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|Network Associates |(NET-NYSE) |

|$17.97 | |

NOTE TO READER: ALL NEW COMMENTS SINCE LAST REPORT HIGHLIGHTED.

Overview

Network Associates has been a market leader and pioneer in security software, however the company has recently lost share in the enterprise market, specifically small and medium sized enterprises (SME). The company is in the process of making itself a pure play security and anti-virus software company as it has divested two unrelated businesses, Magic and Sniffer (expected to be completed June 30th). While analysts are positive on this strategy, many are concerned about the execution risks involved given that the company has to reorganize its sales force and take out significant costs and has a poor track record of execution. Therefore a decision to invest in Network Associates, soon to be called McAfee Associates, should depend upon your view of the company’s ability to achieve its cost savings targets and maintain sales levels as well as regain share against rival Symantec.

|Investment Positives: |Investment Risks: |

|Consumer Antivirus sales have shown strong growth |Revenue in non security businesses has been declining |

|New channel partners should improve NET’s prospects in the consumer and SME |Execution risks associated with reorganization of its businesses |

|market |NET has lagged Symantec in key consumer and SME markets |

|The release of VirusScan Enterprise 8.0i should help sales to enterprises | |

Network Associates is a Santa Clara, California based supplier of availability and security solutions for e-businesses. The company is comprised of three groups: McAfee anti-virus and security products for the consumer and enterprise markets. The company has announced that it will spin of its Sniffer business and rename itself McAfee Associates with a focus on security and anti-virus software.

Once the Sniffer transaction is complete, it will be up to NET to eliminate the costs associated with the business, as the infrastructure will stay with the company. Management has given guidance for 25% operating margins in 2005, which analysts are very skeptical about and currently have a consensus operating margin in the 22% range. In order to achieve the 25% goal, the company would need to eliminate all the costs associated with Sniffer and an additional $50 to $75 million from its continuing business. Even the most bullish analysts believe 25% is overly optimistic and have forecasted lower operating margins, with the belief that there might be some upside. On the sales front, NET will loose some of its sales force with the Sniffer business. This means some of its customers for security software will have a transition with their sales coverage. A number of analysts are concerned that this will cause disruptions to sales in the coming quarters.

Network Associates participates in a growing, but competitive marketplace. The company has lost share to its closest competitor Symantec, particularly in the SME market. Analysts are concerned that NET’s most recent revenue guidance of 7% for 2005 is about half the forecasted industry growth rate for next year. NET recently introduced McAfee VirusScan Enterprise 8.0i, which is a major upgrade from its previous flagship anti-virus product and should help bolster revenues on the enterprise side.

Key Dates

July 14, 2004 Q2 Earnings Announcement

Consensus: Sales $204 million, EPS $0.06

Sales

| | |Annual Estimates | |Quarterly Estimates |

| | |12/2004 |12/2005 | |6/2004 |9/2004 |

| | | | | | | |

|Most Recent Consensus |

| |2003 |2004E |2005E |

|Gross Margin |85.2% |85.1% |86.8% |

|Operating Margin |15.6% |11.3% |22.7% |

|Net Margin |13.0% |10.0% |18.7% |

Earnings Per Share

| | |Annual Estimates | |Quarterly Estimates |

| | |12/2004 |12/2005 | |6/2004 |9/2004 |

| | | | | | | |

Most Recent Consensus | |0.46 |[pic] |0.92 |[pic] | |0.06 |[pic] |0.10 |[pic] | |Zacks Consensus | |0.46 |[pic] |0.92 |[pic] | |0.06 |[pic] |0.10 |[pic] | |Zacks Most Accurate Consensus | |0.46 |[pic] |0.95 |[pic] | |0.05 |[pic] |0.09 |[pic] | |

EPS estimates for 2004 range from $0.38 (US Bancorp) to $0.49 (Legg Mason, Merrill, SG Cowen, First Analysis) and for 2005 range from $0.82 (Friedman Billings) to $1.02 (CSFB). The analyst on the low-end for 2004 (US Bancorp) believes that the end-markets are improving but has concerns about execution and the analyst on the low-end for 2005 (Friedman Billings) believes that aftershocks from the Sniffer divestiture will remain for quarters to come. One of the four analysts (Legg Mason) on the high-end for 2004 believes early signs of few disruptions are positive and the product upgrade cycle is beginning to play out. Another analyst on the high-end for 2004 (Merrill) believes management is taking the right steps to refocus the company and momentum in the security business is favorable and another (First Analysis) believes the restructuring targets are achievable. The analyst (CSFB) on the high-end for 2005 recently raised estimates on the belief that Panther, the restructuring plan, will be successful and the stock buyback is reducing the share count.

Target Price/Valuation

Target prices for NET range from $15 (Prudential) to $25 (Legg Mason, Lehman) with an average of $20.35. Most analysts covering the stock use a P/E valuation metric to justify a price target. Target multiples on 2005 earnings range from 18x to 25x with most analysts in the 20x to 25x range.

Long-Term Growth

Growth rates for NET range from 10% (Smith Barney) to 20% (Wachovia) with an average of 15.5%. The development of the Internet has created exponential threats in security and viruses as enterprise computer networks have become meshed with the Internet, increasing vulnerability. CERT, a federally funded reporting center for Internet security problems, estimates that security threats increased ten fold from 1992 to 2002, with most of this increase coming since 1998. Security incidents are on pace to double again in 2003 from 2002. Large enterprise and government has been the most exposed to security threat and have therefore been the early adapters in security software implementations. The small and medium enterprise market represents a large and still under penetrated opportunity. The consumer market is also a large opportunity, with Antivirus penetration estimated at only 50%. Additional opportunities in the consumer market include protection for other devices such as wireless handsets and personal firewalls for home networks.

According to the Gartner Group security software was an estimated $3.5 billion industry in 2002 and is expected to grow at a CAGR of 10% to $5.7 billion by 2007. Within the overall market, Antivirus and Content Filtering comprise about 50% of security software spending and is expected by Gartner to grow at a CAGR of 14% over the next five years. Firewall and VPN software was an estimated $390 million market in 2002 and is declining at 1.6% per year, however this is software only and most firewalls are sold as appliances. The overall firewall/VPN market was estimated by Gartner to be a $2.8 billion market in 2002. Intrusion detection is an emerging market within the industry, which will likely grow once the technology is developed over the next several years.

Individual Analyst Opinions

POSITIVE RATINGS

Banc of America – Stock is rated Buy with a $23 price target. Analyst is pleased that NET has reset the bar, which clears the way for earnings and revenue growth going forward and further earnings expansion could be driven by the potential for additional stock buybacks, write-off of certain divestiture related expenses and opportunities in wireless.

CIBC – Stock is rated Sector Outperformer with a $21 price target. Although there is much work left to be done on the restructuring and the analyst is remaining somewhat cautious until the company demonstrates meaningful execution, the stock is very attractively priced at current levels.

CSFB – Stock is rated Outperform with a $22 price target. Analyst believes that NET will be among the leaders in enterprise security once it completes the Sniffer divestiture and its restructuring effort will successfully reduce expenses.

Janney Montgomery – Stock is rated Buy with a $23 price target. Analyst believes that although the near-term transition could be difficult, the focus should shift to potential 2005 EPS upside as a result of the operating margin leverage and the reduction of shares outstanding.

Lehman – Stock is rated Overweight with a $25 price target. Analyst believes that the sale of Sniffer, retirement of the convert and visibility on the progress of expense reductions as potential catalysts. The remaining risk is restructuring risk that will take several months to play out, although with the plan already underway, the probability of success has increased.

Merrill – Stock is rated Buy. Analyst believes that management is taking the right steps to refocus the business on its core strengths and improve profitability while momentum continues to be favorable in the IT Security sector and revenue visibility improves. The current valuation more that compensates for execution risks.

SoundView – Stock is rated Outperform with a $23 price target. Although the analyst views cost cutting targets as optimistic, feels revenue targets are conservative and strength or upside to revenue could move the stock higher.

Wachovia – Stock is rated Outperform with a valuation range from $21 to $23. The analyst is positive on the release of VirusScan Enterprise 8.0i and although management’s guidance on cost savings appears aggressive, the analyst believes NET can achieve operating margins of at least 21%, compared to management’s estimate of 25%, allowing for multiple expansion.

Wedbush – Stock is rated Buy with a $21 price target. Analyst believes that NET provides a strong turn around story and is attractive, selling at a discount to its peers with room for upside to EPS if the company can meet its guidance.

NEUTRAL RATINGS

First Albany – Stock is rated Neutral. Analyst believes that the company is going in the right direction with its divestiture of Sniffer and restructuring, it still has a lot to prove and is giving very aggressive financial objectives.

First Analysis – Stock is rated equal-weight. Analyst believes NET is moving in the right direction and its infrastructure and organizational overhaul remains achievable, leaving upside to 2005 estimates; however the analyst is concerned about light revenue growth.

Friedman, Billings – Stock is rated Market Perform with a $17 price target. Analyst expects aggressive cost cutting over the next few quarters, but still has estimates below guidance and believes aftershocks from the Sniffer divestiture will remain with the company for quarters to come.

Fulcrum – Stock is rated Neutral. The analyst believes NET has some good product cycles ahead, but downgraded the stock on risks associated with the restructuring, as the company will need to transition 15% of its current work force and the company may not be able to reduce expenses as quickly as it loses Sniffer revenue.

Goldman – Stock is rated In-Line. Analyst believes NET is taking the right steps by focusing on its core security business, but believes the company is not out of the woods as there is still risk associated with the transition and NET is loosing share to Symantec. At current levels, the stock’s valuation is close to that of its peers, indicating that investors may already be pricing in success.

JP Morgan – Stock is rated Neutral. Analyst believes that the valuation is attractive if you believe in management’s ability to execute, however the street needs to digest lower revenue estimates for 2005 and price in execution risks.

Kaufman Brothers - Stock is rated hold with a $17 price target. Analyst is positive on the transition to McAfee and the focus on its core security business, but thinks it will be an execution challenge to reduce costs and transition the sales force without disrupting sales. Although the company appears ready for the challenge, NET’s history of execution is spotty.

Needham – Stock is rated Hold. Analyst has increasing confidence that NET will be able to meet its expense targets, but is concerned about revenue as the company is loosing share in the SME segment to Symantec and execution continues to be an issue.

Prudential – Stock is rated Neutral Weight with a $15 price target. Analyst is concerned that NET’s guidance is for revenue growth at half the rate of the industry and execution risks are high given the loss of 73 Sniffer sales reps, the restructuring of quotas and the restriction of accounts available for direct sales “around the channel”.

Raymond James – Stock is rated Market Perform. Analyst believes that lackluster execution will continue to be a risk going forward and in order for NET’s multiple to expand, the company will need to show the ability to grow revenue faster than the 7% implied in its guidance.

SG Cowen – Stock is not rated. Analyst believes NET is suffering from industry pricing pressure as products become more commoditized, resulting in sales challenges and is concerned about a recent accounting change to deferring sales expenses.

Smith Barney – Stock is rated Hold with an $18 price target. Analyst believes that the near-term impact of the Sniffer divestiture will be worse that expected, however this is a long-term positive as it streamlines the company, although this could take up to a year to complete.

US Bancorp – Stock is rated Market Perform with a $20 price target. The analyst believes that in spite of company’s inability to manage the business over the past two years, the company’s end markets are improving and visibility has increased from the spinout of the Sniffer business.

NEGATIVE RATINGS

None

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June 30, 2004

[pic]Research Digest Stephen Biggs, CFA, 312.630.9880 x. 224

sbiggs@

155 North Wacker Drive Chicago, IL 60606

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