18, 2003, the Delaware Court of Chancery approved the
settlement and the case was dismissed. Another class action
lawsuit was filed on April 9, 2002 in the United States
District Court for the Northern District of California,
encaptioned Getty v. Sampath, et. al., Case No. C 02
1692. On September 30, 2002, the parties in the Gettyaction filed a joint request with United States District
Court for the entry of an order staying the Gettyproceedings until after the Delaware Chancery Court has an
opportunity to approve the proposed settlement in the Delaware
Consolidated Action. On April 2, 2002, defendants removed
the California state action encaptioned Peyton v. Richards,
et al., No. CV 806199 to the United States District
Court for the Northern District of California. Subsequently, by
stipulation filed June 20, 2002, the parties in Peytonagreed for the action to be remanded to California Superior
Court for the County of Santa Clara solely for the purpose of
allowing plaintiff Justin Peyton to dismiss the action. On
July 1, 2002, a putative class action lawsuit encaptioned
Peyton v. Richards, et al., Case No. CV 809111, was
filed in the California Superior Court for the County of Santa
Clara against Network Associates and various officers and
directors of McAfee.com. The complaint generally alleges that
(i) the defendant directors of McAfee.com are liable for
breach of fiduciary duty because they failed to maximize the
price of Network Associates exchange offer, and (ii)
defendant Network Associates aided and abetted these breaches of
fiduciary duty by structuring the exchange offer in terms
preferential to Network

119



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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Associates. The plaintiff seeks, among other
things, to enjoin or rescind the transaction contemplated by the
offer, to recover costs, and to impose a constructive trust upon
any benefits improperly received by defendants. On
September 20, 2002, the Superior Court entered an order
approving the parties joint stipulation to stay the
Peytonproceedings pending the Delaware Chancery
Courts approval of the proposed settlement in the Del
aware Consolidated Action. On August 14, 2003, the parties
entered into a stipulation for an order that would dismiss the
Peytonaction with prejudice.

Certain investment bank underwriters, the
Company, and certain of our directors and officers have been
named in a putative class action for violation of the federal
securities laws in the United States District Court for the
Southern District of New York, captioned In re McAfee.com
Corp. Initial Public Offering Securities Litigation,01 Civ.
7034 (SAS). This is one of a number of cases challenging
underwriting practices in the initial public offerings
(IPOs) of more than 300 companies. These cases have
been coordinated for pretrial proceedings as In re Initial
Public Offering Securities Litigation,21 MC 92 (SAS).
Plaintiffs generally allege that certain underwriters engaged in
undisclosed and improper underwriting activities, namely the
receipt of excessive brokerage commissions and customer
agreements regarding post-offering purchases of stock in
exchange for allocations of IPO shares. Plaintiffs also allege
that various investment bank securities analysts issued false
and misleading analyst reports. The complaint against the
Company claims that the purported improper underwriting
activities were not disclosed in the registration statements for
McAfee.Coms IPO and seeks unspecified damages on behalf of
a purported class of persons who purchased the Companys
securities or sold put options during the time period from
December 1, 1999 to December 6, 2000. On
February 19, 2003 the Court issued an Opinion and Order
dismissing certain of the claims against the Company with leave
to amend. A settlement proposal was accepted by the Company on
July 15, 2003 and is awaiting Court approval.



| |              
| | -------------
| | Other Matters

On February 6, 2002, the Attorney General of
the State of New York filed a Petition in the Supreme Court, New
York County, alleging that certain restrictions posted by the
Company on and with its software are deceptive, unenforceable
and illegal. The challenged restrictions relate to publication
of benchmark tests and reviews concerning the Companys
software products. The Petition seeks damages, costs and an
injunction requiring the Company to give notice to the Attorney
General before making any representations to consumers
concerning the right to review, test or criticize
its products. This is a special proceeding under New
York law. The Company filed papers in opposition to the Petition
in which it denied the substantive allegations of the Petition
and asserted various affirmative defenses. By a Final Order of
the Supreme Court, New York County dated May 6, 2003, the
Company and the Attorney General of the State of New York
resolved the action.

On June 6, 2002, Paul Cozza filed a
Complaint in the United States District Court, District of
Massachusetts alleging breach of contract, fraud and bad faith
arising out of a dispute concerning the licensing of certain
technology used in the Companys Virex 6.1 product. The
Complaint seeks royalties on the Companys sale of Virex
6.1 products from January 1, 2002 to the present. The
Company filed papers in opposition to the Complaint and asserted
various defenses. The Company also moved to compel arbitration,
which was denied by the District Court. The Company appealed,
and the case is currently stayed pending a ruling by the First
Circuit Court of Appeals on the arbitration issue.

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

21.     Related Party
Transactions

Under the terms of the amended and restated
employment agreement for Mr. George Samenuk, Chairman of the
Board and Chief Executive Officer, the Company agreed to loan
Mr. Samenuk the funds

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NETWORKS ASSOCIATES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

necessary to pay the taxes due on each vesting
date for the 400,000 shares of restricted stock granted to
Mr. Samenuk on January 3, 2001. In addition, the
Company agreed to loan Mr. Samenuk the funds necessary to
pay the taxes due on the 3,000 shares of stock granted to
Mr. Samenuk on January 15, 2002. In accordance with
the provisions of the Sarbanes-Oxley Act of 2002, no additional
loans were made to Mr. Samenuk after July 30, 2002 and
no material modifications were made to any loan outstanding on
that date.

In total, the Company extended five separate
loans to Mr. Samenuk. As of December 31, 2002, four
loans in an aggregate amount of approximately $955,000 were
outstanding. The loans each had a two-year maturity and bore
interest at the applicable federal rate. The loans were full
recourse and secured by Mr. Samenuks restricted stock and
3,000 shares of stock. The last remaining loan was fully repaid
in October 2003.

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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Santa
Clara, State of California, on the 9th day of March, 2004.



| |                          
| | -------------------------
| | NETWORKS ASSOCIATES, INC.



| |     |                   
| | --- | ------------------
| | By: | /s/ GEORGE SAMENUK

| |                        
| | -----------------------
| |                        
| | George Samenuk         
| | Chief Executive Officer

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below on
March 9, 2004 by the following persons on behalf of the
Registrant and in the capacities indicated.

|                                             |  |                                                                                         |  |               |  | 
|-------------------------------------------- |  | --------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                             |  |                                                                                         |  |              
|Signature                                    |  | Title                                                                                   |  | Date         
|                                             |  |                                                                                         |  |              
|                                            
|/s/ GEORGE SAMENUK(George Samenuk)           |  | Chief Executive Officer
    and Chairman of the Board
    (Principal Executive Officer) |  | March 9, 2004
|                                            
|/s/ STEPHEN C. RICHARDS(Stephen C. Richards) |  | Chief Operating Officer and Chief Financial
    Officer                                 |  | March 9, 2004
|                                            
|/s/ ROBERT B. BUCKNAM(Robert B. Bucknam)     |  | Director                                                                                |  | March 9, 2004
|                                            
|/s/ LESLIE G. DENEND(Leslie G. Denend)       |  | Director                                                                                |  | March 9, 2004
|                                            
|/s/ ROBERT DUTKOWSKY(Robert Dutkowsky)       |  | Director                                                                                |  | March 9, 2004
|                                            
|/s/ DENIS J. OLEARY(Denis J. OLeary)       |  | Director                                                                                |  | March 9, 2004
|                                            
|/s/ ROBERT PANGIA(Robert Pangia)             |  | Director                                                                                |  | March 9, 2004
|                                            
|/s/ LIANE WILSON(Liane Wilson)               |  | Director                                                                                |  | March 9, 2004

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SCHEDULE II

NETWORKS ASSOCIATES, INC.

VALUATION AND QUALIFYING ACCOUNTS


|                                                                 |  |                |       |                   |  |               |        |            |  |   |        |   |  |   |       | 
|---------------------------------------------------------------- |  | -------------- | ----- | ----------------- |  | ------------- | ------ | ---------- |  | - | ------ | - |  | - | ----- | 
|                                                                 |  |                |       | Provision for     |  |               |        |           
|                                                                 |  |                |       | Doubtful          |  |               |        |           
|                                                                 |  |                |       | Accounts,         |  | Write-offs of |        |           
|                                                                 |  | Balance at     |       | Additions Charged |  | Previously    |        | Balance at
|                                                                 |  | Beginning of   |       | to Expense or     |  | Provided      |        | End of    
|                                                                 |  | Period         |       | Revenue Net(1)    |  | Accounts      |        | Period    
|                                                                 |  |                |       |                   |  |               |        |           
|                                                                 |  |               
|                                                                 |  | (In thousands)
|Year Ended December 31, 2003 Allowance for
    Doubtful Accounts |  | $              | 6,638 |                   |  | $             | (1,216 | )          |  | $ | (2,352 | ) |  | $ | 3,070 | 
|Year Ended December 31, 2002 Allowance for
    Doubtful Accounts |  | $              | 8,394 |                   |  | $             | (219   | )          |  | $ | (1,537 | ) |  | $ | 6,638 | 
|Year Ended December 31, 2001 Allowance for
    Doubtful Accounts |  | $              | 7,165 |                   |  | $             | 7,449  |            |  | $ | (6,220 | ) |  | $ | 8,394 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Provision for Doubtful Accounts,
    Net.The provision for doubtful
    accounts, net consists of our estimates with respect to the
    uncollectibility of our receivables, net of recoveries of
    amounts previously written off. Our management must make
    estimates of the uncollectibility of our accounts receivables.
    Management specifically analyzes accounts receivable and
    analyzes historical bad debts, customer concentrations, customer
    credit-worthiness, current economic trends and changes in our
    customer payment terms when evaluating the adequacy of the
    allowance for doubtful accounts.

|                             |                              |                |   |               |  |             |   |            |  |  |   |          |   |  |   |        | 
|---------------------------- | ---------------------------- | -------------- | - | ------------- |  | ----------- | - | ---------- |  |  | - | -------- | - |  | - | ------ | 
|                             |                              |                |   | Provision for |  |             |   |           
|                             |                              | Balance at     |   | Sales Returns |  | Actual      |   | Balance at
|                             |                              | Beginning of   |   | and Other     |  | Returns and |   | End of    
|                             |                              | Period         |   | Allowances(2) |  | Allowances  |   | Period    
|                             |                              |                |   |               |  |             |   |           
|                             |                              |               
|                             |                              | (In thousands)
|Year Ended December 31, 2003 |                              |                |   |               |  |             |   |            |  |  |   |          |   |  |   |       
|                             | Sales Returns and Allowances |                | $ | 32,337        |  |             | $ | 85,612     |  |  | $ | (78,350  | ) |  | $ | 39,599 | 
|Year Ended December 31, 2002 |                              |                |   |               |  |             |   |            |  |  |   |          |   |  |   |       
|                             | Sales Returns and Allowances |                | $ | 32,586        |  |             | $ | 130,163    |  |  | $ | (130,412 | ) |  | $ | 32,337 | 
|Year Ended December 31, 2001 |                              |                |   |               |  |             |   |            |  |  |   |          |   |  |   |       
|                             | Sales Returns and Allowances |                | $ | 48,076        |  |             | $ | 134,814    |  |  | $ | (150,304 | ) |  | $ | 32,586 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Provision for Sales Returns and
    Allowances.The provision for sales
    returns and allowances consists of our estimates of potential
    future product returns related to current period product
    revenue, and specific provisions for distributor, reseller, and
    retailer sales incentives (allowances) that are
    reductions in the revenue to be realized. Management analyzes
    historical returns, current economic trends, and changes in
    customer demand and acceptance of our products when evaluating
    the adequacy of the sales returns and allowances. Significant
    management judgments and estimates must be made and used in
    connection with establishing the sales returns and allowances in
    any accounting period. Material differences may result in the
    amount and timing of our revenue for any period if management
    made different judgments or utilized different estimates. The
    total provision for sales returns and other allowances amounted
    to $39.6 million in 2003. The balance at December 31,
    2003, of $39.6 million includes the estimate of potential
    future product returns amounting to $9.1 million and
    specific allowances for distributor, reseller, and retailer
    sales incentives amounting to $30.5 million.

Our accounts receivable balance at
December 31, 2003 was $170.2 million, net of allowance
for doubtful accounts of $3.1 million and allowance for
sales returns and other allowances of $39.6 million.

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EXHIBIT INDEX

|        |    |      |  |             |  |                                                                                                                                                                                                                                       
|------- | -- | ---- |  | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |            
|Number  |    |      |  | Description
|        |    |      |  |            
|        | 2  | .1   |  |            |  | Agreement and Plan of Reorganization, dated
    October 13, 1997, among McAfee Associates, Inc., Mystery
    Acquisition Corp. and Network General Corporation, as amended by
    the First Amendment dated as of October 22, 1997.(1)
|        | 3  | .1   |  |            |  | Second Restated Certificate of Incorporation of
    the Registrant, as amended on December 1, 1997.(2)                                                                                                                                
|        | 3  | .2   |  |            |  | Amended and Restated Bylaws of the Registrant.(3)                                                                                                                                                                                     
|        | 3  | .3   |  |            |  | Certificate of Designation of Series A Preferred
    Stock of the Registrant.(4)                                                                                                                                                      
|        | 3  | .4   |  |            |  | Certificate of Designation of Series B
    Participating Preferred Stock of the Registrant.(5)                                                                                                                                        
|        | 4  | .3   |  |            |  | Indenture dated as of August 17, 2001 between the
    Registrant and State Street Bank and Trust Company of
    California.(6)                                                                                                        
|        | 10 | .1   |  |            |  | Lease Assignment dated November 17, 1997 for
    facility at 3965 Freedom Circle, Santa Clara, California by and
    between Informix Corporation and McAfee Associates, Inc.(7)                                                      
|        | 10 | .2   |  |            |  | Consent to Assignment Agreement dated December
    19, 1997 by and among Birk S. McCandless, LLC, Guaranty Federal
    Bank, F.S.B., Informix Corporation and the Registrant.(7)                                                      
|        | 10 | .3   |  |            |  | Subordination, Nondisturbance and Attornment
    Agreement dated December 18, 1997, between Guaranty Federal
    Bank, F.S.B., the Registrant and Birk S. McCandless, LLC.(7)                                                         
|        | 10 | .4   |  |            |  | Lease dated November 22, 1996 by and between Birk
    S. McCandless, LLC and Informix Corporation for facility at 3965
    Freedom Circle, Santa Clara, California.(7)                                                                
|        | 10 | .5*  |  |            |  | 2002 Employee Stock Purchase Plan.(8)                                                                                                                                                                                                 
|        | 10 | .6*  |  |            |  | 1997 Stock Incentive Plan, as Amended.(8)                                                                                                                                                                                             
|        | 10 | .7*  |  |            |  | Amended and Restated 1993 Stock Option Plan for
    Outside Directors.(3)                                                                                                                                                             
|        | 10 | .8*  |  |            |  | 2000 Nonstatutory Stock Option Plan.(9)                                                                                                                                                                                               
|        | 10 | .9*  |  |            |  | Amended and Restated Employment Agreement between
    George Samenuk and the Registrant, dated October 9, 2001.(10)                                                                                                                   
|        | 10 | .10* |  |            |  | Employment agreement between Stephen C. Richards
    and the Registrant, dated April 3, 2001.(11)                                                                                                                                     
|        | 10 | .11  |  |            |  | 1st Amendment to Lease dated March 20, 1998
    between Birk S. McCandless, LLC and the Registrant.(12)                                                                                                                               
|        | 10 | .12  |  |            |  | Confirmation, Amendment and Notice of Security
    Agreement dated March 20, 1998 among Informix Corporation, Birk
    S. McCandless, LLC and the Registrant.(12)                                                                     
|        | 10 | .13  |  |            |  | Second Amendment to Lease dated September 1, 1998
    among Informix Corporation, Birk S. McCandless, LLC and the
    Registrant.(12)                                                                                                 
|        | 10 | .14  |  |            |  | Subordination, Nondisturbance and Attornment
    Agreement dated June 21, 2000, among Column Financial, Inc.,
    Informix Corporation, Birk S. McCandless, LLC, and the
    Registrant.(12)                                          
|        | 10 | .15  |  |            |  | Lease Agreement dated November 14, 1996 between
    Blue Lake Partners and McAfee Associates, Inc.(12)                                                                                                                                
|        | 10 | .16  |  |            |  | Lease Amendment dated November 24, 1997 between
    Blue Lake Partners and McAfee Software, Inc.(12)                                                                                                                                  
|        | 10 | .17  |  |            |  | Lease Amendment dated March 17, 1998 between Blue
    Lake Partners and McAfee Software, Inc.(12)                                                                                                                                     
|        | 10 | .18  |  |            |  | Lease Amendment dated March 27, 1998 between Blue
    Lake Partners and McAfee Software, Inc.(12)                                                                                                                                     
|        | 10 | .19  |  |            |  | Lease Amendment dated June 4, 1998 between Blue
    Lake Partners and McAfee Software, Inc.(12)                                                                                                                                       
|        | 10 | .20  |  |            |  | Lease Amendment dated July 21, 1998 between Blue
    Lake Partners and McAfee Software, Inc.(12)                                                                                                                                      

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##### Table of Contents



|        |    |      |  |             |  |                                                                                                                                       
|------- | -- | ---- |  | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |            
|Number  |    |      |  | Description
|        |    |      |  |            
|        | 10 | .21  |  |            |  | Lease Amendment dated November 20, 1998 between
    Blue Lake Partners and McAfee Software, Inc.(12)                                  
|        | 10 | .22  |  |            |  | Lease Amendment dated March 18, 1999 between Blue
    Lake Partners and McAfee Software, Inc.(12)                                     
|        | 10 | .23  |  |            |  | Lease Amendment dated June 3, 1999 between Blue
    Lake Partners and McAfee Software, Inc.(12)                                       
|        | 10 | .24  |  |            |  | Lease Amendment dated October 7, 1999 between
    Blue Lake Partners and McAfee Software, Inc.(12)                                    
|        | 10 | .25  |  |            |  | Lease Amendment dated March 25, 2000 between
    Daltex Centre LP and the Registrant.(12)                                             
|        | 10 | .26  |  |            |  | Lease Amendment dated July 31, 2000 between
    Daltex Centre LP and the Registrant.(12)                                              
|        | 10 | .27  |  |            |  | Lease Amendment dated January 24, 2001 between
    Daltex Centre LP and the Registrant.(12)                                           
|        | 10 | .28  |  |            |  | Lease Amendment dated May 31, 2001 between Daltex
    Centre LP and the Registrant.(12)                                               
|        | 10 | .29* |  |            |  | Employment Agreement between Kent H. Roberts and
    the Registrant, dated October 9, 2001.(13)                                       
|        | 10 | .30* |  |            |  | Employment Agreement between Arthur R. Matin and
    the Registrant, dated October 30, 2001.(13)                                      
|        | 10 | .31* |  |            |  | Employment Agreement between Vernon Gene Hodges
    and the Registrant, dated December 3, 2001.(13)                                   
|        | 10 | .32* |  |            |  | Employment Agreement between Raymond J. Smets and
    the Registrant, dated October 7, 2002(13)                                       
|        | 10 | .33* |  |             |  | Employment Agreement between Kevin M. Weiss and
    the Registrant Dated October 15, 2002.                                            
|        | 10 | .34  |  |             |  | Form of Indemnification Agreement between the
    Registrant and its Executive Officers                                               
|        | 10 | .35* |  |            |  | Summary of Pay for Performance Plan.(3)                                                                                               
|        | 10 | .36* |  |            |  | Network Associates, Inc. Tax Deferred Savings
    Plan.(15)                                                                           
|        | 12 | .1   |  |            |  | Calculation of Ratio of Earnings to Fixed Charges                                                                                     
|        | 21 | .1   |  |            |  | Subsidiaries of the Registrant                                                                                                        
|        | 23 | .1   |  |            |  | Consent of PricewaterhouseCoopers LLP,
    independent accountants                                                                    
|        | 31 | .1   |  |            |  | Certification of Chief Executive Officer and
    Chief Financial Officer pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002
|        | 32 | .1   |  |            |  | Certification of Chief Executive Officer and
    Chief Financial Officer pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002



---



|    |                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference from the
    Registrants Registration Statement on Form S-4 filed
    with the Commission on October 31, 1997.                                  
|   
|(2) | Incorporated by reference from the
    Registrants Registration Statement on Form S-4 filed
    with the Commission on March 25, 1998.                                    
|   
|(3) | Incorporated by reference from the
    Registrants Annual Report on Form 10-K for the year ended
    December 31, 2002, filed with the Commission on
    October 31, 2003.
|   
|(4) | Incorporated by reference from the
    Registrants Report on Form 10-Q for the quarter ended
    September 30, 1996, filed with the Commission on
    November 14, 1996.  
|   
|(5) | Incorporated by reference from the
    Registrants Report on Form 8-A filed with the
    Commission on October 22, 1998.                                                  
|   
|(6) | Incorporated by reference from the
    Registrants Registration Statement on Form S-3 filed
    with the Commission on November 9, 2001.                                  
|   
|(7) | Incorporated by reference from the
    Registrants Registration Statement on Form S-3, filed
    with the Commission on February 11, 1998.                                
|   
|(8) | Incorporated by reference from the
    Registrants Registration Statement on Form S-8 filed
    with the Commission on June 28, 2002.                                     

125



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##### Table of Contents





|    |                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|(9) | Incorporated by reference from the
    Registrants report on Form 10-K for the year ended
    December 31, 2000, filed with the Commission on April 2,
    2001.



|     |                                                                                                                                                                          
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference from the
    Registrants report on Form 10-K for the year ended
    December 31, 2001, filed with the Commission on
    February 8, 2002.     
|    
|(11) | Incorporated by reference from the
    Registrants report on Form 10-Q for the quarter ended
    March 31, 2001, filed with the Commission on May 15, 2001.             
|    
|(12) | Incorporated by reference from the
    Registrants report on Form 10-Q for the quarter ended
    September 30, 2001, filed with the Commission on
    November 13, 2001.
|    
|(13) | Incorporated by reference from the
    Registrants report on Form 10-K for the year ended
    December 31, 2001, filed with the Commission on
    February 8, 2002.     
|    
|(14) | Incorporated by reference from the
    Registrants report on Form 10-Q for the quarter ended
    September 30, 2002, filed with the Commission on
    November 12, 2002.
|    
|(15) | Incorporated by reference from the
    Registrants Registration Statement on Form S-8 filed
    with the Commission on November 5, 2003.                                



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

126