e10vq
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-Q
|
|
|
þ
|
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
|
|
|
|
|
|
For the quarterly period ended
March 31, 2006
|
|
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:
001-31216
McAfee, 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 No.)
|
|
|
|
3965 Freedom Circle
Santa Clara, California
(Address of principal
executive offices)
|
|
95054
(Zip Code)
|
Registrants telephone number, including area code:
(408) 988-3832
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 whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act. (Check one):
|
|
|
|
|
|
Large
accelerated filer þ
|
Accelerated
filer o
|
Non-accelerated
filer o
|
|
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
As of April 28, 2006, 159,524,329 shares of the
registrants common stock, $0.01 par value, were
outstanding.
MCAFEE,
INC.
FORM 10-Q
March 31, 2006
CONTENTS
2
MCAFEE,
INC. AND SUBSIDIARIES
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands, except
|
|
|
|
share data)
|
|
|
|
(Unaudited)
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
430,512
|
|
|
$
|
728,592
|
|
Restricted cash
|
|
|
|
|
|
|
50,489
|
|
Short-term marketable securities
|
|
|
412,217
|
|
|
|
316,298
|
|
Accounts receivable, net of
allowance for doubtful accounts of $2,164 and $2,389,
respectively
|
|
|
123,845
|
|
|
|
158,680
|
|
Prepaid expenses and prepaid taxes
|
|
|
98,220
|
|
|
|
78,945
|
|
Other current assets
|
|
|
25,409
|
|
|
|
27,846
|
|
Deferred income taxes
|
|
|
219,136
|
|
|
|
206,811
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
1,309,339
|
|
|
|
1,567,661
|
|
Long-term marketable securities
|
|
|
294,863
|
|
|
|
212,131
|
|
Restricted cash
|
|
|
1,212
|
|
|
|
939
|
|
Property and equipment, net
|
|
|
89,060
|
|
|
|
85,641
|
|
Deferred income taxes
|
|
|
223,557
|
|
|
|
241,315
|
|
Intangible assets, net
|
|
|
74,138
|
|
|
|
80,782
|
|
Goodwill
|
|
|
438,255
|
|
|
|
438,396
|
|
Other assets
|
|
|
15,920
|
|
|
|
15,759
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
2,446,344
|
|
|
$
|
2,642,624
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
34,300
|
|
|
$
|
34,678
|
|
Accrued SEC settlement
|
|
|
|
|
|
|
50,000
|
|
Accrued income taxes
|
|
|
65,372
|
|
|
|
81,227
|
|
Accrued compensation
|
|
|
41,554
|
|
|
|
50,617
|
|
Accrued marketing
|
|
|
21,346
|
|
|
|
15,172
|
|
Other accrued liabilities
|
|
|
66,747
|
|
|
|
66,839
|
|
Deferred revenue
|
|
|
598,602
|
|
|
|
570,458
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
827,921
|
|
|
|
868,991
|
|
Deferred revenue, less current
portion
|
|
|
177,503
|
|
|
|
175,962
|
|
Accrued taxes and other long-term
liabilities
|
|
|
144,482
|
|
|
|
142,638
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
1,149,906
|
|
|
|
1,187,591
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
(Notes 12 and 13)
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS
EQUITY
|
Preferred stock, $0.01 par
value:
|
|
|
|
|
|
|
|
|
Authorized: 5,000,000 shares;
Issued and outstanding: none in 2006 and 2005
|
|
|
|
|
|
|
|
|
Common stock, $0.01 par value:
|
|
|
|
|
|
|
|
|
Authorized:
300,000,000 shares; Issued: 171,649,364 shares at
March 31, 2006 and 170,453,210 shares at
December 31, 2005 Outstanding: 159,239,082 shares at
March 31, 2006 and 167,688,210 shares at
December 31, 2005
|
|
|
1,717
|
|
|
|
1,705
|
|
Treasury stock, at cost:
12,410,282 shares at March 31, 2006 and
2,765,000 shares at December 31, 2005
|
|
|
(298,954
|
)
|
|
|
(68,395
|
)
|
Additional paid-in capital
|
|
|
1,390,253
|
|
|
|
1,356,881
|
|
Deferred stock-based compensation
|
|
|
|
|
|
|
(474
|
)
|
Accumulated other comprehensive
income
|
|
|
28,518
|
|
|
|
31,302
|
|
Retained earnings
|
|
|
174,904
|
|
|
|
134,014
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
1,296,438
|
|
|
|
1,455,033
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders equity
|
|
$
|
2,446,344
|
|
|
$
|
2,642,624
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
MCAFEE,
INC. AND SUBSIDIARIES
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands, except per share
data) (Unaudited)
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
31,100
|
|
|
$
|
35,537
|
|
Subscription
|
|
|
92,726
|
|
|
|
68,078
|
|
Service and support
|
|
|
148,141
|
|
|
|
132,112
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
|
271,967
|
|
|
|
235,727
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
Product
|
|
|
15,667
|
|
|
|
16,923
|
|
Subscription
|
|
|
18,944
|
|
|
|
10,510
|
|
Service and support
|
|
|
6,466
|
|
|
|
7,374
|
|
Amortization of purchased technology
|
|
|
3,841
|
|
|
|
3,850
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
|
44,918
|
|
|
|
38,657
|
|
Operating costs:
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
51,191
|
|
|
|
38,230
|
|
Marketing and sales
|
|
|
84,866
|
|
|
|
71,184
|
|
General and administrative
|
|
|
37,870
|
|
|
|
33,621
|
|
Amortization of intangibles
|
|
|
2,793
|
|
|
|
3,528
|
|
Restructuring charges
|
|
|
551
|
|
|
|
2,296
|
|
Loss on sale of assets and
technology
|
|
|
24
|
|
|
|
259
|
|
(Recovery of) provision for
doubtful accounts, net
|
|
|
(451
|
)
|
|
|
159
|
|
Reimbursement from transition
services agreement
|
|
|
|
|
|
|
(328
|
)
|
|
|
|
|
|
|
|
|
|
Total operating costs
|
|
|
176,844
|
|
|
|
148,949
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
50,205
|
|
|
|
48,121
|
|
Interest and other income
|
|
|
12,036
|
|
|
|
4,960
|
|
Loss on investments, net
|
|
|
(102
|
)
|
|
|
(648
|
)
|
|
|
|
|
|
|
|
|
|
Income before provision for income
taxes
|
|
|
62,139
|
|
|
|
52,433
|
|
Provision for income taxes
|
|
|
21,249
|
|
|
|
16,463
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
40,890
|
|
|
$
|
35,970
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
Unrealized gain (loss) on
marketable securities, net of reclassification adjustment for
losses recognized on marketable securities during the period and
income tax
|
|
$
|
185
|
|
|
$
|
(1,419
|
)
|
Foreign currency translation (loss)
gain
|
|
|
(2,969
|
)
|
|
|
335
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
38,106
|
|
|
$
|
34,886
|
|
|
|
|
|
|
|
|
|
|
Net income per
share Basic
|
|
$
|
0.25
|
|
|
$
|
0.22
|
|
|
|
|
|
|
|
|
|
|
Net income per
share Diluted
|
|
$
|
0.25
|
|
|
$
|
0.21
|
|
|
|
|
|
|
|
|
|
|
Shares used in per share
calculation Basic
|
|
|
164,940
|
|
|
|
162,992
|
|
|
|
|
|
|
|
|
|
|
Shares used in per share
calculation Diluted
|
|
|
166,833
|
|
|
|
167,339
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
MCAFEE,
INC. AND SUBSIDIARIES
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
(Unaudited)
|
|
|
Cash flows from operating
activities:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
40,890
|
|
|
$
|
35,970
|
|
Adjustments to reconcile net income
to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
15,191
|
|
|
|
16,421
|
|
(Recovery of) provision for
doubtful accounts, net
|
|
|
(451
|
)
|
|
|
159
|
|
Non cash restructuring charge
|
|
|
551
|
|
|
|
1,554
|
|
Interest released from restricted
cash
|
|
|
489
|
|
|
|
|
|
(Discount) premium amortization on
marketable securities
|
|
|
(1,393
|
)
|
|
|
654
|
|
Loss on sale of assets and
technology
|
|
|
24
|
|
|
|
259
|
|
Loss on sale of investments
|
|
|
102
|
|
|
|
648
|
|
Deferred income taxes
|
|
|
4,067
|
|
|
|
(6,073
|
)
|
Stock-based compensation charges
(benefits)
|
|
|
13,571
|
|
|
|
(3,292
|
)
|
Excess tax benefits from
stock-based compensation
|
|
|
(3,001
|
)
|
|
|
|
|
Changes in assets and liabilities,
net of acquisitions and divestitures:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
36,483
|
|
|
|
40,128
|
|
Prepaid expenses, prepaid taxes and
other assets
|
|
|
(16,281
|
)
|
|
|
(9,582
|
)
|
Accounts payable
|
|
|
(2,272
|
)
|
|
|
(2,424
|
)
|
Accrued taxes and other liabilities
|
|
|
(64,374
|
)
|
|
|
(71
|
)
|
Deferred revenue
|
|
|
24,778
|
|
|
|
26,099
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
48,374
|
|
|
|
100,450
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities:
|
|
|
|
|
|
|
|
|
Purchase of marketable securities
|
|
|
(323,500
|
)
|
|
|
(253,419
|
)
|
Proceeds from sale and maturity of
marketable securities
|
|
|
146,448
|
|
|
|
207,196
|
|
Decrease (increase) in restricted
cash
|
|
|
49,727
|
|
|
|
(1
|
)
|
Purchase of property, equipment and
leasehold improvements
|
|
|
(10,191
|
)
|
|
|
(9,146
|
)
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(137,516
|
)
|
|
|
(55,370
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities:
|
|
|
|
|
|
|
|
|
Proceeds from issuance of common
stock from option and stock purchase plans
|
|
|
18,040
|
|
|
|
24,816
|
|
Excess tax benefits from
stock-based compensation
|
|
|
3,001
|
|
|
|
|
|
Repurchase of common stock
|
|
|
(230,559
|
)
|
|
|
(47,351
|
)
|
|
|
|
|
|
|
|
|
|
Net cash used in financing
activities
|
|
|
(209,518
|
)
|
|
|
(22,535
|
)
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate fluctuations
|
|
|
580
|
|
|
|
(9,661
|
)
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in cash and
cash equivalents
|
|
|
(298,080
|
)
|
|
|
12,884
|
|
Cash and cash equivalents at
beginning of period
|
|
|
728,592
|
|
|
|
291,155
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
period
|
|
$
|
430,512
|
|
|
$
|
304,039
|
|
|
|
|
|
|
|
|
|
|
Non cash investing activities:
|
|
|
|
|
|
|
|
|
Unrealized gain (loss) on
marketable securities, net
|
|
$
|
185
|
|
|
$
|
(1,419
|
)
|
|
|
|
|
|
|
|
|
|
Purchase of property, equipment and
leasehold improvements
|
|
$
|
(2,974
|
)
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash
flow information:
|
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$
|
31,358
|
|
|
$
|
19,960
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|
|
1.
|
Organization
and Business
|
We and our wholly owned subsidiaries are a worldwide supplier of
computer security solutions designed to prevent intrusions on
networks and secure computer systems and other digital devices
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 consumers
through a network of qualified partners. We operate our business
in five geographic regions: North America; Europe, Middle East
and Africa, or EMEA; Japan; Asia-Pacific, excluding Japan; and
Latin America.
|
|
2.
|
Summary
of Significant Accounting Policies and Basis of
Presentation
|
The accompanying condensed consolidated financial statements
include our accounts as of March 31, 2006 and
December 31, 2005 and for the three months ended
March 31, 2006 and March 31, 2005. All significant
intercompany accounts and transactions have been eliminated in
consolidation. These condensed consolidated financial statements
have been prepared by us, without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission, or
SEC. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such rules
and regulations. The December 31, 2005 consolidated balance
sheet was derived from audited consolidated financial
statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of
America. However, we believe that all disclosures are adequate
to make the information presented not misleading. The
accompanying unaudited condensed consolidated financial
statements should be read in conjunction with the audited
consolidated financial statements and the notes thereto,
included in our Annual Report on
Form 10-K
for the fiscal year ended December 31, 2005.
In the opinion of our management, all adjustments (which consist
of normal recurring adjustments, except as disclosed herein)
necessary to fairly present our financial position as of
March 31, 2006, and results of operations and cash flows
for the three months ended March 31, 2006 and
March 31, 2005 have been included. The results of
operations for the three months ended March 31, 2006 are
not necessarily indicative of the results to be expected for the
full fiscal year or for any future periods.
As of January 1, 2006, we changed the presentation of our
net revenue and cost of net revenue to include three categories:
(i) product, (ii) subscription and (iii) service
and support. See Note 3 for further information.
Foreign
Currency Translation
We have designated the U.S. dollar as the functional
currency of McAfee, Inc. For the majority of our subsidiaries,
we consider the local currency to be their functional currency.
The assets and liabilities of subsidiaries that are denominated
in functional currencies other than the U.S. dollar are
translated using the exchange rate on the condensed consolidated
balance sheet date. Revenues and expenses are translated at
average exchange rates prevailing during the period. Translation
adjustments resulting from this process are charged or credited
to accumulated other comprehensive income, which is a component
of stockholders equity. As of March 31, 2006, our
stockholders equity included $3.0 million of net
foreign currency translation losses for the three months ended
March 31, 2006 and as of March 31, 2005,
stockholders equity includes a $0.3 million gain for
the three months ended March 31, 2005.
Occassionally, a subsidiary enters into transactions that are
denominated in currencies other than its functional currency. In
these cases, the assets and liabilities and revenues and
expenses related to the transactions are translated into the
functional currency and any resulting gains or losses are
recorded in the condensed consolidated statements of income.
During the three months ended March 31, 2006 and 2005, we
recorded net foreign currency transaction losses of
$1.6 million and $1.1 million, respectively, in our
condensed consolidated statements of income.
6
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Inventory
Inventory, which consists primarily of finished goods, is stated
at lower of cost or market and is included in other current
assets on our condensed consolidated balance sheet. Cost is
computed using standard cost, which approximates actual cost on
a first in, first out basis. Inventory balances were
$1.2 million at both March 31, 2006 and
December 31, 2005.
Stock-Based
Compensation
On January 1, 2006, we adopted SFAS No. 123R,
Share-Based Payment, or SFAS 123R, which
is a revision of SFAS No. 123 Accounting for
Stock-Based Compensation, or SFAS 123, and
supersedes APB No. 25, Accounting for Stock Issues
to Employees, or APB 25. Among other items,
SFAS 123R requires companies to record compensation expense
for share-based awards issued to employees and directors in
exchange for services provided. The amount of the compensation
expense is based on the estimated fair value of the awards on
their grant dates and is recognized over the required service
periods. Our share-based awards include stock options,
restricted stock awards, restricted stock units and our Employee
Stock Purchase Plan.
Prior to our adoption of SFAS 123R, we applied the
intrinsic value method set forth in APB 25 to calculate the
compensation expense for share-based awards. Historically, we
have generally set the exercise price for our stock options
equal to the market value on the grant date. As a result, the
options generally had no intrinsic value on their grant dates,
and we did not record any compensation expense unless the terms
of the options were subsequently modified. In addition, we did
not recognize any compensation expense for our Employee Stock
Purchase Plan under APB 25. For restricted stock awards and
units, the calculation of compensation expense under APB 25
and SFAS 123R is the same.
We adopted SFAS 123R using the modified prospective
transition method, which requires the application of the
accounting standard to all share-based awards issued on or after
January 1, 2006 and any outstanding share-based awards that
were issued but not vested as of January 1, 2006.
Accordingly, our condensed consolidated financial statements as
of March 31, 2005 and for the three months then ended have
not been restated to reflect the impact of SFAS 123R.
During the three months ended March 31, 2005, we recognized
a benefit of approximately $3.7 million under APB 25
related to the exchange of McAfee.com options in 2002 and the
re-pricing of options in 1999. This benefit was partially offset
by an expense of approximately $0.4 million for restricted
stock awards. See Note 4 for additional information.
In the three months ended March 31, 2006, we recognized
stock-based compensation expense of $13.6 million in our
condensed consolidated financial statements, which included
$10.9 million for stock options, $1.9 million for
restricted stock awards and units and $0.8 million for our
Employee Stock Purchase Plan. These amounts include
(i) compensation expense for stock options granted prior to
January 1, 2006 but not yet vested as of January 1,
2006, based on the grant date fair value estimated in accordance
with the pro-forma provisions of SFAS 123,
(ii) compensation expense for stock options granted
subsequent to January 1, 2006 based on the grant date fair
value estimated in accordance with the provisions of
SFAS 123R and (iii) compensation expense for
restricted stock award and unit grants made both before and
after January 1, 2006 that are not yet vested.
The estimated fair value underlying our calculation of
compensation expense for stock options is based on the
Black-Scholes pricing model. Upon adoption of SFAS 123R, we
changed our method of attributing the value of stock-based
compensation to the straight-line, single-option method.
Compensation expense for all stock options granted prior to
January 1, 2006 will continue to be recognized using the
accelerated, single-option method. In addition, SFAS 123R
requires forfeitures of share-based awards to be estimated at
the time of grant and revised, if necessary, in subsequent
periods if our estimates change based on the actual amount of
forfeitures we have experienced. In the pro-forma information
required under SFAS 123 for periods prior to
January 1, 2006, we accounted for forfeitures as they
occurred.
7
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
SFAS 123R requires us to calculate the pool of excess tax
benefits, or the APIC pool, available as of January 1, 2006
to absorb tax deficiencies recognized in subsequent periods,
assuming we had applied the provisions of the standard in prior
periods. Pursuant to the provisions of FASB Staff Position
123R-3, Transition Election Related to Accounting for
the Tax Effects of Share-Based Payment Awards, we
adopted the alternative method for determining the tax effects
of share-based compensation, which among other things, provides
a simplified method for estimating the beginning APIC pool
balance.
Accounting
for Income Taxes
At the end of each interim period we make our best estimate of
the effective tax rate expected to be applicable for the full
fiscal year. This effective tax rate is used to determine income
taxes on a current
year-to-date
basis. The effective tax rate may consider, as applicable, tax
credits, foreign tax rates, and other available tax planning
alternatives. It also includes the effect of any valuation
allowance expected to be necessary at the end of the period for
deferred tax assets related to originating deductible temporary
differences and carryforwards. In arriving at this effective tax
rate applied to interim periods no effect is included for the
tax related to significant, unusual, or extraordinary items that
may be separately reported or reported net of their related tax
effect in reports for the interim period or for the fiscal year.
The rate is revised, if necessary, as of the end of each
successive interim period during the fiscal year to our best
current estimate of our expected annual effective tax rate.
The effective tax rate is our best estimate of the tax expense
(or benefit) that will be provided for the fiscal year, stated
as a percentage of our estimated annual ordinary income (or
loss). The tax expense (or benefit) related to ordinary income
(or loss) for the interim period is determined using this
estimated annual effective tax rate. The tax expense (or
benefit) related to other items is individually computed and
recognized when the items occur. The estimated tax rate applied
to interim ordinary income (or loss) is reliant on our estimates
of expected annual operating income (or loss) for the year as
well as our projections of the proportion of income (or loss)
earned in foreign jurisdictions which may have statutory tax
rates significantly lower than tax rates applicable to our
earnings in the United States. In each successive interim
period, to the extent our operating results year to date and our
estimates for the remainder of the fiscal year change from our
original expectations regarding the proportion of earnings in
various tax jurisdictions we expect that our effective tax rate
will change accordingly, affecting tax expense (or benefit) for
both that successive interim period as well as
year-to-date
interim results.
Tax returns are subject to audit by various taxing authorities.
Although we believe that adequate accruals have been made each
period for unsettled issues, additional benefits or expenses
could occur in future years from resolution of outstanding
matters. We record additional expenses each period on unsettled
issues relating to the expected interest we would be required to
pay a tax authority if we do not prevail on an unsettled issue.
We continue to assess our potential tax liability included in
accrued taxes in the condensed consolidated financial
statements, and revise our estimates. Such revisions in our
estimates could materially impact our results of operations and
financial position. We have classified a portion of our tax
liability as non-current in the condensed consolidated balance
sheet based on the expected timing of cash payments to settle
contingencies with taxing authorities.
Computation
of Net Income per Share
Basic net income per share is computed using the
weighted-average number of common shares outstanding during the
period. Diluted net income per share is computed using the
weighted-average number of common shares and dilutive potential
common shares outstanding during the period.
SFAS No. 128, Earnings per Share,
requires that employee equity share options, nonvested shares
and similar equity instruments granted by us be treated as
potential common shares outstanding in computing diluted
earnings per share. Diluted shares outstanding include the
dilutive effect of
in-the-money
options which is calculated based on the average share price for
each reported period using the treasury stock method. Under the
treasury stock method, the amount the employee must pay for
exercising stock options, the amount of compensation cost for
future service that we have not yet recognized and the amount of
tax benefits that would be
8
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
recorded in additional paid-in capital when the award becomes
deductible are assumed to be used to repurchase shares. We
calculate tax benefits that will be recorded in additional
paid-in capital based on the portion of the fair value of the
award that will be recognized in the financial statements, and
exclude the portion of the award that was recognized under the
SFAS 123 pro-forma disclosures prior to the implementation
of SFAS 123R.
Recent
Accounting Pronouncements
Electronic
Equipment Waste Obligations
In June 2005, the FASB issued
SFAS 143-1,
Accounting for Electronic Equipment Waste
Obligations, which provides guidance on the accounting
for certain obligations associated with Directive 2002/96/EC on
Waste Electrical and Electronic Equipment, or the Directive,
which was adopted by the European Union, or EU. Under the
Directive, the waste management obligation for historical
equipment, defined as products put on the market on or prior to
August 13, 2005, remains with the commercial user until the
equipment is replaced.
SFAS 143-1
is required to be applied to the later of the first fiscal
period ending after June 8, 2005 or the date of the
Directives adoption into law by the applicable EU member
countries in which we have significant operations. We are
currently evaluating the impact of FSP
SFAS 143-1
on our financial position and results of operations. The effects
will depend on the respective laws adopted by the EU member
countries.
Accounting
Changes and Error Corrections
In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections, or
SFAS 154, a replacement of APB Opinion No. 20,
Accounting Changes, and
SFAS Statement 3, Reporting Accounting
Changes in Interim Financial Statements. SFAS 154
changes the requirements for the accounting for and reporting of
a change in accounting principle. Previously, most voluntary
changes in accounting principles required recognition via a
cumulative effect adjustment within net income of the period of
the change. SFAS 154 requires retrospective application to
prior periods financial statements, unless it is
impracticable to determine either the period-specific effects or
the cumulative effect of the change. SFAS 154 is effective
for accounting changes made in fiscal years beginning after
December 15, 2005; however, the Statement does not change
the transition provisions of any existing accounting
pronouncements. The adoption of SFAS 154 did not have a
material effect on our consolidated financial position, results
of operations or cash flows.
The
Meaning of
Other-Than-Temporary
Impairment
In November 2005, the FASB issued Staff Position 115-1
The Meaning of
Other-Than-Temporary
Impairment and Its Application to Certain Investments,
or FSP 115-1, that addresses the determination as to when an
investment is considered impaired, whether that impairment is
other than temporary and the measurement of an impairment loss.
FSP 115-1 also includes accounting considerations subsequent to
the recognition of an
other-than-temporary
impairment and requires certain disclosures about unrealized
losses that have not been recognized as
other-than-temporary
impairments. The guidance in FSP 115-1 amends SFAS 115
Accounting for Certain Investments in Debt and Equity
Securities and APB Opinion No. 18, The
Equity Method of Accounting for Investments in Common
Stock. The final FSP nullifies certain requirements of
EITF Issue
No. 03-1,
The Meaning of
Other-Than-Temporary
Impairment and Its Application to Certain Investments,
and supersedes EITF Topic
No. D-44,
Recognition of
Other-Than-Temporary
Impairment upon the Planned Sale of a Security Whose Cost
Exceeds Fair Value. The guidance in FSP 115-1 is
effective for reporting periods beginning after
December 15, 2005. The adoption of FSP 115-1 did not have a
material effect on our consolidated financial position, results
of operations or cash flows.
9
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
3.
|
Net
Revenue and Cost of Net Revenue
|
As disclosed in our 2005 Annual Report on
Form 10-K,
during the three months ended December 31, 2005, we made
certain reclassifications from product revenue to service
revenue, primarily related to online subscriptions. Total net
revenue was not impacted by these reclassifications. The
following table presents our 2005 quarterly net revenue, as
reclassified in 2005, and cost of net revenue, as disclosed in
our respective Quarterly Report on
Form 10-Q
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Twelve Months Ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
45,145
|
|
|
$
|
43,805
|
|
|
$
|
32,578
|
|
|
$
|
46,010
|
|
|
$
|
167,538
|
|
Service and support
|
|
|
190,582
|
|
|
|
201,577
|
|
|
|
220,333
|
|
|
|
207,269
|
|
|
|
819,761
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
235,727
|
|
|
$
|
245,382
|
|
|
$
|
252,911
|
|
|
$
|
253,279
|
|
|
$
|
987,299
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
16,646
|
|
|
$
|
11,865
|
|
|
$
|
10,282
|
|
|
$
|
24,479
|
|
|
$
|
63,272
|
|
Service and support
|
|
|
18,161
|
|
|
|
21,105
|
|
|
|
22,873
|
|
|
|
23,689
|
|
|
|
85,828
|
|
Amortization of purchased
technology
|
|
|
3,850
|
|
|
|
3,886
|
|
|
|
3,938
|
|
|
|
3,841
|
|
|
|
15,515
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
$
|
38,657
|
|
|
$
|
36,856
|
|
|
$
|
37,093
|
|
|
$
|
52,009
|
|
|
$
|
164,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of January 1, 2006, we changed the presentation of our
net revenue and cost of net revenue to include three categories:
(i) product, which includes hardware and perpetual licenses
(ii) subscription, which includes subscription-based
offerings and (iii) service and support, which includes
maintenance, consulting and training. Previously, we chose to
allocate our subscription business between product and services
and support instead of presenting it as a separate category. We
believe this new presentation is consistent with the way we
currently manage our business as we grow the subscription
component of both our corporate and consumer businesses. In the
table below, we have applied the change in presentation
retrospectively to the balances previously reported for each
period during the year ended December 31, 2005. Total net
revenues and cost of net revenues were not affected by the
change.
The following table presents our revised 2005 quarterly net
revenue and cost of net revenue presentation (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Twelve Months Ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
35,537
|
|
|
$
|
34,308
|
|
|
$
|
20,825
|
|
|
$
|
37,185
|
|
|
$
|
127,855
|
|
Subscription
|
|
|
68,078
|
|
|
|
77,828
|
|
|
|
90,891
|
|
|
|
81,409
|
|
|
|
318,206
|
|
Service and support
|
|
|
132,112
|
|
|
|
133,246
|
|
|
|
141,195
|
|
|
|
134,685
|
|
|
|
541,238
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
235,727
|
|
|
$
|
245,382
|
|
|
$
|
252,911
|
|
|
$
|
253,279
|
|
|
$
|
987,299
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
16,923
|
|
|
$
|
11,986
|
|
|
$
|
10,399
|
|
|
$
|
24,636
|
|
|
$
|
63,944
|
|
Subscription
|
|
|
10,510
|
|
|
|
13,709
|
|
|
|
14,909
|
|
|
|
15,147
|
|
|
|
54,275
|
|
Service and support
|
|
|
7,374
|
|
|
|
7,275
|
|
|
|
7,847
|
|
|
|
8,385
|
|
|
|
30,881
|
|
Amortization of purchased
technology
|
|
|
3,850
|
|
|
|
3,886
|
|
|
|
3,938
|
|
|
|
3,841
|
|
|
|
15,515
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
$
|
38,657
|
|
|
$
|
36,856
|
|
|
$
|
37,093
|
|
|
$
|
52,009
|
|
|
$
|
164,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
4.
|
Employee
Stock Benefit Plans
|
Employee
Stock Purchase Plan
In April 2002, our board of directors adopted McAfees 2002
Employee Stock Purchase Plan, or the Employee Stock Purchase
Plan, which reserved 2.0 million shares of our common stock
for issuance to our employees. In December 2003 and May 2005,
our stockholders approved an additional 2.0 million and
1.0 million shares for issuance, respectively, bringing the
total number of shares reserved under the plan to
5.0 million. Generally, individuals who are employed for
30 days and perform at least 20 hours of service per
week are eligible to participate in the Employee Stock Purchase
Plan.
Prior to August 1, 2005, we offered shares of stock for
purchase to eligible employees through a series of two-year
offering periods. Each two-year offering period was comprised of
four consecutive six-month purchase periods. Beginning
August 1, 2005, the term of the offering period was changed
to six months. Outstanding offering periods that commenced prior
to August 1, 2005 will continue until the end of the
two-year offering period.
During an offering period, employees make contributions to the
Employee Stock Purchase Plan through payroll deductions. At the
end of each purchase period, we use the accumulated
contributions to issue shares of our stock to the participating
employees. The issue price of those shares is equal to the
lesser of (i) 85% of our stock price on the first day of
the offering period, or (ii) 85% of our stock price on the
purchase date. No participant may be issued more than $25,000 of
common stock in any one calendar year and the maximum number of
shares a participant may be issued during a single offering
period is 10,000 shares. In both the three months ended
March 31, 2006 and March 31, 2005, approximately
0.4 million shares were issued under the Employee Stock
Purchase Plan at a weighted-average issue price of $17.22 and
$13.93, respectively. The total intrinsic value of shares issued
under the Employee Stock Purchase Plan during the three months
ended March 31, 2006 and March 31, 2005 was
$2.4 million and $4.8 million, respectively.
Company
Stock Incentive Plans
Under the terms of our amended 1997 Stock Incentive Plan, or the
1997 Plan, we have reserved a total of 38.5 million shares
for issuance to employees, officers, directors, third-party
contractors and consultants through awards provided in the form
of options, restricted stock awards, restricted stock units, or
stock appreciation rights. As of March 31, 2006, we have no
share-based issuances outstanding with third-party contractors
or consultants.
For options granted to employees and officers under the 1997
Plan, the exercise price is no less than 100% of the fair value
of our stock on the grant date. For options granted to all other
parties, the exercise price is no less than 85% of the fair
value of our common stock on the grant date. Although some of
the options may be exercised immediately upon granting, the
majority contain gradual vesting provisions, whereby 25% vest
one year from the date of grant and thereafter in monthly
increments over the remaining three years. All unexercised
options expire ten years after the grant date. Restricted stock
awards and restricted stock units also vest over a specified
period, generally 50% two years from the grant date and 50%
three years from the grant date. Restricted stock awards are
common stock issued to the recipient that have not vested.
Restricted stock units are promises to issue stock in the future.
Under the Stock Option Plan for Outside Directors, we have
reserved 1.1 million shares of our common stock for
issuance to certain members of our board of directors who are
not employees of ours or any of our affiliated entities. The
exercise price for these options is equal to the market value of
our common stock on the grant date. Initial grants to each
outside director generally vest ratably over a three-year
period, while any subsequent grants are exercisable three years
from the grant date. All unexercised options expire ten years
after the grant date.
In connection with our acquisition of Foundstone, Inc. in
October 2004, we assumed the obligations of their 2000 Stock
Plan and converted their outstanding options into options to
purchase 428,696 shares of our common stock. We have
reserved 747,144 shares of our common stock for issuance
under this plan. The plan provides for an
11
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
option price no less than 85% of the fair value of our common
stock on the date of grant. The options contain gradual vesting
provisions, whereby 25% vest one year from the date of grant and
thereafter in monthly increments over the remaining three years.
All unexercised options expire ten years after grant date.
Plan
Activity
A summary of the activity of our employee stock options during
the three months ended March 31, 2006 and details regarding
the options outstanding and exercisable at March 31, 2006
are provided below (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31, 2006
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
Number of
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Price
|
|
|
Life (Yrs)
|
|
|
Value
|
|
|
Outstanding at beginning of period
|
|
|
16,111
|
|
|
$
|
19.79
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
600
|
|
|
|
25.88
|
|
|
|
|
|
|
|
|
|
Options exercised
|
|
|
(801
|
)
|
|
|
14.03
|
|
|
|
|
|
|
|
|
|
Options canceled
|
|
|
(717
|
)
|
|
|
21.12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period
|
|
|
15,193
|
|
|
$
|
20.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding, expected to
vest
|
|
|
13,875
|
|
|
$
|
19.99
|
|
|
|
7.7
|
|
|
$
|
74,399
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable
|
|
|
6,176
|
|
|
$
|
18.36
|
|
|
|
6.3
|
|
|
$
|
42,530
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of options exercised during the three
months ended March 31, 2006 and March 31, 2005 was
$8.7 million and $30.9 million, respectively.
The tax benefit realized from stock option exercises and
employee stock purchase rights in the three months ended
March 31, 2006 was $4.0 million. We realized no tax
benefit in the three months ended March 31, 2005.
A summary of the activity for restricted stock awards and
restricted stock units during the three months ended
March 31, 2006 is provided below (in thousands except per
share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2006
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
Restricted
|
|
|
Average
|
|
|
Restricted
|
|
|
Average
|
|
|
|
Stock
|
|
|
Grant Date
|
|
|
Stock
|
|
|
Grant Date
|
|
|
|
Units
|
|
|
Fair Value
|
|
|
Awards
|
|
|
Fair Value
|
|
|
Unvested at beginning of period
|
|
|
|
|
|
$
|
|
|
|
|
185
|
|
|
$
|
29.79
|
|
Grants
|
|
|
3,601
|
|
|
|
23.77
|
|
|
|
|
|
|
|
|
|
Vested
|
|
|
|
|
|
|
|
|
|
|
(25
|
)
|
|
|
28.41
|
|
Canceled
|
|
|
(15
|
)
|
|
|
23.62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested at end of period
|
|
|
3,586
|
|
|
$
|
23.78
|
|
|
|
160
|
|
|
$
|
30.01
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average remaining contractual life for unvested
restricted stock units and restricted stock awards at
March 31, 2006 was 2.5 years and 2.2 years,
respectively. The 3.6 million of restricted stock units
granted in the three months ended March 31, 2006 under the
1997 Plan were valued at $69.6 million when reduced by
estimated forfeitures. The total fair value of restricted stock
awards vested during the three months ended March 31, 2006
and March 31, 2005 was $0.7 million and
$1.2 million, respectively.
12
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Shares available for future grants to employees under our stock
incentive plans totaled 3.9 million at March 31, 2006.
Our management currently plans to issue new shares for the
vesting of restricted stock awards and restricted stock units
and exercises of stock options.
Valuation
and Expense Information under SFAS 123R
As indicated in Note 2, we adopted the provisions of
SFAS 123R on January 1, 2006. In the three
months ended March 31, 2006, we recognized stock-based
compensation expense of $13.6 million in our condensed
consolidated financial statements, which included
$10.9 million for stock options, $1.9 million for
restricted stock awards and units and $0.8 million for our
Employee Stock Purchase Plan. The following table summarizes the
stock-based compensation expense by income statement line item
that we recorded in accordance with the provisions of
SFAS 123R (in thousands):
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2006
|
|
|
Cost of net
revenue product
|
|
$
|
226
|
|
Cost of net
revenue subscription
|
|
|
91
|
|
Cost of net
revenue service and support
|
|
|
359
|
|
|
|
|
|
|
Stock-based compensation expense
included in cost of net revenue
|
|
|
676
|
|
Research and development
|
|
|
3,917
|
|
Sales and marketing
|
|
|
4,691
|
|
General and administrative
|
|
|
4,287
|
|
|
|
|
|
|
Stock-based compensation expense
included in operating expenses
|
|
|
12,895
|
|
|
|
|
|
|
Total stock-based compensation
expense related to stock-based equity awards
|
|
|
13,571
|
|
Deferred tax benefit
|
|
|
3,925
|
|
|
|
|
|
|
Total stock-based compensation
expense related to stock-based equity awards, net of tax
|
|
$
|
9,646
|
|
|
|
|
|
|
We had no stock-based compensation costs capitalized as part of
the cost of an asset.
The adoption of SFAS 123R on January 1, 2006 decreased
our pre-tax income by $13.6 million, decreased net income
by $9.6 million, decreased our basic net income per share
by $0.06 per share and decreased diluted net income per
share by $0.05 per share. Cash provided by operating
activities decreased and cash provided by financing activities
increased $3.0 million, respectively, related to excess tax
benefits from stock-based payment arrangements.
At March 31, 2006, the estimated fair value of all unvested
stock options, restricted stock units, restricted stock awards
and employee stock purchase rights that have not yet been
recognized as compensation expense was $113.6 million, net
of expected forfeitures. We expect to recognize this amount over
a weighted-average period of 3.0 years.
As indicated in Note 2, under both SFAS 123R and
SFAS 123 we used the Black-Scholes model to estimate the
fair value of our option awards and employee stock purchase
rights issued under the Employee Stock Purchase Plan.
13
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The key assumptions used in the model during the three months
ended March 31, 2006 and 2005 are provided below:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Stock option grants:
|
|
|
|
|
|
|
|
|
Risk free interest rate
|
|
|
4.5
|
%
|
|
|
3.8
|
%
|
Weighted average expected lives
|
|
|
5.4
|
|
|
|
4.0
|
|
Volatility
|
|
|
38.0
|
%
|
|
|
60.4
|
%
|
Dividend yield
|
|
|
|
|
|
|
|
|
ESPP:
|
|
|
|
|
|
|
|
|
Risk free interest rate
|
|
|
4.6
|
%
|
|
|
2.9
|
%
|
Weighted average expected lives
|
|
|
0.5
|
|
|
|
1.3
|
|
Volatility
|
|
|
38.0
|
%
|
|
|
40.0
|
%
|
Dividend yield
|
|
|
|
|
|
|
|
|
The fair value of the option awards and employee stock purchase
rights were:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Weighted-average grant date fair
value of options granted
|
|
$
|
10.91
|
|
|
$
|
13.17
|
|
Weighted-average fair value of
employee stock purchase rights
|
|
$
|
6.11
|
|
|
$
|
8.62
|
|
We derive the expected term of our options through the use of a
lattice model that factors in historical data on employee
exercise and post-vesting employment termination behavior. The
risk-free rate for periods within the contractual life of the
option is based on the U.S. Treasury yield curve in effect
at the time of grant. Since January 1, 2006, we have used
the implied volatility of options traded on our stock with a
term of one year or more to calculate the expected volatility of
our option grants. Prior to that time, the expected volatility
was based solely on the historical volatility of our stock. We
changed our method of estimating volatility to using implied
volatility, because we believe that using implied volatility of
options traded on our stock is a better measure of volatility
than historical volatility. We have not declared any dividends
on our stock in the past and do not expect to do so in the
foreseeable future.
14
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Pro-forma
Information under SFAS 123 for Periods Prior to
January 1, 2006
As indicated in Note 2, we applied the provisions of
APB 25 to determine our stock-based compensation expense
for all periods prior to January 1, 2006. The following
table illustrates the effect on net income and net income per
share if we had applied the fair value recognition provision of
SFAS 123 to our stock-based compensation plans during the
three months ended March 31, 2005 (in thousands, except per
share data):
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2005
|
|
|
Net income, as reported
|
|
$
|
35,970
|
|
Deduct: Total stock-based
compensation expense determined under fair value based method
for all awards, net of tax
|
|
|
(7,403
|
)
|
Deduct: Stock-based compensation
benefit, net of tax, included in reported net income under
APB 25
|
|
|
(2,136
|
)
|
|
|
|
|
|
Pro-forma net income
|
|
$
|
26,431
|
|
|
|
|
|
|
Basic net income per share, as
reported
|
|
$
|
0.22
|
|
|
|
|
|
|
Diluted net income per share, as
reported
|
|
$
|
0.21
|
|
|
|
|
|
|
Basic net income per share,
pro-forma
|
|
$
|
0.16
|
|
|
|
|
|
|
Diluted net income per share,
pro-forma
|
|
$
|
0.16
|
|
|
|
|
|
|
Stock-based
Compensation Recognized Prior to January 1,
2006
In the three months ended March 31, 2005, we recorded a
stock-based compensation benefit under APB 25 which
consisted of the following items (in thousands):
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2005
|
|
|
Exchange of McAfee.com options
|
|
$
|
(1,976
|
)
|
Repriced options
|
|
|
(1,699
|
)
|
New and existing executives and
employees
|
|
|
383
|
|
|
|
|
|
|
Total stock-based compensation
benefit
|
|
|
(3,292
|
)
|
Tax expense
|
|
|
1,156
|
|
|
|
|
|
|
Total stock-based compensation
benefit, after-tax
|
|
$
|
(2,136
|
)
|
|
|
|
|
|
The pre-tax stock-based compensation benefit of
$3.3 million in the three months ended March 31, 2005
is included in the following line items in our condensed
consolidated statement of income (in thousands):
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2005
|
|
|
Research and development
|
|
$
|
(2,503
|
)
|
Marketing and sales
|
|
|
(735
|
)
|
General and administrative
|
|
|
(54
|
)
|
|
|
|
|
|
Total stock-based compensation
benefit
|
|
$
|
(3,292
|
)
|
|
|
|
|
|
Exchange of McAfee.com options. On
September 13, 2002, we 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, $11.85 after
applying the option exchange ratio, which is paid to the option
holder upon exercise of the option and without interest.
15
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
McAfee.com options to purchase 4.1 million shares were
converted into options to purchase 2.8 million shares of
our common stock. The assumed options were subject to variable
accounting treatment, which means that the compensation charge
was measured initially at the date of the closing of the
acquisition and was remeasured each reporting period based on
our common stock fair market value at the end of each report
period.
During the three months ended March 31, 2005, we recorded a
benefit of approximately $2.0 million related to exchanged
options subject to variable accounting. The stock-based
compensation benefit in the three months ended March 31,
2005 was due to a decline in our stock price from $28.93 at
December 31, 2004 to $22.56 as of March 31, 2005.
Under SFAS 123R, variable accounting does not apply to the
exchanged options.
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 of
$11.063, the then current fair value of the stock. Options to
purchase a total of 9.5 million shares were cancelled and
the same number of new options was granted. These new options
vested at the same rate that they would have vested under
previous option plans and were subject to variable accounting.
Accordingly, we have remeasured compensation cost for these
repriced options until these options were exercised, cancelled,
or forfeited without replacement. The first valuation period
began July 1, 2000.
The amount of stock-based compensation recorded was 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 our common stock
on July 1, 2000, which was $20.375.
During the three months ended March 31, 2005, we recorded a
benefit of approximately $1.7 million. The stock-based
compensation benefit for these options was based on closing
stock price as of March 31, 2005 of $22.56. The benefit in
the three months ended March 31, 2005 was due to a decline
in our stock price from $28.93 at December 31, 2004 to
$22.56 as of March 31, 2005. These options were fully
vested as of December 31, 2005, therefore, no stock-based
compensation expense will be recognized under SFAS 123R.
New and existing executives and employees. In
January 2005, our board of directors granted 75,000 shares
of restricted stock to our chief financial officer. The price of
the underlying shares is $0.01 per share. The shares will
vest and our right to repurchase the shares will lapse over
three years from the date of grant. The fair value of the
restricted stock award was determined to be approximately
$2.1 million and was based on the difference between the
exercise price of the restricted stock award and the fair value
of the common stock on the date of grant. We recorded expense of
approximately $0.2 million during the three months ended
March 31, 2005, related to the stock-based compensation
associated with the chief financial officers restricted
stock award grant.
In connection with the acquisition of Foundstone in October
2004, we exchanged options to purchase shares of our common
stock for Foundstone stock options. A portion of the fair value
of our stock options was included in the Foundstone purchase
price. In accordance with FIN 44, we recorded
$2.3 million of deferred stock-based compensation related
to the exchange of unvested stock options which are subject to
vesting provisions as employment services are provided to us by
the former Foundstone employees. The unvested stock options
granted to Foundstone employees vest over periods ranging
through 2008. We recorded stock-based compensation of
approximately $0.2 million in the three months ended
March 31, 2005, related to the unvested stock options
exchanged in the Foundstone acquisition.
In January 2002, our board of directors approved a grant of
50,000 shares of restricted stock to our chief executive
officer. The price of the underlying shares is $0.01 per
share. The shares vested and our right to repurchase such shares
lapsed as follows: 3,000 vested as of the grant date and 47,000
were restricted until January 15, 2005. The fair value of
the restricted stock was determined to be approximately
$1.4 million and was determined based on the difference
between the exercise price of the restricted stock and the fair
value of the common stock on the date of grant. During the three
months ended March 31, 2005, we recorded less than
$0.1 million related to stock-based compensation associated
with the chief executive officers restricted stock grant.
16
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
5.
|
Business
Combinations and Divestitures
|
Wireless
Security Corporation
In June 2005, we acquired 100% of the outstanding shares of
Wireless Security Corporation, a provider of home and small
business wireless network security products, for approximately
$20.0 million in cash and $0.3 million of direct
expenses, totaling $20.3 million. We acquired Wireless
Security Corporation to continue to develop their patent-pending
technology, introduce a new consumer offering and to utilize the
technology in our small business managed solutions. The results
of operations of Wireless Security Corporation have been
included in our results of operations since the date of
acquisition.
Our 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. We
recorded $13.2 million of goodwill (none of which is
deductible for tax purposes). The following is a summary of the
assets acquired and liabilities assumed in the acquisition of
Wireless Security Corporation as adjusted during the current
period for resolution of ongoing purchase price valuation
procedures:
|
|
|
|
|
|
|
(In thousands)
|
|
|
Technology
|
|
$
|
1,500
|
|
Other intangibles
|
|
|
300
|
|
Goodwill
|
|
|
13,247
|
|
Cash
|
|
|
129
|
|
Other assets
|
|
|
34
|
|
Deferred tax assets
|
|
|
1,870
|
|
|
|
|
|
|
Total assets acquired
|
|
|
17,080
|
|
Liabilities
|
|
|
38
|
|
Deferred tax liabilities
|
|
|
711
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
749
|
|
|
|
|
|
|
Net assets acquired
|
|
|
16,331
|
|
|
|
|
|
|
In-process research and
development expensed
|
|
|
4,000
|
|
|
|
|
|
|
Total acquisition cost
|
|
$
|
20,331
|
|
|
|
|
|
|
We recorded approximately $4.0 million for in-process
research and development, which was fully expensed upon purchase
because technological feasibility had not been achieved and
there was no alternative use for the projects under development.
The in-process research and development included the development
of the consumer wireless security product that we introduced in
the third quarter of 2005. In addition, the in-process research
and development included existing wireless security offers that
we plan to integrate in our small business managed solution. At
the date of acquisition, we estimated that 60% of the
development effort had been completed and that the remaining 40%
of the development would take approximately three months to
complete and would cost approximately $0.6 million. As of
December 31, 2005, we had completed the remaining
development efforts. The intangible assets, other than goodwill,
are being amortized over their useful lives of 2.0 to
3.5 years or a weighted-average period of 3.2 years.
As part of the acquisition, we did not assume any outstanding
stock options or warrants. A performance and retention plan,
which provides for payment of up to $1.8 million, was
established at the close of the acquisition. At March 31,
2006, approximately $0.8 million had been expensed and
$0.4 million had been paid related to this performance
plan. The results of operations for Wireless Security
Corporation prior to the acquisition would not have a material
impact on our results of operations.
17
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
McAfee
Labs
In April 2005, we completed the sale of our McAfee Labs assets
to SPARTA, Inc. for $1.5 million and recognized a gain on
the sale of $1.3 million. The carrying value of McAfee Labs
assets and liabilities, which were sold in this agreement, were
not significant. The operations of McAfee Labs, which are not
material to our consolidated results of operations, are included
in income from operations for the three months ended
March 31, 2005.
Revenues related to McAfee Labs were approximately
$1.7 million in the three months ended March 31, 2005.
|
|
6.
|
Goodwill
and Other Intangible Assets
|
We account for goodwill and other intangible assets in
accordance with SFAS No. 142, Goodwill and
Other Intangible Assets. Specifically, we perform an
impairment review of our goodwill on at least an annual basis
and amortize all other intangible assets over their estimated
useful lives.
Our goodwill impairment review is conducted as of October 1
of each fiscal year or earlier if indicators of impairment
exists. In 2005 and 2004, these analyses have indicated 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. We 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 our
reporting units below their carrying amounts.
Goodwill by geographic region is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
Goodwill
|
|
|
|
|
|
Effects of Foreign
|
|
|
March 31,
|
|
|
|
2005
|
|
|
Acquired
|
|
|
Adjustments
|
|
|
Currency Exchange
|
|
|
2006
|
|
|
North America
|
|
$
|
353,534
|
|
|
$
|
|
|
|
$
|
(11
|
)
|
|
$
|
(45
|
)
|
|
$
|
353,478
|
|
EMEA
|
|
|
50,024
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
|
|
50,048
|
|
Japan
|
|
|
17,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,519
|
|
Asia-Pacific (excluding Japan)
|
|
|
5,957
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,957
|
|
Latin America
|
|
|
11,362
|
|
|
|
|
|
|
|
|
|
|
|
(109
|
)
|
|
|
11,253
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
438,396
|
|
|
$
|
|
|
|
$
|
(11
|
)
|
|
$
|
(130
|
)
|
|
$
|
438,255
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The adjustment to goodwill during the first quarter of 2006
related to Foundstone stock compensation and the realization of
net deferred tax assets from the Foundstone acquisition.
The components of intangible assets are as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Amortization
|
|
|
|
|
|
|
|
|
Amortization
|
|
|
|
|
|
|
Average
|
|
|
Gross
|
|
|
(Including Effects
|
|
|
Net
|
|
|
Gross
|
|
|
(Including Effects
|
|
|
Amount
|
|
|
|
Useful
|
|
|
Carrying
|
|
|
of Foreign Currency
|
|
|
Carrying
|
|
|
Carrying
|
|
|
of Foreign Currency
|
|
|
Carrying
|
|
|
|
Life
|
|
|
Amount
|
|
|
Exchange)
|
|
|
Amount
|
|
|
Amount
|
|
|
Exchange)
|
|
|
Net
|
|
|
Other intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased technologies
|
|
|
6.0 years
|
|
|
$
|
138,255
|
|
|
$
|
(91,017
|
)
|
|
$
|
47,238
|
|
|
$
|
138,052
|
|
|
$
|
(86,965
|
)
|
|
$
|
51,087
|
|
Trademarks and patents
|
|
|
5.0 years
|
|
|
|
28,838
|
|
|
|
(27,626
|
)
|
|
|
1,212
|
|
|
|
28,838
|
|
|
|
(26,986
|
)
|
|
|
1,852
|
|
Customer base and other intangibles
|
|
|
6.8 years
|
|
|
|
62,083
|
|
|
|
(36,395
|
)
|
|
|
25,688
|
|
|
|
62,089
|
|
|
|
(34,246
|
)
|
|
|
27,843
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
229,176
|
|
|
$
|
(155,038
|
)
|
|
$
|
74,138
|
|
|
$
|
228,979
|
|
|
$
|
(148,197
|
)
|
|
$
|
80,782
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate amortization expenses for the intangible assets
listed above totaled $6.6 million and $7.4 million in
the three months ended March 31, 2006 and 2005,
respectively.
18
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Expected future intangible asset amortization expense as of
March 31, 2006 is as follows (in thousands):
|
|
|
|
|
Fiscal Years:
|
|
|
|
|
Remainder of 2006
|
|
$
|
18,631
|
|
2007
|
|
|
22,471
|
|
2008
|
|
|
16,918
|
|
2009
|
|
|
10,724
|
|
2010
|
|
|
4,317
|
|
Thereafter
|
|
|
1,077
|
|
|
|
|
|
|
|
|
$
|
74,138
|
|
|
|
|
|
|
2005
Restructuring
During 2005, we permanently vacated several leased facilities
and recorded a $1.9 million accrual for estimated lease
related costs associated with the permanently vacated
facilities. The remaining costs associated with vacating the
facilities are primarily comprised of the present value of
remaining lease obligations, along with estimated costs
associated with subleasing the vacated facility, net of
estimated sublease rental income. We also recorded a
restructuring charge of $0.2 million related to a reduction
in headcount of approximately 14 employees.
The following table summarizes our restructuring accrual
established in 2005 and activity through March 31, 2006 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
|
|
|
|
|
|
|
|
|
|
|
|
|
Termination
|
|
|
Severance and
|
|
|
Other
|
|
|
|
|
|
|
Costs
|
|
|
Other Benefits
|
|
|
Costs
|
|
|
Total
|
|
|
Balance, January 1, 2005
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Restructuring accrual
|
|
|
1,852
|
|
|
|
216
|
|
|
|
4
|
|
|
|
2,072
|
|
Cash payments
|
|
|
(1,127
|
)
|
|
|
(216
|
)
|
|
|
(4
|
)
|
|
|
(1,347
|
)
|
Effects of foreign currency
exchange
|
|
|
(14
|
)
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
Accretion
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2005
|
|
|
734
|
|
|
|
|
|
|
|
|
|
|
|
734
|
|
Cash payments
|
|
|
(284
|
)
|
|
|
|
|
|
|
|
|
|
|
(284
|
)
|
Effects of foreign currency
exchange
|
|
|
(12
|
)
|
|
|
|
|
|
|
|
|
|
|
(12
|
)
|
Accretion
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2006
|
|
$
|
444
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
444
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2006, $0.4 million of the
restructuring accrual is due within 12 months and has been
classified as current accrued liabilities, while less than
$0.1 million has been classified as other long-term
liabilities, and will be paid through July 2007. Lease
termination costs are net of estimated sublease income of
$0.1 million at March 31, 2006.
2004
Restructuring
During 2004, we recorded several restructuring charges related
to the reduction of employee headcount. In the first quarter of
2004, we recorded a restructuring charge of approximately
$2.2 million related to the severance of approximately 160
employees, of which $0.7 million and $1.5 million was
related to our North America and EMEA operating segments,
respectively. The workforce size was reduced primarily due to
our sale of Magic in January
19
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
2004. In the second quarter of 2004, we recorded a restructuring
charge of approximately $1.6 million related to the
severance of approximately 80 employees in our sales, technical
support and general and administrative functions. Approximately
$0.6 million of the restructuring charge was related to the
EMEA operating segment and the remaining $1.0 million was
related to the North America operating segment. In the third
quarter of 2004, we recorded a restructuring charge related to
ten employees which totaled approximately $0.9 million, all
of which related to the North America operating segment. In the
fourth quarter of 2004, we recorded a restructuring charge of
$1.3 million related to 111 employees, of which
$0.7 million, $0.2 million, $0.2 million and
$0.2 million related to the Latin America, North America,
EMEA and Asia-Pacific (excluding Japan) operating segments,
respectively. All employees were terminated at December 31,
2004. The reductions in the second, third and fourth quarters
were part of the previously announced cost-savings measures
being implemented by us.
In September 2004, we announced the move of our European
headquarters to Ireland, which was substantially completed by
the end of March 2005. In the third and fourth quarters of 2004,
we recorded restructuring charges of $0.2 million and
$2.2 million, respectively, related to the severance of
approximately 80 employees.
Also in September 2004, we permanently vacated an additional two
floors in our Santa Clara headquarters building. We
recorded a $7.8 million accrual for the estimated lease
related costs associated with the permanently vacated facility,
partially offset by a $1.3 million write-off of deferred
rent liability. 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 estimated costs associated with subleasing the
vacated facility. The remaining costs will generally be paid
over the remaining lease term ending in 2013. We also recorded a
non-cash charge of approximately $0.8 million related to
disposals of certain leasehold improvements.
In the fourth quarter of 2004, we permanently vacated several
leased facilities and recorded a $2.2 million accrual for
estimated lease related costs associated with the permanently
vacated facilities. The remaining costs associated with vacating
the facilities are primarily comprised of the present value of
remaining lease obligations, along with estimated costs
associated with subleasing the vacated facility.
During 2004, we adjusted the restructuring accruals related to
severance costs and lease termination costs recorded in 2004. We
recorded a $0.3 million adjustment to reduce the EMEA
severance accrual for amounts that were no longer necessary
after paying out substantially all accrued amounts to the former
employees. We also recorded a $0.2 million reduction in
lease termination costs due to changes in estimates related to
the sublease income to be received over the remaining lease term
of our Santa Clara headquarters building.
During 2005, we completed the move of our European headquarters
to Ireland and vacated the remaining planned floors. We recorded
an additional $1.4 million restructuring charge for
estimated lease related costs associated with the permanently
vacated facilities and a $1.4 million restructuring charge
for severance costs. All of these restructuring charges were
related to the EMEA operating segment. During 2005, we also made
adjustments to our restructuring accrual totaling
$0.8 million due to a change in assumptions related to
utility costs and sublease income.
During the three months ended March 31, 2006, we made
adjustments to our restructuring accrual totaling
$0.3 million attributable to commissions owed on new
subleases and a change in assumptions related to commissions on
existing subleases.
20
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following table summarizes our restructuring accruals
established in 2004 and activity through March 31, 2006 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
|
|
|
|
|
|
|
|
|
|
|
|
|
Termination
|
|
|
Severance and
|
|
|
Other
|
|
|
|
|
|
|
Costs
|
|
|
Other Benefits
|
|
|
Costs
|
|
|
Total
|
|
|
Balance, January 1, 2004
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Restructuring accrual
|
|
|
8,685
|
|
|
|
7,932
|
|
|
|
480
|
|
|
|
17,097
|
|
Cash payments
|
|
|
(579
|
)
|
|
|
(4,175
|
)
|
|
|
(63
|
)
|
|
|
(4,817
|
)
|
Adjustment to liability
|
|
|
(222
|
)
|
|
|
(275
|
)
|
|
|
|
|
|
|
(497
|
)
|
Accretion
|
|
|
74
|
|
|
|
|
|
|
|
|
|
|
|
74
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004
|
|
|
7,958
|
|
|
|
3,482
|
|
|
|
417
|
|
|
|
11,857
|
|
Restructuring accrual
|
|
|
1,402
|
|
|
|
1,382
|
|
|
|
20
|
|
|
|
2,804
|
|
Cash payments
|
|
|
(2,747
|
)
|
|
|
(4,864
|
)
|
|
|
(297
|
)
|
|
|
(7,908
|
)
|
Adjustment to liability
|
|
|
(819
|
)
|
|
|
|
|
|
|
(140
|
)
|
|
|
(959
|
)
|
Effects of foreign currency
exchange
|
|
|
(46
|
)
|
|
|
|
|
|
|
|
|
|
|
(46
|
)
|
Accretion
|
|
|
341
|
|
|
|
|
|
|
|
|
|
|
|
341
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2005
|
|
|
6,089
|
|
|
|
|
|
|
|
|
|
|
|
6,089
|
|
Cash payments
|
|
|
(895
|
)
|
|
|
|
|
|
|
|
|
|
|
(895
|
)
|
Adjustment to liability
|
|
|
301
|
|
|
|
|
|
|
|
|
|
|
|
301
|
|
Effects of foreign currency
exchange
|
|
|
(21
|
)
|
|
|
|
|
|
|
|
|
|
|
(21
|
)
|
Accretion
|
|
|
70
|
|
|
|
|
|
|
|
|
|
|
|
70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2006
|
|
$
|
5,544
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
5,544
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 2006, $1.2 million of the restructuring accrual
is due within 12 months and has been classified as current
accrued liabilities, while the remaining balance of
$4.3 million has been classified as other long-term
liabilities, and will be paid through March 31, 2013. Lease
termination costs are net of estimated sublease income of
$4.9 million at March 31, 2006.
2003
Restructuring
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 regional headquarters facility in Plano, Texas. The facility
houses employees working in finance, information technology,
legal, human resources, field sales 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, we relocated employees from the Santa Clara,
California headquarters site. As a result of this consolidation,
in March 2003, we recorded a $15.6 million accrual for
estimated lease related costs associated with the permanently
vacated facilities, partially offset by a $1.9 million
write off of deferred rent liability. 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 estimated costs associated
with subleasing the vacated facility. The remaining costs will
generally be paid over the remaining lease term ending in 2013.
We also recorded a non-cash charge of approximately
$2.1 million related to asset disposals and discontinued
use of certain leasehold improvements and furniture and
equipment. This restructuring charge was allocated to our North
American segment.
During the second and third quarters of 2003, we recorded
restructuring charges of $6.8 million and
$0.6 million, respectively, which consisted of
$6.7 million related to a headcount reduction of 210
employees
21
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
and $0.7 million related to other expenses such as legal
expenses incurred in international locations in conjunction with
the headcount reduction. The restructuring charge related to
headcount reductions was $0.9 million and $5.8 million
in our North American and EMEA operating segments, respectively.
The employees were located in 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 $0.7 million of restructuring
accrual in EMEA that was no longer necessary after paying out
substantially all accrued amounts to the former employees.
In 2004, we adjusted the restructuring accrual related to lease
termination costs previously recorded in 2003. The adjustments
decreased the liability by approximately $0.6 million 2004,
due to changes in estimates related to the sublease income to be
received over the remaining lease term. Also in 2004, we
recorded a $0.1 million adjustment to reduce the
restructuring accrual for severance and benefits from our EMEA
operating segment that would not be utilized.
During 2005, we made adjustments to our restructuring accrual
totaling $1.0 million due to a change in assumptions
related to utility costs and sublease income.
During the three months ended March 31, 2006, we made
adjustments to our restructuring accrual totaling
$0.1 million attributable to commissions owed on new
subleases and a change in assumptions related to commissions on
existing subleases.
The following table summarizes our restructuring accrual
established in 2003 and activity through March 31, 2006 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
|
|
|
|
|
|
|
|
|
|
|
|
|
Termination
|
|
|
Severance and
|
|
|
Other
|
|
|
|
|
|
|
Costs
|
|
|
Other 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
|
|
Cash payments
|
|
|
(1,841
|
)
|
|
|
(194
|
)
|
|
|
|
|
|
|
(2,035
|
)
|
Adjustment to liability
|
|
|
(623
|
)
|
|
|
(123
|
)
|
|
|
|
|
|
|
(746
|
)
|
Accretion
|
|
|
548
|
|
|
|
|
|
|
|
|
|
|
|
548
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2004
|
|
|
12,301
|
|
|
|
|
|
|
|
|
|
|
|
12,301
|
|
Cash payments
|
|
|
(1,279
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,279
|
)
|
Adjustment to liability
|
|
|
(1,048
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,048
|
)
|
Accretion
|
|
|
498
|
|
|
|
|
|
|
|
|
|
|
|
498
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2005
|
|
|
10,472
|
|
|
|
|
|
|
|
|
|
|
|
10,472
|
|
Cash payments
|
|
|
(478
|
)
|
|
|
|
|
|
|
|
|
|
|
(478
|
)
|
Adjustment to liability
|
|
|
68
|
|
|
|
|
|
|
|
|
|
|
|
68
|
|
Accretion
|
|
|
106
|
|
|
|
|
|
|
|
|
|
|
|
106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2006
|
|
$
|
10,168
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
10,168
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2006, $1.8 million of the
restructuring accrual is due within 12 months and has been
classified as current accrued liabilities, while the remaining
balance of $8.4 million has been classified as other
long-term liabilities and will be paid through March 31,
2013. Lease termination costs are net of estimated sublease
income of $8.0 million at March 31, 2006.
22
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Our estimate of the excess facilities charges recorded during
2005, 2004 and 2003 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 actual lease exit costs or sublease
income differ from amounts currently expected. The facility
restructuring charges in 2005 were primarily allocated to the
EMEA and Japan operating segments, and the facility
restructuring charges in 2004 and 2003 were primarily allocated
to the North America operating segment.
We have a $17.0 million credit facility with a bank. The
credit facility is available on an offering basis, meaning that
transactions under the credit facility will be on such terms and
conditions, including interest rate, maturity, representations,
covenants and events of default, as mutually agreed between us
and the bank at the time of each specific transaction. The
credit facility is intended to be used for short-term credit
requirements, with terms of one year or less. The credit
facility can be cancelled at any time. No balances were
outstanding as of March 31, 2006 and December 31, 2005.
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):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Numerator Basic
net income
|
|
$
|
40,890
|
|
|
$
|
35,970
|
|
|
|
|
|
|
|
|
|
|
Numerator Diluted
net income
|
|
$
|
40,890
|
|
|
$
|
35,970
|
|
|
|
|
|
|
|
|
|
|
Denominator Basic
|
|
|
|
|
|
|
|
|
Basic weighted average common
stock outstanding
|
|
|
164,940
|
|
|
|
162,992
|
|
|
|
|
|
|
|
|
|
|
Denominator Diluted
|
|
|
|
|
|
|
|
|
Basic weighted average common
stock outstanding
|
|
|
164,940
|
|
|
|
162,992
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Common stock options, Employee
Stock Purchase Plan shares and shares subject to repurchase(1)
|
|
|
1,893
|
|
|
|
4,347
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares
|
|
|
166,833
|
|
|
|
167,339
|
|
|
|
|
|
|
|
|
|
|
Net income per
share Basic
|
|
$
|
0.25
|
|
|
$
|
0.22
|
|
|
|
|
|
|
|
|
|
|
Net income per
share Diluted
|
|
$
|
0.25
|
|
|
$
|
0.21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
At March 31, 2006 and 2005, approximately 7.1 million
and 3.0 million options to purchase common stock,
respectively, were excluded from the calculation since the
effect was anti-dilutive. |
Our consolidated provision for income taxes for the three months
ended March 31, 2006 and 2005 was $21.2 million and
$16.5 million, respectively, reflecting an effective tax
rate of 34% and 31%, respectively. The effective tax rate
differs from the statutory rate primarily due to the impact of
foreign tax credits and lower effective rates in some overseas
jurisdictions. In each successive interim period, to the extent
our operating results year to
23
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
date and our estimates for the remainder of the fiscal year
change from our original expectations regarding the proportion
of earnings in various tax jurisdictions we expect that our
effective tax rate will change accordingly, affecting tax
expense (or benefit) for both that successive interim period as
well as
year-to-date
interim results.
Although we reported an effective tax rate of 34% for the three
months ended March 31, 2006, our total tax expense of
$21.2 million is comprised of tax expense of
$19.0 million on year to date ordinary income at an
estimated 31% annual effective tax rate in addition to a net tax
expense of $2.2 million from discrete items individually
computed and recognized when the items occurred. The discrete
tax expense of $2.2 million primarily related to increases
in foreign valuation allowances.
|
|
11.
|
Business
Segment Information
|
We have concluded that we have one business and operate in one
industry, developing, marketing, distributing and supporting
computer security solutions for large enterprises, small and
medium-sized business and consumer users, as well as resellers
and distributors. Management measures operations based on our
five geographic segments: North America; Europe, Middle East and
Africa, or EMEA; Japan; Asia-Pacific, excluding Japan; and Latin
America. The corporate business activities include the following
expenses for the three months ended March 31, 2006: general
and administrative expenses of $32.2 million, stock-based
compensation expense of $13.6 million, corporate marketing
expenses of $12.6 million, amortization of purchased
technology and other intangibles of $6.6 million,
acquisition bonuses of $0.9 million, restructuring charges
of $0.6 million and SEC compliance costs of
$0.4 million. In the three months ended March 31,
2005, corporate activities included general and administrative
expenses of $32.0 million, corporate marketing expenses of
$8.3 million, amortization of purchased technology and
other intangibles of $7.4 million, restructuring charges of
$2.3 million, acquisition bonuses of $1.5 million,
divestiture costs of $0.6 million, loss on sale of assets
of $0.2 million, stock-based compensation benefit of
$3.3 million, and reimbursement related to transition
services of $0.3 million. These corporate expenses are not
considered attributable to any specific geographic region.
We market and sell anti-virus and security software, hardware
and services through our geographic regions. These products and
services are marketed and sold worldwide primarily through
resellers, distributors, systems integrators, retailers,
original equipment manufacturers, internet service providers and
directly by us. In addition, we offer web sites, which provide
suites of on-line products and services personalized for the
user based on the users personal computer, or PC,
configuration, attached peripherals and resident software. We
also offer managed security and availability applications to
corporations and governments on the internet.
24
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Summarized financial information concerning our net revenue and
operating income by geographic region is as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Net revenue by
region:
|
|
|
|
|
|
|
|
|
North America
|
|
$
|
150,662
|
|
|
$
|
141,433
|
|
EMEA
|
|
|
82,127
|
|
|
|
62,818
|
|
Japan
|
|
|
21,258
|
|
|
|
16,840
|
|
Asia-Pacific, excluding Japan
|
|
|
9,840
|
|
|
|
8,647
|
|
Latin America
|
|
|
8,080
|
|
|
|
5,989
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
271,967
|
|
|
$
|
235,727
|
|
|
|
|
|
|
|
|
|
|
Operating income by
region:
|
|
|
|
|
|
|
|
|
North America
|
|
$
|
55,666
|
|
|
$
|
55,097
|
|
Europe
|
|
|
43,961
|
|
|
|
25,805
|
|
Japan
|
|
|
11,956
|
|
|
|
10,811
|
|
Asia-Pacific, excluding Japan
|
|
|
679
|
|
|
|
1,908
|
|
Latin America
|
|
|
4,813
|
|
|
|
3,222
|
|
Corporate
|
|
|
(66,870
|
)
|
|
|
(48,722
|
)
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
50,205
|
|
|
$
|
48,121
|
|
|
|
|
|
|
|
|
|
|
The difference between operating income and income before taxes
is reflected on the face of our condensed consolidated
statements of income.
General
From time to time, we have been subject to litigation including
the pending litigation described below. Our current estimated
range of liability related to some of the pending litigation
below is based on claims for which our management can estimate
the amount and range of loss. Where there is a range of loss, we
have recorded the minimum estimated liability related to those
claims. Because of the uncertainties related to the range of
loss on the remaining pending litigation, our management is
unable to make a reasonable estimate of the liability that could
result from an unfavorable outcome. As additional information
becomes available, we will assess our potential liability and
revise our estimates. Pending or future litigation could be
costly, could cause the diversion of our managements
attention and could upon resolution have a material adverse
effect on the business, results of operations, financial
condition and cash flow.
In addition, we are engaged in certain legal and administrative
proceedings incidental to our normal business activities and
believe that these matters will not have a material adverse
effect on our financial position, results of operations or cash
flows, except for the $50.0 million settlement with the SEC
related to the Formal Order of Private Investigation
into our accounting practices.
Securities
Cases
In September 2003, we entered into a settlement agreement with
the plaintiffs in the In re Network Associates, Inc. II
Securities Litigation, which was originally filed in
December 2000. Under the settlement agreement we paid
$70.0 million, which was recorded as litigation settlement
in the consolidated statement of income for 2002. The
25
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
settlement was approved by the court in February 2004, and the
case was dismissed with prejudice to all parties and claims. In
2004, we received approximately $25.0 million from our
insurance carriers related to this litigation.
Certain investment bank underwriters, our 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, or 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 us claims that the
purported improper underwriting activities were not disclosed in
the registration statements for McAfee.coms IPO and seeks
unspecified damages on behalf of a purported class of persons
who purchased our 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 us with leave to
amend. We accepted a settlement proposal on July 15, 2003.
In June 2004, a stipulation for the settlement and release of
claims against the issuer defendants, including us, was
submitted to the Court for approval. The terms of the
settlement, if approved, would dismiss and release all claims
against participating defendants, including us. In exchange for
this dismissal, insurance carriers would agree to guarantee a
recovery by the plaintiffs from the underwriter defendants of at
least $1.0 billion, and the issuer defendants would agree
to an assignment or surrender to the plaintiffs of certain
claims the issuer defendants may have against the underwriters.
On August 31, 2005, the Court confirmed preliminary
approval of the settlement. The settlement remains subject to a
number of conditions, including final court approval.
Other
Matters
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 Virex
6.1 product. The Complaint seeks treble damages, attorneys
fees and costs for the alleged unauthorized sale of products
Cozza claims contain or contained his technology from and after
January 1, 2002, and an injunction against the alleged
further use of Cozzas technology. McAfee filed papers in
opposition to the Complaint and asserted various defenses. A
motion by McAfee to compel arbitration and a motion for partial
summary judgment on liability (but not damages) issues relating
to whether the contract claims extended beyond the Virex 6.1
product, have both been denied by the Court. In its order
denying the McAfee motion for partial summary judgment, the
Court also granted a motion for partial summary judgment filed
by Cozza in which Cozza sought a declaration that the language
of an agreement is unambiguous and enforceable against any
McAfee product which might be proved to contain that same
technology referenced in a 1993 License Agreement. Discovery has
closed in anticipation of trial commencing during 2006, although
no trial date has been set.
On March 22, 2002, the SEC notified us that it had
commenced a Formal Order of Private Investigation
into our accounting practices. On September 29, 2005, we
announced we had reserved $50.0 million in connection with
the proposed settlement with the SEC and we had deposited
$50.0 million in an escrow account with the SEC as the
designated beneficiary. On February 9, 2006, the SEC
entered the final judgment for the settlement with us. We also
agreed to release $50.0 million to the SEC for the civil
penalty on February 13, 2006 and certain other
conditions, such as engaging independent consultants to examine
and recommend improvements to our internal controls to ensure
compliance with federal securities laws.
26
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
13.
|
Warranty
Provision and Guarantees
|
We offer warranty on our hardware and software products and
record a liability for the estimated future costs associated
with warranty claims, which is based upon historical experience
and our estimate of the level of future costs. A reconciliation
of the change in our warranty obligation as of March 31,
2006 and December 31, 2005 follows (in thousands):
|
|
|
|
|
|
|
Warranty Provision
|
|
|
Balance, January 1, 2005
|
|
$
|
1,818
|
|
Additional accruals
|
|
|
3,514
|
|
Costs incurred during the period
|
|
|
(4,249
|
)
|
|
|
|
|
|
Balance, December 31, 2005
|
|
|
1,083
|
|
Additional accruals
|
|
|
1,524
|
|
Costs incurred during the period
|
|
|
(1,342
|
)
|
|
|
|
|
|
Balance, March 31, 2006
|
|
$
|
1,265
|
|
|
|
|
|
|
In November 2002, the FASB issued Interpretation No. 45, or
FIN 45, Guarantors 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 following is
a summary of the agreements that the we have determined are
within the scope of FIN 45 as of March 31, 2006:
|
|
|
|
|
Under the terms of our software license agreements with our
customers, we agree 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 our
customer licensees against any loss, expense, or liability from
any damages that may be awarded against our customer. We include
this infringement indemnification in all of our software license
agreements and selected managed service arrangements. In the
event the customer cannot use the software or service due to
infringement and we 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 we may terminate the license
and provide the customer a pro-rata refund of the fees paid by
the customer for the infringing license or service. We have
recorded no liability associated with this indemnification, as
we are not aware of any pending or threatened infringement
actions that are probable losses. We believe 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 our managed services, we have agreed
that in the event the service provided to the customer by the
vendor on behalf of us infringes upon any patent, copyright,
trademark, or any other proprietary right of a third-party, we
will indemnify our vendor, against any loss, expense, or
liability from any damages that may be awarded against our
customer. No maximum liability is stipulated in these vendor
agreements. We have recorded no liability associated with this
indemnification, as we are not aware of any pending or
threatened infringement actions or claims that are probable
losses. We believe the estimated fair value of these
indemnification clauses is minimal.
|
|
|
|
We have agreed to indemnify members of the board of directors,
as well as our officers, 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 us) by reason of the fact that they
are an agent of us, 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
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
|
27
MCAFEE,
INC. AND SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
acted in good faith. We maintain insurance coverage for
directors and officers liability, or D&O insurance. No
maximum liability is stipulated in these agreements that include
indemnifications of members of our board of directors and
officers. We have recorded no liability associated with these
indemnifications as we are not aware of any pending or
threatened actions or claims against our members of the board of
directors or officers that are probable losses in excess of
amounts covered by our D&O insurance. As a result of the
insurance policy coverage, we believe the estimated fair value
of these indemnification agreements is minimal.
|
|
|
|
|
|
Under the terms of our agreement to sell Magic in January 2004,
we agreed to indemnify the purchaser 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). Subject to limited exceptions, the maximum
potential loss related to the indemnification is
$10.0 million. To date, we have paid no amounts under the
representations and warranties indemnification. We have not
recorded any accruals related to these agreements.
|
|
|
|
Under the terms of our agreement to sell Sniffer in July 2004,
we agreed to indemnify the purchaser 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). Subject to limited exceptions, the maximum
potential loss related to the indemnification is
$200.0 million. To date, we have paid no amounts under the
representations and warranties indemnification. We have not
recorded any accruals related to these agreements.
|
|
|
|
Under the terms of our agreement to sell McAfee Labs assets in
December 2004, we agreed to indemnify the purchaser 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). Subject to limited exceptions, the
maximum potential loss related to the indemnification is
$1.5 million. We have not recorded any accruals related to
these agreements.
|
If we believe 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.
On April 3, 2006, we acquired 100% of the outstanding
capital shares of SiteAdvisor Inc., a web safety consumer
software company that tests and rates internet sites on an
ongoing basis. We believe the technology and business model that
SiteAdvisor has developed is not currently available in the
marketplace and it will allow us to enhance our existing product
offerings and add value to the McAfee brand. The purchase price
of the acquisition included approximately $60.8 million of
cash payments made to the former SiteAdvisor shareholders and
approximately $0.3 million of direct acquisition costs. We
have also agreed to make $9.3 million of cash payments to
certain SiteAdvisor employees and advisors over the next two
years that will be contingent upon their fulfillment of future
service obligations. These payments will be recorded as an
expense during the periods in which they are earned. The
financial results of SiteAdvisor will be included in our results
of operations from the date of acquisition. We have not received
a final independent appraisal of the acquired assets and
liabilities. Accordingly, we cannot provide the purchase price
allocation or the valuation of acquired intangible assets at
this time.
In April 2006, our board of directors authorized the repurchase
of an additional $250.0 million of our common stock in the
open market from time to time until October 2007, depending upon
market conditions, share price and other factors.
28
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
Forward-Looking
Statements; Trademarks
This Report on
Form 10-Q
contains forward-looking statements that involve risks and
uncertainties. These statements include, without limitation,
statements regarding our expectations, beliefs, intentions or
strategies regarding the future. All forward-looking statements
included in this Report on
Form 10-Q
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. We
undertake no obligation to revise or update publicly any
forward-looking statements for any reason.
This report includes registered trademarks and trade names of
McAfee and other corporations. Trademarks or trade names owned
by McAfee
and/or our
affiliates include: McAfee, Network
Associates, McAfee Security, ePO,
ePolicy Orchestrator, SpamKiller,
VirusScan, AVERT,
IntruShield, Entercept, and
Foundstone.
The following discussion should be read in conjunction with the
condensed consolidated financial statements and related notes
included elsewhere in this report. The results shown herein are
not necessarily indicative of the results to be expected for the
full year or any future periods.
Overview
and Executive Summary
We are a worldwide supplier of computer security solutions
designed to proactively prevent intrusions on networks and
secure computer systems and other digital devices from a large
variety of known and unknown threats and attacks. We apply
business discipline and a pragmatic approach to security that is
based on four principles of security risk management (identify
and prioritize assets; determine acceptable risk; protect
against intrusions; enforce and measure compliance). We have one
business and operate in one industry, developing, marketing,
distributing and supporting computer security solutions for
large enterprises, governments, small and medium-sized business
and consumers through a network of qualified partners. We
operate our business in five geographic regions: North America;
Europe, Middle East and Africa, collectively referred to as
EMEA; Japan; Asia-Pacific, excluding Japan; and Latin America.
See Note 11 to our condensed consolidated financial
statements for a description of revenues and operating income by
geographic region.
We derive our revenue and generate cash from customers from
primarily three sources (i) product revenue, which includes
hardware and perpetual licenses revenue, (ii) subscription
revenue, which includes revenue from subscription-based
offerings and (iii) services and support revenue, which
includes maintenance, training and consulting revenue. In the
three months ended March 31, 2006 and 2005, our net revenue
was $272.0 million and $235.7 million, respectively,
and our net income was $40.9 million and
$36.0 million, respectively. Our net revenue is impacted by
corporate IT, government and consumer spending levels. In
addition to total net revenue and net income, in evaluating our
business, management considers, among many other factors, the
following:
Net
Revenues by Geography
During the three months ended March 31, 2006 and 2005, 45%
and 40% of our total net revenue, respectively, was generated
outside of North America, with North America and EMEA
collectively accounting for approximately 85% and 87% of our
total net revenue in the three months ended March 31, 2006
and 2005, respectively.
29
Net
Revenues by Product and Customer Category
McAfee. Our McAfee products include our
corporate products and consumer products. Our corporate products
include (i) our small and medium-sized business, or SMB,
products and (ii) our enterprise products, which include
our IntruShield intrusion protection products, our Entercept
host-based intrusion protection products, our Foundstone risk
management products that were acquired in connection with the
Foundstone acquisition in October 2004, our anti-virus products
and our system security management products. Revenues from our
corporate products increased $19.5 million, or 14%, to
$160.3 million in the three months ended March 31,
2006 from $140.8 million in the three months ended
March 31, 2005 due to increased corporate spending on
McAfee security products.
We continued to experience growth in the consumer market. Our
consumer market is comprised of our McAfee consumer on-line
subscription service and retail-boxed product sales. In the
three months ended March 31, 2006, we added approximately
2.0 million net new on-line consumer subscribers. Net
revenue from our consumer security market increased
$18.4 million, or 20%, to $111.7 million in the three
months ended March 31, 2006 from $93.3 million in the
same prior period. At March 31, 2006, we had a total
on-line subscriber base of approximately 19.0 million
consumer customers, compared to approximately 11.0 million
at March 31, 2005. The main driver of this subscriber
growth was our continued strategic relationships with strategic
channel partners, such as AOL, Comcast and Dell.
McAfee Labs. We sold our McAfee Labs assets to
SPARTA, Inc. for $1.5 million in April 2005. Net revenue
related to McAfee Labs was $1.7 million in the three months
ended March 31, 2005.
Deferred
Revenue
Our deferred revenue balance at March 31, 2006 was
$776.1 million compared to $746.4 million at
December 31, 2005, an increase of 4%. The increase was
attributable to an increase in bookings of subscription and
support contracts.
Stock-compensation
Expense
On January 1, 2006, we adopted SFAS 123R on a modified
prospective basis, which requires the application of the
accounting standard to all share-based awards issued on or after
January 1, 2006 and any outstanding share-based awards that
were issued in prior years but not vested as of January 1,
2006.
30
Including stock-based compensation expense related to
equity-based awards under SFAS 123 in the prior-year, the
change in our
year-over-year
net income per share for the periods covered in the following
table is positive. The following table provides a comparison of
net income and basic and diluted net income per share, if the
effect of pro-forma stock-based compensation expense as
disclosed in the notes to the condensed consolidated financial
statements prior to January 1, 2006 were included for prior
periods (in thousands, except per-share data):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Net income as
reported
|
|
$
|
40,890
|
|
|
$
|
35,970
|
|
|
|
|
|
|
|
|
|
|
Deduct: Total stock-based
compensation expense determined under fair value based method
for all awards
|
|
|
|
|
|
|
(11,408
|
)
|
Tax benefit
|
|
|
|
|
|
|
4,005
|
|
|
|
|
|
|
|
|
|
|
Total fair value-based stock-based
compensation expense, net of tax
|
|
|
|
|
|
|
(7,403
|
)
|
Deduct: Stock-based compensation
benefit included in reported net income under APB 25
|
|
|
|
|
|
|
(3,292
|
)
|
Tax expense
|
|
|
|
|
|
|
1,156
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation
benefit included in net income, net of tax
|
|
|
|
|
|
|
(2,136
|
)
|
|
|
|
|
|
|
|
|
|
Net-income, including the effect
of stock-based compensation expense
|
|
$
|
40,890
|
|
|
$
|
26,431
|
|
|
|
|
|
|
|
|
|
|
Net income per share:
|
|
|
|
|
|
|
|
|
Basic as reported
|
|
$
|
0.25
|
|
|
$
|
0.22
|
|
Diluted as
reported
|
|
$
|
0.25
|
|
|
$
|
0.21
|
|
Basic pro-forma
|
|
|
N/A
|
|
|
$
|
0.16
|
|
Diluted pro-forma
|
|
|
N/A
|
|
|
$
|
0.16
|
|
Cash,
Cash Equivalents and Marketable Securities
The balance of cash, cash equivalents and marketable securities
at March 31, 2006 was $1,137.6 million compared to
$1,257.0 million at December 31, 2005. The decrease
was primarily attributable to the repurchase of 9.6 million
shares of common stock for approximately $230.6 million,
including commissions, offset by (i) net cash provided by
operating activities of $48.4 million, (ii) a
$50.7 million release of restricted cash to cash and cash
equivalents and (iii) cash received from the exercise of
stock options and stock purchases under the stock purchase plans
of $18.0 million. See the Liquidity and Capital Resources
section below.
In 2006, our management remains focused on, among other things,
(i) sustaining momentum in the consumer online market,
(ii) increasing revenue in both the corporate and consumer
market, (iii) continuing to streamline our business to make
it easier for strategic channel partners to do business with us,
(iv) delivering new products to our customers,
(v) generating cash to re-invest in our business and for
potential acquisitions and (vi) improving operational
efficiencies and financial systems.
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
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 a
comprehensive range of anti-virus, anti-spyware, anti-spam,
desktop firewall, host intrusion prevention, network access
control and other security products and services designed to
protect systems such as desktops and servers managed from a
single integrated management console, and
|
|
|
|
McAfee Network Protection Solutions, which offer products
designed to maximize the performance and security of networks
and network intrusion prevention with McAfee IntruShield and
McAfee Foundstone.
|
31
The majority of our net revenue has historically been derived
from our McAfee Security anti-virus products and, until the sale
of the Sniffer product line in July 2004, our Sniffer
Technologies network fault identification and application
performance management products. We have also focused our
efforts on building a full line of complementary network and
system protection solutions. In the system protection area, we
strengthened our anti-virus lineup by adding complementary
products in the anti-spam and host intrusion prevention
categories, and through our June 2005 Wireless Security
Corporation acquisition, we have strengthened our solution
portfolio in our consumer and small business segments. On the
network protection side, we have added products in the network
intrusion prevention and detection category, and through our
October 2004 Foundstone acquisition, vulnerability management
products and services.
McAfee
System Protection Solutions
McAfee system protection solutions help large enterprises, small
and medium-sized businesses, consumers, government agencies and
educational organizations assure the availability and security
of their computer desktops, digital devices, application servers
and web service platforms. The McAfee system protection
solutions portfolio features a range of products and services
including anti-virus, anti-spyware, managed services, desktop
firewalls and host intrusion prevention. Each is backed by
McAfee AVERT Labs, a leading threat research organization. A
substantial majority of our net revenue has historically been
derived from our McAfee System Protection Solutions.
Our flagship business offering for system protection is McAfee
Total Protection Solutions, which was introduced in April 2006.
A single solution with a single management console, McAfee Total
Protection reduces the complexity of managing enterprise
security. Delivering comprehensive threat prevention,
centralized management and scalable network access control, this
integrated approach enables organizations to proactively block
known and unknown attacks and ensures business continuity by
controlling non-compliant endpoints. McAfee Total Protection
Solutions come as a licensed offering or in a
software-as-a-service model.
McAfee system protection solutions also include McAfee consumer
security products, offering both traditional retail products and
on-line subscription services. Consumer retail and on-line
subscription applications allow users to protect their personal
computers, or PCs, from malicious code and other attacks, repair
PCs from damage caused by viruses and spyware and block spam and
other undesirable content. Our retail products are sold through
retail outlets, including Best Buy, CompUSA, Costco, Dixons,
Frys, Office Depot, Office Max, Staples, Wal-Mart and
Yamada to single users and small home offices in the form of
traditional boxed product. These products include for-fee
software updates and technical support services. On-line
subscription services are delivered through the use of an
internet browser at our McAfee Consumer Online web site, through
multiple on-line service providers, such as AOL and Comcast, and
through original equipment manufacturers, or OEMs, such as Dell,
Gateway/eMachines, NEC and Toshiba, North America.
Our McAfee system protection solutions previously included our
Magic Service Solutions product line, offering management and
visibility of desktop and server systems. In January 2004, we
sold our Magic Solutions product line to BMC Software.
McAfee
Network Protection Solutions
McAfee network protection solutions help 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 IntruShield for network intrusion detection, Secure
Content Management solutions for complete
e-mail and
web security and prevention, and Foundstone for intrusion
detection and prevention and vulnerability management.
We acquired Foundstone on October 1, 2004. We continue to
integrate Foundstones products with our intrusion
prevention technologies and systems management capabilities to
deliver enhanced risk management of prioritized assets,
automated shielding and risk remediation, and automated policy
enforcement and compliance.
Our McAfee network protection solutions previously included our
Sniffer Technologies product line, offering network fault
identification and application performance management products.
In July 2004, we sold our Sniffer Technologies product line to
Network General Corporation.
32
Policy
Management
Policy management tools keep threat-protection systems
up-to-date
and enforce security policies. Policy management includes live
threat information and identifying and dealing with rogue
systems, and is a key element of complete security protection.
Expert
Services and Technical Support
We have established Professional Services and McAfee Technical
Support to provide professional assistance in the design,
installation, configuration and support of our customers
networks and acquired products. We offer a range of consulting
and educational services under both the McAfee and Foundstone
banners.
McAfee Consulting Services provide product design and deployment
with an array of standardized and custom offerings. This
business is organized around our major product groupings and
also offers a range of classroom education courses designed to
enable customers and partners to successfully deploy and operate
McAfees security products. Services are also available to
help customers deal with security outbreaks and plan for the
upgrade or replacement of key parts of the security
infrastructure.
Foundstone Consulting Services include (i) threat modeling
services that identify detrimental software security problems,
(ii) network assessments and (iii) education.
Foundstone Consulting Services assist clients in the early
assessment and design of their security and risk architectures.
Through research and innovation, the Foundstone Security
Practice is able to advise government and commercial
organizations on the most effective counter measures required to
meet business and legislative targets for security and privacy.
Foundstone Consulting Services are augmented by a range of
classroom-based training courses including the Ultimate Hacking
Series.
The McAfee Technical Support program provides our customers
on-line and telephone-based technical support in an effort to
ensure that our products are installed and working properly.
During the first quarter of 2005, we reorganized our technical
support offerings to better meet our customers varying
needs. McAfee Technical Support offers a choice of Gold or
Platinum support for our customers. In addition, for our legacy
support customers only, we offer the on-line ServicePortal or
the telephone-based Connect. The services in these offerings
have been incorporated into the current Gold and Platinum
Technical Support offerings. All Technical Support programs
include software updates and upgrades. Technical Support is
available to all customers worldwide from various regional
support centers.
|
|
|
|
|
McAfee Technical Support
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 and
the ability to submit and track support cases online.
|
|
|
|
McAfee Gold Technical Support Provides
unlimited, toll-free (where available) telephone access to
technical support 24 hours a day, 7 days a week and
access to the McAfee Technical Support ServicePortal.
|
|
|
|
McAfee Platinum Technical Support Offers
proactive, personalized service and includes an assigned
Technical Account Manager, or TAM. Customers receive
proactive support contact (telephone or
e-mail) with
customer-defined frequency, election of five designated customer
contacts, access to all the services in McAfee Gold Technical
Support and the McAfee Technical Support ServicePortal.
|
In addition, we also offer our consumer users technical support
services made available at our www.mcafee.com website on both a
free and fee-based basis, depending on the support level
selected.
Research
and Development
We are committed to malicious code and vulnerability research
through our McAfee AVERT Labs organization. McAfee AVERT Labs
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.
In April 2005, we sold the assets of McAfee Labs, our research
and development organization focused on performing research for
government agencies, to SPARTA, Inc. McAfee remained as the
general contractor on
33
certain of its government contracts until government approval
was obtained for SPARTA to be the general contractor in the
first quarter of 2006.
Strategic
Alliances
From time to time, we enter into strategic alliances with third
parties to support our future growth plans. These relationships
may include joint technology development and integration,
research cooperation, co-marketing activities and sell-through
arrangements. Strategic alliance partners include AOL, Cable and
Wireless, Comcast, Dell, Gateway, Postini, Telecom Italia,
Telefonica and Wanadoo, among others. As part of our NTT DoCoMo
alliance, we have jointly developed technology to provide
integrated malware protection against mobile threats to owners
of 3G FOMA handsets.
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 2,000 nodes) and government
agencies, we from
time-to-time
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. We also offer one-year licensing
arrangements in Japan. The renewal process provides an
opportunity to cross-sell new products and product lines to
existing customers. Term-based licenses for our customers with
over 2,000 nodes accounts for less than 2% of our total revenues
in the three months ended March 31, 2006.
On-Line
Subscription Services and Managed Applications
For our on-line subscription services, customers essentially
rent the use of our security services for a defined
period of time. Because our on-line subscription services are
version-less, or self-updating, customers
subscribing to these services are capable of using the most
recent version of the software application without the need to
purchase product updates or upgrades. Our on-line subscription
consumer products and services are found at our
www.mcafee.com website 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 systems
with current software updates and upgrades. Our website also
offers customers access to McAfee Personal Firewall Plus, McAfee
SpamKiller and McAfee Privacy Service, as well as combinations
of these services. Our on-line subscription services are also
available to customers and small business through various
relationships with internet service providers, or ISPs, such as
AOL and Comcast, and available through PC OEMs, such as Dell and
Gateway. Our business model allows for ISPs to make McAfee
subscription services available as either a premium service or
as a feature included in the ISPs service. At
March 31, 2006, we had approximately 19.0 million
McAfee consumer on-line subscribers, which includes on-line
customers obtained through our alliances with ISPs and OEMs.
Similarly, our small and medium-sized business on-line
subscription products and services, or our McAfee Total
Protection for small business, provide these customers the most
up-to-date
anti-virus software. Our McAfee Total Protection for small
business provides anti-virus protection for both desktops and
file servers. In addition, McAfee Managed Mail Protection
screens emails to detect and quarantine viruses and infected
attachments, and spam. Our McAfee Desktop Firewall blocks
unauthorized network access and stops known network threats.
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 provider, or MSP, solutions are
customized, monitored and updated by networking professionals
for a specific customer.
34
Critical
Accounting Policies
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 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. We evaluate our estimates on a regular basis and
make changes accordingly. Senior management has discussed the
development, selection and disclosure of these estimates with
the audit committee of our board of directors. Actual results
may materially differ from these estimates under different
assumptions or conditions. If actual results were to differ from
these estimates materially, the resulting changes could have a
material adverse effect on the consolidated financial statements.
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.
Our critical accounting policies are as follows:
|
|
|
|
|
revenue recognition;
|
|
|
|
estimating valuation allowances and accrued liabilities,
specifically sales returns and other incentives, the allowance
for doubtful accounts, our facility restructuring accrual; and
the assessment of the probability of the outcome of litigation
against us;
|
|
|
|
stock-based compensation expense;
|
|
|
|
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.
Our revenue is derived from primarily three sources
(i) product revenue, which includes hardware and perpetual
licenses revenue, (ii) subscription revenue, which includes
revenue from subscription-based offerings and
(iii) services and support revenue, which includes
maintenance, training and consulting revenue.
We apply the provisions of Statement of Position 97-2,
Software Revenue Recognition, or
SOP 97-2,
and related interpretations to all transactions involving the
sale of software products and hardware products that include
software. For hardware products where software is incidental, we
do not separate the license fee and we do not apply separate
accounting guidance to the hardware and software elements. For
hardware transactions where no software is involved or software
is not incidental, we apply the provisions of Staff Accounting
Bulletin 104 Revenue Recognition, or
SAB 104.
We market and distribute our software products both as
standalone software products and as comprehensive security
solutions. We recognize revenue from the sale of software
licenses when all of the following is met:
|
|
|
|
|
persuasive evidence of an arrangement exists,
|
|
|
|
the product or service has been delivered,
|
35
|
|
|
|
|
the fee is fixed or determinable, and
|
|
|
|
collection of the resulting receivable is reasonably assured.
|
Persuasive evidence is generally a binding purchase order or
license agreement. Delivery generally occurs when product is
delivered to a common carrier or upon delivery of a grant letter
and license key, if applicable. If a significant portion of a
fee is due after our normal payment terms of typically
30 90 days, we recognize revenue as the
fees become due. If we determine that collection of a fee is not
reasonably assured, we defer the fees and recognize revenue upon
cash receipt, provided all other revenue recognition criteria
are met.
We enter into perpetual and subscription software license
agreements through direct sales to customers and indirect sales
with partners, distributors and resellers. We recognize revenue
from the indirect sales channel upon sell-through by the partner
or distributor. The license agreements generally include service
and support agreements, for which the related revenue is
deferred and recognized ratably over the performance period. All
revenue derived from our online subscription products is
deferred and recognized ratably over the performance period.
Professional services revenue is generally recognized as
services are performed or if required, upon customer acceptance.
For arrangements with multiple elements, including software
licenses, maintenance
and/or
services, we allocate and defer revenue equivalent to the
vendor-specific objective evidence, or VSOE, of fair value for
the undelivered elements and recognize the difference between
the total arrangement fee and the amount deferred for the
undelivered elements as product revenue. VSOE of fair value is
based upon the price for which the undelivered element is sold
separately or upon substantive renewal rates stated in a
contract. We determine fair value of the undelivered elements
based on historical evidence of stand-alone sales of these
elements to our customers. When VSOE does not exist for
undelivered elements such as maintenance and support, the entire
arrangement fee is recognized ratably over the performance
period generally as services and support revenue.
Sales Incentives and Sales Returns. We reduce
revenue for estimates of sales incentives and sales returns. We
offer sales incentives, including channel rebates, marketing
funds and end-user rebates for products in our corporate and
consumer product lines. Additionally, end-users may return our
products, subject to varying limitations, through distributors
and resellers or to us directly for a refund within a reasonably
short period from the date of purchase. We estimate and record
reserves for sales incentives and sales returns based on our
historical experience. In each accounting period, we must make
judgments and estimates of sales incentives and potential future
sales returns related to current period revenue. These estimates
affect our net revenue line item on our statement of income and
affect our net accounts receivable, deferred revenue or accrued
liabilities line items on our consolidated balance sheet. These
estimates affect all of our operating geographies.
At March 31, 2006, our allowance for sales returns and
incentives was $42.0 million compared to $32.6 million
at December 31, 2005. If our allowance for sales returns
and incentives were to increase by 10%, or $4.2 million,
our net revenue would decrease by approximately
$1.3 million and our deferred revenue would decrease by
approximately $2.9 million in the three months ended
March 31, 2006.
Deferred Costs of Revenue. Deferred costs of
revenue, which consist primarily of costs related to
revenue-sharing arrangements and costs of inventory sold into
our channel which have not been sold through to the end-user,
are included in other current assets on our consolidated balance
sheet. We only defer direct and incremental costs related to
revenue-sharing arrangements and recognize such deferred costs
proportionate to the related revenue recognized. At
March 31, 2006, our deferred costs were $40.6 million
compared to $31.1 million at December 31, 2005.
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
36
receivable line item on the consolidated balance sheet. The
estimation of uncollectible accounts affects all of our
operating geographies.
At March 31, 2006, our allowance for doubtful accounts was
$2.2 million compared to $2.4 million at
December 31, 2005. If an additional 1% of our gross
accounts receivable were deemed to be uncollectible at
March 31, 2006, our allowance for doubtful accounts and
provision for bad debt expense would increase by approximately
$1.6 million.
Estimation
of Restructuring Accrual and Litigation
Restructuring Accrual. During 2005, we
permanently vacated several leased facilities and recorded a
$1.9 million accrual for estimated lease related costs
associated with the permanently vacated facilities. During 2004,
we permanently vacated several leased facilities, including an
additional two floors in our Santa Clara headquarters
building and recorded an $8.7 million restructuring
accrual. In 2003, 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. We recorded these facility restructuring
charges in accordance with Statement of Financial Accounting
Standard No. 146, Accounting for Exit Costs
Associated With Exit or Disposal Activities, or
SFAS 146. In order to determine our restructuring charges
and the corresponding liabilities, 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 the respective locations as well as current
market interest rates. The assumptions used are our
managements best estimate at the time of the accrual, and
adjustments are made on a periodic basis if better information
is obtained. If, at March 31, 2006, our estimated sublease
income were to decrease 10%, the restructuring reserve and
related expense would have increased by approximately
$1.3 million.
The estimates regarding our restructuring accruals affect our
current liabilities and other long-term liabilities line items
in our consolidated balance sheet, since these liabilities will
be settled each year through 2013. These estimates affect our
statement of income in the restructuring line item. At
March 31, 2006, our North American operating segment was
affected by these estimates.
Litigation. Managements 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 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.
Stock-based
Compensation Expense
On January 1, 2006, we adopted SFAS No. 123R,
Share-Based Payment, or SFAS 123R, which
is a revision of SFAS No. 123 Accounting for
Stock-Based Compensation, or SFAS 123, and
supersedes APB No. 25, Accounting for Stock Issues
to Employees, or APB 25. SFAS 123R requires
the measurement and recognition of compensation expense for all
share-based payment awards made to our employees and directors
based on the estimated fair values of the awards on their grant
dates. Our share-based awards include stock options, restricted
stock awards, restricted stock units and our Employee Stock
Purchase Plan.
In the three months ended March 31, 2006, we recognized
stock compensation expense of $13.6 million. Prior to our
adoption of SFAS 123R, we applied the intrinsic value
method set forth in APB 25 to calculate the compensation
expense for share-based awards. Historically, our general policy
was to set the exercise price for our stock options equal to the
market value on the grant date. As a result, the options had no
intrinsic value on their grant dates, and we did not record any
compensation expense unless the terms of the options were
subsequently modified. During the three months ended
March 31, 2005, we recognized a benefit of approximately
$3.7 million under
37
APB 25 related to the exchange of McAfee.com options in
2002 and re-pricing of options in 1999. This benefit was
partially offset by an expense of approximately
$0.4 million for restricted stock awards. See Note 4
to the consolidated financial statements for additional
information.
We use the Black-Scholes model to estimate the fair value of our
option awards and employee stock purchase rights issued under
the Employee Stock Purchase Plan. The Black-Scholes model
requires estimates of the expected term of the option, as well
as future volatility and the risk-free interest rate.
For options issued during the three months ended March 31,
2006, we estimated the weighted-average fair value to be $10.91.
For employee stock purchase rights issued during the three
months ended March 31, 2006, we estimated the
weighted-average fair value to be $6.11. The key assumptions
that we used to calculate this value are provided below:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Stock option grants:
|
|
|
|
|
|
|
|
|
Risk free interest rate
|
|
|
4.5
|
%
|
|
|
3.8
|
%
|
Weighted average expected lives
|
|
|
5.4
|
|
|
|
4.0
|
|
Volatility
|
|
|
38.0
|
%
|
|
|
60.4
|
%
|
Dividend yield
|
|
|
|
|
|
|
|
|
ESPP:
|
|
|
|
|
|
|
|
|
Risk free interest rate
|
|
|
4.6
|
%
|
|
|
2.9
|
%
|
Weighted average expected lives
|
|
|
0.5
|
|
|
|
1.3
|
|
Volatility
|
|
|
38.0
|
%
|
|
|
40.0
|
%
|
Dividend yield
|
|
|
|
|
|
|
|
|
We derive the expected term of our options through a lattice
model that factors in historical data on employee exercise and
post-vesting employment termination behavior. The risk-free rate
for periods within the expected life of the option is based on
the U.S. Treasury yield curve in effect at the time of
grant. Since January 1, 2006, we have used the implied
volatility of options traded on our stock with a term of one
year or more to calculate the expected volatility of our option
grants. Prior to that time, the expected volatility was based
solely on the historical volatility of our stock. We have not
declared any dividends on our stock in the past and do not
expect to do so in the foreseeable future.
The assumptions that we have made represent our
managements best estimate, but they are highly subjective
and inherently uncertain. If management had made different
assumptions, our calculation of the options fair value and
the resulting stock-based compensation expense could differ,
perhaps materially, from the amounts recognized in our financial
statements. For example, if we increased the assumption
regarding our stocks volatility for options granted during
the three months ended March 31, 2006 by 10%, our
stock-based compensation expense would increase by
$0.7 million, net of expected forfeitures, amortized over
4.0 years. Likewise, if we increased our assumption of the
options expected lives by one year, our stock-based
compensation expense would increase by $0.4 million, net of
expected forfeitures, amortized over 4.0 years.
In addition to the assumptions used to calculate the fair value
of our options, we are required to estimate the expected
forfeiture rate of all share-based awards and only recognize
expense for those awards we expect to vest. The stock-based
compensation expense recognized in our condensed consolidated
statement of operations for the three months ended
March 31, 2006 has been reduced for estimated forfeitures.
If we were to change our estimate of forfeiture rates, the
amount of share-based compensation could differ, perhaps
materially, from the amount recognized in our financial
statements. For example, if we had decreased our estimate of
expected forfeitures by 50%, our stock-based compensation
expense for the three months ended March 31, 2006 net of
expected forfeitures would have increased by approximately
$0.7 million. This decrease in our estimate of expected
forfeitures would increase our estimated fair value of all
unvested stock options, restricted stock units, restricted stock
awards and
38
employee stock purchase rights that have not yet been recognized
as compensation expense by $11.1 million, net of expected
forfeitures, amortized over a weighted-average period of
3.0 years.
Accounting
for Income Taxes
At the end of each interim period we make our best estimate of
the effective tax rate expected to be applicable for the full
fiscal year. This effective tax rate is used to determine income
taxes on a current
year-to-date
basis. The effective tax rate may consider, as applicable, tax
credits, foreign tax rates, and other available tax planning
alternatives. It also includes the effect of any valuation
allowance expected to be necessary at the end of the period for
deferred tax assets related to originating deductible temporary
differences and carry-forwards. In arriving at this effective
tax rate applied to interim periods no effect is included for
the tax related to significant, unusual, or extraordinary items
that may be separately reported or reported net of their related
tax effect in reports for the interim period or for the fiscal
year. The rate is revised, if necessary, as of the end of each
successive interim period during the fiscal year to our best
current estimate of our expected annual effective tax rate.
The effective tax rate is our best estimate of the tax expense
(or benefit) that will be provided for the fiscal year, stated
as a percentage of our estimated annual ordinary income (or
loss). The tax expense (or benefit) related to ordinary income
(or loss) for the interim period is determined using this
estimated annual effective tax rate. The tax expense (or
benefit) related to other items is individually computed and
recognized when the items occur. The estimated tax rate applied
to interim ordinary income (or loss) is reliant on our estimates
of expected annual operating income (or loss) for the year as
well as our projections of the proportion of income (or loss)
earned in foreign jurisdictions which may have statutory tax
rates significantly lower than tax rates applicable to our
earnings in the United States. In each successive interim
period, to the extent our operating results year to date and our
estimates for the remainder of the fiscal year change from our
original expectations regarding the proportion of earnings in
various tax jurisdictions we expect that our effective tax rate
will change accordingly, affecting tax expense (or benefit) for
both that successive interim period as well as
year-to-date
interim results.
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
expense (or benefit) line item in our statement of income.
The net deferred tax asset as of March 31, 2006 is
$442.7 million, net of a valuation allowance of
$51.4 million. The valuation allowance is recorded due to
the uncertainty of our ability to utilize some of the deferred
tax assets related to foreign tax credits and net operating
losses of acquired companies. The valuation allowance is based
on our historical experience 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 each
period for unsettled issues, additional benefits or expenses
could occur in future years from resolution of outstanding
matters. We record additional expenses each period on unsettled
issues relating to the expected interest we would be required to
pay a tax authority if we do not prevail on an unsettled issue.
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. We have classified a portion of our tax liability as
non-current in the consolidated balance sheet based on the
expected timing of cash payments to settle contingencies with
taxing authorities.
39
Valuation
of Goodwill, Intangibles, and Long-lived Assets
We account for goodwill and other indefinite-lived intangible
assets in accordance with SFAS No. 142,
Goodwill and Other Intangible Assets, or
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.
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 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 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 most recent 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 March 31, 2006.
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 $438.3 million and $438.4 million
as of March 31, 2006 and December 31, 2005,
respectively. We did not hold any other indefinite-lived
intangibles as of March 31, 2006 and December 31,
2005. Net finite-lived intangible assets and long-lived assets
amounted to $163.2 million and $166.4 million as of
March 31, 2006 and December 31, 2005, respectively.
40
Results
of Operations
Reclassification
of Net Revenue and Cost of Net Revenue
As disclosed in our 2005 Annual Report on
Form 10-K,
during the three months ended December 31, 2005, we made
certain reclassifications from product revenue to service
revenue, primarily related to online subscriptions. Total net
revenue was not impacted by these reclassifications. The
following table presents our 2005 quarterly net revenue, as
reclassified in 2005, and cost of net revenue, as disclosed in
our respective Quarterly Report on
Form 10-Q
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Twelve Months Ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
45,145
|
|
|
$
|
43,805
|
|
|
$
|
32,578
|
|
|
$
|
46,010
|
|
|
$
|
167,538
|
|
Service and support
|
|
|
190,582
|
|
|
|
201,577
|
|
|
|
220,333
|
|
|
|
207,269
|
|
|
|
819,761
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
235,727
|
|
|
$
|
245,382
|
|
|
$
|
252,911
|
|
|
$
|
253,279
|
|
|
$
|
987,299
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
16,646
|
|
|
$
|
11,865
|
|
|
$
|
10,282
|
|
|
$
|
24,479
|
|
|
$
|
63,272
|
|
Service and support
|
|
|
18,161
|
|
|
|
21,105
|
|
|
|
22,873
|
|
|
|
23,689
|
|
|
|
85,828
|
|
Amortization of purchased
technology
|
|
|
3,850
|
|
|
|
3,886
|
|
|
|
3,938
|
|
|
|
3,841
|
|
|
|
15,515
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
$
|
38,657
|
|
|
$
|
36,856
|
|
|
$
|
37,093
|
|
|
$
|
52,009
|
|
|
$
|
164,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of January 1, 2006, we changed the presentation of our
net revenue and cost of net revenue to include three categories:
(i) product, which includes hardware and perpetual licenses
(ii) subscription, which includes subscription-based
offerings and (iii) service and support, which includes
maintenance, consulting and training. Previously, we chose to
allocate our subscription business between product and services
and support instead of presenting it as a separate category. We
believe this new presentation is consistent with the way we
currently manage our business as we grow the subscription
component of both our corporate and consumer businesses. In the
table below, we have applied the change in presentation
retrospectively to the balances previously reported for each
period during the year ended December 31, 2005. Total net
revenues and cost of net revenues were not affected by the
change.
The following table presents our revised 2005 quarterly net
revenue and cost of net revenue presentation (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Twelve Months Ended
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
35,537
|
|
|
$
|
34,308
|
|
|
$
|
20,825
|
|
|
$
|
37,185
|
|
|
$
|
127,855
|
|
Subscription
|
|
|
68,078
|
|
|
|
77,828
|
|
|
|
90,891
|
|
|
|
81,409
|
|
|
|
318,206
|
|
Service and support
|
|
|
132,112
|
|
|
|
133,246
|
|
|
|
141,195
|
|
|
|
134,685
|
|
|
|
541,238
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
235,727
|
|
|
$
|
245,382
|
|
|
$
|
252,911
|
|
|
$
|
253,279
|
|
|
$
|
987,299
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
16,923
|
|
|
$
|
11,986
|
|
|
$
|
10,399
|
|
|
$
|
24,636
|
|
|
$
|
63,944
|
|
Subscription
|
|
|
10,510
|
|
|
|
13,709
|
|
|
|
14,909
|
|
|
|
15,147
|
|
|
|
54,275
|
|
Service and support
|
|
|
7,374
|
|
|
|
7,275
|
|
|
|
7,847
|
|
|
|
8,385
|
|
|
|
30,881
|
|
Amortization of purchased
technology
|
|
|
3,850
|
|
|
|
3,886
|
|
|
|
3,938
|
|
|
|
3,841
|
|
|
|
15,515
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
$
|
38,657
|
|
|
$
|
36,856
|
|
|
$
|
37,093
|
|
|
$
|
52,009
|
|
|
$
|
164,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41
Net
Revenue
The following table sets forth, for the periods indicated, a
year-over-year
comparison of the key components of our net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
31,100
|
|
|
$
|
35,537
|
|
|
$
|
(4,437
|
)
|
|
|
(12
|
)%
|
Subscriptions
|
|
|
92,726
|
|
|
|
68,078
|
|
|
|
24,648
|
|
|
|
36
|
|
Services and support
|
|
|
148,141
|
|
|
|
132,112
|
|
|
|
16,029
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
271,967
|
|
|
$
|
235,727
|
|
|
$
|
36,240
|
|
|
|
15
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of total net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
|
11
|
%
|
|
|
15
|
%
|
|
|
|
|
|
|
|
|
Subscriptions
|
|
|
34
|
|
|
|
29
|
|
|
|
|
|
|
|
|
|
Services and support
|
|
|
55
|
|
|
|
56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in net revenue in the three months ended
March 31, 2006 compared to the three months ended
March 31, 2005 reflected (i) a $18.4 million
increase in our consumer business and (ii) a
$19.5 million increase in our corporate business due to
increased corporate spending on McAfee security products. These
increases were partially offset by (i) a $1.7 million
decrease attributable to McAfee Labs, which was sold in April
2005. Net revenues from our consumer market increased during the
three months ended March 31, 2006 primarily due to
(i) on-line subscriber growth from approximately
11.0 million on-line subscribers at March 31, 2005 to
approximately 19.0 million subscribers at March 31,
2006 due to our stronger strategic channel partner relationships
and (ii) increased online renewal subscriptions.
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America
|
|
$
|
150,662
|
|
|
$
|
141,433
|
|
|
$
|
9,229
|
|
|
|
7
|
%
|
EMEA
|
|
|
82,127
|
|
|
|
62,818
|
|
|
|
19,309
|
|
|
|
31
|
|
Japan
|
|
|
21,258
|
|
|
|
16,840
|
|
|
|
4,418
|
|
|
|
26
|
|
Asia-Pacific, excluding Japan
|
|
|
9,840
|
|
|
|
8,647
|
|
|
|
1,193
|
|
|
|
14
|
|
Latin America
|
|
|
8,080
|
|
|
|
5,989
|
|
|
|
2,091
|
|
|
|
35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
271,967
|
|
|
$
|
235,727
|
|
|
$
|
36,240
|
|
|
|
15
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of total net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America
|
|
|
55
|
%
|
|
|
60
|
%
|
|
|
|
|
|
|
|
|
EMEA
|
|
|
30
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
Japan
|
|
|
8
|
|
|
|
7
|
|
|
|
|
|
|
|
|
|
Asia-Pacific, excluding Japan
|
|
|
4
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
Latin America
|
|
|
3
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
42
Net revenue outside of North America, consisting of U.S. and
Canada, accounted for approximately 45% and 40% of net revenue
in the three months ended March 31, 2006 and 2005,
respectively. Net revenue from North America and EMEA has
historically comprised between 85% and 91% of our business.
During the three months ended March 31, 2006, the
U.S. Dollar strengthened
year-over-year
against many currencies, especially the Euro. As a result of the
stronger U.S. Dollar, we experienced negative impacts on
our net revenue in the EMEA region.
The increase in total net revenue in North America during the
three months ended March 31, 2006 primarily related to
(i) a $1.3 million increase in consumer revenue in
North America due to stronger strategic channel partner
relationships and (ii) a $9.6 million increase in
corporate revenue in North America partially offset by a
$1.7 million decrease in McAfee Labs revenue in North
America due to the sale of McAfee Labs in April 2005.
The increase in total net revenue in EMEA during the three
months ended March 31, 2006 was attributable to (i) a
$16.7 million increase in consumer revenue due to stronger
strategic channel partner relationships and (ii) a
$2.6 million increase in corporate revenue. Although total
net revenue from EMEA increased $19.3 million, the
weakening Euro against the U.S. Dollar did result in an
approximate $7.5 million negative impact to EMEA net
revenue in the three months ended March 31, 2006 compared
to the three months ended March 31, 2005.
Net revenues from our consumer market in both North America and
in EMEA increased during the three months ended March 31,
2006 primarily due to (i) on-line subscriber growth due to
stronger strategic channel partner relationships and
(ii) increased on-line renewal subscriptions.
Our Japan, Latin America and Asia-Pacific operations combined
have historically comprised less than 20% of our total net
revenue 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, political instability, tariffs and other trade
barriers, currency fluctuations, a high incidence of software
piracy in some countries, product localization, international
labor laws and our relationship with our employees and regional
work councils 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 as a percent of product
revenue.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Net product revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses
|
|
$
|
20,157
|
|
|
$
|
20,380
|
|
|
$
|
(223
|
)
|
|
|
(1
|
)%
|
Hardware
|
|
|
10,679
|
|
|
|
6,697
|
|
|
|
3,982
|
|
|
|
59
|
|
Retail and other
|
|
|
264
|
|
|
|
8,460
|
|
|
|
(8,196
|
)
|
|
|
(97
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total product revenue
|
|
$
|
31,100
|
|
|
$
|
35,537
|
|
|
$
|
(4,437
|
)
|
|
|
(12
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of product revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses
|
|
|
65
|
%
|
|
|
57
|
%
|
|
|
|
|
|
|
|
|
Hardware
|
|
|
34
|
|
|
|
19
|
|
|
|
|
|
|
|
|
|
Retail and other
|
|
|
1
|
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total product revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue includes revenue from software licenses,
hardware and retail product. The decrease in product revenue in
the three months ended March 31, 2006 compared to the three
months ended March 31, 2005 was attributable to (i) a
decrease in licenses revenue in the three months ended
March 31, 2006 due to our continued shift in focus from
retail-boxed products to our on-line subscription model for
consumers, (ii) increased incentive rebates
43
and marketing development funds with our partners which are
recorded as an offset to revenue and included in retail and
other revenue in the table above, partially offset by
(iii) increased Foundstone hardware revenue and increased
demand for Intrushield. In April 2005 we increased our support
pricing on selected consumer products, including VirusScan and
McAfee Internet Security, which resulted in a decrease in
product revenue in the three months ended March 31, 2006
compared to the three months ended March 31, 2005 due to
allocating more revenue related to service and support and
recognizing this deferred revenue ratably over the service and
support period.
Our customers license our software on a perpetual subscription
basis. Our perpetual licenses became a larger percentage of our
license revenue in all quarters following the implementation of
our perpetual-plus licensing model worldwide, which has
significantly higher support pricing. Thus, revenue has been
shifting out of product revenue and into services and support
revenue. We expect the remaining mix of product revenue to
stabilize as a percentage of revenue.
Subscription
Revenues
The following table sets forth, for the periods indicated, the
change in subscription revenue from March 31, 2005 to
March 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Total Subscription Revenue
|
|
$
|
92,726
|
|
|
$
|
68,078
|
|
|
$
|
24,648
|
|
|
|
36
|
%
|
Subscription revenues include revenue from subscription
arrangements. The increase in subscriptions revenue in the three
months ended March 31, 2006 compared to the three months
ended March 31, 2005 was attributable to (i) an
increase in our on-line subscription arrangements due to an
increase in our on-line customer base to approximately
19.0 million subscribers at March 31, 2006 from
approximately 11.0 million subscribers at March 31,
2005, (ii) an increase in our McAfee Managed VirusScan
on-line service for small and medium-sized businesses and
(iii) increased royalties from strategic channel partners.
The main driver of this subscriber growth was our continued
relationships with strategic channel partners, such as AOL,
Comcast and Dell.
Service
and Support Revenues
The following table sets forth, for the periods indicated, the
two categories of our service and support revenue as a percent
of total service and support revenue.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Net service and support revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Support and maintenance
|
|
$
|
144,969
|
|
|
$
|
125,611
|
|
|
$
|
19,358
|
|
|
|
15
|
%
|
Consulting and training
|
|
|
3,172
|
|
|
|
6,501
|
|
|
|
(3,329
|
)
|
|
|
(51
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total service and support revenue
|
|
$
|
148,141
|
|
|
$
|
132,112
|
|
|
$
|
16,029
|
|
|
|
12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of service and support
revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Support and maintenance
|
|
|
98
|
%
|
|
|
95
|
%
|
|
|
|
|
|
|
|
|
Consulting and training
|
|
|
2
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total service and support revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service and support revenues include revenues from software
support and maintenance contracts, training and consulting
revenue. The increase in service and support revenue in the
three months ended March 31, 2006 compared to the three
months ended March 31, 2005 was attributable to an increase
in support and maintenance primarily due to amortization of
revenue from support arrangements and increased sales of support
renewals offset slightly by a decrease in consulting and
training revenue. In addition, in April 2005 we increased our
support pricing
44
on selected consumer products, including VirusScan and McAfee
Internet Security, which contributed to the increase in service
and support revenue in the three months ended March 31,
2006.
Our future profitability and rate of growth, if any, will be
directly affected by our revenue-sharing arrangements with our
partners, increased price competition and the size of our
revenue base. Our growth rate and net revenue depend
significantly on renewals of support arrangements 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. Additionally,
support pricing under the perpetual-plus model is significantly
higher than the previous subscription model. In the event
customers choose not to renew their support arrangements or
renew such arrangements at other than the contractual rates,
revenue recognition under the perpetual-plus model could be
negatively impacted.
Cost
of Net Revenue; Gross Margin.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
$
|
15,667
|
|
|
$
|
16,923
|
|
|
$
|
(1,256
|
)
|
|
|
(7
|
)%
|
Subscription
|
|
|
18,944
|
|
|
|
10,510
|
|
|
|
8,434
|
|
|
|
80
|
|
Service and support
|
|
|
6,466
|
|
|
|
7,374
|
|
|
|
(908
|
)
|
|
|
(12
|
)
|
Amortization of purchased
technology
|
|
|
3,841
|
|
|
|
3,850
|
|
|
|
(9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
$
|
44,918
|
|
|
$
|
38,657
|
|
|
$
|
6,261
|
|
|
|
16
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of total cost of net
revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
|
|
|
35
|
%
|
|
|
44
|
%
|
|
|
|
|
|
|
|
|
Subscription
|
|
|
42
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
Service and support
|
|
|
14
|
|
|
|
19
|
|
|
|
|
|
|
|
|
|
Amortization of purchased
technology
|
|
|
9
|
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
$
|
227,049
|
|
|
$
|
197,070
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin percentage
|
|
|
83
|
%
|
|
|
84
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of
Product Revenue
Cost of product revenue consists primarily of the cost of media,
manuals and packaging for products distributed through
traditional channels, and, with respect to hardware-based
anti-virus and security products, computer platforms and other
hardware components. The decrease in cost of product revenue in
the three months ended March 31, 2006 compared to the three
months ended March 31, 2005 was primarily attributable to a
decrease in product revenue. We anticipate that cost of product
revenue will increase in absolute dollars primarily due to the
recognition of stock compensation expense and may fluctuate as a
percentage of cost of net revenue in future periods depending on
mix of products sold and various other factors.
Cost of
Subscription Revenue
Cost of subscription revenue consists primarily of costs related
to the sale of on-line subscription arrangements, the majority
of which are revenue-sharing arrangements and royalties paid to
our strategic channel partners. The increase in subscription
costs in the three months ended March 31, 2006 compared to
the three months ended March 31, 2005 was primarily
attributed to an increase in revenue-sharing arrangements and
royalties paid to our on-line strategic channel partners. Our
margins on cost of subscription have decreased due to higher
percentages paid for royalties. We anticipate that cost of
subscription revenue will increase in absolute dollars due to
the
45
recognition of stock compensation expense and may fluctuate as a
percentage of cost of net revenue in future periods depending on
the mix of products sold, revenue-share arrangements and various
other factors.
Cost of
Service and Support Revenue
Cost of services and support revenue consists principally of
salaries, stock compensation and benefits related to employees
providing customer support and consulting services. The cost of
services and support revenue as a percentage of service and
support net revenue in the three months ended March 31,
2006 was consistent with the three months ended March 31,
2005. The decrease in absolute dollars in the three months ended
March 31, 2006 compared to the three months ended
March 31, 2005 is due to a decrease in professional
services. We anticipate that cost of service and support revenue
will increase in absolute dollars due to the recognition of
stock compensation expense and may fluctuate as percentage of
cost of net revenue in future periods depending on the mix of
products sold and various other factors.
Amortization
of Purchased Technology
Amortization of purchased technology in the three months ended
March 31, 2006 remained relatively consistent compared to
the three months ended March 31, 2005. The purchased
technology is being amortized over estimated useful lives of up
to seven years. Amortization of purchased technology is expected
to be $11.5 million for the remainder of 2006.
Gross
Margins
Our gross margins were stable for the three months ended
March 31, 2006 compared to the three months ended
March 31, 2005. Gross margins may fluctuate in the future
due to various factors, including the mix of products sold,
sales discounts, contra-spend such as rebates and marketing
development funds, revenue-sharing agreements, material and
labor costs and warranty costs.
Stock-based
Compensation Expense
On January 1, 2006, we adopted SFAS 123R, which
requires the measurement and recognition of compensation expense
for all share-based awards made to our employees and directors
based on the estimated fair values. In the three months ended
March 31, 2006, we recognized stock-based compensation
expense of $13.6 million in our condensed consolidated
financial statements, which included $10.9 million for
stock options, $1.9 million for restricted stock awards and
units and $0.8 million for our Employee Stock Purchase
Plan. The following table summarizes stock-based compensation
expense recorded by income statement line item in the three
months ended March 31, 2006 (in thousands):
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2006
|
|
|
Cost of net
revenue product
|
|
$
|
226
|
|
Cost of net
revenue subscription
|
|
|
91
|
|
Cost of net
revenue service and support
|
|
|
359
|
|
|
|
|
|
|
Stock-based compensation expense
included in cost of net revenue
|
|
|
676
|
|
Research and development
|
|
|
3,917
|
|
Sales and marketing
|
|
|
4,691
|
|
General and administrative
|
|
|
4,287
|
|
|
|
|
|
|
Stock-based compensation expense
included in operating expenses
|
|
|
12,895
|
|
|
|
|
|
|
Total stock-based compensation
expense related to stock-based equity awards
|
|
|
13,571
|
|
Deferred tax benefit
|
|
|
3,925
|
|
|
|
|
|
|
Total stock-based compensation
expense related to stock-based equity awards, net of tax
|
|
$
|
9,646
|
|
|
|
|
|
|
46
Prior to our adoption of SFAS 123R, we accounted for
stock-based awards to employees and directors using the
intrinsic value method in accordance with APB 25 as allowed
under SFAS 123. Historically, our general policy was to set
the exercise price for our stock options equal to the market
value on the grant date. As a result, the options had no
intrinsic value on their grant dates, and we did not record any
compensation expense unless the terms of the options were
subsequently modified. During the three months ended
March 31, 2005, we recognized a benefit of approximately of
$3.3 million under APB 25 related to the exchange of
McAfee.com options in 2002 and re-pricing of options in 1999,
partially offset by expense related to restricted stock awards.
The following table summaries the stock-based compensation
benefit recorded in the three months ended March 31, 2005
(in thousands):
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2005
|
|
|
Research and development
|
|
$
|
(2,503
|
)
|
Marketing and sales
|
|
|
(735
|
)
|
General and administrative
|
|
|
(54
|
)
|
|
|
|
|
|
Total stock-based compensation
benefit
|
|
$
|
(3,292
|
)
|
|
|
|
|
|
See Note 4 in the condensed consolidated financial
statements for additional information regarding the benefit
recorded.
During the three months ended March 31, 2006, we changed
our equity compensation program for existing employees by
granting restricted stock units that vest over a specified
period of time instead of awarding stock options. For new
employees, we continue to grant stock options. Going forward,
our management will consider utilizing all types of equity
compensation to reward top-performing employees.
As of March 31, 2006, total compensation cost related to
unvested stock options, restricted stock units, restricted stock
awards and employee stock purchase rights not yet recognized and
reduced by estimated forfeitures was $113.6 million. This
amount is expected to be recognized over a weighted-average
period of approximately 3.0 years.
Operating
Costs
Research
and Development
The following table sets forth, for the periods indicated, a
comparison of our research and development expenses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Research and development
expenses(1)
|
|
$
|
51,191
|
|
|
$
|
38,230
|
|
|
$
|
12,961
|
|
|
|
34
|
%
|
Percentage of net revenues
|
|
|
19
|
%
|
|
|
16
|
%
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes stock-based compensation charges (benefits) of $3,917
and ($2,503) in the three months ended March 31, 2006 and
2005, respectively. |
Research and development expenses consist primarily of salary,
benefits, stock compensation for our development and technical
support staff, contractors fees and other costs associated
with the enhancements of existing products and services and
development of new products and services. The increase in
research and development expenses in the three months ended
March 31, 2006 was primarily attributable to (i) the
recognition of $3.9 million of stock compensation expense
in the three months ended March 31, 2006 due to the
implementation of SFAS 123R on January 1, 2006
compared to the recognition of a $2.5 million stock
compensation benefit under APB 25 in the three months ended
March 31, 2005, (ii) a $2.7 million increase in
salary expense for individuals performing research and
development activities primarily attributable to an increase in
average headcount and (iii) a $0.9 million increase in
discretionary spending specifically due to an increase in events
and travel for certain
47
research and development personnel, partially offset by a
$0.5 million decrease due to weakening foreign currencies
against the U.S. Dollar in EMEA and Japan.
We believe that continued investment in product development is
critical to attaining our strategic objectives. We expect
research and development expenses will increase in absolute
dollars primarily due to the recognition of stock compensation
expense and may fluctuate as a percentage of net revenue
compared to the same prior year periods for the remainder of
2006.
Marketing
and Sales
The following table sets forth, for the periods indicated, a
comparison of our marketing and sales expenses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Marketing and sales expenses(1)
|
|
$
|
84,866
|
|
|
$
|
71,184
|
|
|
$
|
13,682
|
|
|
|
19
|
%
|
Percentage of net revenues
|
|
|
31
|
%
|
|
|
30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes stock-based compensation charges (benefits) of $4,691
and ($735) in the three months ended March 31, 2006 and
2005, respectively. |
Marketing and sales expenses consist primarily of salary,
commissions, stock compensation and benefits for marketing and
sales personnel and costs associated with advertising and
promotions. The increase in marketing and sales expenses during
the three months ended March 31, 2006 compared to the three
months ended March 31, 2005 reflected (i) the
recognition of $4.7 million of stock compensation expense
in the three months ended March 31, 2006 due to the
implementation of SFAS 123R on January 1, 2006
compared to the recognition of a $0.7 million stock
compensation benefit under APB 25 in the three months ended
March 31, 2005, (ii) a $2.1 million increase in
salary expense for individuals performing marketing and sales
activities primarily attributable to an increase in average
headcount and (iii) increased spending on sales and
marketing programs, offset slightly by a $1.7 million
decrease due to weakening foreign currencies against the
U.S. Dollar in EMEA and Japan in the three months ended
March 31, 2006 compared to the same prior-year period.
We anticipate that marketing and sales expenses will increase in
absolute dollars and as a percentage of net revenue compared to
the same prior year periods for the remainder of 2006, primarily
due to the recognition of stock compensation expense beginning
January 1, 2006.
General
and Administrative
The following table sets forth, for the periods indicated, a
comparison of our general and administrative expenses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
General and administrative
expenses(1)
|
|
$
|
37,870
|
|
|
$
|
33,621
|
|
|
$
|
4,249
|
|
|
|
13
|
%
|
Percentage of net revenues
|
|
|
14
|
%
|
|
|
14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes stock-based compensation charges (benefits) of $4,287
and ($54) in the three months ended March 31, 2006 and
2005, respectively. |
General and administrative expenses consist principally of
salary, stock compensation and benefit costs for executive and
administrative personnel, professional services and other
general corporate activities. The increase in general and
administrative expenses during the three months ended
March 31, 2006 compared to the three months ended
March 31, 2005 reflected (i) the recognition of
$4.3 million of stock compensation expense in the three
months ended March 31, 2006 due to the implementation of
SFAS 123R on January 1, 2006 compared to the
recognition of a $0.1 million stock compensation benefit
under APB 25 in the three months ended March 31, 2005,
48
(ii) a $0.6 million increase in salary expense for
individuals performing general and administrative activities
primarily attributable to an increase in average headcount,
(iii) a $1.5 million increase in legal fees and
(iv) $0.4 million related to independent consultants
engaged to examine and recommend improvements to our internal
controls to ensure compliance with federal securities laws as
required by our settlement with the SEC, partially offset by
(i) a $0.9 million decrease in costs incurred to
comply with Section 404 of the Sarbanes-Oxley Act and
(ii) a $0.6 million decrease due to weakening foreign
currencies against the U.S. Dollar in EMEA and Japan.
In the three months ended March 31, 2006 and 2005, we
recognized acquisition-related compensation expense of
$0.9 million and $1.5 million, respectively, which
represents amounts paid to Entercept, IntruVert, Foundstone and
Wireless Security Corporation employees currently providing
services to us.
We anticipate that general and administrative expenses will
increase in absolute dollars primarily due to the recognition of
stock compensation expense and may fluctuate as a percentage of
net revenue compared to the same prior year periods for the
remainder of 2006.
Amortization
of Intangibles
The following table sets forth, for the periods indicated, a
comparison of the amortization of intangibles.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Amortization of intangibles
|
|
$
|
2,793
|
|
|
$
|
3,528
|
|
|
$
|
(735
|
)
|
|
|
(21
|
)%
|
Percentage of net revenues
|
|
|
1
|
%
|
|
|
2
|
%
|
|
|
|
|
|
|
|
|
Intangibles consist of identifiable intangible assets. The
decrease in amortization of intangibles in the three months
ended March 31, 2006 compared to the three months ended
March 31, 2005 was attributable to older intangibles
becoming fully amortized in 2006 and 2005.
Restructuring
Charges
The following table sets forth, for the periods indicated, a
comparison of our restructuring charges.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Restructuring charges
|
|
$
|
551
|
|
|
$
|
2,296
|
|
|
$
|
(1,745
|
)
|
|
|
(76
|
)%
|
Percentage of net revenues
|
|
|
|
|
|
|
1
|
%
|
|
|
|
|
|
|
|
|
During 2005, 2004 and 2003 we permanently vacated several leased
facilities and recorded accruals for estimated lease related
costs associated with the permanently vacated facilities. The
remaining costs associated with vacating the facilities are
primarily comprised of the present value of the remaining lease
obligations, along with estimated costs associated with
subleasing the vacated facility, net of estimated sublease
rental income. The 2006 restructuring charge consists of
accretion totaling $0.2 million and an adjustment to the
accrual totaling $0.4 million attributable to a change in
assumptions associated with commissions on existing subleases.
The 2005 restructuring charge consists of a charge totaling
$0.8 million for permanently vacated leased facilities, a
charge totaling $1.3 million for severance costs being
recognized over the required service period related to the move
of our European headquarters to Ireland and accretion of
$0.2 million. See Note 7 for further information
related to restructuring charges.
49
Loss on
Sale of Assets and Technology
The following table sets forth, for the periods indicated, a
comparison of the loss on sale of assets and technology.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Loss on sale of assets and
technology
|
|
$
|
24
|
|
|
$
|
259
|
|
|
$
|
(235
|
)
|
|
|
(91
|
)%
|
Percentage of net revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We recognized losses of less than $0.1 million and
approximately $0.3 million in the three months ended
March 31, 2006 and 2005, respectively related to the
write-off of property and equipment.
(Recovery
from) Provision for Doubtful Accounts, Net
The following table sets forth, for the periods indicated, a
comparison of our provision for (recovery from) doubtful
accounts, net.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
(Recovery from) provision for
doubtful accounts, net
|
|
$
|
(451
|
)
|
|
$
|
159
|
|
|
$
|
(610
|
)
|
|
|
(384
|
)%
|
Percentage of net revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for doubtful accounts consists of our estimates for
the uncollectibility of receivables, net of recoveries of
amounts previously written off. During the three months ended
March 31, 2006, we recognized a recovery from doubtful
accounts of $0.5 million related to the receipt of several
customer accounts primarily in North America and EMEA that had
previously been written-off.
Reimbursement
from Transition Services Agreement
The following table sets forth, for the periods indicated, a
comparison of our reimbursement from transition services
agreement.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Reimbursement from transition
services agreement
|
|
$
|
|
|
|
$
|
(328
|
)
|
|
$
|
328
|
|
|
|
100
|
%
|
Percentage of net revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In conjunction with the Sniffer sale, we entered into a
transition services agreement with Network General. Under this
agreement, we provided certain back-office services to Network
General for a period of time through June 2005. We completed our
requirements under the transition services agreement in July
2005.
Interest
and Other Income
The following table sets forth, for the periods indicated, a
comparison of our interest and other income.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
|
|
|
|
Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Interest and other income
|
|
$
|
12,036
|
|
|
$
|
4,960
|
|
|
$
|
7,076
|
|
|
|
143
|
%
|
Percentage of net revenues
|
|
|
4
|
%
|
|
|
2
|
%
|
|
|
|
|
|
|
|
|
50
Interest and other income includes interest earned on
investments, partially offset by net foreign currency
transaction losses. The increase in interest and other income is
partially due to an increase in average cash and marketable
securities in the three months ended March 31, 2006
compared to the three months ended March 31, 2005 of
approximately $244.9 million. In addition, our average rate
of annualized return on our investments has also increased from
2% in the three months ended March 31, 2005 to 4% in the
three months ended March 31, 2006. During the three months
ended March 31, 2006 and 2005, we recorded net foreign
currency transaction losses of $1.6 million and
$1.1 million, respectively, in our condensed consolidated
statements of income.
Provision
for Income Taxes
The following table sets forth, for the periods indicated, a
comparison of our provision for income taxes.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
2006 vs. 2005
|
|
|
|
2006
|
|
|
2005
|
|
|
$
|
|
|
%
|
|
|
|
(Dollars in thousands)
|
|
|
Provision for income taxes
|
|
$
|
21,249
|
|
|
$
|
16,463
|
|
|
$
|
4,786
|
|
|
|
29
|
%
|
Effective tax rate
|
|
|
34
|
%
|
|
|
31
|
%
|
|
|
|
|
|
|
|
|
The effective tax rate differs from the statutory rate primarily
due to the impact of foreign tax credits and lower effective
rates in some overseas jurisdictions. In each successive interim
period, to the extent our operating results year to date and our
estimates for the remainder of the fiscal year change from our
original expectations regarding the proportion of earnings in
various tax jurisdictions we expect that our effective tax rate
will change accordingly, affecting tax expense (or benefit) for
both that successive interim period as well as
year-to-date
interim results.
Although we reported an effective tax rate of 34% for the three
months ended March 31, 2006, our total tax expense of
$21.2 million was comprised of tax expense of
$19.0 million on year to date ordinary income at an
estimated 31% annual effective tax rate in addition to a net tax
expense of $2.2 million from discrete items individually
computed and recognized when the items occurred. The discrete
tax expense of $2.2 million primarily relates to increases
in foreign valuation allowances.
The earnings from our foreign operations in India are subject to
a tax holiday from a grant effective through 2010. The tax
holiday provides for zero percent taxation on certain classes of
income and requires certain conditions to be met. We are in
compliance with these conditions as of March 31, 2006.
Recent
Accounting Pronouncements
See Note 2 to the condensed consolidated financial
statements.
Liquidity
and Capital Resources
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Net cash provided by operating
activities
|
|
$
|
48,374
|
|
|
$
|
100,450
|
|
Net cash used in investing
activities
|
|
|
(137,516
|
)
|
|
|
(55,370
|
)
|
Net cash used in financing
activities
|
|
|
(209,518
|
)
|
|
|
(22,535
|
)
|
Overview
At March 31, 2006, we had cash and cash equivalents
totaling $430.5 million, as compared to $728.6 million
at December 31, 2005. In the three months ended
March 31, 2006, we generated positive operating cash flows
of $48.4 million, our restricted cash decreased
$49.7 million and we received cash of $18.0 million
related to our employee stock purchase plan and option exercises
under our employee stock option plans. Uses of cash during the
quarter included the repurchase of common stock of approximately
$230.6 million, including commissions, net purchases of
marketable securities of $177.1 million, payment of the
$50.0 million penalty to the SEC and
51
purchases of property and equipment of $10.2 million. A
more detailed discussion of changes in our liquidity follows.
Operating
Activities
Net cash provided by operating activities in the three months
ended March 31, 2006 and 2005 was primarily the result of
our net income of $40.9 million and $36.0 million,
respectively. Net income for the three months ended
March 31, 2006 was adjusted for non-cash items such as
depreciation and amortization of $15.2 million, stock
compensation charges of $13.6 million, changes in deferred
income taxes of $4.1 million and changes in various assets
and liabilities such as accrued taxes and other liabilities,
accounts receivable, deferred revenue and prepaid expenses,
prepaid taxes and other assets.
Historically, our 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, or DSO. DSOs
were 41 days and 36 days at March 31, 2006 and
2005, respectively. We calculate accounts receivable DSO on a
net basis by dividing the net accounts receivable
balance at the end of the quarter by the amount of net revenue
recognized for the quarter multiplied by 90 days. We expect
DSOs to vary from period to period because of changes in
quarterly revenue and the effectiveness of our collection
efforts. In 2006 and 2005, we did not make any significant
changes to our payment terms for our customers, which are
generally net 30.
The decrease in cash related to accounts payable, accrued taxes
and other liabilities was $66.6 million, which reflected
the payment of the $50.0 million penalty to the SEC. Our
operating cash flows, including changes in accounts payable and
accrued liabilities, are impacted by the timing of payments to
our vendors for accounts payable and taxing authorities. 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 cash payments in future
periods will be impacted by the nature of accounts payable
arrangements. In the three months ended March 31, 2006 and
2005, we did not make any significant changes to our payment
timing to our vendors.
Our cash and marketable securities balances are held in numerous
locations throughout the world, including substantial amounts
held outside the United States. As of March 31, 2006,
approximately $221.2 million was held outside the United
States. We utilize a variety of operational planning and
financing strategies in an effort to ensure that our worldwide
cash is available in the locations in which it is needed. We
have provided for U.S. federal income taxes on these
amounts for consolidated financial statement purposes, except
for foreign earnings that are considered indefinitely reinvested
outside the United States. The American Jobs Creations Act of
2004 provided for a deduction of 85% of certain foreign earnings
that are repatriated in stipulated periods, including our year
ending December 31, 2005. As a result, a
$350.0 million distribution was repatriated in the fourth
quarter of 2005.
Our working capital, defined as current assets minus current
liabilities, was $481.4 million and $698.7 million at
March 31, 2006 and December 31, 2005, respectively.
The decrease in working capital of approximately
$217.3 million from December 31, 2005 to
March 31, 2006 was primarily attributable to a
$202.2 million decrease in cash and short-term marketable
securities balances to repurchase common stock.
In the third quarter of 2005, we placed $50.0 million in
escrow for a proposed settlement with the SEC relating to the
Formal Order of Private Investigation into our
accounting practices that commenced on March 22, 2002 (see
Note 12 to our condensed consolidated financial
statements). On February 9, 2006, the SEC entered the
final judgment for settlement with us. The $50.0 million
escrow was released and transferred to the SEC on
February 13, 2006. The transfer to the SEC is reflected as
cash provided by investing activities of $50.0 million and
cash used in operating activities of $50.0 million. The
interest earned on the amount in escrow was released to us when
the transfer was made to the SEC and is reflected as a positive
adjustment to reconcile net income to net cash provided by
operating activities on our condensed consolidated statement of
cash flows for the three months ended March 31, 2006.
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
52
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
Our investing activities for the three months ended
March 31, 2006 and 2005 are as follows (in thousands).
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Net purchases of marketable
securities
|
|
$
|
(177,052
|
)
|
|
$
|
(46,223
|
)
|
Decrease (increase) in restricted
cash
|
|
|
49,727
|
|
|
|
(1
|
)
|
Purchase of property and equipment
and leasehold improvements, net
|
|
|
(10,191
|
)
|
|
|
(9,146
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided used in
investing activities
|
|
$
|
(137,516
|
)
|
|
$
|
(55,370
|
)
|
|
|
|
|
|
|
|
|
|
Investments
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 money market, U.S. government
fixed income 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 or sale of our investments has no material impact on
our overall liquidity.
Restricted
Cash
The current restricted cash balance of $50.5 million at
December 31, 2005 reflected the $50.0 million we
placed in escrow for the SEC settlement and the interest earned
on the escrow which was restricted until released by the SEC. On
February 9, 2006, the SEC entered the final judgment for
settlement with us. On our consolidated statement of cash flow,
the $50.0 million released from escrow for payment to the
SEC was reflected as cash provided by investing activities and
cash used in operating activities. The interest earned on the
escrow was released to cash upon payment to the SEC.
The non-current restricted cash balance of $1.2 million at
March 31, 2006 and $0.9 million at December 31,
2005 consisted primarily of cash collateral related to the
Foundstone facility lease, the Entercept facility lease and a
facility lease in India, as well as workers compensation
insurance coverage.
Property
and Equipment
The $10.2 million and $9.1 million of property and
equipment purchased during the three months ended March 31,
2006 and 2005, respectively, was primarily for upgrades of our
existing accounting system and purchases of computers, equipment
and software.
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.
Acquisitions
Our available cash and equity securities may be used to acquire
or invest in complementary companies, products and technologies.
53
Financing
Activities
Our financing activities for the three months ended
March 31, 2006 and 2005 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
Proceeds from issuance of common
stock under stock option and stock purchase plans
|
|
$
|
18,040
|
|
|
$
|
24,816
|
|
|
|
|
|
Excess tax benefits from
stock-based compensation
|
|
|
3,001
|
|
|
|
|
|
|
|
|
|
Repurchase of common stock
|
|
|
(230,559
|
)
|
|
|
(47,351
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing
activities
|
|
$
|
(209,518
|
)
|
|
$
|
(22,535
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
Option and Stock Purchase Plans
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 $18.0 million and $24.8 million in three months
ended March 31, 2006 and 2005, 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 are 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. In the three months ended
March 31, 2006, we changed our equity compensation program
for existing employees by granting restricted stock units
instead of awarding stock options. We continued to grant stock
options to new employees. Although management has not determined
what type of equity compensation we will use to reward
top-performing employees going forward, if management decides to
grant only restricted stock units, which provide no proceeds to
us, going forward, our proceeds from issuance of common stock
will decrease significantly.
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, choose not to exercise options, which
results in no cash received by us.
Excess
Tax Benefits from Stock-Based Compensation
The excess tax benefit reflected as a financing cash inflow in
the three months ended March 31, 2006 represents excess tax
benefits realized relating to share-based payments to our
employees, in accordance with SFAS 123R. There is a
corresponding cash outflow included in cash flows from operating
activities.
Repurchase
of Common Stock
In April 2005, our board of directors authorized the repurchase
of an additional $175.0 million of our common stock in the
open market from time to time until August 2006, depending upon
market conditions, share price and other factors. Prior to this
additional authorization, in November 2003 our board of
directors had authorized the repurchase of up to
$150.0 million of our common stock in the open market
through November 2005, and in August 2004, our board of
directors had authorized the repurchase of up to an additional
$200.0 million of our common stock in the open market
through August 2006. During the three months ended
March 31, 2006, we used $230.6 million to repurchase
9.6 million shares of our common stock in the open market,
including commissions paid on these transactions. During the
three months ended March 31, 2005, we used
$47.4 million to repurchase 2.0 million shares of our
common stock in the open market.
In April 2006, our board of directors authorized the repurchase
of an additional $250.0 million of our common stock in the
open market from time to time until October 2007, depending upon
market conditions, share price and other factors.
54
Credit
Facility
We have a $17.0 million credit facility with a bank. The
credit facility is available on an offering basis, meaning that
transactions under the credit facility will be on such terms and
conditions, including interest rate, maturity, representations,
covenants and events of default, as mutually agreed between us
and the bank at the time of each specific transaction. The
credit facility is intended to be used for short-term credit
requirements, with terms of one year or less. The credit
facility can be cancelled at any time. No balances are
outstanding as of March 31, 2006.
Off-Balance
Sheet Arrangements
We do not have 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 condensed consolidated financial statements.
|
|
Item 3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
Our market risks at March 31, 2006, have not changed
significantly from those discussed in Item 7A of our
Form 10-K
for the year ended December 31, 2005 filed with the
Securities and Exchange Commission.
|
|
Item 4.
|
Controls
and Procedures
|
Our management, with the participation of our Chief Executive
Officer and our Chief Financial Officer, evaluated 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 quarterly report on
Form 10-Q.
A control system, no matter how well conceived and operated, can
provide only reasonable assurance that the objectives of the
control system are met. Our management, including our Chief
Executive Officer and Chief Financial Officer, does not expect
that our disclosure controls and procedures or internal control
over financial reporting will prevent all errors and fraud.
Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control
issues within the company have been detected. These inherent
limitations include the reality that judgments in
decision-making can be faulty, and that breakdowns can occur
because of simple errors or mistakes. The design of any control
system is also based, in part, upon certain assumptions about
the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under
all potential future conditions. Over time, controls may become
inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a control system,
misstatements due to error or fraud may occur and not be
detected.
Based upon the material weakness described in Item 9A of
our Annual Report on
Form 10-K
filed on March 3, 2006, our Chief Executive Officer and
Chief Financial Officer have concluded that our disclosure
controls and procedures, and internal controls over financial
reporting, were ineffective as of March 31, 2006. Although
our controls over the financial close and reporting process were
sufficient to prevent a material misstatement of our financial
statements during the first quarter of 2006, they have not yet
operated consistently for an extended period of time to
remediate the material weakness that existed at
December 31, 2005. In accordance with the remediation plan
set forth in our Annual Report on
Form 10-K,
we took the following steps during the first quarter of 2006 to
ensure the continued effectiveness of our controls in subsequent
periods:
(1) Hired additional personnel for key finance and
accounting functions, including a controller of our North
American and Latin American operations and a senior manager of
technical accounting to ensure the consistency of our accounting
policies and procedures worldwide.
55
(2) Reduced our reliance on external consultants.
(3) Continued with our plans to automate and re-engineer
certain business process.
PART II:
OTHER INFORMATION
|
|
Item 1.
|
Legal
Proceedings
|
Information with respect to this item is incorporated by
reference to Note 12 of the notes to the condensed
consolidated financial statements included in this Report on
Form 10-Q.
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, Making It Difficult for
Us to Accurately Estimate Operating Results.
Our revenues and operating results have varied significantly in
the past. We expect fluctuations in our operating results to
continue. 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, making
expenses in the short term relatively fixed. We may be unable to
adjust our expenses in time to compensate for any unexpected
revenue shortfall.
Factors that may cause our revenues, gross margins and operating
results to fluctuate significantly from period to period,
include, but are not limited to:
|
|
|
|
|
introduction of new products, product upgrades or updates by us
or our competitors;
|
|
|
|
revenue recognition which may be influenced by volume, size,
timing and contractual terms of new licenses and renewals of
existing licenses;
|
|
|
|
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, ISPs such as AOL, OEMs such as
Dell, and others, (ii) the product is hardware or software
based and (iii) in the case of software licenses, the
licenses are perpetual licenses or time-based subscription
licenses;
|
|
|
|
changes in our supply chains and product delivery channels,
which may result in product fulfillment delays;
|
|
|
|
personnel limitations, which may adversely impact our ability to
process the large number of orders that typically occur near the
end of a fiscal quarter;
|
|
|
|
costs or charges related to our acquisitions or dispositions,
including our acquisitions of Site Advisor, Inc. in April 2006
and Wireless Security Corporation in June 2005 and the
dispositions of our McAfee Labs assets;
|
|
|
|
the components of our revenue that are deferred, including our
on-line subscriptions and that portion of our software licenses
attributable to support and maintenance;
|
|
|
|
stock-based compensation expense, which we began recognizing for
our stock-based compensation plans in the first quarter of 2006;
|
|
|
|
costs and charges related to certain events, including
Sarbanes-Oxley compliance efforts, litigation, relocation of
personnel and previous financial restatements;
|
|
|
|
changes in generally accepted accounting principles;
|
56
|
|
|
|
|
our ability to effectively manage our operating expense
levels; and
|
|
|
|
factors that lead to substantial declines in estimated values of
long-lived assets below their carrying value.
|
Although a significant portion of our revenue in any quarter
comes from previously deferred revenue, a meaningful part of our
revenue in any quarter depends on contracts entered into or
orders booked and shipped in that quarter. Historically, we have
experienced 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. Any
failure or delay in the closing of new orders in a given quarter
could have a material adverse effect on our quarterly operating
results. For example, during the fourth quarter of 2005, we
failed to meet our previously issued revenue and earnings
guidance due in part to incorrect assumptions regarding
in-period realization of fourth quarter bookings, a higher
proportion of sales involving ratable revenue or multi-year
support and more large, multi-product, multi-year enterprise
transactions that resulted in lower recognition of up-front
revenue. In addition, a significant portion of our revenue is
derived from product sales through our distributors. 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 accurately gather sales information on a timely
basis 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. We
may be required to expend time and money to ensure that
interfaces between our systems and our distributors
systems are up to date and effective. As our reliance upon
interdependent automated computer systems continues to increase,
a disruption in any one of these systems could interrupt the
distribution of our products and impact our ability to
accurately and timely recognize and report revenue. Further, as
we increasingly rely upon third-party manufacturers to
manufacture our hardware-based products, our reliance on their
ability to provide us with timely and accurate product cost
information exposes us to risk. A failure of our third-party
manufacturers to provide us with timely and accurate product
cost information may impact our costs of goods sold and
negatively impact our ability to accurately and timely report
revenue.
Because we expect these trends to continue, it is difficult for
us to accurately estimate operating results prior to the end of
a quarter.
We Face
Risks in Connection With the Material Weakness Resulting From
Our Sarbanes-Oxley Section 404 Management Report and Any
Related Remedial Measures That We Undertake.
In conjunction with (i) our ongoing reporting obligations
as a public company and (ii) the requirements of
Section 404 of the Sarbanes-Oxley Act that management
report as of December 31, 2005 on the effectiveness of our
internal control over financial reporting and identify any
material weaknesses in our internal control over financial
reporting, we engaged in a process to document, evaluate and
test our internal controls and procedures, including corrections
to existing controls and additional controls and procedures that
we may implement. As a result of this evaluation and testing
process, our management identified a material weakness in our
internal control over financial reporting relating to the
financial close process. See Item 9A in the Annual Report
on
Form 10-K
for the year ended December 31, 2005 for additional
disclosure about the material weakness. In response to the
material weakness in our internal control over financial
reporting, we have implemented and will continue to implement,
additional controls and procedures, including automating many of
our controls and financial reporting processes, re-engineering
our close process, standardizing our worldwide policies and
procedures and continuing to hire accounting and finance
personnel where appropriate. In addition, in connection with the
settlement of the SECs formal investigation into our
accounting practices, we are required to appoint an independent
consultant to conduct a one-time, comprehensive review of our
internal accounting and financial reporting controls, among
other matters. These efforts could result in increased cost and
could divert management attention away from operating our
business. As a result of the identified material weakness, even
though our management believes that our efforts to remediate and
re-test our internal control deficiencies have resulted in the
improved operation of our internal control over financial
reporting, we cannot be certain that the measures we have taken
or we are planning to take will sufficiently and satisfactorily
remediate the identified material weakness in full.
In future periods, if the process required by Section 404
of the Sarbanes-Oxley Act reveals further material weaknesses or
significant deficiencies, the correction of any such material
weakness or significant deficiency could
57
require additional remedial measures which could be costly and
time-consuming. In addition, the discovery of further material
weaknesses could also require the restatement of prior period
operating results. If a material weakness exists as of a future
period year-end (including a material weakness identified prior
to year-end for which there is an insufficient period of time to
evaluate and confirm the effectiveness of the corrections or
related new procedures), our management will be unable to report
favorably as of such future period year-end to the effectiveness
of our control over financial reporting. If we are unable to
assert that our internal control over financial reporting is
effective in any future period (or if our independent auditors
are unable to express an opinion on the effectiveness of our
internal controls), or if we continue to experience material
weaknesses in our internal control over financial reporting, we
could lose investor confidence in the accuracy and completeness
of our financial reports, which would have an adverse effect on
our stock price and potentially subject us to litigation.
If We
Fail to Effectively Upgrade Our Information Technology System,
We May Not Be Able to Accurately Report Our Financial Results or
Prevent Fraud.
As part of our efforts to continue improving our internal
control over financial reporting, we plan to upgrade our
existing SAP information technology system during 2006 in order
to automate certain controls that are currently performed
manually. We may experience difficulties in transitioning to new
or upgraded systems, including loss of data and decreases in
productivity as personnel become familiar with new systems. In
addition, our management information systems will require
modification and refinement as we grow and as our business needs
change, which could prolong difficulties we experience with
systems transitions, and we may not always employ the most
effective systems for our purposes. If we experience
difficulties in implementing new or upgraded information systems
or experience significant system failures, or if we are unable
to successfully modify our management information systems and
respond to changes in our business needs, our operating results
could be harmed or we may fail to meet our reporting
obligations. In addition, as a result of the automation of these
manual processes, the data produced may cause us to question the
accuracy of previously reported financial results.
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. As
competition increases, we expect increases in our
product-related expenses, including increased product rebates,
marketing development funds and strategic channel partner
revenue-sharing agreements. Some of our competitors have longer
operating histories, have more extensive international
operations, 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 system protection market, which includes our anti-virus
and risk assessment and vulnerability management solutions,
Symantec Corp., CA, Inc. and Microsoft Corp. Trend Micro Inc.
remains the strongest competitor in the Asian anti-virus market
and has recently entered the U.S. market. F-Secure
Corporation, Dr. Ahns Anti-Virus Lab, Panda Software and
Sophos are also showing growth in their respective
markets; and
|
|
|
|
in the network protection market, which includes our other
intrusion detection and protection products, Cisco Systems Inc.,
CA, Inc., Internet Security Systems Inc., Juniper Networks,
Inc., Symantec Corp. and 3Com Corporation. Qualys and Internet
Security Systems Inc. are the strongest competitors for our
Foundstone products and solutions.
|
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.
A significant portion of our revenue comes from our consumer
business. We will continue to focus on growth in this segment
both directly and through relationships with ISPs such as AOL
and Comcast, and PC OEMs, such as Dell and Gateway. As
competition in this market increases, we may experience pricing
pressures from both our competitors and partners which may have
a negative effect on our ability to sustain our revenue and
market share growth. In addition, as our consumer business
becomes more dependent upon the ISP model, our direct on-line
58
revenue may suffer and our retail box business may also continue
to decline. Furthermore, as penetration of the consumer
anti-virus market through the ISP model increases, this market
may become saturated.
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, in the first
quarter of 2006 Microsoft announced that it intends to release
its consumer security solution in June 2006 and continues to
execute on its announced plans to boost the security
functionality of its Windows platform through its acquisition of
managed service provider FrontBridge Technologies, anti-virus
provider Sybari Software, Inc. and anti-spyware provider GIANT
Company Software. Through its acquisitions of Okena, Inc.,
Riverhead Networks and NetSolv, Cisco Systems Inc. may
incorporate functionality that competes with our content
filtering and anti-virus products. In addition, Juniper
Networks, Inc. acquired Netscreen Technologies.
The widespread inclusion of products that perform the same or
similar functions as our products within computer hardware or
other companies software products could reduce the
perceived need for our products or render our products obsolete
and unmarketable. Furthermore, even if these competitors
incorporated products are inferior or more limited than our
products, customers may elect to accept the incorporated
products rather than purchase our products. Or, if our
competitors products are offered at significant discounts
to our prices or for free, we may be unable to respond
competitively, or may have to significantly reduce our prices
which would negatively impact our revenue. 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 International Operations.
During the three months ended March 31, 2006, net revenue
in our operating regions outside of North America represented
approximately 45% of our net revenue. We intend to continue our
focus on international growth and expect international revenue
to remain a significant percentage of our net revenue.
Risks related to international operations include:
|
|
|
|
|
longer payment cycles and greater difficulty in collecting
accounts receivable;
|
|
|
|
increased costs and management difficulties related to the
growth and operation of our international sales and support
organization;
|
|
|
|
our ability to successfully establish, manage and staff shared
service centers for worldwide sales finance and accounting
operations centralized from locations in the U.S. and Europe;
|
|
|
|
our ability to adapt to sales and marketing practices and
customer requirements in different cultures;
|
|
|
|
our ability to successfully localize software products for a
significant number of international markets;
|
|
|
|
compliance with more stringent consumer protection and privacy
laws;
|
|
|
|
currency fluctuations, including weakness of the
U.S. dollar relative to other currencies, or the
strengthening of the U.S. dollar that may have an adverse
impact on revenues, financial results and cash flows and risks
related to hedging strategies;
|
|
|
|
enactment of additional regulations or restrictions on the use,
import or export of encryption technologies, which would delay
or prevent the acceptance and use of encryption products and
public networks for secure communication;
|
|
|
|
political instability in both established and emerging markets;
|
|
|
|
tariffs, trade barriers and export restrictions;
|
|
|
|
a high incidence of software piracy in some countries; and
|
|
|
|
international labor laws and our relationship with our employees
and regional work councils.
|
59
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,
theft or misappropriation. Competitors may independently develop
technologies or products that are substantially equivalent or
superior to our products or that inappropriately incorporate our
proprietary technology. We are aware that a substantial number
of users of our anti-virus products have not paid any
registration or license fees to us. 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.
We Face
Risks Related to Our Strategic Alliances.
Through our strategic alliances we may from time to time license
technology from third parties to integrate or bundle with our
products or we may license out our technology for others to
integrate or bundle with their products. 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:
|
|
|
|
|
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 agreements with our strategic alliances are terminable
without cause with no or minimal notice or penalties. We may
expend significant time, money and resources to further
relationships with our strategic alliances that are thereafter
terminated.
|
|
|
|
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 sales force and our marketing and professional services
personnel 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.
|
|
|
|
We may be required to share ownership in technology developed as
part of our strategic alliances
|
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;
|
|
|
|
extend security technologies to additional digital devices such
as mobile phones and personal digital assistants;
|
|
|
|
respond promptly to new customer requirements and industry
standards;
|
|
|
|
provide frequent, low cost upgrades and updates for our products;
|
|
|
|
maintain quality; and
|
|
|
|
remain compatible with popular operating systems such as Linux,
Windows XP, and Windows NT, and develop products that are
compatible with new or otherwise emerging operating systems such
as Microsofts Vista Operating System.
|
60
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. The widespread inclusion of products that
perform the same or similar functions as our products within the
Windows platform could reduce the perceived need for our
products. For example, in the first quarter of 2006 Microsoft
announced that it intends to release its consumer security
solution in June 2006 and continues to execute on its announced
plans to boost the security functionality of its Windows
platform. 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. The
occurrence of these events could negatively impact our revenue.
We Face
Risks Associated with Past and Future Acquisitions.
We may buy or make investments in complementary companies,
products and technologies. For example, in October 2004 we
acquired Foundstone to bolster our risk assessment and
vulnerability management capabilities and in June 2005 we
acquired Wireless Security Corporation to continue to develop
their patent-pending technology, to introduce a new consumer
wireless security offering, and to integrate the technology into
our small business managed solution. In addition, we acquired
SiteAdvisor in April 2006. We may not realize the anticipated
benefits from the Foundstone, Wireless Security Corporation or
SiteAdvisor acquisitions.
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 and integrate
back-office accounting, order processing and support 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.
Managements 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.
Internal
Controls, Policies and Procedures
Acquired companies or businesses are likely to have different
standards, controls, contracts, procedures and policies, making
it more difficult to implement and harmonize company-wide
financial, accounting, billing, information and other systems.
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
61
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.
|
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, in April 2006 we used
approximately $60.8 million to acquire SiteAdvisor, Inc.
and in June 2005 we used approximately $20.2 million to
acquire Wireless Security Corporation. Moreover, if we acquire a
company, we may have to incur or assume that companys
liabilities, including liabilities that may not be fully known
at the time of acquisition.
We Face
Manufacturing, Supply, Inventory, Licensing and Obsolescence
Risks Relating to Our Products.
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 we
continue to expand our portfolio of hardware-based network
protection and system protection products. 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,
at a sufficient level of quality, 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.
Furthermore, supply disruptions or cost increases could increase
our costs of goods sold and negatively impact our financial
performance. For example, if the price to us of our
hardware-based products increased and we were unable to offset
the price increase, then the increased cost to us of selling the
product could reduce our overall profitability.
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 software licensed from third
parties. 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.
62
Obsolescence
Hardware-based products may face greater obsolescence risks than
software products. We could incur losses or other charges in
disposing of obsolete inventory.
Product
Fulfillment
We typically fulfill delivery of our hardware-based products
from centralized distribution centers. We have in the past and
may in the future make changes in our product delivery network.
Changes in our product delivery network may disrupt our ability
to timely and efficiently meet our product delivery commitments,
particularly at the end of a quarter. As a result, we may
experience increased costs in the short term as temporary
delivery solutions are implemented to address unanticipated
delays in product delivery. In addition, product delivery delays
may negatively impact our ability to recognize revenue if
shipments are delayed at the end of a quarter.
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 these
products and our intrusion protection products may at times in
the future, falsely detect viruses or computer threats 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 markets perception of
our security products.
We Face a
Number of Risks Related to Our Product Sales Through
Intermediaries.
We sell a significant amount of our products through
intermediaries such as distributors, PC OEMs, ISPs and other
strategic channel partners, referred to collectively as
distributors. Our top ten distributors typically represent
approximately 46% to 65% of our net sales in any quarter. We
expect this percentage to increase as we continue to focus our
sales efforts through the channel and other partners. Our two
largest distributors, Ingram Micro Inc. and Tech Data Corp.,
together accounted for approximately 25% of our net revenue in
the three months ended March 31, 2006.
Sale
of Competing Products
Our distributors may sell other vendors products that are
complementary to, or compete with, our products. While we have
instituted programs designed to motivate our distributors to
focus on our products, these distributors may give greater
priority to products of other suppliers, including competitors.
Our ability to meaningfully increase the amount of our products
sold through our distributors depend on our ability to
adequately and efficiently support these distributors with,
among other things, appropriate financial incentives to
encourage pre-sales investment and sales tools, such as online
sales and technical training as product collateral needed to
support their customers and prospects. Any failure to properly
and efficiently support our distributors may result in our
distributors focusing more on our competitors products
rather than our products and thus in lost sales opportunities.
Loss
of a Distributor
The agreements with our distributors, such as Dell, Ingram Micro
Inc., Tech Data Corp. and AOL, are generally terminable by
either party without cause with no or minimal notice or
penalties. We may expend significant time, money and resources
to further relationships with our distributors that are
thereafter terminated. If one of our significant distributors
terminates its agreement with us, we could experience a
significant interruption in the distribution of our products. In
addition, our business interests and those of our distributors
may diverge over time, which might result in conflict,
termination or a reduction in collaboration. For example, our
relationship with Internet Security Systems Inc. was terminated
following the announcement of our acquisitions in 2003 of
Entercept and IntruVert.
63
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 $2.2 million as of March 31, 2006. 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
Risks Related to Customer Outsourcing to System
Integrators.
Some of our customers have outsourced the management of their
information technology departments to large system integrators.
If this trend continues, our established customer relationships
could be disrupted and our products could be displaced by
alternative system and network protection solutions offered by
system integrators. Significant product displacements could
impact our revenue and have a material adverse effect on our
business.
Critical
Personnel May Be Difficult to Attract, Assimilate and
Retain.
Our success depends in large part on our ability to attract and
retain senior management personnel, as well as technically
qualified and highly-skilled sales, consulting, technical,
finance and marketing personnel. Other than executive management
who have at will employment agreements, our
employees are not typically subject to an employment agreement
or non-competition agreement. For example, in January 2006, Gene
Hodges, our former president, resigned to pursue other
opportunities. In the past we have experienced significant
turnover in our finance organization worldwide and replacing
these personnel remains difficult given the competitive market
for these skill sets.
It could be difficult, time consuming and expensive to replace
any key management member or other critical personnel.
Integrating new management and other key personnel also may be
difficult and costly. Changes in 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. It may take significant time to locate, retain and
integrate qualified management personnel.
Other personnel related issues that we may encounter include:
Competition
for Personnel; Need for Competitive Pay Packages
Competition for qualified individuals in our industry is
intense. To attract and retain critical personnel, we believe
that we must maintain an open and collaborative work
environment. We also believe we need to provide a competitive
compensation package, including stock options and restricted
stock. Increases in shares available for issuance under our
stock option plans require stockholder approval. Institutional
stockholders, or our other stockholders, may not approve future
requests for option pool increases. For example, at our 2003
annual meeting held in December 2003, our stockholders did not
approve a proposed increase in shares available for grant under
our employee stock option plans. Additionally, as of January
2006 we are required to include compensation expense in our
consolidated statement of income and comprehensive income
relating to the issuance of employee stock options. We are
currently evaluating our compensation programs and in particular
our equity compensation philosophy. In the future, we may decide
to issue fewer stock options, possibly impairing our ability to
attract and retain necessary personnel. Conversely, issuing a
comparable number of stock options could adversely impact our
results of operations when compared with periods prior to the
effectiveness of these new rules.
Reduced
Productivity of New Hires; Senior Management
Additions
Notwithstanding our ongoing efforts to reduce our general
personnel levels, we continue to hire in key areas and have
added a number of new employees in connection with our
acquisitions. We have also increased our hiring in Bangalore,
India in connection with the relocation of a significant portion
of our research and development operations to India.
Several members of our senior management were only added in the
last year, and we may add new members to senior management. In
July 2005 we hired Richard Decker as our new senior vice
president and chief information officer and in the second
quarter of 2005, we promoted William Kerrigan to the position of
executive vice president
64
of consumer brands. Also, in March 2006 we promoted Kevin Weiss
to the position of president of McAfee, Inc. and Eric Brown to
the position of chief operating officer and chief financial
officer of McAfee, Inc.
For new employees or management additions, there may be reduced
levels of productivity as recent additions or hires are trained
or otherwise assimilate and adapt to our organization and
culture.
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, or a false positive, failure or bug in our products,
including a security vulnerability, could disrupt or cause
damage to the networks of our customers, including disruption of
legitimate network traffic by our products. For example, in
March 2006 we released a data file update that contained a
defect causing certain of our products to generate false
positives. Failure of our products to perform to specifications
(including the failure of our products to identify or block a
virus), disruption of our customers network traffic or
damages to our customers networks caused by our products
could result in product liability damage claims by our
customers. Our license agreements with our customers typically
contain provisions designed to limit our exposure to potential
product liability claims. It is possible, however, that the
limitation of liability provisions may not be effective under
the laws of certain jurisdictions, particularly in circumstances
involving unsigned licenses.
Intellectual
Property Litigation in the Network and System Security Market Is
Common and Can Be Expensive.
Litigation may be necessary to enforce and protect trade
secrets, patents and other intellectual property rights that we
own. Similarly, we may be required to defend against claimed
infringement by others.
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, or 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.
Computer
Hackers May Damage Our Products, Services and
Systems.
Due to our high profile in the network and system protection
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 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
65
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 compact disk, or CD, duplication by
distributors or our independent agents, CDs containing our
software may be infected with viruses.
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 other 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 managements
attention and resources.
We Face
Risks Related to the Settlement Agreement with the Securities
and Exchange Commission.
On February 9, 2006, the United States District Court for
the Northern District of California entered a final judgment
permanently enjoining us and our officers and agents from future
violations of the securities laws. This final judgment resolved
the charges filed against us in connection with the SECs
investigation of our financial results. As a result of the
judgment, we will forfeit for three years the ability to invoke
the safe harbor for forward-looking statements
provision of the Private Securities Litigation Reform Act or the
Reform Act. This safe harbor provided us enhanced protection
from liability related to forward-looking statements if the
forward-looking statements were either accompanied by meaningful
cautionary statements or were made without actual knowledge that
they were false or misleading. While we may still rely on the
bespeaks caution doctrine that existed prior to the
Reform Act for defenses against securities lawsuits, without the
statutory safe harbor, it may be more difficult for us to defend
against any such claims. In addition, due to the permanent
restraint and injunction against violating applicable securities
laws, any future violation of the securities laws would be a
violation of a federal court order and potentially subject us to
a contempt order. For instance, if, at some point in the future,
we were to discover a fact that caused us to restate our
financial statements similar to the restatements that were the
subject of the SEC action, we could be found to have violated
the final judgment. Further, any collateral criminal or civil
investigation, proceeding or litigation related to any future
violation of the judgment, such as the compliance actions
mandated by the judgment, could result in the distraction of
management from our
day-to-day
business and may materially and adversely affect our reputation
and results of operations.
We Face
Risks Related to Our Anti-Spam and Anti-Spyware Software
Products.
Our anti-spam and anti-spyware products may falsely identify
emails or programs as unwanted spam or
potentially unwanted programs, fail to properly
identify unwanted emails or programs, particularly as
spam emails or spyware are often designed to
circumvent anti-spam or spyware products, or, in the case of our
anti-spam products, incorrectly identify legitimate businesses
as users of phishing technology. Parties whose emails or
programs are blocked by our products, or whose websites are
incorrectly identified as utilizing phishing techniques, may
seek redress against us for labeling them as
spammers or spyware, or for interfering with their
business. In addition, false identification of emails or
programs as unwanted spam or potentially
unwanted programs may reduce the adoption of these
products.
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.
66
Our Tax
Strategy May Expose Us to Risk.
We are generally required to account for taxes in each
jurisdiction in which we operate. This process may require us to
make assumptions, interpretations and judgments with respect to
the meaning and application of promulgated tax laws and related
administrative and judicial interpretations thereof of the
jurisdictions in which we operate. The positions that we take
and our interpretations of the tax laws may differ from the
positions and interpretations of the tax authorities in the
jurisdictions in which we operate. An audit by a tax authority
that results in a contrary decision could have a significant
negative impact on our cash position and net income.
Business
Interruptions May Impede Our Operations and the Operations of
Our Customers.
We are continually updating or modifying our accounting systems.
Modifications of these types of systems are often disruptive to
business and may cause us to incur higher costs than we
anticipate. Failure to properly manage this process 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. 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.
Our Stock
Price Has Been Volatile and Is Likely to Remain
Volatile.
During 2005, our stock price was highly volatile ranging from a
per share high of $33.24 to a low of $20.35. On March 31,
2006, our stocks closing price per share price was $24.33.
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. In addition, third-party
announcements such as those made by our partners and competitors
may contribute to current and future stock price volatility. For
example, future announcements by Microsoft Corp. related to its
consumer security solution may contribute to future volatility
in our stock price. Certain types of investors may choose not to
invest in stocks with this level of stock price volatility.
We Face
the Risk of a Decrease in Our Cash Balances and Losses in Our
Investment Portfolio.
Our cash balances are held in numerous locations throughout the
world. A portion of our cash is invested in marketable
securities as part of our investment portfolio. We rely on
third-party money managers to manage our investment portfolio.
Among other factors, changes in interest rates, foreign currency
fluctuations and macro economic conditions could cause our cash
balances to fluctuate and losses in our investment portfolio.
Most amounts held outside the United States could be repatriated
to the United States, but, under current law, would be subject
to U.S. federal income tax, less applicable foreign tax
credits.
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
2006 annual meeting,
67
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 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.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
Stock
Repurchases
The table below sets forth all repurchases by us of our common
stock during the quarter ended March 31, 2006, all of which
were pursuant to a publicly announced plan or program:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate Dollar
|
|
|
|
|
|
|
|
|
|
Total Number of
|
|
|
Value of Shares
|
|
|
|
Total
|
|
|
|
|
|
Shares Purchased as
|
|
|
That May Yet be
|
|
|
|
Number of
|
|
|
Average
|
|
|
Part of Publicly
|
|
|
Purchased Under
|
|
|
|
Shares
|
|
|
Price Paid
|
|
|
Announced Plan or
|
|
|
Our Stock Repurchase
|
|
Period
|
|
Purchased
|
|
|
per Share
|
|
|
Repurchase Program
|
|
|
Program
|
|
|
|
(In thousands, except price per
share)
|
|
|
January 1, 2006 through
January 31, 2006
|
|
|
7
|
|
|
$
|
27.10
|
|
|
|
|
|
|
$
|
230,217
|
|
February 1, 2006 through
February 28, 2006
|
|
|
4,088
|
|
|
|
23.79
|
|
|
|
4,088
|
|
|
|
132,944
|
|
March 1, 2006 through
March 31, 2006
|
|
|
5,550
|
|
|
|
23.95
|
|
|
|
5,550
|
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
9,645
|
|
|
$
|
23.88
|
|
|
|
9,638
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In April 2005, our board of directors authorized the repurchase
of an additional $175.0 million of our common stock in the
open market from time to time until August 2006. In 2005, we
repurchased approximately 2.8 million shares for a total of
$68.4 million. As of December 31, 2005, we had
authorization from our board of directors to repurchase an
additional $230.2 million of our common stock. In February
2006, we repurchased approximately 4.1 million shares in
open market transactions for a total of $97.3 million. In
March 2006, we repurchased approximately 5.6 million shares
in open market transactions for a total of $132.9 million.
In January 2006, the shares of common stock repurchased were in
connection with our obligation to a holder of restricted stock
to withhold the number of shares required to satisfy such
holders tax liability in connection with the vesting of
such shares. These shares were not part of the publicly
announced repurchase program.
In April 2006, our board of directors authorized the repurchase
of an additional $250.0 million of our common stock in the
open market from time to time until October 2007, depending upon
market conditions, share price and other factors.
68
|
|
Item 3.
|
Defaults
upon Senior Securities
|
None.
|
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
None.
|
|
Item 5.
|
Other
Information
|
None.
(a) Exhibits. The exhibits listed in the
accompanying Exhibit Index are filed or incorporated by
reference as part of this Report.
69
SIGNATURES
Pursuant to the requirements 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.
McAfee Inc.
/s/ Eric F. Brown
Eric F. Brown
Executive Vice President, Chief Financial Officer and
Chief Operating Officer
May 2, 2006
70
EXHIBIT INDEX
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
3
|
.1
|
|
Second Restated Certificate of
Incorporation of the Registrant, as amended on December 1,
1997.(2)
|
|
3
|
.2
|
|
Certificate of Ownership and
Merger between Registrant and McAfee, Inc.(1)
|
|
3
|
.3
|
|
Amended and Restated Bylaws of the
Registrant.(1)
|
|
3
|
.4
|
|
Certificate of Designation of
Series A Preferred Stock of the Registrant.(4)
|
|
3
|
.5
|
|
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,
as amended.(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
|
.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
|
.16*
|
|
Employment Agreement between Kent
H. Roberts and the Registrant, dated October 9, 2001.(13)
|
|
10
|
.18*
|
|
Employment Agreement between Kevin
M. Weiss and the Registrant Dated October 15, 2002. (16)
|
|
10
|
.19
|
|