e10vk
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the Fiscal Year Ended December 31, 2004 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the Transition Period
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Commission File Number: 001-31216
McAfee, Inc.
(Exact name of registrant as specified in its charter)
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Delaware |
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77-0316593 |
(State or other jurisdiction
of incorporation or organization) |
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(I.R.S. Employer
Identification Number) |
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3965 Freedom Circle
Santa Clara, California
(Address of principal executive offices) |
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95054
(Zip Code) |
Registrant’s telephone number, including area code:
(408) 988-3832
Securities registered pursuant to Section 12(b) of the
Act:
None
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock, $0.01 Par Value,
together with associated Rights
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of the
registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the
Act). Yes þ No o
The aggregate market value of the voting stock held by
non-affiliates of the issuer as of the last business day of the
Registrant’s most recently completed second fiscal quarter
(June 30, 2004) was approximately $2.8 billion. The
number of shares outstanding of the issuer’s common stock
as of February 28, 2005 was 163,500,000.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10, 11, 12, 13 and 14 of Part III are
incorporated by reference from the Registrant’s Proxy
Statement for the Annual Meeting of Stockholders to be held on
May 25, 2005.
This document contains 126 pages.
MCAFEE INC.
FORM 10-K
For the fiscal year ended December 31, 2004
TABLE OF CONTENTS
1
PART I
General
This Annual Report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The statements
contained in the Report on Form 10-K that are not
purely historical are forward-looking statements within the
meaning of Section 27A of the Securities Act and
Section 21E of the Exchange Act, including, without
limitation, statements regarding our expectations, beliefs,
intentions or strategies regarding the future. All
forward-looking statements included in this Report on
Form 10-K are based on information available to us on the
date hereof. These statements involve known and unknown risks,
uncertainties and other factors, which may cause our actual
results to differ materially from those implied by the
forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as
“may,” “will,” “should,”
“could,” “expects,” “plans,”
“anticipates,” “believes,”
“estimates,” “predicts,”
“potential,” “targets,” “goals,”
“projects,” “continue,” or variations of
such words, similar expressions, or the negative of these terms
or other comparable terminology. Although we believe that the
expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Therefore, actual results
may differ materially and adversely from those expressed in any
forward-looking statements. Neither we nor any other person can
assume responsibility for the accuracy and completeness of
forward-looking statements. Important factors that may cause
actual results to differ from expectations include, but are not
limited to, those discussed in “Risk Factors”
beginning on page 10 in this document. We undertake no
obligation to revise or update publicly any forward-looking
statements for any reason.
We were incorporated in 1992. In June 2004, we changed our name
to McAfee, Inc. from Network Associates, Inc. We previously
changed our name from McAfee Associates, Inc. to Network
Associates, Inc. in conjunction with our December 1997 merger
with Network General Corporation. In July 2004, we completed the
sale of the Sniffer business assets acquired in the Network
General merger. In 1999, our subsidiary McAfee.com sold to the
public its Class A common stock as a part of its initial
public offering. In September 2002, we repurchased the 25%
minority interest in McAfee.com and merged McAfee.com with and
into us.
This report includes registered trademarks and trade names of
McAfee and other corporations. Trademarks or trade names owned
by McAfee and/or its affiliates include: “McAfee” and
“Network Associates.”
McAfee, Inc. is headquartered at 3965 Freedom Circle,
Santa Clara, California, 95054, and the telephone number at
that location is (408) 988-3832. The McAfee web site is
www.mcafee.com.
OVERVIEW
We are a leading supplier of computer security solutions
designed to prevent intrusions on networks and protect computer
systems from a large variety of threats and attacks. We offer
two families of products, McAfee System Protection Solutions and
McAfee Network Protection Solutions. Our computer security
solutions are offered primarily to large enterprises,
governments, small and medium-sized businesses and consumer
users. We operate our business in five geographic regions: North
America; Europe, Middle East and Africa, (collectively referred
to as “EMEA”); Japan; Asia-Pacific (excluding Japan)
and Latin America. See Note 19 to the consolidated
financial statements for a description of revenues, operating
income and assets by geographic region.
Our McAfee Protection-in-Depth Strategy is designed to provide a
complete set of system and network protection solutions
differentiated by intrusion prevention technology that can
detect and block known and
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unknown attacks. To more effectively market our products in our
various geographic sales regions, as more fully described below,
we have combined complementary products into separate product
groups as follows:
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McAfee System Protection Solutions, which delivers anti-virus
and security products and services designed to protect systems
such as desktops and servers and |
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McAfee Network Protection Solutions, which offers products
designed to maximize the performance and security of networks
and network intrusion prevention with McAfee IntruShield and
McAfee Foundstone. We sold our Sniffer Technologies product line
to Network General Corporation on July 16, 2004.
Previously, this product line included products designed to
capture data, monitor network traffic and collect and report on
key network statistics, and comprised a significant portion of
our revenue. |
The majority of our net revenue has historically been derived
from our McAfee Security anti-virus products and our Sniffer
Technologies network fault identification and application
performance management products, which we sold in July 2004. We
have also focused our efforts on building a full line of
complementary network and system protection solutions. On the
system protection side, we strengthened our anti-virus lineup by
adding complementary products in the anti-spam and host
intrusion prevention categories. On the network protection side,
we have added products in the network intrusion prevention and
detection category, and through our October 2004 Foundstone
acquisition, vulnerability management products and services. We
continuously seek to expand our product lines.
In 2004, our net revenue was $910.5 million and net income
was $225.1 million. See “Management’s Discussion
and Analysis of Financial Condition and Results of
Operations.”
McAfee System Protection Solutions
McAfee System Protection Solutions help large enterprises,
small/medium businesses, consumers, government agencies and
educational organizations assure the availability and security
of their desktops, application servers and web service engines.
The McAfee System Protection Solutions portfolio features a
range of products including anti-virus, anti-spyware, managed
services, application firewalls and McAfee Entercept for
host-based intrusion prevention. Each is backed by the McAfee
Anti-Virus Emergency Response Team, a leading threat research
organization. A substantial majority of our net revenue has
historically been derived from our McAfee Security anti-virus
products.
McAfee System Protection Solutions also includes McAfee Consumer
Security, offering both traditional retail products and our
on-line subscription services. Our consumer retail and on-line
subscription applications allow users to protect their PCs from
malicious code and other attacks, repair PCs from damage caused
by viruses and spyware and block spam and other undesirable
content. Our retail products are sold through retail outlets,
including Best Buy, CompUSA, Costco, Dixons, Fry’s, 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. Our on-line subscription services are
delivered through the use of an Internet browser at our
McAfee.com web site and through multiple on-line service
providers, such as AOL and Comcast, and original equipment
manufacturers, or OEMs, such as Apple, Dell, Gateway/eMachines
and NEC.
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 helps enterprises, small
businesses, government agencies, educational organizations and
service providers maximize the availability, performance and
security of their network infrastructure. The McAfee Network
Protection Solutions portfolio features a range of products
including IntruShield for network intrusion detection and
prevention and Foundstone for intrusion detection and prevention
and vulnerability management.
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We acquired Foundstone on October 1, 2004. We intend to
integrate Foundstone’s 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.
Expert Services and Technical Support
We have established Expert Services and Technical Support to
provide professional assistance in the design, installation,
configuration and implementation of our customers’ networks
and acquired products. Expert Services is focused on two service
markets: Consulting Services and Education Services.
Consulting Services support product integrations and deployment
with an array of standardized and custom offerings. Consulting
Services also offer other services in both the security and
networking areas, including early assessment and design work, as
well as emergency outbreak and network troubleshooting
assistance. Our consulting services organization is organized
around our product groups. The majority of our consulting
services are now delivered through the consulting resources
acquired in the Foundstone acquisition.
Education Services offer customers an extensive curriculum of
web and classroom-based training focused on the deployment and
operation of McAfee’s security products.
The PrimeSupport program provides our customers on-line and
telephone-based technical support in an effort to ensure that
our products are installed and working properly. To meet
customers’ varying needs, PrimeSupport offers a choice of
the on-line ServicePortal or the telephone-based Connect,
Priority and Enterprise. All PrimeSupport programs include
software updates and upgrades. PrimeSupport is available to all
customers worldwide from various regional support centers.
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PrimeSupport ServicePortal — Consists of a
searchable, knowledge base of technical solutions and links to a
variety of technical documents such as product FAQs and
technical notes. |
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PrimeSupport Connect — Provides toll-free
telephone access to technical support during regular business
hours and access to the on-line ServicePortal. |
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PrimeSupport Priority — Provides priority,
unlimited, toll-free (where available) telephone access to
technical support 24 hours a day, 7 days a week and
access to the on-line ServicePortal. |
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PrimeSupport Enterprise — Offers proactive,
personalized service and includes an assigned technical support
engineer from our Enterprise support team, proactive support
contact (telephone or email) with customer-defined frequency,
election of five designated customer contacts and access to the
on-line ServicePortal. |
In addition, we also offer our consumer users technical support
services made available at our mcafee.com website on both a free
and fee-based basis, depending on the support level selected.
Research and Development
We are committed to malicious code and vulnerability research
through our McAfee Anti-virus and Vulnerability Emergency
Response Team (AVERT). AVERT 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 December 2004, we agreed to sell the assets of McAfee Labs,
our research and development organization focused on exploiting
government research, to SPARTA, Inc. The transaction is expected
to close in the first half of 2005. McAfee will remain as the
general contractor on certain of its government contracts until
government approval is obtained for SPARTA as the general
contractor.
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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. For example, we have an alliance with America
Online under which, among other things, our on-line PC
anti-virus services are offered to AOL members as part of their
basic membership. We also provide our host-based email scanning
services and personal firewall services as a value-added service
to AOL. As part of our NTT DoCoMo alliance, we are jointly
developing technology to provide built-in anti-virus protection
against mobile threats to owners of 3G FOMA handsets. Other
alliances involve Comcast, Dell, NEC, Telecom Italia, Telefonica
and Wanadoo.
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 also offer two-year term-based licenses. Our
two-year term licensing model also creates the opportunity for
recurring revenue through the renewal of existing licenses. By
offering two-year licenses, as opposed to traditional perpetual
licenses, we are also able to meet a lower initial cost
threshold for customers with annual budgetary constraints. 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.
On-Line Subscriptions and Managed Applications
For our on-line subscription services, customers essentially
“rent” the use of our software. Because our on-line
subscription services are “version-less,” or
self-updating, customers subscribing to these services are
assured of using the most recent version of the software
application, eliminating the need to purchase product updates or
upgrades. Our on-line subscription consumer products and
services are found at our www.mcafee.com web site where
consumers download our anti-virus application using their
Internet browser which allows the application to detect and
eliminate viruses on their PCs, repair their PCs from damage
caused by viruses, optimize their hard drives and update their
PCs’ virus protection system with current software updates
and upgrades. Our www.mcafee.com web site also offers customers
access to McAfee Personal Firewall Plus, McAfee SpamKiller and
McAfee Privacy Service, as well as combinations of these
services through bundles. Our on-line subscription services are
also available to customers and small business through various
relationships with internet service providers
(“ISP’s”), such as AOL and Comcast. Our business
model allows for ISP’s to make McAfee subscription services
available as either a premium service or as a feature included
in the ISP’s service. At December 31, 2004, we had
approximately 8.5 million McAfee consumer on-line
subscribers, which includes on-line customers obtained through
our alliances with ISP’s and OEM’s.
Similarly, our small and medium sized business on-line
subscription products and services, or our Managed VirusScan
offerings, provide these customers the most up-to-date
anti-virus software. Our Managed VirusScan service 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
and Desktop Firewall ASaP blocks unauthorized network access and
stops known network threats. Our McAfee Managed Small Business
service has approximately 2.2 million active subscriptions
as of December 31, 2004.
We also make our on-line subscription products and services
available over the Internet in what we refer to as a managed
environment. Unlike our on-line subscription service solutions,
these managed service providers, or MSP, solutions are
customized, monitored and updated by networking professionals
for a specific customer.
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Sales and Marketing
To augment and capitalize upon our marketing efforts, our sales
and marketing activities are directed primarily at large
corporate and government customers, small and medium-sized
accounts, as well as resellers, distributors, system
integrators, internet service providers and OEM’s worldwide
through the channels listed below.
Our United States sales force is organized by type of customer
product line supported. Some of our largest accounts are handled
by a direct sales organization. Other medium to large customers
are served primarily through reseller partners, and the sales
organizations supporting these partners are also organized by
product line. One set of sales representatives focuses on the
McAfee anti-virus installed base. A second focuses on our newer
intrusion prevention products and risk management. Small
business customers are served exclusively through our reseller
partners with a telesales organization responsible for lead
generation and a channel support team responsible for partner
training and contract management.
We have sales and support operations in EMEA, Japan, North
America, Asia-Pacific (excluding Japan) and Latin America. In
2004, 2003, and 2002 based on net revenue in our regions,
revenues outside of North America accounted for approximately
39%, 35% and 37% of our net revenues, respectively. Within our
international sales regions, sales forces are organized by
country when and where local demand and sales force
considerations make it advisable.
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Resellers and Distributors |
The majority of our products are sold through partners,
including corporate resellers, retailers and, indirectly,
through distributors in all of our geographic regions. In
addition, our channel efforts include strategic alliances with
complementary manufacturers and publishers to expand our reach
and scale. We currently utilize corporate resellers, including
ASAP Software, CDW, Dell, Insight, Softmart, Software House
International and Software Spectrum, as well as network
integrators who offer our solutions and sell site licenses of
our software to corporate, small business and government
customers.
Independent software distributors who currently supply our
products include GE Access, Ingram Micro, MOCA and Tech Data.
Our relationship with Merisel America terminated during 2004.
These distributors supply our products primarily to large
retailers, value-added resellers, or VARs, mail order and
telemarketing companies. Both through our authorized
distributors and directly with certain retail resellers either
through a consignment model or a non-consignment model, we sell
our retail packaged products to several of the larger computer
and software retailers, including Best Buy, CompUSA, Costco,
Dixons, Fry’s, Office Depot, Office Max, Staples, Wal-Mart
and Yamada. Members of our channel sales force work closely with
our major reseller and distributor accounts to manage demand
generating activities, training, order flow, and affiliate
relationship management.
Our top ten distributors typically account for between 49% and
63% of our net revenues in any quarter. Our agreements with our
distributors are not exclusive and may be terminated by either
party without cause. Terminated distributors may not continue to
represent our products. If one of our significant distributors
terminated its relationship with us, we could experience a
significant interruption in the distribution of our products.
We utilize a sell-through business model for distributors under
which we recognize revenue on products sold through distributors
at the time our distributors resell the products to their
customers. Under this business model, our distributors are
permitted to purchase software licenses at the same time they
fill customer orders and to pay for hardware and retail products
only when these products are resold to the distributors’
customers. In addition, prior to the resale of our products, our
distributors are permitted unlimited, unconditional rights of
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return. After sale by the distributor to its customer, there is
generally no right of return from the distributor to us with
respect to such product, unless we approve the return from the
final customer to the distributor.
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Original Equipment Manufacturers |
OEMs license our products for resale to end users or inclusion
with their products. For example, we are a security services
provider for PC hardware manufacturers such as Apple, Dell,
Gateway/eMachines and NEC. Depending on the arrangement, OEMs
may sell our software bundled with the PC or related services,
pre-install our software and allow us to complete the sale, or
sublicense a single version of our products to end users who
must register the product with us in order to receive updates.
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Other Marketing Activities |
Channel marketing is the means by which we market, promote,
train and incent our resellers and distributors to promote our
products to their end-user customers. We offer our resellers and
distributors technical and sales training classes, marketing and
sales assistance kits. We also provide specific cooperative
marketing programs for end-user seminars, catalogs, demand
creation and sales events.
One of the principal means of marketing our products and
services is through the Internet. In addition to the
www.mcafee.com website, each of our product groups has their own
individual websites. A number of these websites are localized to
serve the various geographic regions in which we operate. Not
only does each of these websites contain various marketing
materials and information about our products, but website
visitors may download and purchase products or obtain free
trials of our products or trial subscriptions for on-line
subscription products and services. We also promote our products
and services through advertising activities in trade
publications, direct mail campaigns and strategic arrangements.
In addition, we attend trade shows, sponsor conferences and
publish a quarterly newsletter, which is mailed to existing and
prospective customers.
We also market our products through the use of rebate programs.
Within most countries we typically offer two types of rebate
programs, volume incentive rebates to channel partners and
promotional rebates to end-users. The channel partner earns a
volume incentive rebate primarily based upon its sale of our
products to end-users. From time to time, we also make rebates
available to individual users of various products purchased
through multiple channels.
Customers
We primarily market our products to large corporate and
government customers through resellers and distributors, except
for the very largest companies where we sell direct. A majority
of our products are distributed indirectly through resellers and
distributors. During 2004, Ingram Micro and TechData accounted
for approximately 22% and 11% of our net revenue, respectively.
We market our products to individual consumers directly through
on-line distribution channels and indirectly through traditional
distribution channels, such as retail stores and OEMs. McAfee
Consumer is responsible for on-line distribution of our products
sold to individual consumers over the Internet or for
Internet-based products, including products distributed by our
on-line partners, and for the licensing of technology to
strategic distribution partners for sale to individual
consumers, with certain exceptions.
Product Development, Investments, and Acquisitions
We believe that our ability to maintain our competitiveness
depends in large part upon our ability to successfully enhance
existing products, develop and acquire new products and develop
and integrate acquired products. The market for computer
software includes low barriers to entry, rapid technological
change, and is highly competitive with respect to timely product
introductions. As part of our growth strategy, we have made and
expect to continue to make investments in complementary
businesses, products and technologies.
In addition to developing new products, our internal development
staff is focused on developing upgrades and updates to existing
products and modifying and enhancing any acquired products.
Future upgrades and updates may include additional
functionality, respond to user problems or address compatibility
problems with new or changing operating systems and environments.
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For 2004, 2003 and 2002, we expensed $172.7 million,
$184.6 million and $148.8 million, respectively, on
research and development. See “Management’s Discussion
and Analysis of Financial Condition and Results of
Operations.”
Manufacturing and Suppliers
Our manufacturing operations consist primarily of assembly,
testing and quality control of materials, components,
subassemblies and systems for our IntruShield, E-ppliance and
Foundstone products. We use a limited number of third-party
manufacturers for these manufacturing operations. Reliance on
third-party manufacturers, including software replicators,
involves a number of risks, including the lack of control over
the manufacturing process and the potential absence or
unavailability of adequate capacity. The loss of one of our
third-party manufacturers could disrupt our business.
Hardware-based products entail other risks, such as the
unavailability of critical components that are supplied by a
limited number of parties and greater obsolescence risks.
Competition
The markets for our products are intensely competitive and are
subject to rapid changes in technology. We also expect
competition to increase in the near-term. We believe that the
principal competitive factors affecting the markets for our
products include, but are not limited to:
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performance |
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quality |
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breadth of product group |
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integration of products |
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brand name recognition |
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price |
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functionality |
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innovation |
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customer support |
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frequency of upgrades and updates |
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manageability of products |
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reputation |
We believe that we compete favorably against our competitors in
each of these areas. However, some of our competitors have
longer operating histories, greater brand recognition, stronger
relationships with channel partners, larger technical staffs,
established relationships with hardware vendors and/or greater
financial, technical and marketing resources. These factors may
provide our competitors with an advantage in penetrating markets
with their network security and management products.
Anti-Virus. Our principal competitors in the anti-virus
market are Symantec and Computer Associates. Trend Micro remains
the strongest competitor in the Asian anti-virus market.
Dr. Ahn’s, F-Secure, Hauri, Panda, and Sophos are also
showing growth in their respective markets. Microsoft continues
to execute on its announced plans to enter all segments of the
anti-virus market and in furtherance of these plans has recently
acquired anti-virus providers GeCAD Software and Sybari Software
and anti-spyware provider Giant Company Software.
Network Security and Intrusion Detection and Protection.
Our principal competitors in the security market vary by product
type. For intrusion detection and prevention products, we
compete with Cisco Systems, Fortinet, Internet Security Systems,
Juniper Networks, Symantec and 3Com.
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Other Competitors. In addition to competition from large
technology companies such as EMC, HP, IBM, Intel, Microsoft, and
Novell that may offer network and system protection products as
enhancements to their operating systems, we also face
competition from smaller companies and shareware authors that
may develop competing products.
Proprietary Technology
Our success depends significantly upon proprietary software
technology. We rely on a combination of patents, trademarks,
trade secrets and copyrights to establish and protect
proprietary rights to our software. However, these protections
may be inadequate or competitors may independently develop
technologies or products that are substantially equivalent or
superior to our products. Often, we do not obtain signed license
agreements from customers who license products from us. In these
cases, we include an electronic version of an end-user license
in all of our electronically distributed software and a printed
license in the box for our products. Since none of these
licenses are signed by the licensee, many legal authorities
believe that such licenses may not be enforceable under the laws
of many states and foreign jurisdictions. In addition, the laws
of some foreign countries either do not protect these rights at
all or offer only limited protection for these rights. The steps
taken by us to protect our proprietary software technology may
be inadequate to deter misuse or theft of this technology. For
example, we are aware that a substantial number of users of our
anti-virus products have not paid any license or support fees to
us.
Employees
As of December 31, 2004, we employed approximately 2,950
individuals worldwide. With limited exceptions, none of our
employees are represented by a labor union. We consider the
relationships with our employees to be positive. Competition for
qualified management and technical personnel is intense in the
software industry. Our continued success depends in part upon
our ability to attract and retain qualified personnel. To date,
we believe that we have been successful in recruiting qualified
employees, but there is no assurance that we will continue to be
successful in the future.
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RISK FACTORS
Investing in our common stock involves a high degree of risk.
The risks described below are not the only ones facing our
company. Additional risks not presently known to us or that we
deem immaterial may also impair our business operations. Any of
the following risks could materially adversely affect our
business, operating results and financial condition and could
result in a complete loss of your investment.
Our Financial Results Will Likely Fluctuate.
Our revenues and operating results have varied significantly in
the past. We expect fluctuations in our operating results to
continue. As a result, we may not sustain profitability. Also,
we believe that period-to-period comparisons of our financial
results should not be relied upon as an indicator of our future
results. Our historical operating results include revenues and
expenses related to our Magic and our Sniffer product lines for
periods prior to their disposition in January 2004 and July
2004, respectively. For 2004, Magic and Sniffer accounted for
$2.9 million and $90.9 million, or less than 1% and
approximately 10%, respectively, of our total revenues. Our
expenses are based in part on our expectations regarding future
revenues and our post-Sniffer support obligations, 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.
Operational factors that may cause our revenues, gross margins
and operating results to fluctuate significantly from period to
period, include, but are not limited to:
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introduction of new products, product upgrades or updates by us
or our competitors; |
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volume, size, timing and contractual terms of new licenses and
renewals of existing licenses; |
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our “perpetual plus” licensing program, in the near
term; |
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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, ISP’s such as AOL, 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; |
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system, supply of manufactured products and personnel
limitations may adversely impact our ability to process the
large number of orders that typically occur near the end of a
fiscal quarter; |
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costs or charges related to our acquisitions or dispositions,
including our acquisitions of Foundstone in 2004 and of
Entercept Security Technologies and IntruVert Networks in 2003,
the dispositions of our Magic and Sniffer product lines and the
announced disposition of our McAfee Labs assets; |
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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; |
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stock-based compensation charges; |
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costs and charges related to certain events, including our
ongoing cost reduction and profitability plan, Sarbanes-Oxley
compliance efforts, litigation, reductions in force, relocation
of personnel and previous financial restatements; and |
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factors that lead to substantial drops in estimated values of
long-lived assets below their carrying value. |
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Seasonal and Macroeconomic Factors |
Our net revenue is typically lower in the first quarter when
many businesses experience lower sales, flat in the summer
months, due in part to the European holiday season, and higher
in the fourth quarter as customers typically complete annual
budgetary cycles.
10
It Is Difficult for Us to Accurately Estimate Operating
Results Prior to the End of a Quarter.
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 to end-user customers in that quarter.
Historically, we have experienced a trend toward more product
orders, and therefore, a higher percentage of revenue shipments,
in the last month of a quarter. Some customers believe they can
enhance their bargaining power by waiting until the end of a
quarter to place their order. Because we expect this trend to
continue, 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. Furthermore, because of this trend,
it is difficult for us to accurately estimate operating results
prior to the end of a quarter.
Our Business Transformation, Dispositions and Cost Reduction
Plan, Expose Us to Significant Risks.
In 2003, we continued our business transformation with the
IntruVert and Entercept acquisitions, followed by the sale of
our Magic Solutions and Sniffer Technologies product lines in
January and July 2004, respectively, the Foundstone acquisition
in October 2004, the announced sale of our McAfee Labs assets in
January 2005 and the changing of our name back to McAfee. Early
in 2004, we also began our ongoing cost reduction and
profitability plan with an objective of significantly improving
our operating margins by mid-2005. In January 2005 we completed
the move of our European finance and sales order operations
organization from the Netherlands to Ireland. These activities
are intended to, among other things, streamline our business,
better leverage the McAfee brand, better position us as the
leading provider of intrusion prevention solutions, and help
accelerate profit and growth. Risks related to these activities
include:
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our growth and/or profitability may not increase in the
near-term or at all and we may fail to achieve desired savings
or performance targets on a timely basis or at all; |
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an increased dependence on our channel and other partners to
sell our products, particularly to enterprise and small to
medium sized business (SMB) customers, following the
transfer of a significant portion of our direct sales force in
the Sniffer transaction; |
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our strategic positioning may result in our competing more
directly with larger, more established competitors, such as
Cisco Systems and Microsoft; |
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our business, including internal finance and IT operations, has
been and may continue to be disrupted and strained due to, among
other things, our cost saving measures, our Sniffer post-closing
support obligations (including our obligation to produce
stand-alone audited historical Sniffer financial statements) and
personnel losses; |
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we have centralized our order processing operations from Latin
America to Plano, Texas and we have also moved the EMEA shared
services center and our localization operations from Amsterdam
to Cork, Ireland. We have also transitioned a significant
portion of our research and development personnel to our
research facility in Bangalore, India. These events could result
in the loss of personnel unwilling to relocate, reduced service
levels due to time zone differences, difficulties in finding
personnel with sufficient language capabilities and loss of
direct, on-the-ground finance and accounting oversight in the
sales regions being serviced on a remote basis; |
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we may experience an undesired loss of sales, research and
development, finance and other personnel and it may be difficult
for us to find suitable replacements; |
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we have installed a new customer relationship management system,
providing our finance and sales teams information in a different
format than previously available and, in some cases, with less
information. During the transition period to our new system, we
may experience, among other things, related reduced operational
efficiencies, losses of information and a decreased ability to
monitor or forecast our business; |
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we may be unable to successfully expand our McAfee brand
significantly beyond our anti-virus products; |
11
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many of our products and service capabilities were recently
acquired and the income potential for these products and
services is unproven and the market for these products is
volatile; |
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there may be customer confusion around our strategy. |
We Are Subject to Intense Competition in the System and
Network Protection Markets, and We Expect to Face Increased
Competition in the Future.
The markets for our products are intensely competitive and we
expect both product and pricing competition to increase. Some of
our competitors have longer operating histories, greater name
recognition, larger technical staffs, established relationships
with hardware vendors and/or greater financial, technical and
marketing resources. We face competition in specific product
markets. Principal competitors include:
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in the anti-virus product market, Symantec and Computer
Associates. Trend Micro remains the strongest competitor in the
Asian anti-virus market. F-Secure, Dr. Ahn’s, Panda
and Sophos are also showing growth in their respective markets.
Microsoft has continued to make acquisitions and has announced
its intention to enter all segments of the anti-virus market at
the end of 2005; and |
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in the market for our other intrusion detection and protection
products, Cisco Systems, Computer Associates, Internet Security
Systems, Juniper Networks, Symantec and 3Com Corporation. |
Other competitors for our various products could include large
technology companies. We also face competition from numerous
smaller companies and shareware authors that may develop
competing products.
Increasingly, our competitors are large vendors of hardware or
operating system software. These competitors are continuously
developing or incorporating system and network protection
functionality into their products. For example, Juniper Networks
acquired Netscreen and, through its acquisitions of Okena,
Riverhead and NetSolv, Cisco Systems may incorporate
functionality that competes with our content filtering and
anti-virus products. Similarly, Microsoft continues to execute
on its announced plans to boost the security of its Windows
platform with related acquisitions including its acquisition of
anti-virus providers GeCAD Software and Sybari Software and
anti-spyware provider Giant Company Software. 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 incorporated products
are inferior or more limited than our products, customers may
elect to accept the incorporated products rather than purchase
our products. In addition, the software industry is currently
undergoing consolidation as firms seek to offer more extensive
suites and broader arrays of software products, as well as
integrated software and hardware solutions. This consolidation
may negatively impact our competitive position.
We Face Risks in Connection With The Material Weaknesses
Resulting From Our Sarbanes-Oxley Section 404 Management
Report and Any Related Remedial Measures That We Undertake.
In the first quarter of 2004, we restated previously reported
quarters of 2003; and in the second quarter of 2004, we restated
the previously reported first quarter of 2004. These matters
were identified by us and reported to our auditors. In
conjunction with these restatements, our former auditors and our
current auditors, respectively, reported that the underlying
control issues giving rise to the respective restatement should
be considered a material weakness under standards established by
the Public Company Accounting Oversight Board. In response to
these restatements, we implemented additional controls over
financial reporting.
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, 2004 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 material weaknesses in our
internal control over financial reporting relating to accounting
for income taxes, revenue accounting, and the financial close
and reporting process. See Item 9A in this Annual Report on
Form 10-K
12
for additional disclosure about these material weaknesses. In
response to these material weaknesses in our internal control
over financial reporting, we have implemented, and may be
required to further implement, additional controls and
procedures. In addition, in response to these material
weaknesses, we may have to hire additional personnel, possibly
requiring significant time and expense. As a result of the
material weaknesses identified in this Annual Report on
Form 10-K, even though our management believes that our
efforts to remediate and re-test certain 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 that are planning to take
will sufficiently and satisfactorily remediate the identified
material weaknesses in full. Furthermore, we intend to continue
improving our internal control over financial reporting, and the
implementation and testing of these continued improvements could
result in increased cost and could divert management attention
away from operating our business.
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 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.
We Face Risks Related to the Pending Formal Securities and
Exchange Commission and Department of Justice Investigations and
Our Accounting Restatements.
In the first quarter of 2002, the SEC commenced a “Formal
Order of Private Investigation” into our accounting
practices. In the first quarter of 2003, we became aware that
the DOJ had commenced an investigation into our consolidated
financial statements. In April and May 2002, we announced our
intention to file, and in June 2002 we filed with the SEC,
restated consolidated financial statements for 2000, 1999 and
1998 to correct certain discovered inaccuracies for these
periods.
As a result of information obtained in connection with the
ongoing SEC and DOJ investigations, we concluded in March 2003,
that we would restate our consolidated financial statements to,
among other things, reflect revenue on sales to our distributors
for 1998 through 2000 on a sell-through basis (which is how we
reported sales to distributors since the beginning of 2001).
The filing of our restated consolidated financial statements in
October 2003 did not resolve the pending SEC inquiry or DOJ
investigation into our accounting practices. We are engaged in
ongoing discussions with, and continue to provide information
regarding our consolidated financial statements for calendar
year 2000 and prior periods. The resolution of the SEC inquiry
and DOJ investigation into our prior accounting practices could
involve the imposition of fines or penalties or other remedies.
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 and
marketing personnel. Personnel related issues include:
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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
13
provide a competitive compensation package, including stock
options. Increases in shares available for issuance under our
stock option plans require stockholder approval. Institutional
stockholders, or our other stockholders generally, may not
approve future requests for option 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, beginning in July 2005, accounting standards will
require corporations to include a compensation expense in their
statement of income relating to the issuance of employee stock
options. As a result, 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.
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Impact of Personnel Reductions |
In recent periods, we have sought to rationalize the size of our
employee base (including through the Sniffer sale). On
December 31, 2004, we had approximately 2,950 employees,
down from approximately 3,800 and 3,700 at the end of 2002 and
2003, respectively. Reductions in personnel, including as a
result of the Sniffer sale, may harm our business, employee
retention or our ability to attract new personnel by, among
other things, reducing overall employee morale, requiring
remaining personnel to perform a greater amount of, or new and
different, responsibilities or result in the loss of personnel
otherwise critical to our business.
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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
IntruVert, Entercept and Foundstone acquisitions and increased
hiring activities in India. We increased our hirings 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
January 2005, we hired Eric Brown as our new executive vice
president and chief financial officer, and in 2004, we promoted
Jake Pyles to the position of vice president of finance. In June
2004, we promoted Christopher Bolin to the position of executive
vice president and chief technology officer.
For new employees or management additions, there also may be
reduced levels of productivity as recent additions or hires are
trained or otherwise assimilate and adapt to our organization
and culture.
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Senior Management and Critical Personnel Losses |
Other than executive management who have “at will”
employment agreements, our employees are not typically subject
to an employment agreement or non-competition agreement. In
December 2004, Stephen Richards, our previous chief operating
officer and chief financial officer, retired and in November
2004 our controller resigned to pursue other opportunities. In
addition, in recent months 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.
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. We have not previously
acquired a company such as Foundstone, which offers high-end
security
14
consulting services as part of their business model. We may not
realize the anticipated benefits from the Foundstone
acquisition. In addition to the risks described below,
acquisitions of professional services organizations present
unique employee retention and integration challenges as well as
customer retention challenges.
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:
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integrate and retain key management, sales, research and
development, and other personnel; |
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integrate the acquired products into our product offerings both
from an engineering and sales and marketing perspective; |
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integrate and support preexisting supplier, distribution and
customer relationships; |
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coordinate research and development efforts; and |
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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.
Management’s focus on the integration of operations may
distract attention from our day-to-day business and may disrupt
key research and development, marketing or sales efforts. In
addition, it is common in the technology industry for aggressive
competitors to attract customers and recruit key employees away
from companies during the integration phase of an acquisition.
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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.
Products or technologies acquired by us may include so-called
“open source” software. Open source software is
typically licensed for use at no initial charge, but imposes on
the user of the open source software certain requirements to
license to others both the open source software as well as the
software that relates to, or interacts with, the open source
software. Our ability to commercialize products or technologies
incorporating open source software or otherwise fully realize
the anticipated benefits of any such acquisition may be
restricted because, among other reasons:
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open source license terms may be ambiguous and may result in
unanticipated obligations regarding our products; |
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competitors will have improved access to information that may
help them develop competitive products; |
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open source software cannot be protected under trade secret law; |
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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 |
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open source software potentially increases customer support
costs because licensees can modify the software and potentially
introduce errors. |
15
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Use of Cash and Securities |
Our available cash and securities may be used to acquire or
invest in companies or products, possibly resulting in
significant acquisition-related charges to earnings and dilution
to our stockholders. For example, in October 2004 we used
approximately $84.7 million, net of cash assumed, to
acquire Foundstone. Moreover, if we acquire a company, we may
have to incur or assume that company’s liabilities,
including liabilities that may not be fully known at the time of
acquisition.
We Face Risks Related to Our International Operations.
During 2004 net revenue in our operating regions outside of
North America represented approximately 39% of our net revenue.
We intend to focus on international growth and expect
international revenue to remain a significant percentage of our
net revenue.
Related risks include:
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longer payment cycles and greater difficulty in collecting
accounts receivable; |
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increased costs and management difficulties related to the
building of our international sales and support organization; |
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the acceptance of our business strategy and the reorganization
of our international sales forces by regions; |
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the ability to successfully localize software products for a
significant number of international markets; |
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our ability to effectively provide service and support for our
hardware based products from the U.S.; |
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our ability to successfully establish, manage and staff shared
service centers for worldwide sales and finance and accounting
operations centralized from locations in the U.S. and Europe; |
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our ability to adapt to sales practices and customer
requirements in different cultures; |
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compliance with more stringent consumer protection and privacy
laws; |
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currency fluctuations, including recent weakness of the
U.S. dollar relative to other currencies, or the
strengthening of the U.S. dollar in future periods that may
have an adverse impact on revenues, and risks related to hedging
strategies; |
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political instability in both established and emerging markets; |
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tariffs, trade barriers and export restrictions; |
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a high incidence of software piracy in some countries; and |
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international labor laws and our relationship with our employees
and regional work councils. |
Additionally, our sales forces are organized by geographic
region. This structure may lead to sales force competition for
sales to multinational customers and may reduce our ability to
effectively market our products to multinational customers.
We May Incur Significant Stock-Based Compensation Charges
Related to Repriced Options, Assumed McAfee.com Options,
IntruVert Restricted Stock and Options, Foundstone Options and
Compensation Expenses Related to the Sniffer Bonus Plan and
Foundstone Retention Payments.
We may incur stock-based compensation charges related to
(i) employee options repriced in April 1999 (“Repriced
Options”), (ii) McAfee.com options we assumed in the
acquisition of the publicly traded McAfee.com shares in
September 2002 (“McAfee.com Options”)
(iii) unvested IntruVert options that were cancelled in May
2003 related to this acquisition (the “IntruVert
Options”) and exchanged for cash placed in escrow,
(iv) unvested IntruVert restricted stock that was cancelled
in May 2003 related to this acquisition (the “IntruVert
Restricted Stock”), and exchanged for monthly cash payments
as the former employees provide services to us,
(v) unvested Foundstone options assumed by us as part of
the acquisition, (vi) the
16
Sniffer Bonus Plan and (vii) Foundstone key employee
retention payments. The size of the charges related to the
Repriced Options and McAfee.com Options could be significant
depending on the movements in the market value of our common
stock. As a result of Financial Accounting Standards Board
Interpretation No. 44, effective July 1, 2000,
Repriced Options and McAfee.com Options are subject to variable
accounting treatment. The stock-based compensation charge (or
credit) for the Repriced Options is determined by the excess of
our closing stock price at the end of a reporting period over
the fair value of our common stock on July 1, 2000,
equivalent to $20.375. The stock-based compensation charge (or
credit) for the McAfee Options is determined by the excess of
our closing stock price over the exercise price of the option
minus $11.85 payable upon exercise of the option. Remeasurement
of the charge continues until the earlier of the date of
exercise, forfeiture or cancellation without replacement. The
resulting compensation charge (or credit) to earnings will be
recorded over the remaining life of the options subject to
variable accounting treatment.
For 2004 and 2003, stock-based compensation charges of
approximately $6.7 million and $3.4 million,
respectively, were recorded for McAfee.com Options, and a
stock-based compensation charge of approximately
$3.3 million was recorded in 2004 for the Repriced Options.
During the remaining life of both the McAfee.com Options and
Repriced Options, we may record additional stock-based
compensation charges or credits. Such charges or credits cannot
be forecasted. We estimate that a $1 increase in our stock price
at December 31, 2004 would increase our future stock
compensation charge by approximately $0.7 million.
For the cash paid to cancel the IntruVert Options that was
placed in escrow, we have been recognizing compensation expense
as the former IntruVert employees provide services to us. For
2005, we expect to recognize $1.2 million in expense
related to these payments, and an additional $0.8 million
through 2007. For the IntruVert Restricted Stock, we have been
recognizing compensation expense monthly since the acquisition
and will continue to do so through 2006 as the former IntruVert
employees provide services to us. For 2005, we expect the
expense to be approximately $0.4 million with respect to
the IntruVert Restricted Stock.
In connection with the Foundstone acquisition, we exchanged
McAfee stock options for Foundstone stock options. Approximately
$1.4 million in compensation expense may be recorded
through 2008 related to unvested McAfee options which were
exchanged for unvested Foundstone options. We expect to record
approximately $0.6 million in compensation expense in 2005.
In connection with the Sniffer disposition, we implemented the
Sniffer Bonus Plan primarily to encourage Sniffer’s
management to assist us in the sales process and remain with the
business through the sale. Subject to reduction in certain
cases, we expect total related cash payments of approximately
$7.7 million, of which approximately $5.3 million was
paid in 2004 and the balance is payable in the first quarter of
2006.
Approximately $25.0 million of the amount paid to acquire
Foundstone was placed into escrow accounts. Of this amount,
approximately $5.6 million was placed into a key employee
escrow account and is being paid to four Foundstone employees as
they provide services to us through September 2007. The
Foundstone employees forfeit any unvested amounts if their
employment is terminated under provisions in the escrow
agreements. Any forfeited amounts will be returned to us. We
recognized compensation expense of approximately
$0.3 million in 2004, and expect to record approximately
$2.9 million of expense in 2005.
We Depend on Revenue from Our Flagship Anti-Virus
Products.
Our McAfee anti-virus software products account for a
substantial majority of our net revenues. Because of this
revenue concentration, our business could be harmed by a decline
in demand for, or in the prices of, our McAfee anti-virus
software as a result of, among other factors, any change in our
pricing model, increased competition in anti-virus software, a
maturation in the markets for these products or other risks
described in this document.
Customers May Cancel or Delay Purchases.
Weakening economic conditions, new product introductions and
expansions of our business may increase the time necessary to
sell our products and services and require us to spend more on
our sales efforts. Our
17
products and services may be considered to be capital purchases
by our current or prospective customers. Capital purchases are
often discretionary and, therefore, are canceled or delayed if
the customer experiences a downturn in its business prospects or
as a result of economic conditions in general.
We Face 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:
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offer a broad range of network and system protection products; |
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enhance existing products and expand product offerings; |
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extend security technologies to additional digital devices; |
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respond promptly to new customer requirements and industry
standards; |
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provide frequent, low cost upgrades and updates for our
products; and |
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remain compatible with popular operating systems such as Linux,
NetWare, Windows XP, Windows 2000, Windows 98 and
Windows NT, and develop products that are compatible with
new or otherwise emerging operating systems. |
We may experience delays in product development as we have at
times in the past. Complex products like ours may contain
undetected errors or version compatibility problems,
particularly when first released, which could delay or harm
market acceptance. Furthermore, Microsoft continues to execute
on its announced plans to boost the security of its Windows
platform with related acquisitions, including its acquisition of
anti-virus providers GeCAD Software and Sybari Software and
anti-spyware provider Giant Company Software. 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 or render our products obsolete
and unmarketable. Furthermore, even if these incorporated
products are inferior or more limited than our products,
customers may elect to accept the incorporated products rather
than purchase our products. The occurrence of these events could
negatively impact our revenue.
We Face a Number of Risks Related to Our Product Sales
Through Distributors.
We sell a significant amount of our products through
intermediaries such as distributors and other channel partners,
referred to collectively as distributors. Our top ten
distributors typically represent approximately 49% to 63% 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
and Tech Data, together accounted for approximately 33% of net
revenue in 2004.
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|
|
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 depends 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.
18
Our distributor agreements may be terminated by either party
without cause. If one of our significant distributors terminates
its distribution agreement, we could experience a significant
interruption in the distribution of our products.
We recently began offering several of the Foundstone risk
management products through distributors. We may not see
immediate results from our distributors’ efforts as they
introduce these and other new products to their customers.
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|
|
Need for Accurate Distributor Information |
We recognize revenue on products sold by our distributors when
distributors sell our products to their customers. To determine
our business performance at any point in time or for any given
period, we must timely and accurately gather sales information
from our distributors’ information systems at an increased
cost to us. Our distributors’ information systems may be
less accurate or reliable than our internal systems. 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. In addition, 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.
Some of our distributors may experience financial difficulties,
which could adversely impact our collection of accounts
receivable. Our allowance for doubtful accounts was
approximately $2.5 million as of December 31, 2004. We
regularly review the collectibility and credit-worthiness of our
distributors to determine an appropriate allowance for doubtful
accounts. Our uncollectible accounts could exceed our current or
future allowances.
We Face the Risk of Future Charges in the Event of Impairment
and Will Experience Significant Amortization Charges Related to
Purchased Technology.
We adopted Statement of Financial Accounting Standard
(“SFAS”) No. 142 (“SFAS 142”)
beginning in 2002 and, as a result, we no longer amortize
goodwill. However, we continue to have significant amortization
related to purchased technology, trademarks, patents and other
intangibles. For 2004, our amortization charge for purchased
technology and other intangibles was approximately
$27.4 million. In addition, we must evaluate our goodwill,
at least annually for impairment according to the guidance
provided by SFAS 142. We completed the annual impairment
review during the fourth quarter of 2004. Additionally, as
required by SFAS 142, we also performed an additional
goodwill impairment test in conjunction with the Sniffer sale.
As a result of these reviews, goodwill was determined not to be
impaired. If during subsequent testing, we determine that
goodwill is impaired, we will be required to take a non-cash
charge to earnings.
In addition, we will continue to evaluate potential impairments
of our long lived assets, including our property and equipment
and amortizable intangibles under SFAS 144
“Accounting for Impairment or Disposal of Long-Lived
Assets.” For 2004, we determined that we had no
impairment of our property and equipment and amortizable
intangibles.
We Face Risks Related to Our Strategic Alliances.
We may not realize the desired benefits from our strategic
alliances on a timely basis or at all. We face a number of risks
relating to our strategic alliances, including the following:
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| |
• |
Our strategic alliances are generally terminable by either party
with no or minimal notice or penalties. We may expend
significant time, money and resources to further strategic
alliances that are thereafter terminated. |
19
|
|
|
| |
• |
Business interests may diverge over time, which might result in
conflict, termination or a reduction in collaboration. For
example, our alliance with Internet Security Systems was
terminated following the announcement of our acquisition in 2003
of Entercept and IntruVert. |
| |
| |
• |
Strategic alliances require significant coordination between the
parties involved. To be successful, our alliances may require
the integration of other companies’ products with our
products, which may involve significant time and expenditure by
our technical staff and the technical staff of our strategic
allies. |
| |
| |
• |
Our sales and marketing force may require additional training to
market products that result from our strategic alliances. The
marketing of these products may require additional sales force
efforts and may be more complex than the marketing of our own
products. |
| |
| |
• |
The integration of products from different companies may be more
difficult than we anticipate, and the risk of integration
difficulties, incompatible products and undetected programming
errors or bugs may be higher than that normally associated with
new products. |
| |
| |
• |
Our strategic alliances may involve providing professional
services, which might require significant additional training of
our professional services personnel and coordination between our
professional services personnel and other third-party
professional service personnel. |
| |
| |
• |
We may be required to share ownership in technology developed as
part of our strategic alliances. |
| |
| |
• |
Due to the complex nature of our products and of those parties
with whom we have strategic alliances, it may take longer than
we anticipate to successfully integrate and market our
respective products. |
Our Products Face Manufacturing, Supply, Inventory, Licensing
and Obsolescence Risks.
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|
|
Third-Party Manufacturing |
We rely on a small number of third parties to manufacture some
of our hardware-based network protection and system protection
products. We expect the number of our hardware-based products
and our reliance on third-party manufacturers to increase as
software-only network and system security solutions become less
viable. Reliance on third-party manufacturers, including
software replicators, involves a number of risks, including the
lack of control over the manufacturing process and the potential
absence or unavailability of adequate capacity. If any of our
third party manufacturers cannot or will not manufacture our
products in required volumes on a cost-effective basis, in a
timely manner, 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.
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.
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.
20
Hardware based products may face greater obsolescence risks than
software products. We could incur losses or other charges in
disposing of obsolete inventory.
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.
We Rely Heavily on Our Intellectual Property Rights Which
Offer Only Limited Protection Against Potential Infringers.
We rely on a combination of contractual rights, trademarks,
trade secrets, patents and copyrights to establish and protect
proprietary rights in our software. However, the steps taken by
us to protect our proprietary software may not deter its misuse
or theft. We are aware that a substantial number of users of our
anti-virus products have not paid any registration or license
fees to us. Competitors may also independently develop
technologies or products that are substantially equivalent or
superior to our products. Certain jurisdictions may not provide
adequate legal infrastructure for effective protection of our
intellectual property rights. Changing legal interpretations of
liability for unauthorized use of our software or lessened
sensitivity by corporate, government or institutional users to
avoiding infringement of intellectual property could also harm
our business.
Intellectual Property Litigation in the Network and System
Security Market Is Common and Can Be Expensive.
Litigation may be necessary to enforce and protect trade secrets
and other intellectual property rights that we own. Similarly,
we may be required to defend against claimed infringement by
others.
In addition to the expense and distractions associated with
litigation, adverse determinations could:
|
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| |
• |
result in the loss of our proprietary rights; |
| |
| |
• |
subject us to significant liabilities, including monetary
liabilities; |
| |
| |
• |
require us to seek licenses from third parties; or |
| |
| |
• |
prevent us from manufacturing or selling our products. |
The litigation process is subject to inherent uncertainties. We
may not prevail in these matters, or we may be unable to obtain
licenses with respect to any patents or other intellectual
property rights that may be held valid or infringed upon by our
products or us.
If we acquire a portion of software included in our products
from third parties, our exposure to infringement actions may
increase because we must rely upon these third parties as to the
origin and ownership of any software being acquired. Similarly,
notwithstanding measures taken by our competitors or us to
protect our competitors’ intellectual property, exposure to
infringement claims increases if we employ or hire software
engineers previously employed by competitors. Further, to the
extent we utilize “open source” software we face
risks. For example, the scope and requirements of the most
common open source software license, the GNU General Public
License (“GPL”), have not been interpreted in a court
of law. Use of GPL software could subject certain portions of
our proprietary software to the GPL requirements. Other forms of
“open source” software licensing present license
compliance risks, which could result in litigation or loss of
the right to use this software.
21
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 management’s
attention and resources.
Our Stock Price Has Been Volatile and Is Likely to Remain
Volatile.
During 2004, our stock price was highly volatile ranging from a
per share high of $33.55 to a low of $14.96. On March 24,
2005, our stock’s closing price per share price was $22.93.
Announcements, business developments, such as a material
acquisition or disposition, litigation developments and our
ability to meet the expectations of investors with respect to
our operating and financial results, may contribute to current
and future stock price volatility. Certain types of investors
may choose not to invest in stocks with this level of stock
price volatility. Further, we may not discover, or be able to
confirm, revenue or earnings shortfalls until the end of a
quarter. This could result in an immediate drop in our stock
price.
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.
Product Liability and Related Claims May Be Asserted Against
Us.
Our products are used to protect and manage computer systems and
networks that may be critical to organizations. Because of the
complexity of the environments in which our products operate, an
error, failure or bug in our products, including a security
vulnerability, could disrupt or cause damage to the networks of
our customers, including disruption of legitimate network
traffic by our intrusion prevention products. Failure of our
products to perform to specifications, disruption of our
customers’ network traffic or damages to our
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.
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
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 CD duplication by distributors or our
independent agents, CDs containing our software may be infected
with viruses.
22
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 market’s perception of
our security products.
We Face New 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,” or alternatively fail
to properly identify unwanted emails or programs, particularly
as “spam” emails or spyware are often designed to
circumvent anti-spam or spyware products. Parties whose emails
or programs are blocked by our products 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.
Business Interruptions May Impede Our Operations and the
Operations of Our Customers.
We have implemented a new customer relationship management
information system and we are in the process of transitioning
finance and sales order processing to a new shared services
center in Cork, Ireland. We are planning modifications to our
accounting systems which we expect to complete in 2005.
Implementation and modifications of these types of computer
systems are often disruptive to business and may cause us to
incur higher costs than we anticipate. Failure to manage a
smooth transition to the new shared services center and the
implementation of a new customer relationship management system
could materially harm our business operations. In addition, we
and our customers face a number of potential business
interruption risks that are beyond our respective control.
Natural disasters or other events could interrupt our business
or the business of our customers, and each of us is reliant on
external infrastructure that may be antiquated. Also, an
outbreak of SARS, bird flu or other highly contagious illnesses
could have an adverse impact on our operations and the
operations of our customers. Our corporate headquarters are
located near a major earthquake fault. The potential impact of a
major earthquake on our facilities, infrastructure and overall
operations is not known. Despite safety precautions that have
been implemented, there is no guarantee that an earthquake would
not seriously disturb our entire business process. We are
largely uninsured for losses and business disruptions caused by
an earthquake and other natural disasters.
Potential Terrorist Attacks and Any Governmental Response
Could Have a Material Adverse Effect on the U.S. and Global
Economies and Could Adversely Impact the Internet and Our
Products and Business.
The U.S. military global presence, coupled with the
possibility of potential terrorist attacks, could have a
continued adverse effect upon an already weakened world economy
and could cause U.S. and foreign businesses to slow spending on
products and services, delay sales cycles and otherwise
negatively impact consumer and business confidence. Terrorists
may also seek to interfere with the operation of the Internet,
the operation of our customers’ computer systems and
networks, and the operation of our systems and networks,
particularly given our status as an American company providing
security products. Any significant interruption of the Internet
could adversely impact our ability to rapidly and efficiently
provide anti-virus and other product updates to our customers.
23
We Face Risks Associated with Governmental Contracting.
Our customers include the U.S. government and a significant
number of other U.S. state and local governments or
agencies.
Contracting with public sector customers is highly competitive
and can be expensive and time-consuming, often requiring that we
incur significant upfront time and expense without any assurance
that we will win a contract.
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|
|
Budgetary Constraints and Cycles |
Demand and payment for our products and services are impacted by
public sector budgetary cycles and funding availability, with
funding reductions or delays adversely impacting public sector
demand for our products and services.
|
|
|
Modification or Cancellation of Contracts |
Public sector customers often have contractual or other legal
rights to terminate current contracts for convenience or due to
a default. If a contract is cancelled for convenience, which can
occur if the customer’s product needs change, we may only
be able to collect for products and services delivered prior to
termination. If a contract is cancelled because of default, we
may only be able to collect for products and services delivered,
and we may be forced to pay any costs incurred by the customer
for procuring alternative products and services.
U.S. government and other state and local agencies
routinely investigate and audit government contractors’
administrative processes. They may audit our performance and
pricing and review our compliance with applicable rules and
regulations. If they find that we have improperly allocated
costs, they may require us to refund those costs or may refuse
to pay us for outstanding balances related to the improper
allocation. An unfavorable audit could result in a reduction of
revenue, and may result in civil or criminal liability if the
audit uncovers improper or illegal activities.
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.
Our Charter Documents and Delaware Law and Our Rights Plan
May Impede or Discourage a Takeover, Which Could Lower Our Stock
Price.
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|
|
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
24
stockholder wishing to make a stockholder proposal (including
director nominations) at our 2005 annual meeting, must meet the
qualifications and follow the procedures specified under both
the Exchange Act of 1934 and our bylaws.
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.
Our worldwide headquarters currently occupy approximately
135,000 square feet in facilities located in
Santa Clara, California under leases expiring through 2017.
Worldwide, we lease facilities with approximately 815,000 total
square feet, with leases that expire at various times. Our
primary international facilities are located in Germany, India,
Ireland, Japan, the Netherlands and the United Kingdom. We
recently moved our European headquarters from the Netherlands to
a 25,000 square foot facility in Cork, Ireland. Significant
domestic sites include California, Maryland, Oregon and Texas.
We believe that our existing facilities are adequate for the
present and that additional space will be available as needed.
We own our regional office located in Plano, Texas. The
170,000 square feet facility opened in January 2003 and is
located on 15.6 acres of owned land. This facility supports
approximately 600 employees working in our customer support,
engineering, accounting and finance, information technology,
internal audit, legal and telesales groups.
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| Item 3. |
Legal Proceedings |
Information with respect to this item is incorporated by
reference to Note 20 to the notes to consolidated financial
statements included in this Form 10-K.
|
|
| Item 4. |
Submission of Matters to a Vote of Security Holders |
No matters were submitted to a vote of stockholders during the
quarter ended December 31, 2004.
25
PART II
|
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| Item 5. |
Market for the Registrant’s Common Equity and Related
Stockholder Matters |
Price Range of Common Stock
In June 2004, we changed our name to McAfee, Inc., and our
common stock began trading under the symbol MFE. Our common
stock began to trade on the New York Stock Exchange effective
February 12, 2002, and traded under the symbol NET from
February 12, 2002 until we changed our name to McAfee in
June 2004. Prior to February 12, 2002, our common stock
traded on the NASDAQ National Market. From December 1,
1997, our common stock traded under the symbol NETA, and prior
thereto, under the symbol MCAF.
The following table sets forth, for the period indicated the
high and low closing sales prices for our common stock for the
last eight quarters, all as reported by NYSE. The prices
appearing in the table below do not reflect retail mark-up,
mark-down or commission.
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High | |
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Low | |
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Year Ended December 31, 2004
|
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|
|
|
|
|
|
|
First Quarter
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|
$ |
18.50 |
|
|
$ |
14.96 |
|
|
Second Quarter
|
|
|
19.75 |
|
|
|
15.68 |
|
|
Third Quarter
|
|
|
20.10 |
|
|
|
16.04 |
|
|
Fourth Quarter
|
|
|
33.39 |
|
|
|
20.46 |
|
|
Year Ended December 31, 2003
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$ |
20.28 |
|
|
$ |
13.72 |
|
|
Second Quarter
|
|
|
14.40 |
|
|
|
10.80 |
|
|
Third Quarter
|
|
|
15.50 |
|
|
|
10.75 |
|
|
Fourth Quarter
|
|
|
15.59 |
|
|
|
12.95 |
|
Dividend Policy
We have not paid any cash dividends since our reorganization
into a corporate form in October 1992. We intend to retain
future earnings for use in our business and do not anticipate
paying cash dividends in the foreseeable future.
Holders of Common Stock
As of January 31, 2005, there were approximately 850 record
owners of our common stock.
26
Common Stock Repurchases
The table below sets forth all repurchases by us of our common
stock during 2004 and 2003, all of which were pursuant to a
publicly announced plan or program (in thousands, except price
per share):
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|
|
Total Number of | |
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Approximate Dollar | |
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Shares Purchased as | |
|
Value of Shares | |
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|
Total | |
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|
Part of Publicly | |
|
That May yet be | |
| |
|
Number of | |
|
Average | |
|
Announced Plan or | |
|
Purchased Under | |
| |
|
Shares | |
|
Price Paid | |
|
Repurchase | |
|
Our Stock Repurchase | |
| Period |
|
Purchased | |
|
per Share | |
|
Program(1) | |
|
Program(1) | |
| |
|
| |
|
| |
|
| |
|
| |
|
November 1, 2003 - November 30, 2003
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
$ |
150,000 |
|
|
December 1, 2003 - December 31, 2003
|
|
|
350 |
|
|
$ |
13.45 |
|
|
|
350 |
|
|
$ |
145,293 |
|
|
April 1, 2004 - April 30, 2004
|
|
|
450 |
|
|
$ |
15.86 |
|
|
|
450 |
|
|
$ |
138,154 |
|
|
May 1, 2004 - May 31, 2004
|
|
|
8,213 |
|
|
$ |
16.82 |
|
|
|
8,213 |
|
|
$ |
— |
|
|
August 1, 2004 - August 31, 2004
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
$ |
200,000 |
|
|
August 1, 2004 - August 31, 2004
|
|
|
1,913 |
|
|
$ |
19.35 |
|
|
|
1,913 |
|
|
$ |
163,029 |
|
|
September 1, 2004 - September 30, 2004
|
|
|
2,047 |
|
|
$ |
19.28 |
|
|
|
2,047 |
|
|
$ |
123,556 |
|
|
October 1, 2004 - October 31, 2004
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
$ |
123,556 |
|
|
November 1, 2004 - November 30, 2004
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
$ |
123,556 |
|
|
December 1, 2004 - December 31, 2004
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
$ |
123,556 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total
|
|
|
12,973 |
|
|
$ |
17.46 |
|
|
|
12,973 |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
In November 2003, our board of directors authorized the
repurchase of up to $150.0 million of our common stock in
the open market from time to time over the next two years,
depending upon market conditions, share price and other factors.
Through May 2004, we had repurchased the $150.0 million in
shares authorized in November 2003, and in August 2004, our
board of directors authorized an additional $200.0 million
in stock repurchases over the next two years. In 2004 we
purchased approximately 12.6 million shares for a total of
$221.8 million, and in 2003 we purchased
350,000 shares for a total of $4.7 million. As of
December 31, 2004, we had authorization from the board of
directors to repurchase an additional $123.6 million of our
common stock. In March 2005, we repurchased approximately
2.0 million shares for $47.4 million.
Retirements of Common Stock
In 2004, we retired the approximately 13.0 million treasury
shares we had repurchased on the open market in 2003 and 2004.
In 1998, we deposited approximately 1.7 million shares of
our common stock with a trustee for the benefit of the employees
of our Dr. Solomon’s acquisition to cover the stock
options assumed in our acquisition of this company. These
shares, which have been included in our outstanding share
balance, were to be issued upon the exercise of stock options by
Dr. Solomon’s employees. We determined in June 2004
that Dr. Solomon’s employees had exercised
approximately 1.6 million options, and that we had issued
new shares in connection with these exercises rather than using
the trust shares to satisfy the option exercises. The trustee
returned the 1.6 million shares to us in June 2004, at
which time we retired them and they were no longer included in
our outstanding share balance. In December 2004, the trustee
sold the remaining 133,288 shares in the trust for proceeds
of $3.8 million, and remitted the funds to us. The terms of
the trust prohibited the trustee from returning the shares to us
and stipulated that only employees could benefit from the
shares. We distributed these funds to all employees below the
level of vice president through a bonus which was recognized as
expense in 2004.
Public Filings
Our Internet address is www.mcafee.com. We make available free
of charge through our Internet website current and archived
press releases and presentations, our annual report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to those reports filed
or furnished pursuant to Sections 13(a) or 15(d) of the
Securities and Exchange Act, as amended, as soon as reasonably
practicable
27
after we electronically file such material with the SEC. We also
make available through our Internet website our Corporate
Governance Guidelines, the charter for the committees of our
board of directors and our Code of Business Conduct and Ethics.
The public may read and copy any materials we file with the SEC
at the SEC’s Public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Members of the public
may obtain information on the operation of the Public Reference
Room by calling the SEC at 1-800-SEC-0300. Information can also
be downloaded from the SEC’s web-site at www.sec.gov.
The annual certification to the NYSE attesting to our compliance
with the NYSE’s corporate governance listing standards was
submitted by our chief executive officer to the NYSE in June
2004.
|
|
| Item 6. |
Selected Financial Data |
You should read the following selected financial data with the
consolidated financial statements and related notes and
“Management’s Discussion and Analysis of Financial
Conditions and Results of Operations” appearing elsewhere
in this Form 10-K.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004(1) | |
|
2003 | |
|
2002(2) | |
|
2001 | |
|
2000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except for per share amounts) | |
|
Statement of Operations Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$ |
910,542 |
|
|
$ |
936,336 |
|
|
$ |
1,043,044 |
|
|
$ |
1,071,660 |
|
|
$ |
709,372 |
|
|
Income (loss) from operations
|
|
|
322,671 |
|
|
|
64,402 |
|
|
|
124,028 |
|
|
|
153,483 |
|
|
|
(127,541 |
) |
|
Income (loss) before provision for (benefit from) income taxes,
minority interest and cumulative effect of change in accounting
principle
|
|
|
316,471 |
|
|
|
73,125 |
|
|
|
129,933 |
|
|
|
148,136 |
|
|
|
(70,924 |
) |
|
Income (loss) before cumulative effect of change in accounting
principle
|
|
|
225,065 |
|
|
|
59,905 |
|
|
|
128,312 |
|
|
|
83,253 |
|
|
|
(108,014 |
) |
|
Cumulative effect of change in accounting principle, net of taxes
|
|
|
— |
|
|
|
10,337 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Net income (loss)
|
|
|
225,065 |
|
|
|
70,242 |
|
|
|
128,312 |
|
|
|
83,253 |
|
|
|
(108,014 |
) |
| |
Income (loss) per share, before cumulative effect of change in
accounting principle, basic
|
|
$ |
1.40 |
|
|
$ |
0.37 |
|
|
$ |
0.86 |
|
|
$ |
0.60 |
|
|
$ |
(0.78 |
) |
| |
Income (loss) per share, before cumulative effect of change in
accounting principle, diluted
|
|
$ |
1.31 |
|
|
$ |
0.36 |
|
|
$ |
0.80 |
|
|
$ |
0.53 |
|
|
$ |
(0.78 |
) |
|
Cumulative effect of change in accounting principle, basic
|
|
$ |
— |
|
|
$ |
0.07 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
Cumulative effect of change in accounting principle, diluted
|
|
$ |
— |
|
|
$ |
0.07 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
Net income (loss) per share, basic
|
|
$ |
1.40 |
|
|
$ |
0.44 |
|
|
$ |
0.86 |
|
|
$ |
0.60 |
|
|
$ |
(0.78 |
) |
|
Net income (loss) per share, diluted
|
|
$ |
1.31 |
|
|
$ |
0.43 |
|
|
$ |
0.80 |
|
|
$ |
0.53 |
|
|
$ |
(0.78 |
) |
|
Shares used in per share calculation — basic
|
|
|
160,714 |
|
|
|
160,338 |
|
|
|
149,441 |
|
|
|
137,847 |
|
|
|
138,072 |
|
|
Shares used in per share calculation — diluted
|
|
|
177,099 |
|
|
|
164,489 |
|
|
|
176,249 |
|
|
|
164,363 |
|
|
|
138,072 |
|
28
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004(1) | |
|
2003 | |
|
2002(2) | |
|
2001 | |
|
2000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Balance Sheet Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
291,155 |
|
|
$ |
333,651 |
|
|
$ |
674,226 |
|
|
$ |
612,832 |
|
|
$ |
275,539 |
|
|
Working capital
|
|
|
259,870 |
|
|
|
415,768 |
|
|
|
475,418 |
|
|
|
443,035 |
|
|
|
79,591 |
|
|
Total assets
|
|
|
2,237,676 |
|
|
|
2,120,498 |
|
|
|
2,045,487 |
|
|
|
1,658,093 |
|
|
|
1,465,622 |
|
|
Deferred revenue
|
|
|
601,373 |
|
|
|
459,557 |
|
|
|
329,195 |
|
|
|
404,826 |
|
|
|
531,555 |
|
|
Long term debt and other long-term liabilities
|
|
|
204,796 |
|
|
|
570,162 |
|
|
|
519,150 |
|
|
|
579,243 |
|
|
|
400,456 |
|
|
Total equity
|
|
|
1,201,248 |
|
|
|
888,089 |
|
|
|
770,168 |
|
|
|
341,493 |
|
|
|
222,923 |
|
|
|
| (1) |
In January 2004, we sold our Sniffer and Magic product lines for
net cash proceeds of $260.9 million and recognized pre-tax
gains on the sale of assets and technology aggregating
$243.5 million. |
| |
| (2) |
We agreed to settle a pending class action lawsuit in September
2003 for $70.0 million, which was recorded as expense in
2002 as the settlement agreement was entered into prior to the
filing of the 2002 financial statements. |
|
|
| Item 7. |
Management’s Discussion and Analysis of Financial
Condition and Results of Operations |
Forward-Looking Statements and Factors That May Affect Future
Results
This Management’s Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking
statements that involve known and unknown risks, uncertainties
and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different
from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking
statements. Such factors include, among others things, those
risk factors set forth in this section and elsewhere in this
report. We identify forward-looking statements by words such as
“may,” “will,” “should,”
“could,” “expects,” “plans,”
“anticipates,” “believes,”
“estimates,” “predicts,”
“potential” or “continue” or similar terms
that refer to the future. We cannot guarantee future results,
levels of activity, performance or achievements. Therefore,
actual results may differ materially and adversely from those
expressed in any forward-looking statements. We undertake no
obligation to revise or update publicly any forward-looking
statements for any reason.
Overview and Executive Summary
We are a leading supplier of computer security solutions
designed to prevent intrusions on networks and protect computer
systems from the next generation of blended attacks and threats.
We offer two families of products, McAfee System Protection
Solutions and McAfee Network Protection Solutions. Our computer
security solutions are offered primarily to large enterprises,
governments, small and medium sized business and consumer users.
We derive our revenue and generate cash from customers from
primarily two sources (i) product revenue, which includes
software license, hardware and royalty revenue, and
(ii) services and support revenue, which includes software
license maintenance, training, consulting and on-line
subscription arrangements revenue. For 2004 and 2003, our net
revenue was $910.5 million and $936.3 million, and our
net income was $225.1 million and $70.2 million,
respectively. Our net revenue was impacted by a gradual recovery
in the global economy which resulted in increased corporate IT
spending in 2004. Additionally, the sales of our Sniffer and
Magic businesses in 2004 resulted in a $179.6 million
reduction in revenues from 2003 to 2004. In addition to total
net revenue and net income, in evaluating our business,
management considers, among many other factors, the following:
|
|
|
| |
• |
Sales by geography. We operate our business in five
geographic regions: North America (U.S. and Canada); Europe,
Middle East and Africa, or EMEA; Japan; Asia-Pacific (excluding
Japan) and Latin America. In 2004, 39% of our net revenue was
generated outside of North America, with North America and EMEA
collectively accounting for 87% of our total net revenue. North
America and |
29
|
|
|
| |
|
EMEA have benefited from increased corporate IT spending. Our
2004 sales in EMEA totaling $241.7 million were favorably
impacted by the strengthening of the Euro during the year. |
|
|
| |
The following table illustrates the strengthening of foreign
currencies in geographic regions outside of North America from
which we derive a significant portion of our revenues: |
| |
|
|
|
|
|
|
|
|
| |
|
|
|
Japanese | |
| |
|
Euro | |
|
Yen | |
| |
|
| |
|
| |
|
2003 Average Exchange Rate to $1 US
|
|
|
.8854 |
|
|
|
115.98 |
|
|
2004 Average Exchange Rate to $1 US
|
|
|
.8051 |
|
|
|
108.17 |
|
| |
|
|
|
|
|
|
|
% Change
|
|
|
9% |
|
|
|
7% |
|
| |
|
|
|
|
|
|
|
|
|
| |
• |
McAfee. Our McAfee products include enterprise, small and
medium sized businesses (“SMB”) and consumer products,
with enterprise including our Entercept host-based intrusion
protection products which were acquired in connection with the
Entercept acquisition in April 2003. SMB sales remained
relatively consistent from $232.6 million for 2003 to
$228.9 million for 2004. Enterprise sales, excluding
IntruShield, for 2004 were $238.9 million, a
$13.0 million, or 6%, increase from $225.9 million for
2003. The year over year increase reflects an increase in
corporate IT spending in 2004, partially offset by the impact of
our perpetual plus license model, which recognizes less revenue
upfront and defers more revenue to future periods. |
|
|
|
| |
|
We continue to experience significant growth in the consumer
market. Our consumer market is comprised of our McAfee consumer
on-line subscription service and retail boxed product sales. In
2004, we added 4.7 million net new subscribers. |
| |
| |
|
Revenue from our consumer security market increased
$122.6 million, or 70% from $176.3 million in 2003 to
$298.9 million in 2004. At December 31, 2004, we had a
total subscriber base of approximately 8.5 million consumer
customers, compared to 3.7 million at December 31,
2003. Drivers of this subscriber growth include
(i) numerous virus outbreaks during the second half of 2003
and through 2004, including variations of Sasser, MyDoom, Bagle
and NetSky, and (ii) continued strategic relationships with
channel partners, such as AOL and Dell. In October 2004, we
announced a renewed relationship with AOL under which, among
other things, AOL will offer our on-line PC anti virus services
to AOL members as part of their AOL subscription and membership
experience for both broadband and dial up members. |
|
|
|
| |
• |
IntruShield. Our IntruShield network protection products,
acquired by us in the second quarter of 2003, are sold primarily
to enterprises and small and medium sized businesses. During
2004, we had revenues of approximately $43.7 million,
compared to $15.5 million in 2003. The $28.2 million
increase is due to the full year impact on revenues in 2004, as
well as sequential quarter growth in 2004. |
| |
| |
• |
Foundstone. Our Foundstone network protection products,
acquired by us in October 2004, are sold primarily to
enterprises and small and medium sized businesses. We are in the
process of integrating Foundstone’s operations with ours
and its products with our intrusion prevention technologies and
systems management capabilities. Revenues from Foundstone were
not significant in 2004. |
| |
| |
• |
Sniffer Technologies. We sold Sniffer in July 2004 for
net cash proceeds of $213.8 million. As there were only
approximately six months of Sniffer revenue in 2004, there was a
significant decline in revenue from $210.2 million in 2003
to $90.9 million in 2004. Additionally, there was a
declining trend in Sniffer revenues in 2004 prior to the sale. |
|
|
|
| |
|
We have agreed to provide certain post-closing transitional
services to Network General. We are reimbursed for our cost plus
a profit margin and present these reimbursements as a reduction
of operating expenses on a separate line in our income
statement. For the year ended December 31, 2004, we have
recorded approximately $6.0 million for these transition
services. |
|
|
|
| |
• |
Magic. We sold the assets of our Magic Solutions service
desk business to BMC Software, Inc. in January 2004 for cash
proceeds of $47.1 million, net of direct expenses. During
2004 and 2003, net |
30
|
|
|
| |
|
revenue from Magic Solutions products totaled approximately
$2.9 million and $63.2 million, respectively. |
| |
| |
• |
McAfee Labs. We entered into an agreement to sell the
assets of McAfee Labs on December 21, 2004 for cash
proceeds of $1.5 million. During 2004 and 2003, net revenue
from McAfee Labs totaled approximately $6.4 million and
$11.0 million, respectively. |
| |
| |
• |
Deferred revenue balances. Our deferred revenue balance
at December 31, 2004 was $601.4 million, and at
December 31, 2003 it was $459.6 million, excluding
approximately $22.0 million relating to our Magic product
line which was classified as liabilities related to assets held
for sale. The increase from December 31, 2003 to
December 31, 2004 was 31%. We believe that the deferred
revenue balance improves predictability of future revenues. In
the middle of 2003, we introduced our perpetual plus licensing
program in EMEA and introduced this program in the United States
in the first quarter of 2004. Under the perpetual plus licensing
program more revenue is allocated to service and support due to
a change in pricing structure, which was the primary reason for
the increase in deferred revenue. The strengthening of foreign
currencies against the U.S. dollar resulted in
approximately $18 million of the increase. These increases
were partially offset by the sale of our Sniffer business in
2004, which had a deferred revenue balance at December 31,
2003 of approximately $60.2 million. |
| |
| |
• |
Cash, cash equivalents and investment balances. Cash,
cash equivalents and investment balances at December 31,
2004 and 2003 totaled $924.7 million and
$766.3 million. During 2004, we generated approximately
$358.9 million in cash from operations. We used
approximately $39.4 million of cash for investing
activities and $369.9 million for financing activities. We
received $260.9 million for the sale of Sniffer and Magic,
and paid $84.7 million, net of cash assumed, for the
acquisition of Foundstone, which is reflected in investing
activities. Our primary utilizations of cash in 2004 were for
the net purchases of marketable securities of approximately
$210.6 million, the repurchase shares of common stock for
$221.8 million and the redemption of convertible debt for
$265.6 million. |
In 2005, our management is focused, on among other things,
(i) continuing to build on the current momentum in the
consumer market and to grow faster than the competition in the
consumer space; (ii) increasing revenue from the small to
medium sized business customers by improving our channel
distribution relationships; (iii) implementing cost
controls and business streamlining measures required to improve
operating margins; and (iv) continuing to grow our
intrusion prevention business.
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. Senior management has discussed the development,
selection and disclosure of these estimates with the audit
committee of our board of directors. Actual results may differ,
and could be material, from these estimates under different
assumptions or conditions.
An accounting policy is deemed to be critical if it requires an
accounting estimate to be made based on assumptions about
matters that are highly uncertain at the time the estimate is
made, and if different estimates that reasonably could have been
used, or changes in the accounting estimates that are reasonably
likely to occur periodically, could materially impact the
consolidated financial statements. Management believes the
following critical accounting policies reflect our more
significant estimates and assumptions used in the preparation of
the consolidated financial statements. We have not materially
changed our methodology for calculating the estimates below in
the past three years.
31
Our critical accounting policies are as follows:
|
|
|
| |
• |
revenue recognition; |
| |
| |
• |
estimating valuation allowances and accrued liabilities,
specifically sales returns and other allowances, the allowance
for doubtful accounts, our facility restructuring accrual; and
the assessment of the probability of the outcome of litigation
against us; |
| |
| |
• |
accounting for income taxes; and |
| |
| |
• |
valuation of goodwill, intangibles and long-lived assets. |
As described below, significant management judgments and
estimates must be made and used in connection with the revenue
recognized in any accounting period. Material differences may
result in the amount and timing of our revenue for any period if
our management made different judgments or utilized different
estimates. These estimates affect the deferred revenue line item
on our consolidated balance sheet and the net revenue line item
on our consolidated statement of income. Estimates regarding
revenue affect all of our operating geographies.
We apply the provisions of Statement of Position 97-2,
“Software Revenue Recognition,”
(“SOP 97-2”) as amended by Statement of
Position 98-9 “Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain
Transactions” to all transactions involving the sale of
software products and hardware transactions where the software
is not incidental. For hardware transactions where software is
not incidental, we do not bifurcate the fee and we do not apply
separate accounting guidance to the hardware and software
elements. For hardware transactions where no software is
involved, we apply the provisions of Staff Accounting
Bulletin 104 “Revenue Recognition”
(“SAB 104”). In addition, we apply the
provisions of Emerging Issues Task Force Issue No. 00-03
“Application of AICPA Statement of Position 97-2 to
Arrangements that Include the Right to Use Software Stored on
Another Entity’s Hardware” to our on-line software
subscription services.
We license our software products on a one and two-year
subscription basis or on a perpetual basis. Our two-year
subscription licenses include the first year of maintenance and
support. Our on-line subscription arrangements require customers
to pay a fixed fee and receive service over a period of time,
generally one or two years. Customers do not pay set-up fees. We
recognize revenue from the sale of software licenses when
persuasive evidence of an arrangement exists, the product has
been delivered, the fee is fixed or determinable and collection
of the resulting receivable is reasonably assured. For all
sales, except those completed over the Internet, we use either a
binding purchase order or signed license agreement as evidence
of an arrangement. For sales over the Internet, we use a credit
card authorization as evidence of an arrangement. Sales through
our distributors are evidenced by a master agreement governing
the relationship together with binding purchase orders on a
transaction by transaction basis.
Delivery generally occurs when product is delivered to a common
carrier or upon delivery of the license key which is delivered
primarily through email. At the time of the transaction, we
assess whether the fee associated with our revenue transactions
is fixed or determinable and whether or not collection is
reasonably assured. We assess whether the fee is fixed or
determinable based on the payment terms associated with the
transaction. If a significant portion of a fee is due after our
normal payment terms, which are 30 to 90 days from invoice
date, we account for the fee as not being fixed or determinable.
In these cases, we recognize revenue as the fees become due.
With respect to rebate programs, we make estimates of amounts
for promotional and rebate programs based on our historical
experience, and reduce revenue by the amount of the estimates.
We assess collection based on a number of factors, including
past transaction history and credit-worthiness of direct
customers. We do not request collateral from our customers. If
we determine that collection of a fee is not reasonably assured,
we defer the fee and recognize revenue at the time collection
becomes reasonably assured, which is generally upon receipt of
cash. For indirect customers, we monitor the financial condition
and ability to pay for goods sold. If we do not identify
potential collection problems with
32
our indirect customers on a timely basis, we could incur a
charge for bad debt that could be material to our consolidated
financial statements.
For arrangements with multiple obligations (for example,
undelivered maintenance and support), we allocate revenue to
each component of the arrangement using the residual value
method based on the fair value of the undelivered elements,
which is specific to our company. This means that we defer
revenue from the arrangement fee equivalent to the fair value of
the undelivered elements. Fair values for the ongoing
maintenance and support obligations for both our two-year time
based licenses and perpetual licenses are based upon separate
sales of renewals to other customers or upon renewal rates
quoted in the contracts. This assessment generally includes
analyses of the variability of renewal rates by product and
region and determination of whether a majority of renewals
supports our estimated fair value of the maintenance and support
obligations. In cases where renewal rates are not quoted in the
initial sales contracts, our assessment is critical because if
an estimated fair value cannot be established through separate
sales then the fee for the entire arrangement (e.g. delivered
software and undelivered maintenance and support obligations) is
deferred until delivery occurs which for maintenance would be
ratably over the service period. Fair value of services, such as
training or consulting, is based upon separate sales by us of
these services to other customers. Our arrangements do not
generally include acceptance clauses. However, if an arrangement
includes a specified acceptance provision, recognition occurs
upon the earlier of receipt of a written customer acceptance or
expiration of the acceptance period.
We recognize revenue for maintenance services ratably over the
contract term. Our training and consulting services are billed
based on hourly rates, and we generally recognize revenue as
these services are performed. However, at the time of entering
into a transaction, we assess whether or not any services
included within the arrangement require us to perform
significant work either to alter the underlying software or to
build additional complex interfaces so that the software
performs as the customer requests. If these services are
included as part of an arrangement, we recognize the entire fee
using the percentage of completion method. We estimate the
percentage of completion based on our estimate of the total
costs estimated to complete the project as a percentage of the
costs incurred to date and the estimated costs to complete.
Estimation of Sales Returns and Other Allowances, Allowance
for Doubtful Accounts, Restructuring Accrual and Litigation
Sales Returns and Other Allowances. In each accounting
period, our management must make judgments and estimates of
potential future product returns related to current period
product revenue. We analyze and monitor current and historical
return rates, current economic trends, and changes in customer
demand and acceptance of our products when evaluating the
adequacy of the sales returns and other allowances. We also
budget for our sales incentives each quarter and determine
amounts to be spent and we monitor amounts spent against our
budgets. These estimates affect our net revenue line item on our
statement of income and affect our net accounts receivable line
item on our consolidated balance sheet. These estimates affect
all of our operating geographies.
If our sales returns experience were to increase by an
additional 1% of license revenues, our allowance for sales
returns at December 31, 2004 would increase and net revenue
and operating income for 2004 would decrease by approximately
$1.6 million.
Allowance for Doubtful Accounts. We also make estimates
of the uncollectibility of our accounts receivables. Management
specifically analyzes accounts receivable balances, current and
historical bad debt trends, customer concentrations, customer
credit-worthiness, current economic trends and changes in our
customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. We specifically reserve for any
account receivable for which there are identified collection
issues. Bad debts have historically been approximately 2% of our
average accounts receivable. These estimates affect the
provision for
33
doubtful accounts line item on our statement of income and the
net accounts receivable line item on the consolidated balance
sheet. The estimation of uncollectible accounts affects all of
our operating geographies.
| |
|
|
|
|
|
|
|
|
| |
|
December 31, | |
|
December 31, | |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(In millions) | |
|
Allowance for sales return and incentives
|
|
$ |
29.2 |
|
|
$ |
39.6 |
|
|
Allowance for doubtful accounts
|
|
|
2.5 |
|
|
|
3.1 |
|
| |
|
|
|
|
|
|
|
Total allowance
|
|
$ |
31.7 |
|
|
$ |
42.7 |
|
| |
|
|
|
|
|
|
At December 31, 2004, our accounts receivable balance was
$137.5 million, net of allowance for doubtful accounts of
$2.5 million, and our allowance for sales return and
incentives amounts to $29.2 million. At December 31,
2003, our accounts receivable balance was $170.2 million,
net of allowance for doubtful accounts of $2.9 million
(excluding the allowance related to Magic accounts receivable)
and provision for sales returns and other allowances of
$39.6 million as of December 31, 2003. If an
additional 1% of our gross accounts receivable were deemed to be
uncollectible at December 31, 2004, our allowance for
doubtful accounts and provision for bad debt expense would
increase by approximately $1.7 million.
Restructuring Accrual. During 2004, we permanently
vacated several leased facilities, including an additional two
floors in our Santa Clara headquarters building. As a
result of these vacancies, we recorded $8.7 million in
restructuring accruals. 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. In 2004, we recorded adjustments
to the 2004 and 2003 lease termination restructuring accruals of
$0.2 million and $0.6 million, respectively. 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” (“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 management’s best
estimate at the time of the accrual, and adjustments are made on
a periodic basis if better information is obtained. If, at
December 31, 2004, our estimated sublease income were to
decrease 10%, the restructuring reserve and related expense
would have increased by approximately $0.2 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
December 31, 2004, our North American operating segment was
affected by these estimates.
Litigation. Management’s current estimated range of
liability related to litigation that is brought against us from
time to time is based on claims for which our management can
estimate the amount and range of loss. We recorded the minimum
estimated liability related to those claims, where there is a
range of loss as there is no better point of estimate. Because
of the uncertainties related to an unfavorable outcome of
litigation, and the amount and range of loss on pending
litigation, management is often unable to make a reasonable
estimate of the liability that could result from an unfavorable
outcome. As litigation progresses, we continue to assess our
potential liability and revise our estimates. Such revisions in
our estimates could materially impact our results of operations
and financial position. Estimates of litigation liability affect
our accrued liability line item on our consolidated balance
sheet and our general and administrative expense line item on
our statement of income.
|
|
|
Accounting for Income Taxes |
As part of the process of preparing our consolidated financial
statements we are required to estimate our income taxes in each
of the jurisdictions in which we operate. This process involves
estimating our actual
34
current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as
deferred revenue, for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which
are included within our consolidated balance sheet. We must then
assess and make significant estimates regarding the likelihood
that our deferred tax assets will be recovered from future
taxable income and to the extent we believe that recovery is not
likely, we must establish a valuation allowance. To the extent
we establish a valuation allowance or increase this allowance in
a period, we must include an expense within the tax provision in
the statement of income. Estimates related to income taxes
affect the deferred tax asset and liability line items and
accrued liabilities in our consolidated balance sheet and our
income tax (benefit) expense line item in our statement of
income. Income tax estimates affect all of our operating
geographies.
The net deferred tax asset as of December 31, 2004 is
$421.1 million, net of a valuation allowance of
$65.8 million due to uncertainties related to our ability
to utilize some of our deferred tax assets related to acquired
companies, primarily consisting of certain net operating losses
carried forward and foreign tax credits, before they expire. 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 for
unsettled issues, additional benefits or expenses could occur in
future years from resolution of outstanding matters. We continue
to assess our potential tax liability included in accrued taxes
in the consolidated financial statements, and revise our
estimates. Such revisions in our estimates could materially
impact our results of operations and financial position. We have
classified a portion of our tax liability as noncurrent in the
consolidated balance sheet based on the expected timing of cash
payments to settle contingencies with taxing authorities.
|
|
|
Valuation of Goodwill, Intangibles, and Long-lived
Assets |
We account for goodwill and other indefinite-lived intangible
assets in accordance with SFAS 142, “Goodwill and
Other Intangible Assets” (“SFAS 142”).
SFAS 142 requires, among other things, the discontinuance
of amortization for goodwill and indefinite-lived intangibles
and at least an annual test for impairment. An impairment review
may be performed more frequently in the event circumstances
indicate that the carrying value may not be recoverable. The
goodwill impairment review involves a two-step process as
described in Note 2 to the consolidated financial
statements.
We are required to make estimates regarding the fair value of
our reporting units when testing for potential impairment. We
estimate the fair value of our reporting units using a
combination of the income approach and the market approach.
Under the income approach, we calculate the fair value of a
reporting unit based on the present value of estimated future
cash flows. Under the market approach, we estimate the fair
value based on market multiples of revenues or earnings for
comparable companies. We estimate cash flows for these purposes
using internal budgets based on recent and historical trends. We
base these estimates on assumptions we believe to be reasonable,
but which are unpredictable and inherently uncertain. We also
make certain judgments about the selection of comparable
companies used in the market approach in valuing our reporting
units, as well as certain assumptions to allocate shared assets
and liabilities to calculate the carrying 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 current impairment test, there would have to be a
significant change in assumptions used in such calculation in
order for an impairment to occur as of December 31, 2004.
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
35
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 $439.2 million and $443.6 million
as of December 31, 2004 and 2003, respectively. We did not
hold any other indefinite-lived intangibles as of
December 31, 2004 or 2003. Net finite-lived intangible
assets and long-lived assets amounted to $198.8 million and
$217.6 million as of December 31, 2004 and 2003,
respectively.
Results of Operations
|
|
|
Years Ended December 31, 2004, 2003, and 2002 |
The following table sets forth for the periods indicated our
product revenue and services and support revenue as a percent of
net revenue (in thousands, except percentages):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Percentage of | |
| |
|
For the Year Ended December 31, | |
|
Net Revenue | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
|
|
|
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
$ |
294,163 |
|
|
$ |
513,610 |
|
|
$ |
631,550 |
|
|
|
32 |
% |
|
|
55 |
% |
|
|
61 |
% |
| |
Services and support
|
|
|
616,379 |
|
|
|
422,726 |
|
|
|
411,494 |
|
|
|
68 |
|
|
|
45 |
|
|
|
39 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$ |
910,542 |
|
|
$ |
936,336 |
|
|
$ |
1,043,044 |
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue decreased 3%, or $25.8 million from 2003 to
2004. The decrease reflects (i) a $119.3 million
decrease in our Sniffer product line related to declining
Sniffer revenues throughout 2004 and its sale in July 2004, and
(ii) a $60.3 million decrease due to the January 2004
sale of Magic, (iii) a decrease due to the introduction of
our perpetual “plus” licensing model in 2003, offset
by (iv) a $28.2 million increase in our IntruShield
product sales from our May 2003 IntruVert acquisition,
(v) a $103.9 million increase in our McAfee.com
consumer business due to on-line subscriber growth, (vi) an
increase in revenues in EMEA and Japan of approximately
$26.0 million due to a weakening U.S. Dollar, and
(vii) increased corporate IT spending in 2004, which had a
positive impact on our revenues. Net revenue decreased 10% or
$106.7 million from 2002 to 2003. The decline was due
primarily to weaknesses in the United States and other economies
and continued reductions in corporate spending. Many of our
customers and potential customers: (i) delayed initiating
the purchase process; (ii) increased the evaluation time to
complete a purchase or postponed, sometimes indefinitely, full
IT deployments; and/or (iii) reduced their capital
expenditure budgets, thereby restricting their software/services
purchases to those believed by them to be necessary to satisfy
an immediate need.
36
In 2003, we began introducing our perpetual “plus”
licensing arrangements outside of North America. In the first
quarter of 2004, we expanded our perpetual “plus”
licensing arrangements to North America. Under these
arrangements, we provide a perpetual license coupled with
additional support, with a higher percentage of the contract
value allocated to support revenues. As a result of these
arrangements, there has been an increase in services and support
revenue relative to product revenue due to higher renewal rates
for support bundled in these arrangements and an increase of
revenue being deferred to future periods as support revenues are
deferred and recognized over the life of the arrangement. The
perpetual plus licensing model is designed to make our products
more competitive in the channel and increase channel volumes,
while having the added effect of improving the visibility and
predictability of our business through increased deferred
revenue balances. The balance of deferred revenue has increased
31% from $459.6 million at December 31, 2003 to
$601.4 million at December 31, 2004.
The following table sets forth for the periods indicated net
revenue, in each of the five geographic regions in which we
operate:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Percentage of | |
| |
|
For the Year Ended December 31, | |
|
Net Revenue | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
|
|
|
|
|
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
North America
|
|
$ |
554,641 |
|
|
$ |
606,685 |
|
|
$ |
653,532 |
|
|
|
61 |
% |
|
|
65 |
% |
|
|
63 |
% |
| |
EMEA
|
|
|
241,724 |
|
|
|
240,616 |
|
|
|
298,659 |
|
|
|
27 |
|
|
|
26 |
|
|
|
28 |
|
| |
Japan
|
|
|
54,609 |
|
|
|
40,519 |
|
|
|
39,369 |
|
|
|
6 |
|
|
|
4 |
|
|
|
4 |
|
| |
Asia-Pacific (excluding Japan)
|
|
|
38,494 |
|
|
|
29,014 |
|
|
|
33,595 |
|
|
|
4 |
|
|
|
3 |
|
|
|
3 |
|
| |
Latin America
|
|
|
21,074 |
|
|
|
19,502 |
|
|
|
17,889 |
|
|
|
2 |
|
|
|
2 |
|
|
|
2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$ |
910,542 |
|
|
$ |
936,336 |
|
|
$ |
1,043,044 |
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue outside of North America (United States and Canada)
accounted for approximately 39%, 35% and 37% of net revenue for
2004, 2003 and 2002. Historically and for 2004, North America
and EMEA has comprised between 87% and 91% of our business. In
2004, we saw a weakening of the U.S. dollar against many
currencies, but most dramatically against the Euro. As a result
of the weakening U.S. dollar, we experienced positive
impacts on our net revenue in EMEA region.
In 2004, total net revenue in North America decreased 9% or
$52.0 million as compared to 2003 and decreased 7% or
$46.8 million from 2002 to 2003. The revenue decline from
2003 to 2004 was due to (i) a decline of $92.4 million
due to the July 2004 sale of Sniffer as well as declining
Sniffer revenues in 2004, (ii) a decline of
$40.9 million due to the January 2004 sale of Magic, and
(iii) a decrease in our enterprise revenues, excluding
IntruShield, of approximately $26.3 million, partially
offset by (iv) an increase of $99.9 million related to
the increase in McAfee.com on-line subscriptions and (v) a
$15.9 million increase due to our IntruShield product. The
economic growth and increased corporate IT spending had a
positive impact on our revenues, while the introduction of the
perpetual “plus” model in North America in 2004
resulted in an increase in the amount of revenue deferred to
future periods. The revenue decline from 2002 to 2003 was due to
the impact of an economic downturn as well as softness in
corporate IT spending.
In EMEA, total net revenue remained consistent from 2003 to
2004, and decreased 19% or $58.0 million from 2002 to 2003.
For 2004, the Sniffer sale and declining revenues in 2004
resulted in an $18.0 million decrease, the sale of Magic
resulted in an $18.4 million decrease and IntruShield
resulted in a $4.4 million increase. The strengthening of
foreign currencies against the U.S. dollar resulted in an
approximate $22.0 million increase in revenues from 2003 to
2004, and we also benefited from increased corporate IT spending
in 2004. The decline in revenue from 2002 to 2003 was due to the
effects of the economic downturn and reduced corporate IT
spending, as well as the introduction of the perpetual
“plus” pricing model in the middle of 2003.
37
Our Japan, Latin America and Asia-Pacific operations combined
have historically been less than 15% of our total business, and
we expect this trend to continue. Revenues increased in each of
these geographic regions primarily due to the strengthening of
foreign currencies against the U.S. Dollar and increased
corporate IT spending.
Risks inherent in international revenue include the impact of
longer payment cycles, greater difficulty in accounts receivable
collection, unexpected changes in regulatory requirements,
seasonality due to the slowdown in European business activity
during the third quarter, tariffs and other trade barriers,
currency fluctuations, product localization and difficulties
staffing and managing foreign operations. These factors may have
a material adverse effect on our future international revenue.
The following table sets forth for the periods indicated each
major category of our product revenue:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Percentage of | |
| |
|
For the Year Ended December 31, | |
|
Product Revenue | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
|
|
|
|
|
|
Term subscription licenses
|
|
$ |
39,682 |
|
|
$ |
113,696 |
|
|
$ |
181,825 |
|
|
|
14 |
% |
|
|
23 |
% |
|
|
29 |
|
|
Perpetual licenses
|
|
|
118,301 |
|
|
|
227,492 |
|
|
|
277,882 |
|
|
|
40 |
|
|
|
44 |
|
|
|
44 |
|
|
Hardware
|
|
|
79,828 |
|
|
|
99,502 |
|
|
|
93,359 |
|
|
|
27 |
|
|
|
19 |
|
|
|
15 |
|
|
Retail
|
|
|
27,787 |
|
|
|
45,993 |
|
|
|
63,236 |
|
|
|
9 |
|
|
|
9 |
|
|
|
10 |
|
|
Other
|
|
|
28,565 |
|
|
|
26,927 |
|
|
|
15,248 |
|
|
|
10 |
|
|
|
5 |
|
|
|
2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total product revenue
|
|
$ |
294,163 |
|
|
$ |
513,610 |
|
|
$ |
631,550 |
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue includes revenue from software licenses,
hardware, our retail product and royalties. The
$219.4 million, or 43% decrease from 2003 to 2004 is due to
(i) the introduction of our perpetual plus licensing
arrangements in the United States in the first quarter of 2004,
and in EMEA and Asia-Pacific (excluding Japan) in the middle of
2003, resulting in reduced product revenues and increased
services and support revenues, (ii) our continued shift in
focus from retail boxed products to our on-line subscription
model for consumers and SMB’s, and (iii) the Sniffer
sale in July 2004 and declining 2004 revenues, partially offset
by the effects of the strengthening foreign currencies against
the U.S. Dollar and increased corporate IT spending. The
introduction of the perpetual plus licensing arrangement has
resulted in revenue declines in the term subscription license
and perpetual license revenues. Our hardware revenue decreased
$19.7 million, or 20%, due to the Sniffer sale in July
2004, which was partially offset by an increase in revenue from
our IntruShield product due to our purchase of IntruVert in the
second quarter of 2003. The $18.2 million, or 40%, decrease
in retail revenues is due to our shift to the on-line
subscription model for consumers and SMB.
The $117.9 million, or 19%, decrease in product revenue
from 2002 to 2003 was due to (i) the introduction of our
perpetual plus licensing arrangements in EMEA and Asia-Pacific
(excluding Japan) in 2003, (ii) our continued shift in
focus from retail boxed products to our on-line subscription
model for consumers and SMB’s, and (iii) the continued
softness in corporate IT spending in 2003.
Our customers license our software on a perpetual or term
subscription basis depending on their preference. We are
continuing to see perpetual licenses become a larger percentage
of our license revenue in any quarter following the
implementation of our perpetual plus licensing model worldwide.
Furthermore, support pricing under the perpetual plus model is
significantly higher than the subscription model. Thus, revenue
is shifting out of the product revenue and into services and
support revenue. We expect the remaining mix of product revenue
to fluctuate as a percentage of revenue.
38
|
|
|
Services and Support Revenue |
The following table sets forth for the periods indicated each
major category of our services and support revenue:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Percentage of Services | |
| |
|
For the Year Ended December 31, | |
|
and Support Revenue | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
|
|
|
|
|
|
Support and maintenance
|
|
$ |
436,299 |
|
|
$ |
313,731 |
|
|
$ |
310,473 |
|
|
|
71 |
% |
|
|
74 |
% |
|
|
75 |
% |
|
Consulting
|
|
|
19,157 |
|
|
|
27,421 |
|
|
|
36,740 |
|
|
|
3 |
|
|
|
7 |
|
|
|
9 |
|
|
Training
|
|
|
8,394 |
|
|
|
9,486 |
|
|
|
12,527 |
|
|
|
1 |
|
|
|
2 |
|
|
|
3 |
|
|
On-line subscription arrangements
|
|
|
152,529 |
|
|
|
72,088 |
|
|
|
51,754 |
|
|
|
25 |
|
|
|
17 |
|
|
|
13 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total services and support revenue
|
|
$ |
616,379 |
|
|
$ |
422,726 |
|
|
$ |
411,494 |
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services and support revenues include revenues from software
support and maintenance contracts, consulting, training and
on-line subscription arrangements. The $193.7 million, or
46%, increase from 2003 to 2004 is due to (i) an increase
in support and maintenance due to our perpetual plus licensing
model and (ii) a $80.4 million increase in our on-line
subscription arrangements, (iii) the positive impact of
foreign currencies strengthening against the U.S. Dollar,
partially offset by (iv) a $9.4 million combined
decrease in consulting and training revenues. The increase in
our on-line subscription arrangements is due to an increase in
our customer base to approximately 8.5 million subscribers
at December 31, 2004, from 3.7 million subscribers at
December 31, 2003. The increase in customers was due to our
continued channel relationships with Dell, AOL and others, as
well as an outbreak of computer viruses in the second half of
2003 continuing through 2004.
The $11.2 million, or 3%, increase in service and support
revenue from 2002 to 2003 was due to a $20.3 million
increase in our on-line subscription arrangements, partially
offset by decreases in consulting and training revenues totaling
$12.4 million. The increase in our on-line subscription
arrangements was due to an increase in our customer base to
approximately 3.7 million subscribers at the end of 2003,
as well as an increase in our McAfee ASaP on-line service for
small-to-medium sized businesses. We saw decreases in our
consulting and training revenues in each year because our
customers typically first reduce consulting and training budgets
when reducing overall corporate IT costs and projects.
Our future profitability and rate of growth, if any, will be
directly affected by increased price competition and the size of
our revenue base. Our growth rate and net revenue depend
significantly on renewals of existing licenses 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
impacted.
39
|
|
|
Cost of Net Revenue; Gross Margin |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Percentage of Cost of | |
| |
|
For the Year Ended December 31, | |
|
Net Revenue | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
|
|
|
|
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
$ |
73,058 |
|
|
$ |
80,895 |
|
|
$ |
101,019 |
|
|
|
49 |
% |
|
|
54 |
% |
|
|
61 |
% |
| |
Services and support
|
|
|
62,520 |
|
|
|
57,362 |
|
|
|
60,539 |
|
|
|
42 |
|
|
|
38 |
|
|
|
37 |
|
| |
Amortization of purchased technology
|
|
|
13,331 |
|
|
|
11,369 |
|
|
|
3,153 |
|
|
|
9 |
|
|
|
8 |
|
|
|
2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of net revenue
|
|
$ |
148,909 |
|
|
$ |
149,626 |
|
|
$ |
164,711 |
|
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
$ |
761,633 |
|
|
$ |
786,710 |
|
|
$ |
878,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin percentage
|
|
|
84 |
% |
|
|
84 |
% |
|
|
84 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
Our total cost of revenue remained consistent at
$148.9 million for 2004 and $149.6 million for 2003 as
revenues remained relatively consistent, with a slight decline
of 3%. Our total cost of net revenue decreased
$15.1 million, or 9% due primarily to our 10% decrease in
net revenue from 2002 to 2003.
Cost of Product Revenue. Our cost of product revenue
consists primarily of the cost of media, manuals and packaging
for products distributed through traditional channels, and, with
respect to hardware-based anti-virus and security products and
network fault and performance products, computer platforms and
other hardware components. Our cost of product revenue decreased
$7.8 million from 2003 to 2004 and $20.1 million from
2002 to 2003. The decrease from 2003 to 2004 is primarily due to
the sale of Sniffer in July 2004, partially offset by
IntruShield hardware due to a full year of activity in 2004. The
decrease from 2002 to 2003 was due to lower costs of computer
platforms and other hardware components as at the end of 2002 we
began using a more competitive contract manufacturer which also
utilized a greater number of standardized computer platforms and
hardware components. We also benefited from the favorable impact
of cost control measures. These costs have decreased as a
percentage of total cost of net revenue from 2002 to 2004 due to
the change in the mix of our revenues, with a shift from product
revenues to service and support revenues over this period.
We anticipate that cost of product revenue will continue to
fluctuate as a percent of cost of net revenue, due to various
factors including product mix, material and labor costs and
warranty costs.
Cost of Services and Support. Cost of services and
support revenue consists principally of salaries and benefits
related to employees providing customer support and consulting
services, and costs related to the sale of on-line subscription
arrangements, including revenue sharing arrangements and
royalties paid to our on-line strategic partners. Cost of
services and support revenue increased $5.2 million from
2003 to 2004, and decreased $3.2 million from 2002 to 2003.
The increase from 2003 to 2004 is due to an increase in revenue
sharing arrangements and royalties paid to our on-line strategic
partners, which was partially offset by reduced support and
consulting headcount as a result of the sale of Magic in January
2004, as well as on-going cost reduction efforts. Cost of
services and support have increased as a percentage of total
cost of net revenue from 2002 through 2004 primarily as a result
of the increase in revenue sharing arrangements and royalty
payments to our on-line strategic partners. We anticipate that
cost of service revenue will continue to fluctuate as a
percentage of cost of net revenue.
Amortization of Purchased Technology. Amortization of
purchased technology increased $2.0 million, or 17%, from
2003 to 2004 and increased $8.2 million, or 261%, from 2002
to 2003. The increases are due to our acquisitions of Entercept
and IntruVert in 2003, for which we recorded purchased
technology of $21.7 million and $18.2 million,
respectively, and our acquisition of Foundstone in October 2004,
for which we recorded purchased technology of
$27.0 million. Amortization for these items was
$9.0 million and $5.2 million in 2004 and 2003,
respectively. The increase in amortization related to the 2003
and 2004 acquisitions was partially offset by certain purchased
technology assets becoming fully amortized in 2003. The
40
purchased technology is being amortized over its estimated
useful lives of four to seven years. Amortization of purchased
technology is expected to be $15.3 million in 2005.
Gross Margins. Our gross margins were stable at 84% from
2002 to 2004. The increase in cost of service and support
revenue was offset by the decrease in cost of product revenue in
2004. The increase of amortization of purchased technology as a
percentage of cost of net revenue in 2003 to 8% offset the
improvement we experienced in our cost of product revenues from
2002 to 2003. Gross margins may fluctuate in the future due to
various factors, including the mix of products sold, sales
discounts, revenue sharing agreements, material and labor costs
and warranty costs.
The following table sets forth for the periods indicated each
major category of our operating expenses:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Percentage of | |
| |
|
For the Year Ended December 31, | |
|
Net Revenue | |
| |
|
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
|
|
|
|
|
|
Research and development(1)
|
|
$ |
172,717 |
|
|
$ |
184,606 |
|
|
$ |
148,801 |
|
|
|
19 |
% |
|
|
20 |
% |
|
|
14 |
% |
|
Marketing and sales(2)
|
|
|
354,380 |
|
|
|
363,306 |
|
|
|
397,747 |
|
|
|
39 |
|
|
|
39 |
|
|
|
38 |
|
|
General and administrative(3)
|
|
|
139,845 |
|
|
|
129,920 |
|
|
|
119,393 |
|
|
|
15 |
|
|
|
14 |
|
|
|
11 |
|
|
(Gain)loss on sale of assets and technology(4)
|
|
|
(240,336 |
) |
|
|
788 |
|
|
|
(9,301 |
) |
|
|
(26 |
) |
|
|
— |
|
|
|
(1 |
) |
|
Litigation (reimbursement) settlement
|
|
|
(24,991 |
) |
|
|
— |
|
|
|
70,000 |
|
|
|
(3 |
) |
|
|
— |
|
|
|
7 |
|
|
Restructuring charges
|
|
|
17,493 |
|
|
|
22,667 |
|
|
|
1,116 |
|
|
|
2 |
|
|
|
2 |
|
|
|
— |
|
|
Amortization of intangibles
|
|
|
14,065 |
|
|
|
15,637 |
|
|
|
10,742 |
|
|
|
2 |
|
|
|
2 |
|
|
|
1 |
|
|
Severance/bonus costs related to Sniffer and Magic
dispositions(5)
|
|
|
10,070 |
|
|
|
— |
|
|
|
— |
|
|
|
1 |
|
|
|
— |
|
|
|
— |
|
|
Reimbursement from transition services agreement
|
|
|
(5,997 |
) |
|
|
— |
|
|
|
— |
|
|
|
(1 |
) |
|
|
— |
|
|
|
— |
|
|
Provision for (recovery from) doubtful accounts
|
|
|
1,716 |
|
|
|
(1,216 |
) |
|
|
(219 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Acquisition related costs not subject to capitalization
|
|
|
— |
|
|
|
— |
|
|
|
16,026 |
|
|
|
— |
|
|
|
— |
|
|
|
2 |
|
|
In-process research and development
|
|
|
— |
|
|
|
6,600 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total operating costs, including the effects of stock-based
compensation
|
|
$ |
438,962 |
|
|
$ |
722,308 |
|
|
$ |
754,305 |
|
|
|
48 |
% |
|
|
77 |
% |
|
|
72 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
Includes stock-based compensation charge of $6,518, $5,157 and
$3,963 in 2004, 2003 and 2002, respectively. |
| |
| (2) |
Includes stock-based compensation charge of $2,642, $5,065 and
$1,980 in 2004, 2003 and 2002, respectively. |
| |
| (3) |
Includes stock-based compensation charge of $4,085, $2,285 and
$16,461 in 2004, 2003 and 2002, respectively. |
| |
| (4) |
Net of stock-based compensation charge of $84 in 2004 |
| |
| (5) |
Includes stock-based compensation charge of $991 in 2004 |
Research and Development. Research and development
expenses consist primarily of salary, benefits, and contractors
fees for our development and technical support staff, and other
costs associated with the enhancements of existing products and
services and development of new products and services. Research
and development expenses decreased $11.9 million, or 6%,
from 2003 to 2004, and increased $35.8 million, or 24%,
41
from 2002 to 2003. The decrease from 2003 to 2004 reflects
(i) a $16.5 million decrease due to the Sniffer sale
in July 2004, (ii) a $6.7 million decrease related to
the Magic sale in January 2004, and (iii) a decrease in
expenses due to headcount reductions and the movement of
research and development headcount to the Bangalore research
facility, which has lower salary costs, partially offset by
(iv) a $9.2 million increase due to a full year impact
of the IntruVert acquisition in 2003, (v) a
$2.1 million increase due to strengthening foreign
currencies against the US Dollar in EMEA and Japan in 2004,
(vi) a $1.4 million increase in stock-based
compensation, and (vii) a $1.1 million increase due to
the acquisition of Foundstone in October 2004.
The $35.8 million increase from 2002 to 2003 was due to
$9.7 million and $3.2 million, respectively, related
to our acquisitions IntruVert and Entercept, and our
acquisitions Deersoft, Inc. and Traxess, Inc.; $4.6 million
related to the 2003 opening of our research and development
facility in Bangalore, India and $9.0 million related to
increased McAfee research and development expenditures; and
$8.0 million related to higher headcount.
Research and development expenses include stock-based
compensation charges of $6.5 million, $5.2 million and
$4.0 million in 2004, 2003 and 2002, respectively. See
“Stock Based Compensation” below for further
discussion.
We believe that continued investment in product development is
critical to attaining our strategic objectives and, as a result,
expect product development expenses to remain relatively flat in
future periods and continue to fluctuate as a percentage of net
revenue.
Marketing and Sales. Marketing and sales expenses consist
primarily of salary, commissions and benefits for marketing and
sales personnel and costs associated with advertising and
promotions. Marketing and sales expenses decreased
$8.9 million, or 2%, from 2003 to 2004, and decreased
$34.4 million, or 9% from 2002 to 2003. The decrease from
2003 to 2004 reflects (i) a $14.6 million decrease due
to the Sniffer sale in July 2004, the Magic sale in January 2004
and the impact of headcount reductions in 2004, and (ii) a
$2.4 million decrease in stock-based compensation,
partially offset by (iii) a $6.4 million increase in
expenses due to strengthening foreign currencies against the
U.S. Dollar in EMEA and Japan in 2004, and (iv) a
$1.7 million increase due to the Foundstone acquisition in
October 2004.
The decrease of $34.4 million from 2002 to 2003 was
primarily due to a corresponding 10% decrease in net revenue
from 2002 to 2003. We also experienced lower sales and marketing
expense in 2003 of approximately (i) $10.6 million due
to a reduction of salary, benefit and commission expenses
following a decrease in headcount of approximately 100 sales
personnel, (ii) $5.7 million from our reduced use of
outside services and other cost saving measures, and
(iii) $2.1 million related to travel expense cost
savings measures, which were partially offset by (iv) an
increase in stock-based compensation expense of
$3.1 million. As a result of the change in the way we
account for sales commissions, we had lower sales and marketing
expense of approximately $5.0 million.
Marketing and sales expenses include stock-based compensation
charges of $2.6 million, $5.1 million and
$2.0 million for 2004, 2003 and 2002, respectively. See
“Stock Based Compensation” below for further
discussion.
We anticipate that marketing and sales expenses will decrease in
absolute dollars, and will continue to fluctuate as a percentage
of net revenue.
General and Administrative. General and administrative
expenses consist principally of salary and benefit costs for
executive and administrative personnel, professional services
and other general corporate activities. General and
administrative expenses increased $9.9 million, or 8%, from
2003 to 2004, and increased $10.5 million, or 9%, from 2002
to 2003. The increase from 2003 to 2004 reflects (i) a
$11.1 million increase in costs incurred to comply with
Section 404 of the Sarbanes-Oxley Act (SOX 404),
(ii) $2.9 million in consulting fees paid in
connection with strategic planning, (iii) a
$4.3 million increase in depreciation expense due to a full
year impact of significant hardware additions for back-office
functions in 2003, (iv) a $2.7 million increase due to
strengthening foreign currencies against the US Dollar in EMEA
and Japan in 2004, (v) a $1.8 million increase in
stock-based compensation expense, and (vi) a
$0.8 million increase due to the Foundstone acquisition in
October 2004, partially offset by (vi) $8.8 million in
expenses incurred in 2003
42
related to financial statement restatements which did not occur
in 2004, and a reduction in headcount and facilities costs
related to restructurings in 2004 and 2003.
The increase from 2002 to 2003 is due to costs incurred in
connection with our restatement of $8.8 million and
acquisition related bonuses of $4.0 million. In 2003, our
legal expenses increased approximately $4.6 million in 2003
from 2002 due to an increase in outside legal services due to
our on-going SEC and DOJ investigations. Our information
technology department expenses increased approximately
$6.2 million due to increases in headcount and depreciation
and equipment expense. We also had a full year of internal audit
and four months of SOX 404 related expenses in 2003, resulting
in an increase of approximately $0.8 million and
$1.4 million, respectively, as compared to 2002. These
increases were partially offset by a decrease in stock-based
compensation charges of $14.2 million from 2002 to 2003.
In 2004 and 2003, we recognized acquisition-related compensation
of $3.6 million and $4.0 million, respectively, which
represents amounts paid to Entercept, IntruVert and Foundstone
employees currently providing services to us. We expect to
recognize an additional $4.4 million in expense related to
these services in 2005, and an additional $3.3 million
through 2007.
General and administrative expenses include stock-based
compensation charges of $4.1 million, $2.3 million and
$16.5 million in 2004, 2003 and 2002, respectively. See
“Stock Based Compensation” below for further
discussion.
We expect our general and administrative expenses to decrease as
we continue to implement cost control measures and decrease as a
percentage of net revenue.
(Gain) loss on Sale of Assets and Technology. In January
2004, we completed the sale of our Magic product line to BMC
Software and, as a result, recognized a gain of approximately
$46.1 million. In July 2004, we completed the sale of our
Sniffer product line to Network General and, as a result,
recognized a gain of approximately $197.4 million. These
gains were partially offset by write-offs of property and
equipment.
The loss on sale of assets and technology of $0.8 million
in 2003 consists of the write-off of property and equipment.
We recognized a $6.7 million and $2.6 million gain on
the sale of the PGP Gauntlet businesses in February 2002, and
the PGP Desktop/ Encryption assets and technology in August
2002, respectively.
Litigation Reimbursement/ Settlement. We agreed to settle
a securities class action litigation in September 2003. The
$70.0 million litigation charge was recorded in 2002
because our agreement to settle, which established the liability
to be probable and estimable, occurred prior to the publication
of our 2002 consolidated financial statements in October 2003.
We paid the $70.0 million settlement in October 2003.
During 2004, we received insurance reimbursements of
approximately $25.0 million from our insurance carriers for
insurance coverage related to the class action lawsuit settled
in October 2003.
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 was reduced primarily due to our
sale of Magic in January 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 our EMEA operating segment
and the remaining $1.0 million was related to our 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
our 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 our Latin America, North America, EMEA
43
and Asia-Pacific (excluding Japan) operating segments,
respectively. All employees have been terminated at
December 31, 2004. The reductions in the second, third and
fourth quarters are 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 is expected to be substantially
completed by the first quarter of 2005. As a result of this
relocation, approximately 80 employees in EMEA research and
development, operations and finance were notified that their
jobs would be moving to Ireland. We recorded restructuring
charges of $0.2 million and $2.2 million in the third
and fourth quarters of 2004, respectively. The costs will be
substantially paid in the first half of 2005.
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,
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. The restructuring
charge of $6.5 million and related cash outlay are based on
management’s current estimates.
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, net of estimated sublease income,
along with estimated costs associated with subleasing the
vacated facility.
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
its Santa Clara headquarters building.
The following table summarizes our restructuring accrual
established from January 1, 2004 through December 31,
2004 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Lease | |
|
Severance | |
|
|
|
|
| |
|
Termination | |
|
and Other | |
|
|
|
|
| |
|
Costs | |
|
Benefits | |
|
Other 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 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
In January 2003, as part of a restructuring effort to gain
operational efficiencies, we consolidated operations formerly
housed in three leased facilities in the Dallas, Texas area into
our newly constructed regional headquarters facility in Plano,
Texas. The facility houses employees working in finance,
information technology, and the customer support and telesales
groups servicing the McAfee System Protection Solutions and
McAfee Network Protection Solutions businesses.
As part of the consolidation of activities into the Plano
facility, we relocated employees from our 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, offset
44
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. The restructuring charge of $15.8 million
and related cash outlay are based on management’s current
estimates.
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 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 Europe that was no
longer necessary after paying out substantially all accrued
amounts to the former employees.
In 2004 and 2003, we adjusted the restructuring accrual related
to lease termination costs previously recorded in 2003. The
adjustments decreased the liability by approximately
$0.6 million and $0.3 million 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.
The following table summarizes the Company’s restructuring
accrual established in 2003 and activity through
December 31, 2004 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Lease | |
|
Severance | |
|
|
|
|
| |
|
Termination | |
|
and Other | |
|
|
|
|
| |
|
Costs | |
|
Benefits | |
|
Other 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 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Our estimates of the excess facilities charge recorded during
2003 and 2004 may vary significantly depending, in part, on
factors which may be beyond our control, such as our success in
negotiating with our lessor, the time periods required to locate
and contract suitable subleases and the market rates at the time
of such subleases. Adjustments to the facilities accrual will be
made if further consolidations are required or if actual lease
exit costs or sublease income differ from amounts currently
expected. The facility restructuring charges in 2003 and 2004
were allocated to the North American operating segment.
Restructuring Costs — 2002. As part of the plan
to integrate certain activities of our PGP product group into
our other product groups and to dispose of other product lines,
we sold our Gauntlet business during the first quarter of 2002.
In connection with this process, a restructuring charge of
approximately $1.1 million was recorded. The restructuring
charge consists of costs of severance packages for 44 employees
as well as related legal and outplacement services. All amounts
were paid as of December 31, 2002.
45
Amortization of Intangibles. We expensed
$14.1 million, $15.6 million and $10.7 million of
amortization related to intangibles in 2004, 2003, and 2002,
respectively. Intangibles consist of identifiable intangible
assets. The decrease in amortization of $1.6 million in
2004 is the result of certain intangible assets becoming fully
amortized in 2003 and 2004, partially offset by a
$0.5 million increase related to the acquisitions of
IntruVert and Entercept in 2003 and Foundstone in 2004. The
increase in amortization of $4.9 million from 2002 to 2003
was primarily due to the full year impact in 2003 of
amortization of intangible assets resulting from the acquisition
of the McAfee.com minority interest in September 2002.
Severance/ Bonus Costs Related to Sniffer and Magic
Dispositions. In conjunction with the sale of the Sniffer
product line, we incurred severance and bonuses to the former
executives of Sniffer for their assistance in the transaction.
The total bonuses and severance expensed was $7.7 million
in 2004, of which $5.3 million has been paid, and the
remaining $2.4 million will be paid in the first quarter of
2006. Furthermore, we accelerated the vesting of these
executives’ stock options, which resulted in a stock-based
compensation charge of approximately $1.0 million.
In conjunction with the Magic sale, we incurred bonus expense of
approximately $1.4 million for amounts paid to an executive.
Reimbursement from Transition Services Agreement. In
conjunction with the Sniffer sale, we entered into a transition
services agreement with Network General. Under this agreement,
we provide certain back office services to Network General for a
period of time, generally expected to be through June 2005. The
reimbursements we have recognized under this agreement totaled
approximately $6.0 million in 2004.
Provision for (Recovery from) Doubtful Accounts, Net.
Provision for doubtful accounts consists of our estimates for
the uncollectibility of receivables, net of recoveries of
amounts previously written off. The provision for doubtful
accounts was $1.7 million in 2004. The recovery of doubtful
accounts was $1.2 million and $0.2 million in 2003 and
2002, respectively.
Acquisition Related Costs not Subject to Capitalization.
Acquisition costs not subject to capitalization consist
primarily of expenses incurred by McAfee.com related to our
exchange offer for all outstanding publicly held shares of
McAfee.com class A common stock. As of December 31,
2002, these charges totaled $16.0 million, or 2%, of net
revenue. No additional costs were incurred after 2002.
In-Process Research and Development. In 2003, we expensed
$5.7 million of in-process research and development related
to IntruVert. The ongoing project at IntruVert at the time of
the purchase included the development of the Infinity model of
IntruShield sensor. Infinity is a lower end model of the
IntruShield sensor product family that is targeted towards
remote offices and branch offices of large enterprises as well
as small/medium businesses. At the date we acquired IntruVert,
we estimated that, on average, 86% of the development effort had
been completed and that the remaining 14% of the development
effort would take approximately
21/2 months
to complete and would cost $0.3 million. The efforts
required to complete the development of these projects
principally related to finalization of coding, and completion of
prototyping, verification, and testing activities required to
establish that products associated with the technologies can be
successfully introduced. The product was completed in the third
quarter of 2003 and is being shipped to customers. The value of
the in-process technologies was determined by estimating the
projected net cash flows related to products, including costs to
complete the development of the technologies or products, and
the future net revenues that may be earned from the products,
excluding the value attributed to integration with our products
or that may have been achieved due to efficiencies resulting
from the combined sales force or the use of our more effective
distribution channel. These cash flows were discounted back to
their net present value using a discount rate of 20% (which
represents a premium of approximately 4% over our weighted
average cost of capital) and excluding the value attributable to
the use of the in-process technologies in future products.
In 2003, we expensed $0.9 million of in-process research
and development related to Entercept. The ongoing projects at
Entercept at the time of the purchase consisted of a Linux
version of their current product. At the date we acquired
Entercept, we estimated that, on average, 31% of the development
effort had been completed and that the remaining 69% of the
development effort would take approximately eight months to
46
complete and would cost $0.3 million. The efforts required
to complete the development of these projects principally
related to additional design efforts, finalization of coding,
and completion of prototyping, verification, and testing
activities required to establish that products associated with
the technologies can be successfully introduced. The product was
released in the fourth quarter of 2004. The value of the
in-process technologies was determined by estimating the
projected net cash flows related to products, including costs to
complete the development of the technologies or products, and
the future net revenues that may be earned from the products,
excluding the value attributed to integration with our products
or that may have been achieved due to efficiencies resulting
from the combined sales force or the use of the our more
effective distribution channel. These cash flows were discounted
back to their net present value using a discount rate of 35%
(which represents a premium of approximately 19% over our
weighted average cost of capital) and excluding the value
attributable to the use of the in-process technologies in future
products.
Interest and Other Income. Interest and other income was
$15.9 million in 2004, $15.9 million in 2003 and
$27.3 million in 2002. Interest and other income remained
consistent from 2003 to 2004 primarily due to an increase in
cash and marketable securities of $158.4 million from 2003
to 2004, partially offset by a $1.3 million loss in 2004 on
the interest rate swap we entered into in 2002. Interest and
other income decreased from 2002 to 2003 due to a decrease of
cash and marketable securities of $247.5 million from 2002
to 2003 and an overall decrease in average yields on our
marketable securities. In 2003, we used cash of approximately
$217.1 million to purchase Entercept and IntruVert and
$177.3 million to redeem the remaining portion of our
outstanding zero coupon debentures.
Interest and Other Expenses. Interest and other expense
was $5.3 million in 2004, $7.5 million in 2003 and
$25.1 million in 2002. Interest and other expense decreased
from 2003 to 2004 due to the redemption and conversion of the
convertible debt in August 2004. The $17.6 million decrease
in interest and other expenses from 2002 to 2003 was due to an
$8.8 million reduction related to the repurchase in 2003 of
the remaining zero coupon debentures and a $9.2 million
reduction related to the realization of a full year of effect of
the interest rate swap we entered into in July 2002.
(Loss) gain on repurchase of convertible debt. In 2004
and 2003, we recognized losses of $15.1 million and
$2.7 million, respectively, on the redemption of all our
remaining convertible debt. In 2003, we redeemed debt which had
an aggregate face amount at maturity of $358.0 million for
approximately $177.1 million resulting in a loss on
redemption of $2.7 million. In August 2004, we redeemed all
of our outstanding $345.0 million 5.25% convertible
notes for approximately $265.6 million in cash and the
issuance of approximately 4.6 million of our common shares.
The $15.1 million loss was the result of the write-off of
unamortized debt issuance costs, fair value adjustment of the
debt and a 1.3125% premium paid for redemption.
(Loss) gain on Investments, Net. In 2004, we recognized a
loss on the sale marketable securities of $1.7 million. In
2003 and 2002, we recognized gains of $3.1 million and
$3.8 million, respectively. Our investments are classified
as available for sale and we may sell securities from time to
time to move funds into investments with more lucrative
investment yields, thus resulting in gains and losses on sale.
Impairment of Strategic and Other Investments. In 2002,
we recorded impairment charges of $0.2 million related to
an other than temporary decline in the value of our venture and
strategic investments. No such impairment charges were incurred
in 2004 and 2003 as all of our investments had no carrying value.
Provision for (benefit from) Income Taxes. The provision
for (benefit from) income taxes was $91.4 million,
$16.8 million (including $3.6 million included in the
cumulative effect of change in accounting principle) and
$(0.3) million in 2004, 2003 and 2002, respectively. Tax
expense was 28.9%, 18.1% (excluding $3.6 million included
in the cumulative effect of change in accounting principle) and
0% of income before income taxes and minority interest for 2004,
2003 and 2002, respectively. The effective tax rate differs from
the statutory rate primarily due to the impact of research and
development tax credits, utilization of foreign tax credits, and
lower effective rates in some overseas jurisdictions. Our future
effective tax rates could be adversely affected if earnings are
lower than anticipated in countries where we have lower
statutory rates or by unfavorable changes in tax laws and
regulations.
47
Cumulative Effect of Change in Accounting Principle. In
2003, we changed our method of accounting for recognizing
commission expenses to sales personnel, and recorded a one-time
credit of $13.9 million, $10.3 million net of tax.
Prior to January 1, 2003, we expensed sales commissions as
incurred. Commissions are now directly related to sales
transactions and are deferred and recognized ratably over the
same period as the revenue is recognized and recorded.
Stock-Based Compensation
We recognized stock-based compensation expense of
$14.3 million, $12.5 million and $22.4 million in
2004, 2003 and 2002, respectively, which is included in research
and development, marketing and sales, general and administrative
expenses and severance costs related to Sniffer disposition in
the consolidated statements of income. Our stock-based
compensation charges are comprised of the following for the
years presented (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Exchange of McAfee.com options
|
|
$ |
6,669 |
|
|
$ |
3,369 |
|
|
$ |
16,101 |
|
|
Former employees
|
|
|
1,216 |
|
|
|
1,125 |
|
|
|
10,118 |
|
|
New and existing executives and employees
|
|
|
1,928 |
|
|
|
424 |
|
|
|
1,478 |
|
|
Extended life of vested options of terminated employees
|
|
|
1,164 |
|
|
|
3,720 |
|
|
|
— |
|
|
Extended vesting term of options
|
|
|
— |
|
|
|
— |
|
|
|
193 |
|
|
Extended period of Employee Stock Purchase Plan
|
|
|
— |
|
|
|
3,869 |
|
|
|
— |
|
|
Shares purchased outside Employee Stock Purchase Plan and other
|
|
|
— |
|
|
|
— |
|
|
|
62 |
|
|
Repriced options
|
|
|
3,343 |
|
|
|
— |
|
|
|
(5,548 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Total stock-based compensation
|
|
$ |
14,320 |
|
|
$ |
12,507 |
|
|
$ |
22,404 |
|
| |
|
|
|
|
|
|
|
|
|
Described below are the events giving rise to the stock-based
compensation charges in 2004. These stock-based compensation
charges are described in greater detail in Note 16 to our
consolidated financial statements. We expect significant future
stock-based compensation charges related to the exchange of
McAfee.com options and repriced employee stock options, with the
amount of these charges being impacted by fluctuations in our
stock price.
Exchange of McAfee.com options. For 2004, 2003 and 2002,
we recorded stock-based compensation of approximately
$6.7 million, $3.4 million and $16.1 million,
respectively, related to exchanged options subject to variable
accounting. Our stock-based compensation charge related to
exchanged options subject to variable accounting was based on
our closing share price of $28.93, $15.04 and $16.09,
respectively. As of December 31, 2004, we had outstanding
exchanged options to acquire approximately 0.4 million
shares subject to this variable accounting. Further increases in
our stock price may result in significant additional stock-based
compensation expense related to these options.
Former employees. As a result of the Sniffer sale in July
2004, we modified the stock option agreements of several Sniffer
executives by accelerating the vesting of their unvested
options. We recorded a stock-based compensation charge of
approximately $1.0 million in 2004.
In November and December 2003, we extended the vesting period of
two employees and also extended the period after which vesting
ends to exercise their options. As these employees continued to
vest after termination and their exercise period was extended an
additional 90 days, we recorded a one-time stock-based
compensation charge of approximately $0.1 million in 2004.
In October 2002, we terminated the employment of four former
McAfee.com executives. These executives held McAfee.com
exchanged options, which are subject to variable accounting.
Upon termination, the options were modified in accordance with a
change in control provision, which resulted in stock-based
compensation charges of $1.1 million and $9.9 million
in 2003 and 2002, respectively.
48
New and existing executives and employees. In September
2004, our chief financial officer and chief operating officer
announced that he was retiring effective December 31, 2004.
Under the terms of his transition agreement, all of his options
vested on December 31, 2004. We recorded stock-based
compensation expense due to the acceleration of vesting of
$1.3 million in 2004.
In connection with the acquisition of Foundstone in October
2004, we granted stock options to Foundstone employees which are
subject to vesting provisions as the employees provide service
to us. The total stock-based compensation charge was
$2.3 million, of which approximately $0.2 million was
recognized in 2004, and an additional $0.5 million was
reversed due to terminated employees. An additional
$1.4 million will be recognized through 2008, which is
subject to a reduction based on employees terminating prior to
full vesting of their options.
In January 2002, our board of directors granted
50,000 shares of restricted stock to our chief executive
officer. The fair value of the restricted stock grant was
$1.4 million and is being recognized as stock-based
compensation expense over the vesting period through January
2005. We recorded stock-based compensation expense of
$0.4 million, $0.4 million and $0.5 million in
2004, 2003 and 2002, respectively.
In January 2001, we entered into an employment agreement with
our chief executive officer which provided for the grant of
400,000 shares of restricted stock that vested over a two
year period from the date of grant. The fair value of the
restricted stock was $2.0 million, of which the remaining
$1.0 million was recognized as stock-based compensation
expense in 2002.
Extended life of vested options held by terminated
employees. As part of the purchase of Foundstone in October
2004, we granted stock options to Foundstone employees, certain
of which terminated their employment after the acquisition. The
terminated employees had 90 days to exercise their stock
options from the date of termination, otherwise the options
would expire. We determined in December 2004 that we would not
be able to file the required public company reports with the SEC
that would allow the option holders to exercise their options
within the 90 day period. In December 2004, we extended the
expiration date of the options approximately one month,
resulting in a new measurement date for the options. We recorded
a one-time stock-based compensation charge of $1.0 million
in 2004 due to the extension of the expiration date.
During a significant portion of 2003, we suspended exercises of
stock options until our required public company reports were
filed with the SEC. The period during which stock option
exercises were suspended is known as the black-out period. Due
to the blackout period, we have extended the exercisability of
any options that would otherwise terminate during the blackout
period for a period of time equal to a specified period after
termination of the blackout period. Accordingly, we have
recorded stock-based compensation charges on the dates the
options should have terminated based on the intrinsic value of
the option on the modification date and the option price. In
2004 and 2003, we recorded stock-based compensation charges of
approximately $0.1 million and $3.7 million,
respectively.
Extended period of Employee Stock Purchase Plan. During
the blackout period in 2003, we suspended all stock purchases
under our 2002 Employee Stock Purchase Plan (“2002 Purchase
Plan”). Due to the blackout period, we extended the
purchase period for shares in the 2002 Purchase Plan that would
otherwise have been purchased on July 31, 2003.
Accordingly, in 2003 we recorded a one-time stock-based
compensation charge of approximately $3.9 million.
Repriced Options. In April 1999, we offered to
substantially all of our employees, excluding executive
officers, the right to cancel certain outstanding stock options
and receive new options with an exercise price equivalent to the
fair market value of our stock at the time of grant. Options to
purchase a total of 9.5 million shares were cancelled and
the same number of new options were granted. These new options
vest at the same rate that they would have vested under previous
option plans and are subject to variable accounting. Stock-based
compensation expense will be recorded in the event our stock
price closes above $20.375 at the end of period. We have and
will continue to remeasure compensation cost for these repriced
options until these options are exercised, cancelled or
forfeited without replacement. Depending upon movements in the
market value of our common stock, this accounting treatment may
result in additional stock-based compensation charges or
reversals in future periods.
49
During 2004 and 2002, we incurred charges (credits) to
earnings of approximately $3.3 million and
($6.5) million, respectively, based on closing stock prices
of $28.93 and $16.09, respectively. We did not record any
stock-based compensation for the repriced options in 2003 as our
stock price was below $20.375 as of December 31, 2002 and
throughout 2003. As of December 31, 2004, 0.3 million
options were outstanding and subject to variable accounting.
We also incurred an initial stock-based compensation charge in
connection with the initial issuance of the repriced options.
Approximately $1.0 million was recorded in 2002.
Impact of Recent Accounting Pronouncement on Stock-Based
Compensation. In December 2004, the Financial Accounting
Standards Board (“FASB”) issued SFAS 123R,
“Share Based Payment”
(“SFAS 123R”) which requires the measurement
of all employee share-based payments to employees, including
grants of employee stock options, using a fair-value-based
method and the recording of such expense in the consolidated
statements of income. The accounting provisions of
SFAS 123R are effective for reporting periods beginning
after June 15, 2005. We are required to adopt
SFAS 123R in the third quarter of 2005. The pro forma
disclosures previously permitted under SFAS 123 no longer
will be an alternative to financial statement recognition. See
Note 2 for the pro forma net income and net income per
share amounts, for fiscal 2002 through fiscal 2004, as if we had
used a fair-value-based method similar to the methods required
under SFAS 123R to measure compensation expense for
employee stock incentive awards. Although we have not yet
determined whether the adoption of SFAS 123R will result in
amounts that are similar to the current pro forma disclosures
under SFAS 123, we are evaluating the requirements under
SFAS 123R and expect the adoption to have a significant
adverse impact on the consolidated results of operations.
Acquisition
On October 1, 2004, we acquired 100% of the outstanding
capital shares of Foundstone, Inc., a provider of risk
assessment and vulnerability services and products for
$82.5 million in cash and $3.1 million of direct
expenses, totaling $85.6 million. Total consideration paid
for the acquisition was $90.4 million including
$4.8 million for the fair value of vested stock options
assumed in the acquisition. We acquired Foundstone to enhance
our network protection product line. The results of operations
of Foundstone have been included in our consolidated financial
statements since the date of acquisition.
Under the transaction, we recorded approximately
$27.0 million for developed technology, $1.0 million
for acquired product rights, including revenue related order
backlog and contracts, $0.6 million for trade
names/trademarks and non-compete arrangements,
$59.2 million for goodwill (none of which is deductible for
tax purposes), $2.6 million for net deferred tax
liabilities and $5.1 million of tangible assets, net of
liabilities. The intangible assets acquired in the acquisition,
excluding goodwill, are being amortized over their estimated
useful lives of two to 6.5 years or a weighted average
period of 6.4 years. We accrued $0.3 million in
severance costs for employees terminated at the time of the
acquisition, of which less than $0.1 million remains as an
accrual as of December 31, 2004.
Liquidity and Capital Resources
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Cash, cash equivalents and investments
|
|
$ |
924,681 |
|
|
$ |
766,257 |
|
|
$ |
1,013,709 |
|
|
Net cash provided by operating activities
|
|
$ |
358,913 |
|
|
$ |
156,304 |
|
|
$ |
195,093 |
|
|
Net cash used in investing activities
|
|
$ |
(39,373 |
) |
|
$ |
(374,480 |
) |
|
$ |
(183,646 |
) |
|
Net cash (used in)provided by financing activities
|
|
$ |
(369,867 |
) |
|
$ |
(146,579 |
) |
|
$ |
43,736 |
|
We ended 2004 with cash, cash equivalents and investments
totaling $924.7 million, as compared to $766.3 million
at the end of 2003. The increase was due primarily to our sale
of Sniffer in July 2004 for cash
50
proceeds of $213.8 million, net of direct expenses; our
sale of Magic Solutions in January 2004 for cash proceeds of
$47.1 million, net of direct expenses; the receipt of
$113.8 million in proceeds from stock issued under options
and employee stock purchase plans; the receipt of
$25.0 million in reimbursements from our insurance carriers
related to the securities class action lawsuit; and an increase
in deferred revenue, net of dispositions of businesses, of
$161.9 million. The receipts of cash were partially offset
by our use of $265.6 million to repurchase the remaining
balance of convertible debt; our use of $221.8 million to
repurchase shares of our common stock; our use of
$210.6 million for the net purchase of marketable
securities; and our use of $84.7 million to purchase
Foundstone. A more detailed discussion of changes in our
liquidity follows.
Net cash provided by operating activities in 2004, 2003 and 2002
was primarily the result of our net income of
$225.1 million, $70.2 million and $128.3 million,
respectively, which is adjusted for non-cash items such as
depreciation and amortization, non-cash restructuring charges,
acquired in-process research and development, stock-based
compensation, tax benefits from the exercise of employee stock
options and changes in various assets and liabilities such as
accounts payable, deferred revenue, accounts receivable and
other current assets.
Our historical and primary source of operating cash flow is the
collection of accounts receivable from our customers and the
timing of payments to our vendors and service providers. One
measure of the effectiveness of our collection efforts is
average accounts receivable days sales outstanding
(“DSO”). DSOs were 71 days, 92 days and
69 days at December 31, 2004, 2003 and 2002,
respectively. We calculate accounts receivable DSO on a
“gross” basis by dividing the gross accounts
receivable balance at the end of the quarter by the amount of
revenue recognized for the quarter multiplied by 90 days.
We expect DSO to vary from period to period because of changes
in quarterly revenue and the effectiveness of our collection
efforts. In 2004, 2003 and 2002, we have not made any
significant changes to our payment terms for our customers,
which are generally “net 30.”
Our balances in accounts payable, accrued liabilities and
accrued taxes and other liabilities increased from
$402.1 million at December 31, 2003 to
$435.1 million at December 31, 2004, causing a
$6.1 million increase in cash from operating activities,
net of acquisitions, dispositions and non-cash items. The
increase is primarily due to an increase in accrued taxes
payable. Our operating cash flows will be impacted in the future
based on the timing of payments to our vendors for accounts
payable and to 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 future cash payments in future periods
will be impacted by the nature of accounts payable arrangements
and management’s assessment of our cash inflows. In 2004,
2003 and 2002, we have not made any significant changes to our
payment timing to our vendors.
Our cash balances are held in numerous locations throughout the
world, including substantial amounts held outside the United
States. As of December 31, 2004, approximately
$327.8 million of our cash and cash equivalents were held
outside the United States. We utilize a variety of tax planning
and financing strategies in an effort to ensure that our
worldwide cash is available in the locations in which it is
needed. 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 (“AJCA”) introduced a limited
time 85% dividends received reduction on the repatriation of
certain foreign earnings to a U.S. taxpayer, provided
certain criteria are met. We are analyzing the impact of the
AJCA and may repatriate to the United States some or all of our
offshore earnings currently characterized as indefinitely
reinvested outside the United States. The range of possible
amounts we are considering for repatriation under this provision
is between $0 and $500 million, and the range of potential
additional income taxes is between $0 and $30 million.
Our working capital, defined as current assets minus current
liabilities, was $259.9 million and $415.8 million at
December 31, 2004 and December 31, 2003, respectively.
The cause of the decrease in working capital of approximately
$155.9 million is primarily due to the $132.8 million
increase in the current
51
portion of deferred revenue. Our new perpetual plus licensing
model results in less revenue recognition up-front, therefore
causing increases in our deferred revenue. Additionally, the
strengthening of foreign currencies against the U.S. dollar
resulted in an increase in deferred revenue of approximately
$18 million. The remainder of the decrease in working
capital is primarily due to an increase in the current portion
of accrued taxes payable from 2003 to 2004.
We are currently under an SEC and DOJ investigation. As a result
of these investigations, we may be exposed to penalties that may
be material to our consolidated financial statements.
We expect to meet our obligations as they become due through
available cash and internally generated funds. We expect to
continue generating positive working capital through our
operations. However, we cannot predict whether current trends
and conditions will continue or what the effect on our business
might be from the competitive environment in which we operate.
We believe the working capital available to us will be
sufficient to meet our cash requirements for at least the next
12 months.
A summary of our investing activities at December 31, 2004,
2003 and 2002 is as follows (in thousands). The detail of these
line items can be seen in our consolidated statement of cash
flows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Activity |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Cash payments for acquisitions, net
|
|
$ |
(84,650 |
) |
|
$ |
(217,256 |
) |
|
$ |
(118,308 |
) |
|
Cash payments for property and equipment
|
|
|
(25,374 |
) |
|
|
(60,027 |
) |
|
|
(59,427 |
) |
|
Net (purchases) proceeds of investments in marketable securities
|
|
|
(210,588 |
) |
|
|
(97,861 |
) |
|
|
8,668 |
|
|
Decrease(increase) in restricted cash
|
|
|
19,930 |
|
|
|
664 |
|
|
|
(21,734 |
) |
|
Proceeds from sale of assets and technology
|
|
|
261,309 |
|
|
|
— |
|
|
|
7,155 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
$ |
(39,373 |
) |
|
$ |
(374,480 |
) |
|
$ |
(183,646 |
) |
| |
|
|
|
|
|
|
|
|
|
In 2004, we paid cash for our acquisition of Foundstone in the
amount of $84.7 million, net of cash assumed. In 2003, we
paid cash for our acquisitions of Entercept and IntruVert in the
amount of $124.8 million and $92.3 million,
respectively. We purchased IntruVert and Entercept to enhance
our network intrusion prevention products. In September 2002,
to, among other things, reduce customer and brand confusion, we
acquired the outstanding minority interest in McAfee.com for a
combination of shares our common stock and $98.4 million
total cash payments. In 2002, we also purchased several smaller
entities for cash in the amount of $19.1 million in order
to enhance our products and improve distribution in Latin
America.
We may buy or make investments in complementary companies,
products and technologies. Our available cash and equity and
debt securities may be used to acquire or invest in companies or
products, possibly resulting in significant acquisition-related
charges to earnings and dilution to our stockholders.
We have also made divestitures previously. In July and January
2004, we completed the sales of our Sniffer and Magic
businesses, respectively, as part of our continued focus on
security and security related products. In 2004, we received
cash proceeds of approximately $213.8 million for the
Sniffer sale and approximately $47.1 million for the Magic
sale.
We added $25.4 million of equipment during 2004 to update
hardware for our employees and enhance various back office
systems and purchases of equipment for our Bangalore research
and development facility. We added $60.0 million of
equipment during 2003 to update hardware for our employees and
enhance various back office systems, including our new customer
relationship management system which we deployed in early
52
2004. In 2002, we added $59.4 million of property and
equipment, including approximately $17.0 million related to
the construction of our regional office in Plano, Texas. Our
property and equipment additions have been funded from
operations.
We anticipate that we will continue to purchase property and
equipment necessary in the normal course of our business. The
amount and timing of these purchases and the related cash
outflows in future periods is difficult to predict and is
dependent on a number of factors including our hiring of
employees, the rate of change in computer hardware/ software
used in our business and our business outlook.
We (made net purchases of) and received net proceeds from
sales/maturities of our marketable securities of
$(210.6) million, $(97.9 million), and
$8.7 million in 2004, 2003 and 2002, respectively. We have
classified our investment portfolio as “available for
sale,” and our investments are made with a policy of
capital preservation and liquidity as the primary objectives. We
generally hold investments in corporate bonds and
U.S. government agency securities to maturity; however, we
may sell an investment at any time if the quality rating of the
investment declines, the yield on the investment is no longer
attractive or we are in need of cash. Because we invest only in
investment securities that are highly liquid with a ready
market, we believe that the purchase, maturity or sale of our
investments has no material impact on our overall liquidity.
At December 31, 2003, we had on deposit approximately
$20.2 million as collateral for our interest rate swap
arrangements we entered into related to our $345.0 million
of 5.25% subordinated convertible debt. The arrangements
required us to keep a minimum amount of $20.0 million on
deposit with the swap counterparties, subject to increase based
on the fair value of the swap. The swap agreement terminated in
October 2004. The December 31, 2004 restricted cash balance
of $0.6 million consists primarily of cash collateral
related to our workers’ compensation insurance coverage.
The primary uses of cash for financing activities in 2004 were
the use of $265.6 million of cash to repurchase our
convertible debt, and the use of $221.8 million for the
repurchase common stock. In 2003 and 2002, we also repurchased
debt using $177.3 million and $66.2 million of cash,
respectively.
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 $113.8 million, $35.4 million and
$109.9 million in 2004, 2003 and 2002, 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.
As our stock price rises, more participants are “in the
money” in their options, and, thus, more likely to exercise
their options, which results in cash to us. As our stock price
decreases, more of our employees are “out of the
money” or “under water” in regards to their
options, and, therefore, are not able to exercise options,
resulting in no cash received by us. The decrease in cash
proceeds from the exercise of stock options and employee stock
purchase plans from 2002 to 2003 was primarily the result of the
blackout period in most of 2003 due to our restatement. From
March 2003 through November 2003, all purchases under our stock
option plans and employee stock purchase plan were suspended
pending the filing with the SEC of our public company reports,
including our restated financial results. Following the
October 31, 2003 filing of these reports, activity under
our plans was resumed and increased in 2004.
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,
53
with terms of one year or less. The credit facility can be
cancelled at any time. No balances are outstanding as of
December 31, 2004.
Contractual Obligations
A summary of our contractual obligations at December 31,
2004 is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Payments Due by Period | |
| |
|
| |
| |
|
|
|
Less Than | |
|
1-3 | |
|
3-5 | |
|
More Than | |
| Contractual Obligations |
|
Total | |
|
1 Year | |
|
Years | |
|
Years | |
|
5 Years | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Operating leases(1)
|
|
$ |
153,489 |
|
|
$ |
24,197 |
|
|
$ |
37,201 |
|
|
$ |
30,281 |
|
|
$ |
61,810 |
|
|
Other commitments(2)
|
|
|
21,298 |
|
|
|
7,049 |
|
|
|
11,416 |
|
|
|
2,833 |
|
|
|
— |
|
|
Purchase obligations(3)
|
|
|
2,781 |
|
|
|
2,781 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
177,568 |
|
|
$ |
34,027 |
|
|
$ |
48,617 |
|
|
$ |
33,114 |
|
|
$ |
61,810 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
Operating leases are for office space and office equipment. The
operating lease commitments above reflect contractual and
reasonably assured rent escalations under the lease
arrangements. The operating lease contractual obligations
reflect $60.0 million and $56.8 million in minimum
non-cancelable payments under leases for the Santa Clara,
California and Cork, Ireland facilities, respectively. |
| |
| (2) |
Other commitments are minimum commitments on telecom contracts
and contractual commitments for naming rights and advertising
services. |
| |
| (3) |
We generally issue purchase orders to our contract manufacturers
with delivery dates from four to six weeks from the purchase
order date. In addition, we regularly provide such contract
manufacturers with rolling six-month forecasts of product
requirements for planning and long-lead time parts procurement
purposes only. We are committed to accept delivery of materials
pursuant to our purchase orders subject to various contract
provisions which allow us to delay receipt of such order or
allow us to cancel orders beyond certain agreed lead times. Such
cancellations may or may not include cancellation costs payable
by us. If we are unable to adequately manage our contract
manufacturers and adjust such commitments for changes in demand,
we may incur additional inventory expenses related to excess and
obsolete inventory. |
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in
transactions that generate relationships with unconsolidated
entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities,
often established for the purpose of facilitating off-balance
sheet arrangements or other contractually narrow or limited
purposes. All of our subsidiaries are 100% owned by us and are
fully consolidated into our consolidated financial statements.
Convertible Debt
On August 17, 2001, we issued 5.25% convertible
subordinated notes (“Notes”) with an aggregate
principal amount of $345.0 million. The issuance generated
net proceeds to us of approximately $335.1 million (after
deducting fees and expenses). The Notes had a maturity date of
August 15, 2006, unless earlier redeemed by us at our
option or converted at the holder’s option. Interest was
payable semi-annually in cash in arrears on February 15 and
August 15 of each year, commencing February 15, 2002. At
the option of the holder, the Notes could be converted into our
common stock at any time, unless previously redeemed, at a
conversion price of $18.07 per share. We had the option to
redeem all or a portion of the Notes for cash at a repurchase
price of 101.3125% of the principal amount at any time between
August 20, 2004 and August 14, 2005. On
August 20, 2004, we redeemed the outstanding balance for
approximately $265.6 million in cash. Prior to the
redemption date, approximately $83.4 million in aggregate
principal was converted into approximately 4.6 million
shares of our common stock. We recorded a loss on redemption of
the Notes of
54
approximately $15.1 million due to the write-off of
unamortized debt issuance costs, fair value adjustment of the
debt and the premium paid for redemption.
We had interest rate swap agreements with two banks to hedge the
interest rate risk on the Notes. The Swap agreements had a
maturity date of August 15, 2006, subject to early
termination provisions if on or after August 20, 2004 and
prior to August 15, 2006 the average closing price of our
common stock equals or exceeds $22.59 per share for a
five-day period. We left the swap agreements intact after the
Notes were redeemed in August 2004. On October 27, 2004,
the swap agreements automatically terminated under the terms of
the agreements as our five-day average stock price equaled the
$22.59 threshold.
In February 1998, we issued zero coupon convertible subordinated
debentures due 2018 with an aggregate face amount at maturity of
$885.5 million and generating net proceeds to us of
approximately $337.6 million. Prior to December 31,
2002, we repurchased zero coupon debentures with an aggregate
face amount of approximately $527.0 million, at a total
price of $239.9 million. On February 13, 2003, we paid
approximately $177.1 million in cash to redeem
approximately $358.0 million in face amount of the zero
coupon debentures. On June 9, 2003, we redeemed the
remaining zero coupon debentures with an aggregate face amount
at maturity of $0.5 million for a net price of
$0.2 million.
Stock Repurchases
In 2004 and 2003, we repurchased 12.6 million and
0.4 million shares or our common stock in the open market
for $221.8 million and $4.7 million, respectively. As
of December 31, 2004, we were authorized to repurchase an
additional $123.6 million of our common stock from time to
time through August 2006, depending upon market conditions,
share price and other factors.
We repurchased approximately 2.0 million shares of our
common stock in the open market for $47.4 million in March
2005.
Financial Risk Management
The following discussion about our risk management activities
includes “forward-looking statements” that involve
risks and uncertainties. Actual results could differ materially
from those projected in the forward-looking statements.
As a global concern, we face exposure to movements in foreign
currency exchange rates. These exposures may change over time as
business practices evolve and could have a material adverse
impact on our financial results. Our primary exposures are
related to non U.S. dollar-denominated sales and operating
expenses in Japan, Canada, Australia, Europe, Latin America, and
Asia. At the present time, we hedge only those currency
exposures associated with certain assets and liabilities
denominated in nonfunctional currencies and do not generally
hedge anticipated foreign currency cash flows. Our hedging
activity is intended to offset the impact of currency
fluctuations on certain nonfunctional currency assets and
liabilities. The success of this activity depends upon estimates
of transaction activity denominated in various currencies,
primarily the Japanese Yen, Canadian dollar, Australian dollar,
the Euro, and the British Pound. To the extent that these
estimates are overstated or understated during periods of
currency volatility, we could experience unanticipated currency
gains or losses.
To reduce exposures associated with nonfunctional net monetary
asset positions in various currencies, we enter into spot,
forward and swap foreign exchange contracts. Our foreign
exchange contracts typically range from one to three months in
original maturity. In general, we have not hedged anticipated
foreign currency cash flows nor do we enter into forward
contracts for trading purposes. We do not use any derivatives
for speculative purposes. Our existing forward contracts do not
qualify for hedge accounting and accordingly are marked to
market at the end of each reporting period with any unrealized
gain or loss being recognized in the consolidated statements of
income. Net realized gains and losses arising from settlement of
our forward foreign exchange contracts were not significant in
2004, 2003, and 2002.
55
The forward contracts outstanding and their fair values are
presented below as of December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
Carrying | |
|
Fair | |
|
Carrying | |
|
Fair | |
| |
|
Value | |
|
Value | |
|
Value | |
|
Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
Euro
|
|
$ |
116 |
|
|
$ |
116 |
|
|
$ |
490 |
|
|
$ |
490 |
|
|
British Pound Sterling
|
|
|
288 |
|
|
|
288 |
|
|
|
54 |
|
|
|
54 |
|
|
Brazilian Real
|
|
|
420 |
|
|
|
420 |
|
|
|
— |
|
|
|
— |
|
|
Singapore Dollar
|
|
|
— |
|
|
|
— |
|
|
|
(16 |
) |
|
|
(16 |
) |
|
Japanese Yen
|
|
|
1 |
|
|
|
1 |
|
|
|
— |
|
|
|
— |
|
|
Australian Dollar
|
|
|
4 |
|
|
|
4 |
|
|
|
75 |
|
|
|
75 |
|
|
Canadian Dollar
|
|
|
39 |
|
|
|
39 |
|
|
|
255 |
|
|
|
255 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
868 |
|
|
$ |
868 |
|
|
$ |
858 |
|
|
$ |
858 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
In July 2002, we entered into interest rate swap transactions
(the “Transactions”) with two investment banks (the
“Banks”), to hedge the interest rate risk of its
outstanding 5.25% Convertible Subordinated Note due 2006
(“Notes”) (See Note 7 to the consolidated
financial statements).
The notional amount of the Transactions was $345.0 million
to match the entire principal amount of the Notes. We received
from the Banks fixed payments equal to 5.25% percent of the
notional amount, payable on February 15 and August 15 which
started on August 15, 2002. In exchange, we paid to the
Banks floating rate payments based upon the London Interbank
Offered Rate (“LIBOR”) plus 1.66% multiplied by the
notional amount of the Transactions with the LIBOR resetting
every three months which began on August 15, 2002.
The Transactions were to terminate on August 15, 2006
(“Termination Date”), subject to certain early
termination provisions if on or after August 20, 2004 and
prior to August 15, 2006 the five-day average closing price
of our common stock were to equal or exceed $22.59. On
October 27, 2004, the Transactions automatically terminated
as our five-day average common stock price equaled $22.59.
The Transactions qualified and were designated as a fair value
hedge under SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” to hedge against
movements in the fair value of the Notes due to changes in the
benchmark interest rate. Under the fair value hedge model, the
derivative was recognized at fair value on the consolidated
balance sheet with an offsetting entry to the consolidated
income statement. In addition, changes in fair value of the
Notes due to changes in the benchmark interest rate were
recognized as a basis adjustment to the carrying amount of the
Notes with an offsetting entry to the consolidated income
statement. The gain or loss from the change in fair value of the
Transaction and the offsetting change in the fair value of the
Notes were recognized as interest and other expense. The net
gain recorded as of December 31, 2003 was approximately
$5.6 million. There was no net gain or loss as of
December 31, 2004 as the Transactions terminated in October
2004.
To test effectiveness of the hedges, regression analysis was
performed at least quarterly comparing the change in fair value
of the Transactions and the Notes. The fair values of the
Transactions and the Notes were calculated at least quarterly as
the present value of the contractual cash flows to the expected
maturity date, where the expected maturity date is based on
probability-weighted analysis of interest rates relating to the
five-year LIBOR curve and our stock prices. For the year ended
December 31, 2003, the hedge was highly effective and
therefore, the ineffective portion did not have a material
impact on earnings.
In support of our obligation under the Transactions, we were
required to maintain with the Banks a minimum level of cash and
investment collateral of $20.0 million and periodically
adjust the overall level of collateral depending on the fair
market value of the Transactions. This minimum amount of
collateral was presented as restricted cash in our consolidated
financial statements at December 31, 2003.
56
We maintain balances in cash, cash equivalents and investment
securities. We maintain our investment securities in portfolio
holdings of various issuers, types and maturities including
money market, government, agency and corporate bonds. These
securities are classified as available-for-sale, and
consequently are recorded on the consolidated balance sheet at
fair value with unrealized gains and losses reported as a
separate component of accumulated other comprehensive income.
These securities are not leveraged and are held for purposes
other than trading.
The following tables present the hypothetical changes in fair
values in the securities held at December 31, 2004 that are
sensitive to the changes in interest rates. The modeling
technique used measures the change in fair values arising from
hypothetical parallel shifts in the yield curve of plus or minus
50 basis points (“BPS”), 100 BPS and 150 BPS over
six and twelve-month time horizons. Beginning fair values
represent the market principal plus accrued interest and
dividends at December 31, 2004. Ending fair values are the
market principal plus accrued interest, dividends and
reinvestment income at six and twelve month time horizons.
The following table estimates the fair value of the portfolio at
a six-month time horizon (in millions):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Valuation of | |
|
|
|
|
|
|
|
|
| |
|
Securities Given | |
|
|
|
|
| |
|
an Interest Rate | |
|
|
|
Valuation of Securities Given | |
| |
|
Decrease of | |
|
|
|
an Interest Rate Increase of | |
| |
|
X Basis Points | |
|
No | |
|
X Basis Points | |
| |
|
| |
|
Change in | |
|
| |
| Issuer |
|
100 BPS | |
|
50 BPS | |
|
Interest Rate | |
|
50 BPS | |
|
100 BPS | |
|
150 BPS | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
U.S. Government notes and bonds
|
|
$ |
288.8 |
|
|
$ |
287.3 |
|
|
$ |
285.8 |
|
|
$ |
285.4 |
|
|
$ |
283.9 |
|
|
$ |
282.4 |
|
|
Municipal bonds
|
|
|
4.9 |
|
|
|
4.9 |
|
|
|
4.9 |
|
|
|
4.9 |
|
|
|
4.9 |
|
|
|
4.9 |
|
|
Corporate notes, bonds and preferreds
|
|
|
422.1 |
|
|
|
421.1 |
|
|
|
420.1 |
|
|
|
419.1 |
|
|
|
418.1 |
|
|
|
417.1 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total
|
|
$ |
715.8 |
|
|
$ |
713.3 |
|
|
$ |
710.8 |
|
|
$ |
709.4 |
|
|
$ |
706.9 |
|
|
$ |
704.4 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table estimates the fair value of the portfolio at
a twelve-month time horizon (in millions):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Valuation of | |
|
|
|
|
|
|
|
|
| |
|
Securities Given | |
|
|
|
|
| |
|
an Interest Rate | |
|
|
|
Valuation of Securities Given | |
| |
|
Decrease of | |
|
|
|
an Interest Rate Increase of | |
| |
|
X Basis Points | |
|
No | |
|
X Basis Points | |
| |
|
| |
|
Change in | |
|
| |
| Issuer |
|
100 BPS | |
|
50 BPS | |
|
Interest Rate | |
|
50 BPS | |
|
100 BPS | |
|
150 BPS | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
U.S. Government notes and bonds
|
|
$ |
292.9 |
|
|
$ |
291.6 |
|
|
$ |
290.3 |
|
|
$ |
289.1 |
|
|
$ |
287.8 |
|
|
$ |
286.5 |
|
|
Municipal bonds
|
|
|
5.0 |
|
|
|
5.0 |
|
|
|
5.0 |
|
|
|
5.0 |
|
|
|
5.0 |
|
|
|
5.0 |
|
|
Corporate notes, bonds and preferreds
|
|
|
428.3 |
|
|
|
427.5 |
|
|
|
426.6 |
|
|
|
425.8 |
|
|
|
425.0 |
|
|
|
424.2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total
|
|
$ |
726.2 |
|
|
$ |
724.1 |
|
|
$ |
721.9 |
|
|
$ |
719.9 |
|
|
$ |
717.8 |
|
|
$ |
715.7 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recent Accounting Pronouncements Update
See Note 2 of the consolidated financial statements for a
full description of recent accounting pronouncements, including
the expected dates of adoption and effects on financial
condition, results of operations and cash flows.
|
|
| Item 7A. |
Quantitative and Qualitative Disclosure About Market
Risk |
Quantitative and qualitative disclosure about market risk is set
forth at “Management’s Discussion and Analysis of
Financial Condition and Results of Operation” under
Item 7.
57
|
|
| Item 8. |
Financial Statements and Supplementary Data |
Quarterly Operating Results (Unaudited)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended | |
| |
|
| |
| |
|
December 31, | |
|
September 30, | |
|
June 30, | |
|
March 31, | |
|
December 31, | |
|
September 30, | |
|
June 30, | |
|
March 31, | |
| |
|
2004 | |
|
2004 | |
|
2004 | |
|
2004 | |
|
2003 | |
|
2003 | |
|
2003 | |
|
2003 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share data) | |
Statement of Operations
and Other Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
$ |
244,153 |
|
|
$ |
221,633 |
|
|
$ |
225,678 |
|
|
$ |
219,078 |
|
|
$ |
272,222 |
|
|
$ |
227,775 |
|
|
$ |
217,025 |
|
|
$ |
219,314 |
|
|
Gross margin
|
|
|
204,273 |
|
|
|
187,360 |
|
|
|
188,114 |
|
|
|
181,886 |
|
|
|
230,335 |
|
|
|
189,840 |
|
|
|
180,882 |
|
|
|
185,653 |
|
|
Income from operations
|
|
|
23,427 |
|
|
|
210,717 |
|
|
|
13,201 |
|
|
|
75,326 |
|
|
|
51,141 |
|
|
|
9,708 |
|
|
|
1,911 |
|
|
|
1,642 |
|
|
Income before provision for income taxes and cumulative effect
of change in accounting principle
|
|
|
23,621 |
|
|
|
199,457 |
|
|
|
13,969 |
|
|
|
79,424 |
|
|
|
55,478 |
|
|
|
13,268 |
|
|
|
2,903 |
|
|
|
1,476 |
|
|
Income before cumulative effect of change in accounting principle
|
|
|
38,747 |
|
|
|
118,148 |
|
|
|
10,200 |
|
|
|
57,970 |
|
|
|
45,308 |
|
|
|
10,774 |
|
|
|
2,491 |
|
|
|
1,332 |
|
|
Cumulative effect of, change in accounting principle, net of
taxes
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(805 |
) |
|
|
— |
|
|
|
— |
|
|
|
11,142 |
|
|
Net income
|
|
|
38,747 |
|
|
|
118,148 |
|
|
|
10,200 |
|
|
|
57,970 |
|
|
|
44,503 |
|
|
|
10,774 |
|
|
|
2,491 |
|
|
|
12,474 |
|
|
Cumulative effect of change in accounting principle, per share
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
0.07 |
|
|
Basic income per share
|
|
$ |
.24 |
|
|
$ |
.75 |
|
|
$ |
.06 |
|
|
$ |
.35 |
|
|
$ |
0.28 |
|
|
$ |
0.07 |
|
|
$ |
0.02 |
|
|
$ |
0.08 |
|
|
Diluted income per share
|
|
$ |
.23 |
|
|
$ |
.70 |
|
|
$ |
.06 |
|
|
$ |
.33 |
|
|
$ |
0.26 |
|
|
$ |
0.07 |
|
|
$ |
0.02 |
|
|
$ |
0.08 |
|
We believe that period-to-period comparisons of our financial
results should not be relied upon as an indication of future
performance.
Our revenues and results of operations have been subject to
significant fluctuations, particularly on a quarterly basis, and
our revenues and results of operations could fluctuate
significantly quarter to quarter and year to year. Causes of
such fluctuations may include the volume and timing of new
orders and renewals, the sales cycle for our products, the
introduction of new products, return rates, product upgrades or
updates by us or our competitors, changes in product mix,
changes in product prices and pricing models, the portion of our
licensing fees deferred and recognized as support and
maintenance revenue, seasonality, trends in the computer
industry, general economic conditions, extraordinary events such
as acquisitions and sales of business or litigation and the
occurrence of unexpected events. Results for the quarter ended
December 31, 2004 reflect a tax benefit of
$15.1 million due to the release of income tax
contingencies upon the lapse of statutes of limitations, as well
as a shift in taxable income from higher to lower tax
jurisdictions. Results for the quarter ended September 30,
2004 reflect a $197.4 million gain on the Sniffer sale and
a $15.1 million loss on repurchase of debt. Results for the
quarter ended March 31, 2004 reflect a gain of
$46.1 million on the Magic sale and a $19.1 million
insurance reimbursement. Significant quarterly fluctuations in
revenues will cause significant fluctuations in our cash flows
and the cash and cash equivalents, accounts receivable and
deferred revenue accounts on our consolidated balance sheet. In
addition, the operating results of many software companies
reflect seasonal trends, and our business, financial condition
and results of operations may be affected by such trends in the
future. These trends may include higher net revenue in the
fourth quarter as many customers complete annual budgetary
cycles, and lower net revenue in the summer months when many
businesses experience lower sales, particularly in the European
market.
Our financial statements and supplementary data required by this
item are set forth at the pages indicated at Item 15(a).
58
|
|
| Item 9. |
Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure |
Nothing to report.
|
|
| Item 9A. |
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Our management evaluated, with the participation of our Chief
Executive Officer (CEO) and Chief Financial Officer (CFO),
the effectiveness of the design and operation 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
(the “Exchange Act”)) as of the end of the period
covered by this annual report on Form 10-K. Based on this
evaluation, and because of the material weaknesses in our
internal control over financial reporting described below, our
management, including our CEO and CFO, has concluded that, as of
December 31, 2004, our disclosure controls and procedures
were ineffective to ensure that the information we are required
to disclose in reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the
time periods specified in Securities and Exchange Commission
rules and forms.
Management’s Report on Internal Control over Financial
Reporting
Our management, with the participation of our CEO and CFO, is
responsible for establishing and maintaining adequate internal
control over financial reporting as defined in
Rules 13a-15(f) of the Exchange Act. Our internal controls
are designed to provide reasonable assurance to our management
and members of our Board of Directors regarding the preparation
and fair presentation of published financial statements in
accordance with generally accepted accounting principles of the
United States of America (GAAP).
As part of our compliance efforts relative to Section 404
of the Sarbanes-Oxley Act of 2002, our management assessed the
effectiveness of our internal control over financial reporting
as of December 31, 2004. In making this assessment,
management used the criteria set forth in the Internal
Control — Integrated Framework by the
Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”).
In performing the assessment, our management has identified
three material weaknesses in internal control over financial
reporting existing as of December 31, 2004.
Accounting for Income Taxes
While preparing the annual provision for 2004 income taxes, we
identified certain unreconciled differences in our tax reserve
accounts dating back to calendar years 2002 and 2003. After
further analysis, we determined that no adjustments were
required to prior or current year financial statements. However,
in reaching this conclusion, our management noted that there was
a lack of historic analysis and documentation, ineffective
account reconciliation procedures, and insufficient tax
accounting personnel which did not allow the timely calculation
of the year end tax provisions. Given the significance of the
tax account balances and the absence of sufficient mitigating
controls, these deficiencies which existed as of
December 31, 2004 represent a material weakness in internal
control over financial reporting on the basis that there is more
than a remote likelihood that a material misstatement in our
interim or annual financial statements due to errors in
accounting for income taxes could occur and would not be
prevented or detected by our internal control over financial
reporting.
Revenue Accounting
In August 2004, we restated our results for the first quarter of
2004 as a result of revenue accounting misstatements that
resulted from the improper system set up of a limited number of
product stock keeping units. Subsequent to this event, we took
action to remediate our revenue accounting controls. During the
fourth quarter 2004 review and audit process, we noted that
certain revenue accounting controls relating to (a) the
analysis of transactions in certain geographies and (b) the
deferral and amortization of the appropriate amounts of post
contract support had not operated as designed and adjustments
were recorded in the
59
consolidated financial statements for the year ended
December 31, 2004 to correct the identified errors. Our
management has concluded that given the magnitude of the revenue
adjustments recorded and the potential for misstatements to
occur as a result of internal control deficiencies in revenue
accounting existing as of December 31, 2004, there is more
than a remote likelihood that a material misstatement in our
interim or annual financial statements could occur and would not
be prevented or detected by our internal control over financial
reporting.
Financial Close and Reporting Process
During the 2004 year end review and audit process, we
identified a series of adjustments relating to complex
transactions and balance sheet reconciliations and were unable
to complete the financial close process in a timely manner due
to a lack of sufficient accounting personnel. Given the number
of adjustments identified, the significance of the financial
closing and reporting process to the preparation of reliable
financial statements, and the potential for errors to
significant account balances to occur as of December 31,
2004, our management has concluded that there is more than a
remote likelihood that a material misstatement in our interim or
annual financial statements could occur and would not be
prevented or detected by our internal control over financial
reporting.
As a result of the material weaknesses described above,
management’s conclusion is that, as of December 31,
2004, the Company did not maintain effective internal control
over financial reporting based upon the criteria set forth in
COSO’s Internal Control — Integrated
Framework.
Deloitte & Touche LLP, an independent registered public
accounting firm, has issued an attestation report on
management’s assessment of our internal control over
financial reporting. That report appears below.
On October 1, 2004, we completed the acquisition of all of
Foundstone, Inc., as discussed elsewhere in this report under
“Business — Overview,”
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and Note 4 to our
consolidated financial statements. Therefore, in making
management’s assessment of the effectiveness of our
internal control over financial reporting, we have excluded
Foundstone, whose financial statements reflect total assets and
revenues constituting 0.6% and 0.3%, respectively, of the
related consolidated financial statement amounts as of and for
the year ended December 31, 2004, from our report on
internal control over financial reporting as management did not
have sufficient time to make an assessment of Foundstone’s
internal controls using the COSO criteria in accordance with
Section 404 of the Sarbanes-Oxley Act.
Changes in Internal Control over Financial Reporting
We undertook significant efforts in 2004 to establish a
framework to improve internal controls over financial reporting.
We committed considerable resources to the design,
implementation, documentation and testing of our internal
controls. Additional efforts were required to remediate and
re-test certain internal control deficiencies. Our management
believes that these efforts have improved our internal control
over financial reporting.
While these steps have helped address some of the internal
control deficiencies noted above, they have not been sufficient
to remedy the control issues that existed as of
December 31, 2004. We are taking the following steps to
remediate these material weaknesses:
|
|
|
| |
• |
Increasing the number of internal general ledger and tax
accounting personnel trained in reporting under accounting
principles generally accepted in the United States (GAAP) |
| |
| |
• |
Improving the documentation, communication and periodic review
of our accounting policies throughout our domestic and
international locations for consistency and application with
GAAP at each of our operating locations |
| |
| |
• |
Improving the interim and annual review and reconciliation
process for certain key account balances |
| |
| |
• |
Enhancing the training and education for our international
finance and accounting personnel and new hire additions to the
worldwide finance team |
60
|
|
|
| |
• |
Implementing more stringent policies and procedures regarding
revenue accounting and change management of our product catalogue |
| |
| |
• |
Directing more internal audit time and attention to sales order
processing and revenue accounting activities |
| |
| |
• |
Increasing diligence regarding user access and change management
to our network, databases and applications |
| |
| |
• |
Automating certain controls that are currently performed manually |
| |
| |
• |
Simplifying and integrating systems |
Inherent Limitation on the Effectiveness of Internal
Controls
The effectiveness of any system of internal control over
financial reporting, including McAfee’s, is subject to
inherent limitations, including the exercise of judgment in
designing, implementing, operating, and evaluating the controls
and procedures, and the inability to eliminate misconduct
completely. Accordingly, any system of internal control over
financial reporting, including McAfee’s, can only provide
reasonable, not absolute assurances. In addition, projections of
any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the
policies or procedures may deteriorate. We intend to continue to
monitor and upgrade our internal controls as necessary or
appropriate for our business, but cannot assure you that such
improvements will be sufficient to provide us with effective
internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of McAfee, Inc.
(formerly known as Network Associates, Inc.):
We have audited management’s assessment, included in the
accompanying Management’s Report on Internal Control Over
Financial Reporting (“Management’s Report”), that
McAfee, Inc. and subsidiaries (the “Company”) did not
maintain effective internal control over financial reporting as
of December 31, 2004, because of the effect of the material
weaknesses identified in management’s assessment based on
criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. As described in
Management’s Report, management excluded from their
assessment the internal control over financial reporting at
Foundstone, Inc. which was acquired on October 1, 2004 and
whose financial statements reflect total assets and revenues
constituting 0.6% and 0.3%, respectively, of the related
consolidated financial statement amounts as of and for the year
ended December 31, 2004. Accordingly, our audit did not
include the internal control over financial reporting at
Foundstone, Inc. The Company’s management is responsible
for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is
to express an opinion on management’s assessment and an
opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinions.
A company’s internal control over financial reporting is a
process designed by, or under the supervision of, the
company’s principal executive and principal financial
officers, or persons performing similar functions, and effected
by the company’s board of directors, management, and other
personnel to provide reasonable
61
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A
company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions
of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance
with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a
material effect on the financial statements.
Because of the inherent limitations of internal control over
financial reporting, including the possibility of collusion or
improper management override of controls, material misstatements
due to error or fraud may not be prevented or detected on a
timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting
to future periods are subject to the risk that the controls may
become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.
A material weakness is a significant deficiency, or combination
of significant deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. The
following material weaknesses have been identified and included
in management’s assessment:
|
|
|
| |
• |
The Company’s controls over the calculation of the income
tax provision, taxes payable and deferred income tax amounts did
not operate effectively as of December 31, 2004. In
particular, (1) the Company did not have a sufficient
number of personnel with adequate expertise in income tax
accounting matters, (2) historical analyses were not
maintained in sufficient detail and (3) account
reconciliations, which are necessary to detect whether income
tax amounts are calculated properly and recorded in the proper
period, were not completed and reviewed in time to permit timely
reporting of financial results. Due to the potential that a
material misstatement could occur related to the income tax
amounts and the absence of mitigating controls, there is a more
than remote likelihood that a material misstatement of the
interim and annual financial statements would not have been
prevented or detected. |
| |
| |
• |
The Company’s controls over the recognition of revenue for
software contracts did not operate effectively as of
December 31, 2004. In particular, controls to properly
apply the provisions of AICPA Statement of Position 97-2,
Software Revenue Recognition (as amended) to
(1) analyze the terms of new contracts from a certain
geographic region and (2) defer and amortize the
appropriate amount applicable to post contract support, did not
operate effectively and audit adjustments to defer revenue that
had been improperly recognized were recorded by the Company for
the quarter ended December 31, 2004. Such adjustments in
the aggregate were material to the interim financial statements
for that period and the potential misstatement could have been
material to the annual financial statements. In addition, based
on (1) the amount of the misstatements identified and the
potential for additional misstatements related to the revenue
recognized, (2) the elevated risk of misstatement
associated with revenue recognition and (3) the absence of
mitigating controls, there is a more than remote likelihood that
a material misstatement of the interim and annual financial
statements would not have been prevented or detected. |
| |
| |
• |
The Company’s controls over the period-end financial
closing and reporting process are inadequate and constitute a
material weakness in the design of internal control over
financial reporting. Specifically, the Company lacks sufficient
resources with the appropriate level of technical accounting
expertise within the accounting function and therefore was
unable to accurately perform certain of the designed controls
over the December 31, 2004 financial closing and reporting
process on a timely basis, evidenced by a significant number of
adjustments which were necessary to present the financial
statements for the year ended December 31, 2004 in
accordance with generally accepted accounting |
62
|
|
|
| |
|
principles. Based on (1) the misstatements identified and
(2) the significance of the financial closing and reporting
process to the preparation of reliable financial statements,
there is a more than remote likelihood that a material
misstatement of the interim and annual financial statements
would not have been prevented or detected. |
These material weaknesses were considered in determining the
nature, timing, and extent of audit tests applied in our audit
of the consolidated financial statements and financial statement
schedule as of and for the year ended December 31, 2004 of
the Company and this report does not affect our report on such
consolidated financial statements and financial statement
schedule.
In our opinion, management’s assessment that the Company
did not maintain effective internal control over financial
reporting as of December 31, 2004, is fairly stated, in all
material respects, based on the criteria established in
Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission. Also in our opinion, because of the effect of the
material weakness described above on the achievement of the
objectives of the control criteria, the Company has not
maintained effective internal control over financial reporting
as of December 31, 2004, based on the criteria established
in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated financial statements and financial statement
schedule as of and for the year ended December 31, 2004, of
the Company and our report dated March 30, 2005 expressed
an unqualified opinion on such consolidated financial statements
and financial statement schedule.
DELOITTE & TOUCHE LLP
San Jose, California
March 30, 2005
Item 9B. Other
Information
None.
63
PART III
|
|
| Item 10. |
Directors and Executive Officers of the Registrant |
The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our
annual meeting of stockholders to be held on May 25, 2005.
We have adopted a code of ethics that applies to our chief
executive officer, chief financial officer, corporate controller
and other finance organization employees and establishes minimum
standards of professional responsibility and ethical conduct.
The finance code of ethics is publicly available on our website
at www.mcafee.com. If we make any substantive amendments to the
finance code of ethics or grant any waiver, including any
implicit waiver, from a provision of the code to our chief
executive officer, chief financial officer or corporate
controller, we will disclose the nature of such amendment or
waiver on that website or in a report on Form 8-K.
Section 16(a) Beneficial Ownership Reporting
Compliance
Section 16(a) of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”), requires the
Company’s officers and directors, and persons who own more
than ten percent of a registered class of the Company’s
equity securities, to file certain reports of ownership with the
SEC. Such officers, directors and stockholders are also required
by SEC rules to furnish us with copies of all Section 16(a)
forms they file. All reports required to be filed during fiscal
year 2004 pursuant to Section 16(a) of the exchange act by
directors, executive officers and 10% beneficial owners were
filed on timely basis, except as follows: Ms. Amanda
Hodges’, the wife of our President, option grant of
1,000 shares in July 2004 was not reported in a timely
manner to the SEC.
|
|
| Item 11. |
Executive Compensation |
The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our
annual meeting of stockholders to be held on May 25, 2005.
|
|
| Item 12. |
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters |
The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our
annual meeting of stockholders to be held on May 25, 2005.
|
|
| Item 13. |
Certain Relationships and Related Transactions |
The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our
annual meeting of stockholders to be held on May 25, 2005.
|
|
| Item 14. |
Principal Accountant Fees and Services |
The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our
annual meeting of stockholders to be held on May 25, 2005.
64
PART IV
|
|
| Item 15. |
Exhibits and Financial Statement Schedules |
(a)(1) Financial Statements:
| |
|
|
|
|
|
| |
|
Page | |
| |
|
Number | |
| |
|
| |
|
|
|
|
66 |
|
|
|
|
|
|
|
| |
December 31, 2004 and 2003
|
|
|
68 |
|
|
|
|
|
|
|
| |
Years ended December 31, 2004, 2003 and 2002
|
|
|
69 |
|
|
|
|
|
|
|
| |
Years ended December 31, 2004, 2003 and 2002
|
|
|
71 |
|
|
|
|
|
|
|
| |
Years ended December 31, 2004, 2003, and 2002
|
|
|
72 |
|
|
|
|
|
73 |
|
(a)(2) Financial Statement Schedule
The following financial statement schedule of McAfee, Inc. for
the years ended December 31, 2004, 2003, and 2002 is filed
as part of this Form 10-K and should be read in conjunction
with McAfee, Inc.’s Consolidated Financial Statements.
Schedule II — Valuation and Qualifying Accounts
on Page 126
Schedules not listed above have been omitted because they are
not applicable or are not required or because the required
information is included in the Consolidated Financial Statements
or Notes thereto.
(a)(3) Exhibits: See Index to Exhibits on Page 123.
The Exhibits listed on the accompanying Index of Exhibits are
filed or incorporated by reference as part of this report.
65
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
McAfee, Inc. (formerly Network Associates, Inc.):
We have audited the accompanying consolidated balance sheet of
McAfee, Inc. and subsidiaries (the “Company”) as of
December 31, 2004, and the related consolidated statements
of income and comprehensive income, stockholders’ equity,
and cash flows for the year then ended. Our audit also included
the financial statement schedule listed in the Index at
Item 15(a)(2) for the year ended December 31, 2004.
These financial statements and financial statement schedule are
the responsibility of the Company’s management. Our
responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such 2004 consolidated financial statements
present fairly, in all material respects, the financial position
of the Company as of December 31, 2004, and the results of
its operations and its cash flows for the year then ended in
conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such 2004
financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set
forth therein.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of the Company’s internal control over
financial reporting as of December 31, 2004, based on the
criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated
March 30, 2005 expressed an unqualified opinion on
management’s assessment of the effectiveness of the
Company’s internal control over financial reporting and an
adverse opinion on the effectiveness of the Company’s
internal control over financial reporting.
DELOITTE & TOUCHE LLP
San Jose, California
March 30, 2005
66
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
of McAfee, Inc. (formerly Networks Associates, Inc.):
In our opinion, the consolidated balance sheet as of
December 31, 2003 and the related consolidated statements
of income and comprehensive income, of shareholders’ equity
and of cash flows for each of the two years in the period ended
December 31, 2003 present fairly, in all material respects,
the financial position, results of operations and cash flows of
McAfee, Inc. and its subsidiaries at December 31, 2003 and
for each of the two years in the period ended December 31,
2003, in conformity with accounting principles generally
accepted in the United States of America. In addition, in our
opinion, the financial statement schedule listed in the index
appearing under Item 15 (a) (2) for each of the two
years in the period ended December 31, 2003 presents
fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial
statement schedule are the responsibility of the Company’s
management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 3 to the consolidated financial
statements, the Company changed its method of accounting for
sales commissions effective January 1, 2003.
/s/ PricewaterhouseCoopers LLP
Dallas, Texas
February 26, 2004
67
MCAFEE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| |
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(In thousands, except | |
| |
|
share data) | |
|
ASSETS |
|
Current assets:
|
|
|
|
|
|
|
|
|
| |
Cash and cash equivalents
|
|
$ |
291,155 |
|
|
$ |
333,651 |
|
| |
Short-term marketable securities
|
|
|
232,929 |
|
|
|
174,499 |
|
| |
Accounts receivable, net of allowance for doubtful accounts of
$2,536 and $2,863, respectively
|
|
|
137,520 |
|
|
|
170,218 |
|
| |
Prepaid expenses, income taxes and other current assets
|
|
|
103,687 |
|
|
|
97,616 |
|
| |
Deferred income taxes
|
|
|
200,459 |
|
|
|
160,550 |
|
| |
Assets held for sale
|
|
|
— |
|
|
|
24,719 |
|
| |
|
|
|
|
|
|
| |
|
Total current assets
|
|
|
965,750 |
|
|
|
961,253 |
|
|
Long-term marketable securities
|
|
|
400,597 |
|
|
|
258,107 |
|
|
Restricted cash
|
|
|
617 |
|
|
|
20,547 |
|
|
Property and equipment, net
|
|
|
91,715 |
|
|
|
111,672 |
|
|
Deferred income taxes
|
|
|
220,604 |
|
|
|
199,196 |
|
|
Intangible assets, net
|
|
|
107,133 |
|
|
|
105,952 |
|
|
Goodwill
|
|
|
439,180 |
|
|
|
443,593 |
|
|
Other assets
|
|
|
12,080 |
|
|
|
20,178 |
|
| |
|
|
|
|
|
|
| |
|
Total assets
|
|
$ |
2,237,676 |
|
|
$ |
2,120,498 |
|
| |
|
|
|
|
|
|
| |
|
LIABILITIES |
|
Current liabilities:
|
|
|
|
|
|
|
|
|
| |
Accounts payable
|
|
$ |
32,891 |
|
|
$ |
32,099 |
|
| |
Accrued liabilities
|
|
|
197,368 |
|
|
|
147,281 |
|
| |
Deferred revenue
|
|
|
475,621 |
|
|
|
342,795 |
|
| |
Liabilities related to assets held for sale
|
|
|
— |
|
|
|
23,310 |
|
| |
|
|
|
|
|
|
| |
|
Total current liabilities
|
|
|
705,880 |
|
|
|
545,485 |
|
|
Deferred revenue, less current portion
|
|
|
125,752 |
|
|
|
116,762 |
|
|
Convertible debt
|
|
|
— |
|
|
|
347,397 |
|
|
Accrued taxes and other long term liabilities
|
|
|
204,796 |
|
|
|
222,765 |
|
| |
|
|
|
|
|
|
| |
|
Total liabilities
|
|
|
1,036,428 |
|
|
|
1,232,409 |
|
| |
|
|
|
|
|
|
|
Commitments and contingencies (Notes 11, 12 and 20)
|
|
|
|
|
|
|
|
|
| |
|
STOCKHOLDERS’ EQUITY |
|
Preferred stock, $0.01 par value:
|
|
|
|
|
|
|
|
|
| |
Authorized: 5,000,000 shares; Issued and outstanding: none
in 2004 and 2003
|
|
|
— |
|
|
|
— |
|
|
Common stock, $0.01 par value:
|
|
|
|
|
|
|
|
|
| |
Authorized: 300,000,000 shares;
Issued:162,266,174 shares and 162,071,798 shares for
2004 and 2003, respectively;
|
|
|
|
|
|
|
|
|
| |
Outstanding: 162,266,174 shares and 161,721,798 for 2004
and 2003, respectively
|
|
|
1,623 |
|
|
|
1,621 |
|
|
Treasury stock, at cost: no shares in 2004 and
350,000 shares in 2003
|
|
|
— |
|
|
|
(4,707 |
) |
|
Additional paid-in capital
|
|
|
1,178,855 |
|
|
|
1,087,625 |
|
|
Deferred stock-based compensation
|
|
|
(1,777 |
) |
|
|
(598 |
) |
|
Accumulated other comprehensive income
|
|
|
27,361 |
|
|
|
34,027 |
|
|
Accumulated deficit
|
|
|
(4,814 |
) |
|
|
(229,879 |
) |
| |
|
|
|
|
|
|
| |
|
Total stockholders’ equity
|
|
|
1,201,248 |
|
|
|
888,089 |
|
| |
|
|
|
|
|
|
| |
|
Total liabilities and stockholders’ equity
|
|
$ |
2,237,676 |
|
|
$ |
2,120,498 |
|
| |
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
68
MCAFEE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share data) | |
|
Net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
$ |
294,163 |
|
|
$ |
513,610 |
|
|
$ |
631,550 |
|
| |
Services and support
|
|
|
616,379 |
|
|
|
422,726 |
|
|
|
411,494 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Total net revenue
|
|
|
910,542 |
|
|
|
936,336 |
|
|
|
1,043,044 |
|
| |
|
|
|
|
|
|
|
|
|
|
Cost of net revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Product
|
|
|
73,058 |
|
|
|
80,895 |
|
|
|
101,019 |
|
| |
Services and support
|
|
|
62,520 |
|
|
|
57,362 |
|
|
|
60,539 |
|
| |
Amortization of purchased technology
|
|
|
13,331 |
|
|
|
11,369 |
|
|
|
3,153 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Total cost of net revenue
|
|
|
148,909 |
|
|
|
149,626 |
|
|
|
164,711 |
|
| |
|
|
|
|
|
|
|
|
|
|
Operating costs:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Research and development(1)
|
|
|
172,717 |
|
|
|
184,606 |
|
|
|
148,801 |
|
| |
Marketing and sales(2)
|
|
|
354,380 |
|
|
|
363,306 |
|
|
|
397,747 |
|
| |
General and administrative(3)
|
|
|
139,845 |
|
|
|
129,920 |
|
|
|
119,393 |
|
| |
(Gain) loss on sale of assets and technology(4)
|
|
|
(240,336 |
) |
|
|
788 |
|
|
|
(9,301 |
) |
| |
Litigation (reimbursement) settlement
|
|
|
(24,991 |
) |
|
|
— |
|
|
|
70,000 |
|
| |
Restructuring charges
|
|
|
17,493 |
|
|
|
22,667 |
|
|
|
1,116 |
|
| |
Amortization of intangibles
|
|
|
14,065 |
|
|
|
15,637 |
|
|
|
10,742 |
|
| |
Severance/bonus costs related to Sniffer and Magic disposition(5)
|
|
|
10,070 |
|
|
|
— |
|
|
|
— |
|
| |
Reimbursement from transition services agreement
|
|
|
(5,997 |
) |
|
|
— |
|
|
|
— |
|
| |
Provision for (recovery of) doubtful accounts, net
|
|
|
1,716 |
|
|
|
(1,216 |
) |
|
|
(219 |
) |
| |
Acquisition related costs not subject to capitalization
|
|
|
— |
|
|
|
— |
|
|
|
16,026 |
|
| |
In-process research and development
|
|
|
— |
|
|
|
6,600 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Total operating costs
|
|
|
438,962 |
|
|
|
722,308 |
|
|
|
754,305 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Income from operations
|
|
|
322,671 |
|
|
|
64,402 |
|
|
|
124,028 |
|
|
Interest and other income
|
|
|
15,889 |
|
|
|
15,917 |
|
|
|
27,324 |
|
|
Interest and other expenses
|
|
|
(5,315 |
) |
|
|
(7,543 |
) |
|
|
(25,085 |
) |
|
(Loss) gain on repurchase of convertible debt
|
|
|
(15,070 |
) |
|
|
(2,727 |
) |
|
|
26 |
|
|
(Loss) gain on investments, net
|
|
|
(1,704 |
) |
|
|
3,076 |
|
|
|
3,838 |
|
|
Impairment of strategic and other investments
|
|
|
— |
|
|
|
— |
|
|
|
(198 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Income before provision for (benefit from) income taxes,
minority interest and cumulative effect of change in accounting
principle
|
|
|
316,471 |
|
|
|
73,125 |
|
|
|
129,933 |
|
|
Provision for (benefit from) income taxes
|
|
|
91,406 |
|
|
|
13,220 |
|
|
|
(274 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Income before minority interest and cumulative effect of change
in accounting principle
|
|
|
225,065 |
|
|
|
59,905 |
|
|
|
130,207 |
|
|
Minority interest in income of consolidated subsidiaries
|
|
|
— |
|
|
|
— |
|
|
|
(1,895 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Income before cumulative effect of change in accounting principle
|
|
|
225,065 |
|
|
|
59,905 |
|
|
|
128,312 |
|
|
Cumulative effect of change in accounting principle, net of
taxes of $3,590
|
|
|
— |
|
|
|
10,337 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
225,065 |
|
|
$ |
70,242 |
|
|
$ |
128,312 |
|
| |
|
|
|
|
|
|
|
|
|
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized losses on marketable securities, net of
reclassification adjustment for losses recognized on marketable
securities during the period and income tax
|
|
$ |
(2,129 |
) |
|
$ |
(709 |
) |
|
$ |
(2,667 |
) |
| |
Foreign currency translation (loss) gain
|
|
|
(4,537 |
) |
|
|
10,578 |
|
|
|
10,744 |
|
| |
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$ |
218,399 |
|
|
$ |
80,111 |
|
|
$ |
136,389 |
|
| |
|
|
|
|
|
|
|
|
|
69
MCAFEE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME — (Continued)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands, except per share data) | |
|
Basic net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income before cumulative effect of change in accounting principle
|
|
$ |
1.40 |
|
|
$ |
0.37 |
|
|
$ |
0.86 |
|
| |
Cumulative effect of change in accounting principle, net of taxes
|
|
|
— |
|
|
|
0.07 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net income per share — basic
|
|
$ |
1.40 |
|
|
$ |
0.44 |
|
|
$ |
0.86 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Shares used in per share calculation — basic
|
|
|
160,714 |
|
|
|
160,338 |
|
|
|
149,441 |
|
| |
|
|
|
|
|
|
|
|
|
|
Diluted net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income before cumulative effect of change in accounting principle
|
|
$ |
1.31 |
|
|
$ |
0.36 |
|
|
$ |
0.80 |
|
| |
Cumulative effect of change in accounting principle, net of taxes
|
|
|
— |
|
|
|
0.07 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net income per share — diluted
|
|
$ |
1.31 |
|
|
$ |
0.43 |
|
|
$ |
0.80 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Shares used in per share calculation — diluted
|
|
|
177,099 |
|
|
|
164,489 |
|
|
|
176,249 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
| (1) |
Includes stock-based compensation charge of $6,518, $5,157 and
$3,963 in 2004, 2003 and 2002, respectively. |
| |
| (2) |
Includes stock-based compensation charge of $2,642, $5,065 and
$1,980 in 2004, 2003 and 2002, respectively. |
| |
| (3) |
Includes stock-based compensation charge of $4,085, $2,285 and
$16,461 in 2004, 2003 and 2002, respectively. |
| |
| (4) |
Net of stock-based compensation charge of $84 in 2004. |
| |
| (5) |
Includes stock-based compensation charge of $991 in 2004. |
| |
|
|
|
|
|
| |
|
Year Ended | |
| |
|
December 31, 2002 | |
| |
|
| |
|
Pro forma amounts assuming the change in accounting principle is
applied retroactively:
|
|
|
|
|
| |
Net income
|
|
$ |
121,513 |
|
| |
Basic income per share
|
|
$ |
0.81 |
|
| |
Diluted income per share
|
|
$ |
0.76 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
70
MCAFEE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Accumulated | |
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Other | |
|
|
|
|
| |
|
Common Stock | |
|
|
|
Additional | |
|
Deferred | |
|
Comprehensive | |
|
|
|
Total | |
| |
|
| |
|
Treasury | |
|
Paid-In | |
|
Stock-Based | |
|
Income | |
|
Accumulated | |
|
Stockholders’ | |
| |
|
Shares | |
|
Amount | |
|
Stock | |
|
Capital | |
|
Compensation | |
|
(Loss) | |
|
Deficit | |
|
Equity | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Balances, December 31, 2001
|
|
|
140,681 |
|
|
$ |
1,406 |
|
|
$ |
— |
|
|
$ |
752,439 |
|
|
$ |
— |
|
|
$ |
16,081 |
|
|
$ |
(428,433 |
) |
|
$ |
341,493 |
|
| |
Issuance of common stock upon exercise of stock options
|
|
|
8,197 |
|
|
|
82 |
|
|
|
— |
|
|
|
99,664 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
99,746 |
|
| |
Issuance of common stock upon exercise of stock options by
McAfee.com
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3,633 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3,633 |
|
| |
Issuance of common stock from Employee Stock Purchase Plans
|
|
|
743 |
|
|
|
8 |
|
|
|
— |
|
|
|
6,524 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,532 |
|
| |
Issuance of common stock for acquisition of minority interest in
McAfee.com, net of cost of $1,956
|
|
|
8,307 |
|
|
|
83 |
|
|
|
— |
|
|
|
119,397 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
119,480 |
|
| |
Deferred stock-based compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
31,955 |
|
|
|
(31,955 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Amortization of deferred stock-based compensation and other
compensation charge
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(3,815 |
) |
|
|
26,219 |
|
|
|
— |
|
|
|
— |
|
|
|
22,404 |
|
| |
Reclassification of cash payable in excess of exercise price
related to exchange of McAfee.com options
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,190 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,190 |
) |
| |
Tax benefits from exercise of non-qualified stock options
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
45,962 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
45,962 |
|
| |
Stock options issued in connection with acquisition
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
357 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
357 |
|
| |
Minority interest attributed to McAfee.com
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(1,638 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(1,638 |
) |
| |
Foreign currency translation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
10,744 |
|
|
|
— |
|
|
|
10,744 |
|
| |
Net decrease in unrealized gains on investments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(2,667 |
) |
|
|
— |
|
|
|
(2,667 |
) |
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
128,312 |
|
|
|
128,312 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2002
|
|
|
157,928 |
|
|
|
1,579 |
|
|
|
— |
|
|
|
1,050,288 |
|
|
|
(5,736 |
) |
|
|
24,158 |
|
|
|
(300,121 |
) |
|
|
770,168 |
|
| |
Issuance of common stock upon exercise of stock options
|
|
|
2,548 |
|
|
|
26 |
|
|
|
— |
|
|
|
19,610 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
19,636 |
|
| |
Issuance of common stock from Employee Stock Purchase Plans
|
|
|
1,596 |
|
|
|
16 |
|
|
|
— |
|
|
|
15,765 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
15,781 |
|
| |
Repurchase of common stock
|
|
|
(350 |
) |
|
|
— |
|
|
|
(4,707 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,707 |
) |
| |
Deferred stock-based compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(643 |
) |
|
|
643 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Amortization of deferred stock-based compensation and other
stock-based compensation charge
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
8,012 |
|
|
|
4,495 |
|
|
|
— |
|
|
|
— |
|
|
|
12,507 |
|
| |
Reclassification of cash payable in excess of exercise price
related to exchange of McAfee.com options
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(5,407 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(5,407 |
) |
| |
Foreign currency translation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
10,578 |
|
|
|
— |
|
|
|
10,578 |
|
| |
Net decrease in unrealized gains on investments
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(709 |
) |
|
|
— |
|
|
|
(709 |
) |
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
70,242 |
|
|
|
70,242 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2003
|
|
|
161,722 |
|
|
|
1,621 |
|
|
|
(4,707 |
) |
|
|
1,087,625 |
|
|
|
(598 |
) |
|
|
34,027 |
|
|
|
(229,879 |
) |
|
|
888,089 |
|
| |
Issuance of common stock upon exercise of stock options
|
|
|
9,152 |
|
|
|
92 |
|
|
|
— |
|
|
|
105,638 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
105,730 |
|
| |
Issuance of common stock from Employee Stock Purchase Plans
|
|
|
775 |
|
|
|
8 |
|
|
|
— |
|
|
|
8,055 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
8,063 |
|
| |
Issuance of common stock upon exercise of warrants
|
|
|
184 |
|
|
|
2 |
|
|
|
— |
|
|
|
(2 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Issuance of common stock upon conversion of debt
|
|
|
4,616 |
|
|
|
46 |
|
|
|
— |
|
|
|
83,364 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
83,410 |
|
| |
Repurchase of common stock
|
|
|
(12,623 |
) |
|
|
— |
|
|
|
(221,816 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(221,816 |
) |
| |
Retirement of treasury stock
|
|
|
— |
|
|
|
(130 |
) |
|
|
226,523 |
|
|
|
(226,393 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Deferred stock-based compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,443 |
|
|
|
(6,443 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Shares returned from trust
|
|
|
(1,560 |
) |
|
|
(16 |
) |
|
|
— |
|
|
|
16 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Amortization of deferred stock-based compensation and other
stock-based compensation charge
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,804 |
|
|
|
7,516 |
|
|
|
— |
|
|
|
— |
|
|
|
14,320 |
|
| |
Reclassification of cash payable in excess of exercise price
related to exchange of McAfee.com options
|
|
|
— |
|
|
|
|
|
|
|
— |
|
|
|
(3,154 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(3,154 |
) |
| |
Contribution of proceeds from sale of common stock held in trust
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3,779 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3,779 |
|
| |
Tax benefits from exercise of non-qualified stock options
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
72,622 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
72,622 |
|
| |
Stock options issued in connection with acquisition
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
7,039 |
|
|
|
(2,252 |
) |
|
|
— |
|
|
|
— |
|
|
|
4,787 |
|
| |
Release of deferred tax valuation allowance related to
acquisition accounted for as a pooling of interests
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
27,019 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
27,019 |
|
| |
Foreign currency translation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,537 |
) |
|
|
— |
|
|
|
(4,537 |
) |
| |
Net decrease in unrealized gains on investment
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(2,129 |
) |
|
|
— |
|
|
|
(2,129 |
) |
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
225,065 |
|
|
|
225,065 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2004
|
|
|
162,266 |
|
|
$ |
1,623 |
|
|
$ |
— |
|
|
$ |
1,178,855 |
|
|
$ |
(1,777 |
) |
|
$ |
27,361 |
|
|
$ |
(4,814 |
) |
|
$ |
1,201,248 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
71
MCAFEE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income
|
|
$ |
225,065 |
|
|
$ |
70,242 |
|
|
$ |
128,312 |
|
| |
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Cumulative effect of change in accounting principle, net
|
|
|
— |
|
|
|
(10,337 |
) |
|
|
— |
|
| |
|
Depreciation and amortization
|
|
|
66,699 |
|
|
|
62,830 |
|
|
|
53,684 |
|
| |
|
Non-cash restructuring charge
|
|
|
9,624 |
|
|
|
14,534 |
|
|
|
— |
|
| |
|
Acquired in-process research and development
|
|
|
— |
|
|
|
6,600 |
|
|
|
— |
|
| |
|
Premium amortization of marketable securities
|
|
|
4,614 |
|
|
|
7,114 |
|
|
|
— |
|
| |
|
Provision for (recovery of) doubtful accounts
|
|
|
1,716 |
|
|
|
(1,216 |
) |
|
|
(219 |
) |
| |
|
Non-cash interest and other expense on convertible debt
|
|
|
1,224 |
|
|
|
3,162 |
|
|
|
12,025 |
|
| |
|
Stock-based compensation charges
|
|
|
14,320 |
|
|
|
12,507 |
|
|
|
22,404 |
|
| |
|
Deferred income taxes
|
|
|
(21,503 |
) |
|
|
(25,368 |
) |
|
|
(65,208 |
) |
| |
|
Loss (gain) on sale of investments
|
|
|
1,704 |
|
|
|
(3,076 |
) |
|
|
(3,838 |
) |
| |
|
Impairment of strategic and other investments
|
|
|
— |
|
|
|
— |
|
|
|
198 |
|
| |
|
Minority interest
|
|
|
— |
|
|
|
— |
|
|
|
1,895 |
|
| |
|
Loss (gain) on repurchase of zero coupon convertible debenture
|
|
|
15,070 |
|
|
|
2,727 |
|
|
|
(26 |
) |
| |
|
(Gain) loss on sale of assets and technology
|
|
|
(238,923 |
) |
|
|
788 |
|
|
|
(9,301 |
) |
| |
|
Tax benefit from exercise of nonqualified stock options
|
|
|
72,622 |
|
|
|
— |
|
|
|
45,962 |
|
| |
|
Change in fair value of interest rate swap, net of change in the
fair value of the debt
|
|
|
382 |
|
|
|
(5,646 |
) |
|
|
(1,402 |
) |
| |
|
Changes in assets and liabilities, net of acquisitions:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
Accounts receivable
|
|
|
44,524 |
|
|
|
(6,676 |
) |
|
|
(15,805 |
) |
| |
|
|
Prepaid expenses, income taxes and other assets
|
|
|
(6,267 |
) |
|
|
(17,624 |
) |
|
|
9,699 |
|
| |
|
|
Accounts payable, accrued taxes and other liabilities
|
|
|
6,109 |
|
|
|
(78,452 |
) |
|
|
77,993 |
|
| |
|
|
Deferred revenue
|
|
|
161,933 |
|
|
|
124,195 |
|
|
|
(61,280 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Net cash provided by operating activities
|
|
|
358,913 |
|
|
|
156,304 |
|
|
|
195,093 |
|
| |
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Purchase of marketable securities
|
|
|
(1,243,990 |
) |
|
|
(1,120,561 |
) |
|
|
(773,093 |
) |
| |
Proceeds from sale and maturity of marketable securities
|
|
|
1,033,402 |
|
|
|
1,022,700 |
|
|
|
781,761 |
|
| |
Decrease (increase) in restricted cash
|
|
|
19,930 |
|
|
|
664 |
|
|
|
(21,734 |
) |
| |
Purchase of minority interest in McAfee.com
|
|
|
— |
|
|
|
— |
|
|
|
(98,447 |
) |
| |
Purchases of acquired technology
|
|
|
— |
|
|
|
(178 |
) |
|
|
(807 |
) |
| |
Acquisitions, net of cash acquired
|
|
|
(84,650 |
) |
|
|
(217,078 |
) |
|
|
(19,054 |
) |
| |
Purchase of property and equipment and leasehold improvements,
net
|
|
|
(25,374 |
) |
|
|
(60,027 |
) |
|
|
(59,427 |
) |
| |
Sale of Secure Computing shares and collar
|
|
|
— |
|
|
|
— |
|
|
|
5,105 |
|
| |
Proceeds from sale of assets and technology
|
|
|
261,309 |
|
|
|
— |
|
|
|
2,050 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Net cash used in investing activities
|
|
|
(39,373 |
) |
|
|
(374,480 |
) |
|
|
(183,646 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Proceeds from issuance of common stock under stock option plan
and stock purchase plans
|
|
|
113,793 |
|
|
|
35,417 |
|
|
|
109,911 |
|
| |
Contribution of proceeds from sale of common stock held in trust
|
|
|
3,779 |
|
|
|
— |
|
|
|
— |
|
| |
Repurchase of common stock
|
|
|
(221,816 |
) |
|
|
(4,707 |
) |
|
|
— |
|
| |
Repurchase of convertible debt
|
|
|
(265,623 |
) |
|
|
(177,289 |
) |
|
|
(66,175 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Net cash (used in) provided by financing activities
|
|
|
(369,867 |
) |
|
|
(146,579 |
) |
|
|
43,736 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Effect of exchange rate fluctuations
|
|
|
7,831 |
|
|
|
24,180 |
|
|
|
6,211 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net (decrease) increase in cash and cash equivalents
|
|
|
(42,496 |
) |
|
|
(340,575 |
) |
|
|
61,394 |
|
| |
Cash and cash equivalents at beginning of period
|
|
|
333,651 |
|
|
|
674,226 |
|
|
|
612,832 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Cash and cash equivalents at end of period
|
|
$ |
291,155 |
|
|
$ |
333,651 |
|
|
$ |
674,226 |
|
| |
|
|
|
|
|
|
|
|
|
|
Non cash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Unrealized losses on marketable investments, net
|
|
$ |
(2,129 |
) |
|
$ |
(709 |
) |
|
$ |
(2,667 |
) |
| |
Issuance of common stock for acquisition of minority interest in
McAfee.com, net of costs of $1,956
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
119,480 |
|
| |
Fair value of assets acquired in business combinations
|
|
$ |
110,394 |
|
|
$ |
247,958 |
|
|
$ |
— |
|
| |
Liabilities assumed in business combinations
|
|
$ |
20,037 |
|
|
$ |
25,465 |
|
|
$ |
— |
|
| |
Realization of deferred tax assets of acquired company
|
|
$ |
27,019 |
|
|
$ |
— |
|
|
$ |
— |
|
| |
Issuance of common stock upon conversion of debt
|
|
$ |
83,410 |
|
|
$ |
— |
|
|
$ |
— |
|
| |
Stock options issued in connection with acquisition
|
|
$ |
7,039 |
|
|
$ |
— |
|
|
$ |
357 |
|
| |
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Cash paid during the year for interest
|
|
$ |
6,349 |
|
|
$ |
10,434 |
|
|
$ |
20,666 |
|
| |
Cash paid during the year for income taxes
|
|
$ |
31,393 |
|
|
$ |
20,864 |
|
|
$ |
18,547 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
72
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
| 1. |
Organization and Business |
McAfee, Inc. (formerly Network Associates, Inc.) and its wholly
owned subsidiaries (the “Company”) are a leading
supplier of computer security solutions designed to prevent
intrusions on networks and protect computer systems from the
next generation of blended attacks and threats. The Company
offers two families of products, McAfee System Protection
Solutions and McAfee Network Protection Solutions. The
Company’s computer security solutions are offered primarily
to large enterprises, governments, small and medium sized
businesses and consumers. The Company operates its business in
five geographic regions: North America; Europe, Middle East and
Africa (“EMEA”); Japan; Asia-Pacific (excluding Japan)
and Latin America.
In January 2004, the Company sold its Magic Solutions product
line (“Magic”), and in July 2004, the Company sold its
Sniffer product line (“Sniffer”).
In October 2004, the Company purchased Foundstone, Inc.
(“Foundstone”), a provider of risk assessment and
vulnerability services and products.
In December 2004, the Company entered into an agreement to sell
its McAfee Labs assets. The sale is expected to close in the
first half of 2005.
|
|
| 2. |
Summary of Significant Accounting Policies |
The accompanying consolidated financial statements include the
accounts of McAfee, Inc. and its wholly owned subsidiaries. On
September 13, 2002, the Company repurchased the 25%
minority interest in its McAfee.com subsidiary. Therefore, since
the date of acquisition, no minority interest exists in
McAfee.com and accordingly the Company’s consolidated net
income beginning in 2002 includes the full amount of McAfee.com
results from this date. All significant intercompany accounts
and transactions have been eliminated.
Certain reclassifications have been made to the prior
year’s consolidated financial statements to conform to the
current year’s presentation. These reclassifications had no
effect on the prior year’s stockholders’ equity or
results of operations.
Minority interest in income of consolidated subsidiaries in the
consolidated statement of income for 2002 represents the
minority stockholders’ share of the income of McAfee.com.
As of December 31, 2002 and for all subsequent periods, the
Company’s consolidated subsidiaries were all wholly owned
and there were no minority interests.
The preparation of consolidated financial statements in
conformity with accounting principals generally accepted in the
United States of America requires management to make estimates
and assumptions that affect the reported amount of assets and
disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts
of revenues and expenses during the reported period. Significant
estimates include those required in the valuation of intangible
assets acquired in purchase combinations, impairment analysis of
goodwill and intangibles, property and equipment, allowances for
doubtful accounts, sales returns and allowances, vendor specific
objective evidence of the fair value of the various elements of
the Company’s multiple element software transactions,
valuation allowances for deferred tax assets, tax accruals, and
warranty obligation accrual. Although the Company believes that
adequate accruals have been made for unsettled issues,
additional gains or losses could occur in future years from
resolutions of outstanding matters. Actual results could differ
materially from original estimates.
73
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
|
|
|
Certain Risks and Concentrations |
The Company has historically derived a majority of its net
revenue from its McAfee anti-virus software products and its
Sniffer network fault identification and application performance
management products. The Company sold its Sniffer business in
July 2004, which accounted for $90.9 million and
$210.2 million of revenues in 2004 and 2003, respectively,
which represented 10% and 22% of total revenue for those
periods, respectively. McAfee anti-virus software products and
support renewals are expected to continue to account for an even
more significant portion of the Company’s net revenues
after the sale of Sniffer. The markets in which the Company
operates are highly competitive and rapidly changing.
Significant technological changes, changes in customer
requirements, or the emergence of competitive products with new
capabilities or technologies could adversely affect operating
results. As a result of this revenue concentration, the
Company’s business could be harmed by a decline in demand
for, or in the prices of, these products as a result of, among
other factors, any change in pricing model, a maturation in the
markets for these products, increased price competition or a
failure by the Company to keep up with technological change.
The Company sells a significant amount of its products through
intermediaries such as distributors, resellers and others. The
Company’s top ten distributors represented 49% to 63% of
net sales per quarter during 2004, 2003 and 2002. During 2004,
2003 and 2002, one customer accounted for 22%, 24% and 25%,
respectively, of the total net revenue for each year. During
2004 and 2002, another customer accounted for 11% and 10%,
respectively, of the net revenue. At December 31, 2004 and
2003, one distributor had an accounts receivable balance which
comprised 23% and 22%, respectively, of the Company’s total
accounts receivable balance. The Company’s distributor
agreements may be terminated by either party without cause. If
one of the Company’s significant distributors terminates
its distribution agreement, the Company could experience a
significant interruption in the sale and distribution of its
products. The distributors may sell other vendor’s products
that are complementary to, or compete with, its products. While
the Company encourages its distributors to focus on the
Company’s products through market and support programs,
these distributors may give greater priority to products of
other suppliers, including competitors.
Some of the Company’s distributors may experience financial
difficulties, which could adversely impact collection of
accounts receivable. The Company regularly reviews the
collectibility and credit-worthiness of its distributors to
determine an appropriate allowance for doubtful accounts. The
Company’s bad debt allowance was $2.5 million at
December 31, 2004 and $2.9 million at
December 31, 2003. The Company’s uncollectible
accounts could exceed its current or future allowances. The
Company determines its allowance for doubtful accounts by
assessing the collectibility of individual accounts receivable
over a specified aging and amount and provides an amount equal
to the historical percentage of write-off experience of the
remaining accounts receivable. Accounts receivable are written
off on a case by case basis, considering the probability that
any amounts can be collected.
Some of the Company’s products incorporate licensed
software and the Company must be able to obtain reasonably
priced licenses and successfully integrate this software with
its hardware. In addition, some of the Company’s products
may include “open source” software. The Company’s
ability to commercialize products or technologies incorporating
open source software may be restricted because, among other
reasons, open source license terms may be ambiguous and may
result in unanticipated obligations regarding its products.
The Company maintains the majority of cash balances and all of
its short-term investments with seven financial institutions.
The Company invests with financial institutions with high
quality credit and, by policy, limits the amount of deposit
exposure to any one financial institution.
The Company receives certain of its critical components from
sole suppliers. Additionally, the Company relies on a limited
number of contract manufacturers and suppliers to provide
manufacturing services for its products. The inability of any
contract manufacturer or supplier to fulfill supply requirements
of the Company could materially impact future operating results.
74
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
|
|
|
Foreign Currency Translation |
The Company considers the local currency to be the functional
currency for its international subsidiaries. Assets and
liabilities denominated in foreign currencies are translated
using the exchange rate on the consolidated balance sheet date.
Revenues and expenses are translated at average exchange rates
prevailing during the year. Translation adjustments resulting
from this process are charged or credited to accumulated other
comprehensive income. Where the United States Dollar is the
functional currency of the subsidiary, all remeasurement
adjustments are recorded in the consolidated statement of income.
Foreign currency transaction gains and losses, which to date
have not been material, are included in the consolidated
statements of income.
The Company follows the guidance in Statement of Financial
Accounting Standard (“SFAS”) No. 133,
“Accounting for Derivative Instruments and Hedging
Activities,” as amended, in accounting for derivatives.
The standard requires the Company to recognize all derivatives
on the consolidated balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through the
consolidated statement of income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value
of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities or firm commitments
through earnings, or recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective
portion of a derivative’s change in fair value is
immediately recognized in earnings. The Company’s use of
derivative financial instruments is discussed in Note 7.
|
|
|
Cash and Cash Equivalents |
Cash equivalents are comprised of highly liquid debt instruments
with original maturities or remaining maturities at date of
purchase of 90 days or less.
Restricted cash balances were $0.6 million and
$20.5 million at December 31, 2004 and 2003,
respectively. The restricted cash balance at December 31,
2004 consists of deposits restricted related to the
Company’s workers’ compensation insurance coverage.
The restricted cash balance at December 31, 2003 consists
primarily of collateral for an interest rate swap arrangement
that terminated in 2004.
All marketable securities are classified as available-for-sale
securities. Available-for-sale securities are carried at fair
value with resulting unrealized gains and losses, net of related
taxes, reported as a component of accumulated other
comprehensive income. Premium and discount on debt securities
recorded at the date of purchase are amortized and accreted,
respectively, to interest income using the effective interest
method. Short-term marketable securities are those with
remaining maturities at the consolidated balance sheet date of
one year or less. Long-term marketable securities have remaining
maturities at the consolidated balance sheet date of greater
than one year. Realized gains and losses on sales of all such
investments are reported in earnings and computed using the
specific identification cost method.
The Company assesses the value of its available-for-sale
marketable securities on a regular basis to assess whether an
other-than-temporary decline in the fair value has occurred.
Factors which the Company uses to assess whether an other than
temporary decline has occurred include, but are not limited to,
the period of time which the fair value is below original cost,
significant changes in the operating performance, financial
condition or business model, and changes in market conditions.
Any “other than temporary decline” in value is
75
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
reported in earnings and a new cost basis for the marketable
security established. The Company did not record any “other
than temporary declines” in marketable securities for 2004,
2003 or 2002.
Inventory, which consists primarily of finished goods, is stated
at lower of cost or market and is included in other current
assets. Cost is computed using standard cost, which approximates
cost on a first in, first out basis. Inventory of
$5.1 million at December 31, 2004 and
$15.9 million at December 31, 2003 is included in
other current assets.
Property and equipment are presented at cost less accumulated
depreciation and amortization (see Note 8). Depreciation
and amortization of property and equipment are computed using
the straight-line method over the estimated useful lives as
follows:
|
|
|
| |
• |
building — interior — seven years;
exterior — twenty years; |
| |
| |
• |
office furniture and equipment — three to seven
years; and |
| |
| |
• |
computer hardware and software — three to five years; |
| |
| |
• |
leasehold improvements — the shorter of the lease
term, including assumed lease renewal periods that are
reasonably assured or the estimated useful life of the asset. |
The costs associated with projects eligible for capitalization
are accumulated on the consolidated balance sheet until the
project is substantially complete and is placed into service.
Capitalized interest is calculated on all eligible projects in
progress. Interest capitalization begins when three conditions
have been met (1) expenditures have occurred,
(2) activities necessary to prepare the asset have begun,
and (3) interest cost has been incurred. For 2004 and 2003,
the Company recorded $0.1 million and $0.3 million of
capitalized interest, respectively.
When assets are disposed, the Company removes the asset and
accumulated depreciation from its records and recognizes the
related gain or loss in results of operations.
Repairs and maintenance expenditures, which are not considered
improvements and do not extend the useful life of property and
equipment, are expensed as incurred.
The Company follows the guidance in Statement of Position 98-1,
“Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use.” Software development
costs, including costs incurred to purchase third party
software, are capitalized beginning when the Company has
determined factors are present, including among others, that
technology exists to achieve the performance requirements, buy
versus internal development decisions have been made and the
Company’s management has authorized the funding for the
project. Capitalization of software costs ceases when the
software is substantially complete and is ready for its intended
use and is amortized over its estimated useful life of three
years using the straight-line method.
When events or circumstances indicate the carrying value of
internal use software might not be recoverable, the Company
assesses the recoverability of these assets by determining
whether the amortization of the asset balance over its remaining
life can be recovered through undiscounted future operating cash
flows. The amount of impairment, if any, is recognized to the
extent that the carrying value exceeds the projected discounted
future operating cash flows and is recognized as a write down of
the asset. In addition, when it is no longer probable that
computer software being developed will be placed in service, the
asset will be recorded at the lower of its carrying value or
fair value, if any, less direct selling costs.
76
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Company follows the guidance of SFAS No. 142,
“Goodwill and Other Intangible Assets”
(“SFAS 142”) in accounting for its goodwill
and intangible assets. The Company adopted SFAS 142 as of
January 1, 2002, and as required, ceased amortizing
goodwill. In lieu of amortization, an impairment review of
goodwill is performed on at least an annual basis and on an
interim basis if an event occurs or circumstances change that
would more likely than not reduce the fair value of the
Company’s reporting units below their carrying value. The
Company’s reporting units are consistent with the operating
geographies discussed in Note 19.
|
|
|
Finite-Lived Intangibles, Long-Lived Assets and Assets
Held for Sale |
Purchased technology and other identifiable intangible assets
are carried at cost less accumulated amortization. The Company
amortizes other identifiable intangibles on a straight-line
basis over their estimated useful lives. The range of estimated
useful lives of the Company’s identifiable intangibles is
one to seven years (see Note 10).
The Company accounts for finite-lived intangibles and long-lived
assets in accordance with SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived
Assets.” Under this standard, the Company reviews
finite-lived intangibles or long-lived assets to be held and
used for impairment whenever events or changes in circumstances
indicate that the carrying value such assets may not be
recoverable.
Based upon the existence of one or more potential indicators of
impairment, recoverability is assessed based upon an estimate of
undiscounted cash flows resulting from the use of the assets and
its eventual disposition. Measurement of an impairment loss is
based on a projected discounted cash flow method using a
discount rate determined by management to be commensurate with
the risk inherent in the Company’s current business model.
Finite-lived intangibles and long-lived assets to be disposed of
are reported at the lower of carrying amount of fair value less
the costs to sell.
The Company announced plans to sell its McAfee Labs assets
(“McAfee Labs”) in December 2004. The assets and
liabilities related to this disposal group are not significant
as of December 31, 2004. The Company sold its Magic assets
in January 2004. This disposal group met the criteria stated in
SFAS 144 to be held for sale in December 2003, and
consequently, depreciation on the equipment related to Magic
ceased, and all assets and liabilities related to Magic were
presented as held for sale in the consolidated balance sheet at
December 31, 2003.
|
|
|
Fair Value of Financial Instruments |
Carrying amounts of the Company’s financial instruments
including accounts receivable, accounts payable and accrued
liabilities approximate fair value due to their short
maturities. The fair values of the Company’s investments in
marketable securities are disclosed in Note 6. The fair
value of the Company’s derivative instruments is disclosed
in Note 7. The fair value of the Company’s convertible
debt instruments is disclosed in Note 13.
The Company’s revenue is derived from primarily two sources
(i) product revenue, which includes software license,
hardware, retail and royalty revenue and (ii) services and
support revenue which includes software license maintenance and
support, training, consulting, and on-line subscription revenue.
The Company licenses its software products under one and
two-year term or perpetual licenses. The two-year licenses
include the first year of maintenance and support. The Company
sells its products and services via its direct sales force,
through domestic and foreign distributors and via the Internet.
Under the Company’s
77
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
on-line subscription arrangements, which do not include any
upfront setup fees, customers pay a fixed fee and receive
service over a period of time, generally one year.
The Company applies the provisions of Statement of Position
97-2, “Software Revenue Recognition,”
(“SOP 97-2”) as amended by Statement of Position
98-9 “Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions” to
all transactions involving the sale of software products and
hardware transactions where the software is not incidental. For
hardware transactions where software is not incidental, the
Company does not bifurcate the fee and apply separate accounting
guidance to the hardware and software elements. For hardware
transactions where no software is involved, the Company applies
the provisions of Staff Accounting Bulletin 104
“Revenue Recognition.” In addition, the Company
applies the provisions of Emerging Issues Task Force Issue
No. 00-03 “Application of AICPA Statement of
Position 97-2 to Arrangements that Include the Right to Use
Software Stored on Another Entity’s Hardware” to
its on-line subscription software transactions.
Product revenue from the license of the Company’s software
products and sale of hardware products where the software is and
is not incidental is recognized when persuasive evidence of an
arrangement exists, the product has been delivered, the fee is
fixed or determinable, and collection of the resulting
receivable is reasonably assured, and, if applicable, upon
acceptance when acceptance criteria are specified or upon
expiration of the acceptance period. Maintenance and support
revenue for providing product updates and customer support is
deferred and recognized ratably over the service period. On-line
subscription revenue is recognized ratably over the service
period, which is generally one year. Training and consulting
revenue is recognized as services are performed and billable
according to the terms of the service arrangement. Revenue on
one-year time-based subscription licenses is recognized ratably
over the contract term. Royalty revenue is generally recognized
upon receipt of periodic royalty reports received from
customers, which generally coincides with receipt of cash.
For all sales except those completed via the Internet, the
Company uses either a binding purchase order or signed license
agreement as evidence of an arrangement. For sales over the
Internet, the Company uses a credit card authorization as
evidence of an arrangement. Sales through distributors are
evidenced by a master agreement governing the relationship
together with binding purchase orders on a transaction by
transaction basis.
Fees due under an arrangement are generally deemed not to be
fixed or determinable if a significant portion of the fee is due
beyond the Company’s normal payment terms that are 30 to
90 days from the date of invoice. Fees due under an
arrangement with distributors and resellers are generally deemed
not to be fixed or determinable if a significant portion of the
fee is due beyond the date when the products have been sold by
the distributor or reseller to the customers. In these cases,
revenue is not recognized until the fees become due. The Company
assesses collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness
of the customer. The Company does not request collateral from
its customers. If the Company determines that collection of a
fee is not reasonably assured, the fee is deferred and revenue
recognized at the time collection becomes reasonably assured,
which is generally upon receipt of cash.
The Company’s distributors are permitted to purchase
software licenses at the same time they fill customer orders and
to pay for hardware and retail products only when these products
are resold to the distributors’ customers. In addition, the
distributors have an unlimited right of return up until the
point of sale. After sale, the Company must approve any returns
from end-users. As a result, the Company recognizes revenue from
sales to distributors and resellers when products have been sold
by the distributors or resellers to their customers
(sell-through or sell-out method). In addition, the Company
makes an estimate of returns from end users and amounts for
promotional and rebate programs based on its historical
experience. The provisions are recorded as a reduction of
revenue.
78
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
For arrangements with multiple obligations (e.g. undelivered
maintenance and support bundled with term and perpetual
licenses), the Company allocates revenue to each component of
the arrangement using the residual value method based on
evidence of the fair value of the undelivered elements, which is
specific to the Company. The vendor specific objective evidence
of fair values for the ongoing maintenance and support
obligations for both term and perpetual licenses are based upon
the prices paid for the separate renewal of these services by
the customer or upon substantive renewal rates stated in the
contractual arrangements. Vendor specific objective evidence of
the fair value of other services, primarily consulting and
training services, is based upon separate sales of these
services.
McAfee Labs performs a significant portion of the Company’s
research and development activities with government agencies.
The Company enters into research and development contracts with
government agencies under various pricing arrangements.
Government contracting revenue is classified as services and
support revenue in the accompanying consolidated statements of
income and comprehensive income. Under government contracts, the
Company is subject to audit by the Defense Contract Audit Agency
(“DCAA”) which could result in the renegotiation of
amounts previously billed.
Revenue from “cost-plus-fixed-fee” contracts is
recognized on the basis of reimbursable contract costs incurred
during the period, plus a percentage of the fixed fee. Revenue
from “time and material” contracts is recognized on
the basis of hours utilized, plus other reimbursable contract
costs incurred during the period. Revenue from
“firm-fixed-price” contracts is recognized on the
percentage of completion method. Under this method, individual
contract revenues are recorded based on the percentage
relationship that contract costs incurred bear to costs incurred
plus management’s estimate of costs to complete. Losses, if
any, are accrued when their occurrence becomes known and the
amount of the loss is reasonably determinable. During 2004,
2003, and 2002, the Company recognized revenue of approximately
$6.4 million, $11.0 million, and $17.3 million,
respectively, associated with government contracts. The Company
entered into an agreement for the sale of its McAfee Labs assets
in December 2004.
Costs incurred in the research and development of new software
products are expensed as incurred until technological
feasibility is established. Research and development costs
include salaries and benefits of researchers, supplies, and
other expenses incurred with research and development efforts.
Development costs are capitalized beginning when a
product’s technological feasibility has been established
and ending when the product is available for general release to
customers. Technological feasibility is reached when the product
reaches the working model stage. To date, products and
enhancements have generally reached technological feasibility
and have been released for sale at substantially the same time
and all research and development costs have been expensed.
Advertising production costs are expensed as incurred. Media
(television and print) placement costs are expensed in the
period the advertising appears. Total advertising and
promotional expenses were $9.0 million, $7.9 million,
and $13.6 million for 2004, 2003 and 2002, respectively.
As permitted by SFAS No. 123, “Accounting for
Stock-Based Compensation” (“SFAS 123”),
the Company accounts for employee stock-based compensation in
accordance with Accounting Principles Board Opinion No. 25
(“APB 25”), “Accounting for Stock Issued
to Employees,” and Financial Accounting Standards Board
(“FASB”) Interpretation No. 44
(“FIN 44”), “Accounting for Certain
Transactions
79
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Involving Stock-Based Compensation, an interpretation of APB
Opinion No. 25” and related interpretations in
accounting for its stock-based compensation plans. Accordingly,
with respect to fixed-plan awards, the Company measures the
excess, if any, of the market value of its common stock on the
date of the award over the exercise price of options granted as
deferred compensation expense (intrinsic method) and recognizes
any such excess over the vesting period using the straight-line
method. With respect to variable-plan awards resulting from
award modifications or award terms where the amount of shares
and the exercise price are not fixed at the date of grant, the
Company records stock-based deferred compensation for the
excess, if any, of the market value of its common stock at the
end of each reporting period (or date of exercise, forfeiture or
cancellation without replacement, if earlier) over the fair
value of its common stock on the date of the award or
modification. The resulting deferred compensation charge to
earnings will be recorded over the remaining vesting term using
the accelerated method of amortization. When variable plan
options become fully vested, any remaining deferred compensation
is recognized.
The Company accounts for options awarded to non-employees
(consultants) at fair value using the Black-Scholes option
pricing model. The resulting fair value is recognized in expense
upon performance.
The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee
compensation. The Company recognizes pro forma expense for
FAS 123 purposes under the accelerated method of
amortization.
For pro forma purposes, the compensation costs for the 1997
Plan, the Stock Option Plan for Outside Directors, the 2000
Nonstatutory Stock Option Plan and the 2002 and 1994
“Employee Stock Purchase Plans” (“ESPPs”)
has been determined based on fair value at the grant date for
awards from 1998 through 2004 consistent with the provisions of
SFAS 123 using assumptions defined in Note 15, the
Company’s net income and net income per share would have
been as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Net income, as reported
|
|
$ |
225,065 |
|
|
$ |
70,242 |
|
|
$ |
128,312 |
|
| |
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of
tax
|
|
|
(25,632 |
) |
|
|
(55,848 |
) |
|
|
(76,721 |
) |
| |
Add back: stock-based compensation expense, net of tax, included
in reported net income
|
|
|
9,182 |
|
|
|
7,504 |
|
|
|
13,442 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Pro forma net income
|
|
$ |
208,615 |
|
|
$ |
21,898 |
|
|
$ |
65,033 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic — as reported
|
|
$ |
1.40 |
|
|
$ |
0.44 |
|
|
$ |
0.86 |
|
| |
Basic — pro forma
|
|
$ |
1.30 |
|
|
$ |
0.14 |
|
|
$ |
0.44 |
|
| |
Diluted — as reported
|
|
$ |
1.31 |
|
|
$ |
0.43 |
|
|
$ |
0.80 |
|
| |
Diluted — pro forma
|
|
$ |
1.25 |
|
|
$ |
0.13 |
|
|
$ |
0.41 |
|
The impact on pro forma income per share and net income in the
table above may not be indicative of the effect in future years
as options vest over several years and the Company continues to
grant stock options to new employees.
The Company accounts for income taxes in accordance with the
liability method of accounting for income taxes. Under the
liability method, deferred assets and liabilities are recognized
based upon anticipated future tax consequences attributable to
differences between financial statement carrying amounts of
assets and liabilities and their respective tax bases. The
provision for income taxes is comprised of the current tax
liability
80
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
and the change in deferred tax assets and liabilities. The
Company establishes a valuation allowance to the extent that it
is more likely than not that deferred tax assets will not be
recoverable against future taxable income.
Basic net income per share is computed using the
weighted-average common shares outstanding during the period.
Diluted net income per share is computed using the weighted
average common shares and potentially dilutive shares
outstanding during the period. Potentially dilutive common
shares include incremental common shares issuable upon exercise
of stock options, stock purchase warrants, restricted stock, and
potential dilution upon conversion of the convertible debt.
Diluted loss per share is computed using the weighted average
number of common shares and excludes potentially dilutive shares
outstanding, as their effect is anti-dilutive.
The Company offers a warranty on its software and hardware
products and records a liability for the estimated future costs
associated with warranty claims, which is based upon historical
experience and the Company’s estimate of the level of
future costs.
|
|
|
Comprehensive Income (Loss) |
Unrealized gains (losses) on available-for-sale securities and
foreign currency translation adjustments are included in the
Company’s components of comprehensive income (loss), which
are excluded from net income.
For 2004, 2003 and 2002 other comprehensive income (loss) is
comprised of the following items (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Before | |
|
|
|
Net of | |
| |
|
Income Tax | |
|
Income Tax | |
|
Income Tax | |
| |
|
| |
|
| |
|
| |
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized loss on marketable securities and investments, net
|
|
$ |
(5,253 |
) |
|
$ |
2,102 |
|
|
$ |
(3,151 |
) |
|
Reclassification adjustment for net loss on marketable
securities recognized during the period
|
|
|
1,704 |
|
|
|
(682 |
) |
|
|
1,022 |
|
|
Foreign currency translation loss
|
|
|
(4,537 |
) |
|
|
— |
|
|
|
(4,537 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Total other comprehensive loss
|
|
$ |
(8,086 |
) |
|
$ |
1,420 |
|
|
$ |
(6,666 |
) |
| |
|
|
|
|
|
|
|
|
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gain on marketable securities and investments, net
|
|
$ |
1,894 |
|
|
$ |
(757 |
) |
|
$ |
1,137 |
|
|
Reclassification adjustment for net gain on marketable
securities recognized during the period
|
|
|
(3,076 |
) |
|
|
1,230 |
|
|
|
(1,846 |
) |
|
Foreign currency translation gain
|
|
|
10,578 |
|
|
|
— |
|
|
|
10,578 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Total other comprehensive income
|
|
$ |
9,396 |
|
|
$ |
473 |
|
|
$ |
9,869 |
|
| |
|
|
|
|
|
|
|
|
|
81
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Before | |
|
|
|
Net of | |
| |
|
Income Tax | |
|
Income Tax | |
|
Income Tax | |
| |
|
| |
|
| |
|
| |
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized loss on marketable securities and investments, net
|
|
$ |
(805 |
) |
|
$ |
322 |
|
|
$ |
(483 |
) |
|
Reclassification adjustment for net gain on marketable
securities recognized during the period
|
|
|
(3,838 |
) |
|
|
1,535 |
|
|
|
(2,303 |
) |
|
Impairment recognized
|
|
|
198 |
|
|
|
(79 |
) |
|
|
119 |
|
|
Foreign currency translation gain
|
|
|
10,744 |
|
|
|
— |
|
|
|
10,744 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Total other comprehensive income
|
|
$ |
6,299 |
|
|
$ |
1,778 |
|
|
$ |
8,077 |
|
| |
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income is comprised of the
following (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Unrealized (loss) gain on available-for-sale securities
|
|
$ |
(1,384 |
) |
|
$ |
745 |
|
|
$ |
1,454 |
|
|
Cumulative translation adjustment
|
|
|
28,745 |
|
|
|
33,282 |
|
|
|
22,704 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Total
|
|
$ |
27,361 |
|
|
$ |
34,027 |
|
|
$ |
24,158 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Recent Accounting Pronouncements and Guidance |
In December 2004, the FASB issued SFAS 123R, “Share
Based Payment” (“SFAS 123R”) which
requires the measurement of all employee share-based payments to
employees, including grants of employee stock options, using a
fair-value-based method and the recording of such expense in the
consolidated statements of income. The accounting provisions of
SFAS 123R are effective for reporting periods beginning
after June 15, 2005. The Company is required to adopt
SFAS 123R in the third quarter of fiscal 2005. The pro
forma disclosures previously permitted under SFAS 123 will
no longer be an alternative to financial statement recognition.
See “Stock-based Compensation” above for the pro forma
net income and net income per share amounts, for fiscal 2002
through fiscal 2004, as if the Company had used a
fair-value-based method similar to the methods required under
SFAS 123R to measure compensation expense for employee
stock incentive awards. Although the Company has not yet
determined whether the adoption of SFAS 123R will result in
amounts that are similar to the current pro forma disclosures
under SFAS 123, the Company is evaluating the requirements
under SFAS 123R and expects the adoption to have a
significant adverse impact on the consolidated results of
operations.
In December 2004, the FASB issued Staff Position
(“FSP”) FAS 109-2, “Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creations Act of 2004
(“AJCA”) (“FSP 109-2”).” The AJCA
introduces a limited time 85% dividends received deduction on
the repatriation of certain foreign earnings to a
U.S. taxpayer (repatriation provision), provided certain
criteria are met. FSP 109-2 provides accounting and disclosure
guidance for the repatriation provision. Although FSP 109-2
is effective immediately, the Company does not expect to be able
to complete its evaluation of the repatriation provision until
after Congress or the Treasury Department provides additional
clarifying language on key elements of the provision. In January
2005, the Treasury Department began to issue the first of a
series of clarifying guidance documents related to this
provision. The Company expects to complete its evaluation of the
effects of the repatriation provision by the end of fiscal 2005.
The range of possible amounts that the Company is considering
for repatriation under this provision is between $0 and
$500 million. While the Company estimates that the related
potential range of additional income tax is between $0 and
$30 million,
82
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
this estimation is subject to change following technical
correction legislation that the Company believes is forthcoming
from Congress. The amount of additional income tax would be
reduced by the part of the eligible dividend that is
attributable to foreign earnings on which a deferred tax
liability had been previously accrued.
In December 2004, the FASB issued SFAS 151,
“Inventory Costs, an Amendment of ARB No. 43,
Chapter 4.” SFAS 151 clarifies the accounting
for inventory when there are abnormal amounts of idle facility
expense, freight, handling costs, and wasted materials. Under
existing pronouncements, items such as idle facility expense,
excessive spoilage, double freight, and re-handling costs may be
“so abnormal” as to require treatment as current
period charges rather than recorded as adjustments to the value
of the inventory. SFAS 151 requires that those items be
recognized as current-period charges regardless of whether they
meet the criterion of “so abnormal.” In addition,
SFAS 151 requires that allocation of fixed production
overheads to the costs of conversion be based on the normal
capacity of the production facilities. The provisions of
SFAS 151 shall be effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. Earlier
application is permitted for inventory costs incurred during
fiscal years beginning after the date SFAS 151 is issued.
The adoption of SFAS 151 is not expected to have a material
effect on the Company’s consolidated financial position or
results of operations as the Company does not manufacture any of
its products.
|
|
|
The Meaning of Other-Than-Temporary Impairment |
In March 2004, the FASB issued Emerging Issues Task Force Issue
No. 03-1 (“EITF 03-1”), “The Meaning
of Other-Than-Temporary Impairment and Its Application to
Certain Investments,” which provided new guidance for
assessing impairment losses on investments. Additionally,
EITF 03-1 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In
September 2004, the FASB delayed the accounting provisions of
EITF 03-1; however the disclosure requirements remain
effective for annual periods ending after June 15, 2004
(see Note 6). The Company does not believe that the
adoption of EITF 03-01 will have a material impact on its
financial position, results of operations or cash flows,
however, the Company will evaluate the impact of EITF 03-1
once final guidance is issued.
|
|
| 3. |
Cumulative Effect of Change in Accounting Principle |
Effective January 1, 2003, the Company changed its method
for recognizing commission expenses to sales personnel. Prior to
January 1, 2003, the Company’s policy had been to
expense the commissions as incurred, however, the Company
believed that expensing the commissions as incurred did not
provide a fair representation of the income from operations
where part or all of the revenue related to these sales
transactions is deferred and recognized over time. Commission
expense directly related to sales transactions is now deferred
and recognized ratably over the same period as the related
revenue is recognized and recorded, which the Company believes
will provide greater transparency into its performance. The
cumulative effect of the change in accounting principle resulted
in a one-time credit of $10.3 million, net of taxes of
$3.6 million, that was recorded in 2003.
83
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table illustrates 2002 after considering the
retroactive application of the adopted principle:
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Pro Forma for | |
| |
|
|
|
Commission | |
| |
|
Actual | |
|
Change | |
| |
|
| |
|
| |
|
Operating expenses
|
|
$ |
763,606 |
|
|
$ |
774,938 |
|
| |
|
|
|
|
|
|
|
Income before cumulative effect of change in accounting principle
|
|
$ |
128,312 |
|
|
$ |
121,513 |
|
| |
|
|
|
|
|
|
| |
Per common share — basic
|
|
$ |
0.86 |
|
|
$ |
0.81 |
|
| |
|
|
|
|
|
|
| |
Per common share — diluted
|
|
$ |
0.80 |
|
|
$ |
0.76 |
|
| |
|
|
|
|
|
|
|
Net income
|
|
$ |
128,312 |
|
|
$ |
121,513 |
|
| |
|
|
|
|
|
|
| |
Per common share — basic
|
|
$ |
0.86 |
|
|
$ |
0.81 |
|
| |
|
|
|
|
|
|
| |
Per common share — diluted
|
|
$ |
0.80 |
|
|
$ |
0.76 |
|
| |
|
|
|
|
|
|
|
|
| 4. |
Business Combinations and Other Acquisitions |
On October 1, 2004, the Company acquired 100% of the
outstanding capital shares of Foundstone, Inc.,
(“Foundstone”), a provider of risk assessment and
vulnerability services and products for $82.5 million in
cash and $3.1 million of direct expenses, totaling
$85.6 million. Total consideration paid for the acquisition
was $90.4 million including $4.8 million for the fair
value of vested stock options assumed in the acquisition. The
Company acquired Foundstone to enhance its network protection
product line. The Company acquired Foundstone to deliver
enhanced risk classification of prioritized assets, automated
shielding and risk remediation using intrusion prevention
technology, and automated enforcement and compliance. The
results of operations of Foundstone have been included in these
consolidated financial statements since the date of acquisition.
Under the transaction, the Company recorded approximately
$27.0 million for developed technology, $1.0 million
for acquired product rights, including revenue related order
backlog and contracts, $0.6 million for trade
names/trademarks and non-compete arrangements,
$59.2 million for goodwill (none of which is deductible for
tax purposes), $2.6 million for net deferred tax
liabilities and $5.1 million of tangible assets, net of
liabilities. The intangible assets acquired in the acquisition,
excluding goodwill, are being amortized over their estimated
useful lives of two to 6.5 years or a weighted average
period of 6.4 years. The Company accrued $0.3 million
in severance costs for employees terminated at the time of the
acquisition, of which less than $0.1 million remains as an
accrual as of December 31, 2004.
As part of the Foundstone acquisition, the Company assumed a
portion of outstanding vested and unvested Foundstone stock
option options. The fair value of the Company’s stock
options exchanged was $7.0 million, of which
$4.8 million was reflected as part of the purchase price
and $2.3 million was reflected as unearned compensation to
be recognized by the Company through 2008 as employment services
are provided.
The Company cancelled the Foundstone stock options it did not
assume, such options being held by four executives, in exchange
for a cash payment equal to the intrinsic value of the cancelled
stock options based on the purchase price per share. Forty
percent of this amount was placed into escrow accounts for the
four executives (Key Employee Escrow), along with 40% of the
proceeds for the purchase of shares from the four executives.
The four executives also received retention bonus payments,
which were placed into Key Employee Escrow accounts. The Key
Employee Escrow amounts are subject to vesting provisions from
the date of acquisition through October 1, 2007. The
Company recorded the $5.6 million paid into Key Employee
Escrow as prepaid compensation, which is being recognized as
expense over the vesting period. The Company
84
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
recognized expense of approximately $0.3 million in 2004.
In January 2005, the vesting schedule was amended such that a
greater portion of the escrow amount vests within one year of
the close of the transaction. The Company expects to record
approximately $2.9 million in expense for escrow amounts
vesting in 2005.
Management determined the preliminary purchase price allocation
based on estimates of the fair values of the tangible and
intangible assets acquired and liabilities assumed. These
estimates were arrived at utilizing recognized valuation
techniques and the assistance of valuation consultants. The
following is a summary of the assets acquired and liabilities
assumed in the acquisition of Foundstone:
| |
|
|
|
|
|
| |
|
(In thousands) | |
|
Technology
|
|
$ |
27,000 |
|
|
Other intangible assets
|
|
|
1,600 |
|
|
Goodwill
|
|
|
59,235 |
|
|
Cash
|
|
|
920 |
|
|
Other assets
|
|
|
12,918 |
|
|
Deferred tax assets
|
|
|
8,721 |
|
| |
|
|
|
| |
Total assets acquired
|
|
|
110,394 |
|
| |
|
|
|
|
Liabilities
|
|
|
8,740 |
|
|
Deferred tax liabilities
|
|
|
11,297 |
|
| |
|
|
|
| |
Total liabilities assumed
|
|
|
20,037 |
|
| |
|
|
|
|
Net assets acquired
|
|
$ |
90,357 |
|
| |
|
|
|
The following unaudited pro forma financial information presents
the combined results of the Company and Foundstone as if the
acquisitions had occurred at the beginning of 2004 and 2003 (in
thousands except per share amounts):
| |
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(Unaudited) | |
|
Net revenue
|
|
$ |
927,595 |
|
|
$ |
954,136 |
|
| |
|
|
|
|
|
|
|
Income before cumulative effect of change in accounting principle
|
|
$ |
212,610 |
|
|
$ |
46,838 |
|
| |
|
|
|
|
|
|
|
Net income
|
|
$ |
212,610 |
|
|
$ |
57,175 |
|
| |
|
|
|
|
|
|
|
Basic net income per share
|
|
$ |
1.32 |
|
|
$ |
0.36 |
|
| |
|
|
|
|
|
|
|
Shares used in per share calculation — basic
|
|
|
160,714 |
|
|
|
160,338 |
|
| |
|
|
|
|
|
|
|
Diluted net income per share
|
|
$ |
1.24 |
|
|
$ |
0.35 |
|
| |
|
|
|
|
|
|
|
Shares used in per share calculation — diluted
|
|
|
177,099 |
|
|
|
164,489 |
|
| |
|
|
|
|
|
|
The above unaudited pro forma financial information includes
adjustments for interest income on cash disbursed for the
acquisitions, amortization of identifiable intangible assets and
adjustments for expenses incurred in conjunction with the
acquisitions.
On May 14, 2003, the Company acquired 100% of the
outstanding capital shares of IntruVert Networks, Inc.,
(“IntruVert”) a provider of network-based intrusion
prevention solutions designed to proactively detect and stop
system and network security attacks before they occur, for
$98.1 million in cash and $5.2 million of
85
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
direct expenses, totaling $103.3 million. The Company
acquired IntruVert to enhance its intrusion detection product
line, improve its position in the emerging intrusion prevention
marketplace, embed the acquired technologies in the
Company’s current product offering, and sell IntruVert
products to its existing customer base. The results of
operations of IntruVert have been included in these consolidated
financial statements since the date of acquisition.
The Company recorded approximately $5.7 million for
acquired in-process research and development which was fully
expensed at the time of acquisition because technological
feasibility had not been established and there was no
alternative use for the projects under development. The ongoing
project at IntruVert at the time of acquisition was the
development of the Infinity model of the IntruShield sensor. The
product was completed in the third quarter of 2003.
The intangibles acquired in the acquisition, excluding goodwill,
are being amortized over their estimated useful lives of two to
five years or a weighted average period of 4.5 years. The
Company also accrued approximately $0.3 million in
duplicative site costs for lease space no longer being utilized
and permanently vacated related to the IntruVert acquisition,
which has been fully paid as of December 31, 2004.
As part of the IntruVert acquisition, the Company cancelled all
outstanding IntruVert restricted stock and outstanding stock
options and agreed to make cash payments to former IntruVert
employees contingent upon their continued employment with the
Company based on the same vesting terms of their restricted
stock or stock option agreements. The payments to former
IntruVert employees are recorded ratably over the vesting period
as salary expense as the employees are currently providing
services to the Company. Payments under the restricted stock
plan are paid monthly from an escrow account and will total
approximately $3.0 million from the purchase date through
the fourth quarter of 2006. The Company recorded expense of
approximately $1.4 million and $1.1 million in 2004
and 2003, respectively. Payments under the stock option plan are
being paid monthly through the Company’s payroll, and will
total approximately $4.1 million. The Company recorded
expense of approximately $1.4 million and $0.8 million
in 2004 and 2003, respectively, and will record an additional
$2.0 million through the first quarter of 2007. Cash
payments that were fully vested at the date of acquisition were
included in the purchase price. If a former IntruVert employee
ceases employment with the Company, unvested payment amounts
will be returned to the Company.
|
|
|
Entercept Security Technologies, Inc. |
On April 30, 2003, the Company acquired 100% of the
outstanding capital shares of Entercept Security Technologies,
Inc. (“Entercept”), a provider of host-based intrusion
prevention solutions designed to proactively detect and stop
system and network security attacks before they occur, for
$121.9 million in cash and $3.9 million of direct
expenses, totaling $125.8 million. The Company acquired
Entercept to enhance its intrusion detection product line,
achieve a leading position in the emerging intrusion prevention
marketplace, embed the acquired technologies in the
Company’s current product offering, and sell Entercept
products to its existing customer base. The results of
operations of Entercept have been included in these consolidated
financial statements since the date of acquisition.
The Company recorded approximately $0.9 million for
acquired in-process research and development which was fully
expensed upon purchase because technological feasibility had not
been established and there was no alternative use for the
projects under development. The ongoing project at Entercept at
the time of acquisition was a Linux version of their current
product. The project was completed in the fourth quarter of
2004. The intangibles acquired in the acquisition, excluding
goodwill, are being amortized over their estimated useful lives
of two to six years or a weighted average period of
5.6 years.
The Company accrued $2.8 for permanently vacated facilities at
the acquisition date. The accrual will be fully utilized by
2006, the end of the original lease term. The Company made
payments of $0.7 million in 2003, and in the fourth quarter
of 2003, the Company entered into a sublease for the vacated
facility, and
86
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
therefore, adjusted the accrual and related goodwill by the
value of the sublease, which was $1.1 million. The
following is a summary of activity in the restructuring accrual
related to Entercept (in thousands):
| |
|
|
|
|
|
Original accrual, April 30, 2003
|
|
$ |
2,837 |
|
|
Cash payments
|
|
|
(1,106 |
) |
|
Adjustments
|
|
|
(1,137 |
) |
| |
|
|
|
|
Balance, December 31, 2004
|
|
$ |
594 |
|
| |
|
|
|
As part of the Entercept acquisition, the Company assumed all
outstanding unvested Entercept cash bonus units and agreed to
make specified per unit cash payments to former Entercept
employees contingent upon their continued employment with the
Company for one year based on the vesting terms of such units,
generally one year. The payments to former Entercept employees
totaling $2.4 million have been expensed monthly as salary
expense as the employees were providing services to the Company.
The Company recorded expense related to these payments of
$0.6 million and $1.8 million in 2004 and 2003,
respectively.
Management determined the purchase price allocation based on
estimates of the fair values of the tangible and intangible
assets acquired and liabilities assumed. These estimates were
arrived at utilizing recognized valuation techniques and the
assistance of valuation consultants. The following table
summarizes the final fair values of the assets acquired and
liabilities assumed in the acquisitions:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Total Assets | |
| |
|
IntruVert | |
|
Entercept Security | |
|
Acquired and | |
| |
|
Networks, Inc. | |
|
Technologies, Inc. | |
|
Liabilities Assumed | |
| |
|
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Deferred tax assets
|
|
$ |
436 |
|
|
$ |
10,560 |
|
|
$ |
10,996 |
|
|
Technology
|
|
|
18,200 |
|
|
|
21,700 |
|
|
|
39,900 |
|
|
Other intangible assets
|
|
|
1,900 |
|
|
|
2,800 |
|
|
|
4,700 |
|
|
Cash
|
|
|
10,986 |
|
|
|
1,028 |
|
|
|
12,014 |
|
|
Goodwill
|
|
|
71,598 |
|
|
|
99,565 |
|
|
|
171,163 |
|
|
Other assets
|
|
|
4,984 |
|
|
|
3,517 |
|
|
|
8,501 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Total assets acquired
|
|
|
108,104 |
|
|
|
139,170 |
|
|
|
247,274 |
|
| |
|
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
2,649 |
|
|
|
4,739 |
|
|
|
7,388 |
|
|
Deferred tax liabilities
|
|
|
7,839 |
|
|
|
9,555 |
|
|
|
17,394 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Total liabilities assumed
|
|
|
10,488 |
|
|
|
14,294 |
|
|
|
24,782 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net assets acquired
|
|
$ |
97,616 |
|
|
$ |
124,876 |
|
|
$ |
222,492 |
|
| |
|
|
|
|
|
|
|
|
|
|
In-process research and development (expensed)
|
|
$ |
5,700 |
|
|
$ |
900 |
|
|
$ |
6,600 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total acquisition cost
|
|
$ |
103,316 |
|
|
$ |
125,776 |
|
|
$ |
229,092 |
|
| |
|
|
|
|
|
|
|
|
|
87
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following unaudited pro forma financial information presents
the combined results of the Company, IntruVert and Entercept as
if the acquisitions had occurred at the beginning of 2003 and
2002 (in thousands except per share amounts):
| |
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
| |
|
(Unaudited) | |
|
Net revenue
|
|
$ |
939,953 |
|
|
$ |
1,052,474 |
|
| |
|
|
|
|
|
|
|
Income before cumulative effect of change in accounting principle
|
|
$ |
49,721 |
|
|
$ |
93,367 |
|
| |
|
|
|
|
|
|
|
Net income
|
|
$ |
60,058 |
|
|
$ |
93,367 |
|
| |
|
|
|
|
|
|
|
Basic net income per share
|
|
$ |
0.38 |
|
|
$ |
0.62 |
|
| |
|
|
|
|
|
|
|
Shares used in per share calculation — basic
|
|
|
160,338 |
|
|
|
149,441 |
|
| |
|
|
|
|
|
|
|
Diluted net income per share
|
|
$ |
0.37 |
|
|
$ |
0.59 |
|
| |
|
|
|
|
|
|
|
Shares used in per share calculation — diluted
|
|
|
164,489 |
|
|
|
157,156 |
|
| |
|
|
|
|
|
|
The above unaudited pro forma financial information includes
adjustments for interest income on cash disbursed for the
acquisitions, amortization of identifiable intangible assets and
adjustments for expenses incurred in conjunction with the
acquisitions. The pro forma financial information excludes the
effects of the in-process research and development totaling
$6.6 million that was expensed immediately.
In September 2002, the Company repurchased the 25% minority
interest in its McAfee.com subsidiary for $219.9 million in
cash and stock. The Company issued 8.3 million shares of
its common stock valued at $14.62 per share, which
corresponds to the average market price of the Company’s
common stock two days before and after the date the terms of the
acquisition were agreed and announced. The acquisition was an
effort to reduce or eliminate customer, market and brand
confusion due to the similarity in its products, names and web
addresses and to reduce or eliminate actual and potential
conflicts between the companies and their sales forces, and
related senior management distraction, due to confusion over
market boundaries. This acquisition increased the Company’s
ownership of McAfee.com to 100% and was accounted for using the
purchase method of accounting. As part of the acquisition,
McAfee.com was merged with and into the Company. The results of
operations of McAfee.com have always been included in the
consolidated income before minority interest of the Company.
Prior to the acquisition, the minority interest in the
McAfee.com income was excluded from the Company’s
consolidated net income.
Since the date of acquisition on September 13, 2002, no
minority interest exists in McAfee.com and accordingly the
consolidated net income includes the full amount of McAfee.com
results from this date. The aggregate purchase price was
allocated to tangible and identified intangible assets acquired
and liabilities assumed based on estimates of fair value.
Identifiable intangible assets totaled $50.7 million and
are amortized using an estimated useful life identified for each
type of intangible ranging from two to seven years, or a
weighted average period of 6.7 years. The excess of the
aggregate purchase price over the fair value of the identifiable
net assets acquired of approximately $145.8 million has
been recognized as goodwill of which none is deductible for tax
purposes.
88
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table summarizes the final fair values of the
assets acquired and liabilities assumed.
| |
|
|
|
|
|
| |
|
(In thousands) | |
|
Deferred tax assets
|
|
$ |
25,767 |
|
|
Technology
|
|
|
1,401 |
|
|
Other intangible assets
|
|
|
49,335 |
|
|
Goodwill
|
|
|
145,756 |
|
|
Minority interest
|
|
|
21,044 |
|
| |
|
|
|
| |
Total assets acquired
|
|
|
243,303 |
|
| |
|
|
|
|
Current liabilities
|
|
|
2,065 |
|
|
Deferred tax liabilities
|
|
|
21,345 |
|
| |
|
|
|
| |
Total liabilities assumed
|
|
|
23,410 |
|
| |
|
|
|
|
Net assets acquired
|
|
$ |
219,893 |
|
| |
|
|
|
The following unaudited pro forma financial information presents
the combined results of the Company and McAfee.com as if the
acquisition had occurred at the beginning of 2002, after giving
effect to certain adjustments, including amortization of
identifiable intangible assets (in thousands, except per share
amounts):
| |
|
|
|
|
| |
|
(Unaudited) | |
|
Net revenue
|
|
$ |
1,043,044 |
|
| |
|
|
|
|
Net income
|
|
$ |
141,334 |
|
| |
|
|
|
|
Basic net income per share
|
|
$ |
0.91 |
|
| |
|
|
|
|
Shares used in per share calculation — basic
|
|
|
155,245 |
|
| |
|
|
|
|
Diluted net income per share
|
|
$ |
0.84 |
|
| |
|
|
|
|
Shares used in per share calculation — diluted
|
|
|
183,150 |
|
| |
|
|
|
The above unaudited pro forma financial information includes
adjustments for interest income on cash disbursed for the
acquisition, amortization of identifiable intangible assets and
adjustments for the expenses incurred by McAfee.com related to
the Company’s exchange offer for all McAfee.com outstanding
publicly held shares.
In December 2004, the Company entered into an agreement for the
sale of its McAfee Labs assets to SPARTA, Inc.
(“SPARTA”) for $1.5 million. The transaction is
expected to close in the first half of 2005. The assets and
liabilities of McAfee Labs are not presented as held for sale
since the purchase agreement requires the Company to be involved
under certain contracts that are in progress at the close of the
transaction until SPARTA obtains government approval as the
contractor. As the Company will continue to be involved in the
operations of the McAfee Labs business in 2005, its results of
operations are included in income from operations in the
consolidated statements of income. The cash flows resulting from
this continued involvement are not expected to be material to
the Company’s consolidated financial statements.
The assets and liabilities of McAfee Labs are present in the
Company’s North American operating region. Revenues related
to McAfee Labs were approximately $6.4 million,
$11.0 million and $17.3 million for 2004, 2003 and
2002, respectively.
89
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In July 2004, the Company completed its sale of the Sniffer
product line to Network General Corporation (“the
Buyer”) for $213.8 million in cash, net of
approximately $4.0 million in direct costs. The Company
recorded a gain on sale of $197.4 million in 2004. Sniffer
does not represent a separate component of the Company as its
operations and cash flows cannot be sufficiently separated from
the rest of the Company, consequently, its results of operations
are included in income from continuing operations in the
consolidated statements of income.
The following is a detail of assets and liabilities that were
sold to or assumed by the Buyer upon the close of the
transaction:
| |
|
|
|
|
|
| |
|
(In thousands) | |
|
Assets:
|
|
|
|
|
| |
Prepaid expenses
|
|
$ |
2,227 |
|
| |
Inventory
|
|
|
6,759 |
|
| |
Equipment, net
|
|
|
2,396 |
|
| |
Goodwill
|
|
|
50,547 |
|
| |
|
|
|
|
Total assets
|
|
$ |
61,929 |
|
| |
|
|
|
|
Liabilities:
|
|
|
|
|
| |
Accrued liabilities
|
|
$ |
2,069 |
|
| |
Deferred revenue
|
|
|
43,477 |
|
| |
|
|
|
|
Total liabilities
|
|
$ |
45,546 |
|
| |
|
|
|
The assets and liabilities of Sniffer were located primarily in
the Company’s North America and EMEA operating segments.
Sniffer assets and liabilities in the Company’s other
reporting units were not material. Revenues related to Sniffer
were $90.9 million and $210.2 million in 2004 and
2003, respectively.
In conjunction with the sale of Sniffer, the Company entered
into a transition services agreement with the Buyer. Under this
agreement, the Company provides certain transitional services,
including initial order processing, use of facilities,
transaction processing services and certain other back office
functions for the Buyer. The Company is reimbursed for its costs
plus a margin. Operating expenses under this agreement are
included in general and administrative expenses, while
reimbursements for such expenses are included in the caption
“Reimbursement from transition services agreement” on
the accompanying consolidated statements of income. The Company
recorded approximately $6.0 million of reimbursements under
the transition services agreement.
Also in conjunction with the sale of the Sniffer product line,
the Company paid severance and bonuses to the former executives
of Sniffer for their assistance in the transaction. The total
bonuses and severance accrued was $7.7 million in 2004, of
which $5.3 million has been paid as of December 31,
2004, and the remaining $2.4 million will be paid in the
first quarter of 2006. Furthermore, the Company accelerated the
vesting of these executive’s stock options, which resulted
in a stock-based compensation charge of approximately
$1.0 million.
In December 2003, the Company entered into an agreement for the
sale of its Magic Solutions product line (“Magic”) to
BMC Software for $47.1 million in cash. The Company
completed the transaction on January 30, 2004, and recorded
a gain of $46.1 million. At December 31, 2003, the
carrying values of assets and liabilities related to Magic sale
were presented as held for sale on the consolidated balance
sheet. Magic
90
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
does not represent a separate component of the Company as its
operations and cash flows cannot be sufficiently separated from
the rest of the Company, consequently, its results of operations
are included in income from continuing operations in the
consolidated statements of income.
The following were the components of Magic at December 31,
2003:
| |
|
|
|
|
|
| |
|
(In thousands) | |
|
Assets:
|
|
|
|
|
| |
Accounts receivable
|
|
$ |
12,991 |
|
| |
Prepaid expenses
|
|
|
888 |
|
| |
Inventory
|
|
|
20 |
|
| |
Equipment, net
|
|
|
1,023 |
|
| |
Goodwill
|
|
|
9,797 |
|
| |
|
|
|
|
Assets held for sale
|
|
$ |
24,719 |
|
| |
|
|
|
|
Liabilities:
|
|
|
|
|
| |
Accounts payable
|
|
$ |
215 |
|
| |
Accrued liabilities
|
|
|
1,050 |
|
| |
Deferred revenue
|
|
|
22,045 |
|
| |
|
|
|
|
Liabilities related to assets held for sale
|
|
$ |
23,310 |
|
| |
|
|
|
The assets and liabilities of Magic were located primarily in
the Company’s North American and EMEA operating regions.
Magic assets and liabilities in the Company’s other
operating regions were not material. Revenues related to Magic
were approximately $2.9 million and $63.2 million in
2004 and 2003, respectively.
In conjunction with the Magic sale, the Company paid a
$1.4 million bonus to an executive related to the
transaction.
In October 2001, the Board of Directors of the Company approved
a plan to integrate the activities of the Company’s PGP
product group into its other product groups. In addition to the
integration plan, the Company began to look for a buyer for the
PGP desktop encryption and Gauntlet firewall product. In
February 2002, the Company announced the sale of Gauntlet
firewall/ VPN business to Secure Computing. As a result of the
transaction, the Company received common shares of Secure
Computing in exchange for the Gauntlet business. The Company
recorded a gain on sale of the business of $6.7 million. In
August 2002, the Company announced the sale of the PGP business
to PGP Corporation, a new venture funded company unrelated to
the Company, for $2.0 million in cash and assumed
liabilities. As a result of the transaction, the Company
recorded a gain on sale of the business of $2.6 million.
91
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
|
|
| 6. |
Marketable Securities and Cash and Cash Equivalents |
Marketable securities, which are classified as
available-for-sale, are summarized as follows as of
December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
| |
|
| |
| |
|
Purchase/ | |
|
Gross | |
|
Gross | |
|
|
| |
|
Amortized | |
|
Unrealized | |
|
Unrealized | |
|
Aggregate | |
| |
|
Cost | |
|
Gains | |
|
Losses | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
U.S. Government debt securities
|
|
$ |
274,594 |
|
|
$ |
40 |
|
|
$ |
(1,021 |
) |
|
$ |
273,613 |
|
|
Corporate debt securities
|
|
|
340,037 |
|
|
|
138 |
|
|
|
(1,458 |
) |
|
|
338,717 |
|
|
Municipal debt securities
|
|
|
4,850 |
|
|
|
— |
|
|
|
— |
|
|
|
4,850 |
|
|
Time deposits
|
|
|
16,350 |
|
|
|
— |
|
|
|
(4 |
) |
|
|
16,346 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
635,831 |
|
|
$ |
178 |
|
|
$ |
(2,483 |
) |
|
$ |
633,526 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2003 | |
| |
|
| |
| |
|
Purchase/ | |
|
Gross | |
|
Gross | |
|
|
| |
|
Amortized | |
|
Unrealized | |
|
Unrealized | |
|
Aggregate | |
| |
|
Cost | |
|
Gains | |
|
Losses | |
|
Fair Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
U.S. Government debt securities
|
|
$ |
190,567 |
|
|
$ |
401 |
|
|
$ |
(76 |
) |
|
$ |
190,892 |
|
|
Corporate debt securities and money market funds
|
|
|
484,156 |
|
|
|
607 |
|
|
|
(180 |
) |
|
|
484,583 |
|
|
Equity securities
|
|
|
118 |
|
|
|
293 |
|
|
|
— |
|
|
|
411 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
674,841 |
|
|
$ |
1,301 |
|
|
$ |
(256 |
) |
|
$ |
675,886 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2004, $232.9 million of marketable
debt securities had scheduled maturities of less than one year
and are classified as current assets. Marketable securities of
$400.6 million have maturities ranging from greater than
one year to less than three years and are classified as non
current assets.
The following table summarizes the components of the cash and
cash equivalents balance at December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Cash and money market funds, at cost which approximates fair
value
|
|
$ |
262,216 |
|
|
$ |
325,360 |
|
|
Corporate debt securities, primarily commercial paper
|
|
|
28,939 |
|
|
|
8,291 |
|
| |
|
|
|
|
|
|
| |
Total cash and cash equivalents
|
|
$ |
291,155 |
|
|
$ |
333,651 |
|
| |
|
|
|
|
|
|
The Company recognizes realized gains(losses) upon the sale of
investments using the specific identification method. The
following table summarizes the gross realized gains (losses) for
the years ending December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Realized gains
|
|
$ |
922 |
|
|
$ |
3,753 |
|
|
$ |
4,670 |
|
|
Realized losses
|
|
|
(2,626 |
) |
|
|
(677 |
) |
|
|
(832 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Net realized (loss) gain
|
|
$ |
(1,704 |
) |
|
$ |
3,076 |
|
|
$ |
3,838 |
|
| |
|
|
|
|
|
|
|
|
|
92
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In accordance with EITF 03-1, the following table
summarizes the fair value and gross unrealized losses related to
available-for-sale securities, aggregated by investment category
and length of time that the individual securities have been in a
continuous unrealized loss position, at December 31, 2004
(in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Less Than 12 Months | |
|
More Than 12 Months | |
|
Total | |
| |
|
| |
|
| |
|
| |
| |
|
|
|
Gross | |
|
|
|
Gross | |
|
|
|
Gross | |
| |
|
|
|
Unrealized | |
|
|
|
Unrealized | |
|
|
|
Unrealized | |
| |
|
Fair Value | |
|
Losses | |
|
Fair Value | |
|
Losses | |
|
Fair Value | |
|
Losses | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
U.S. Government debt securities
|
|
$ |
242,316 |
|
|
$ |
(1,056 |
) |
|
$ |
2,625 |
|
|
$ |
(33 |
) |
|
$ |
244,941 |
|
|
$ |
(1,089 |
) |
|
Corporate debt securities
|
|
|
185,359 |
|
|
|
(1,076 |
) |
|
|
48,241 |
|
|
|
(318 |
) |
|
|
233,600 |
|
|
|
(1,394 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
427,675 |
|
|
$ |
(2,132 |
) |
|
$ |
50,866 |
|
|
$ |
(351 |
) |
|
$ |
478,541 |
|
|
$ |
(2,483 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market values were determined for each individual security in
the investment portfolio. The declines in value of these
investments are primarily related to changes in interest rates
and are considered to be temporary in nature. The Company
invests in government securities and debt instruments with high
credit ratings, and believes that the financial position of the
issuers of these securities are indicators that the securities
are not impaired as of December 31, 2004.
|
|
|
Forward Exchange Contracts |
The Company conducts business globally. As a result, it is
exposed to movements in foreign currency exchange rates. The
Company enters into forward exchange contracts to reduce
exposures associated with nonfunctional currency monetary assets
and liabilities such as accounts receivable and accounts payable
denominated in Euros, British Pound Sterling, Japanese Yen, and
Singapore, Canadian and Australian dollars. The forward
contracts typically range from one to three months in original
maturity. In general, the Company does not hedge anticipated
foreign currency cash flows nor does the Company enter into
forward contracts for trading purposes. The Company does not use
any foreign exchange derivatives for trading or speculative
purposes.
The forward contracts do not qualify for hedge accounting and
accordingly are marked to market at the end of each reporting
period with any unrealized gain or loss being recognized in the
statement of income as interest and other income.
The forward contracts outstanding and their fair values are
presented below as of December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
Carrying | |
|
Fair | |
|
Carrying | |
|
Fair | |
| |
|
Value | |
|
Value | |
|
Value | |
|
Value | |
| |
|
| |
|
| |
|
| |
|
| |
|
Euro
|
|
$ |
116 |
|
|
$ |
116 |
|
|
$ |
490 |
|
|
$ |
490 |
|
|
British Pound Sterling
|
|
|
288 |
|
|
|
288 |
|
|
|
54 |
|
|
|
54 |
|
|
Brazilian Real
|
|
|
420 |
|
|
|
420 |
|
|
|
— |
|
|
|
— |
|
|
Singapore Dollar
|
|
|
— |
|
|
|
— |
|
|
|
(16 |
) |
|
|
(16 |
) |
|
Japanese Yen
|
|
|
1 |
|
|
|
1 |
|
|
|
— |
|
|
|
— |
|
|
Australian Dollar
|
|
|
4 |
|
|
|
4 |
|
|
|
75 |
|
|
|
75 |
|
|
Canadian Dollar
|
|
|
39 |
|
|
|
39 |
|
|
|
255 |
|
|
|
255 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
868 |
|
|
$ |
868 |
|
|
$ |
858 |
|
|
$ |
858 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
93
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In July 2002, the Company entered into interest rate swap
transactions (the “Transactions”) with two investment
banks (the “Banks”) to hedge the interest rate risk of
its outstanding 5.25% Convertible Subordinated Notes due
2006 (the “Notes”) (see Note 13).
The notional amount of the Transactions was $345.0 million
to match the entire principal amount of the Notes. The Company
received from the Banks fixed payments equal to 5.25% percent of
the notional amount, payable on February 15 and August 15 which
started on August 15, 2002. In exchange, the Company paid
to the Banks floating rate payments based upon the London
Interbank Offered Rate (“LIBOR”) plus 1.66% multiplied
by the notional amount of the Transactions with the LIBOR
resetting every three months which began on August 15, 2002.
The Transactions had a termination date of August 15, 2006
(“Termination Date”), subject to certain early
termination provisions if on or after August 20, 2004 and
prior to August 15, 2006 the five-day average closing price
of the Company’s common stock were to equal or exceed
$22.59 per share. Depending on the timing of the early
termination event, the Banks would be obligated to pay the
Company an amount equal to the repurchase premium called for
under the terms of the Notes.
The Transactions qualified and were designated as a fair value
hedge against movements in the fair value of the Notes due to
changes in the benchmark interest rate. Under the fair value
hedge model, the derivative is recognized at fair value on the
balance sheet with an offsetting entry to the income statement.
In addition, changes in fair value of the Notes due to changes
in the benchmark interest rate are recognized as a basis
adjustment to the carrying amount of the Notes with an
offsetting entry to the income statement. The gain or loss from
the change in fair value of the Transactions and the offsetting
change in the fair value of the Notes are recognized as interest
and other expense. The net unrealized gain recorded as of
December 31, 2003 was approximately $5.6 million and
the estimated fair value of the Transactions was
$9.4 million at December 31, 2003.
The Notes were fully repaid in August 2004, and the Transactions
were left intact and became a speculative investment, with gains
and losses being recorded in the consolidated statement of
income. On October 27, 2004, the Transactions automatically
terminated as the Company’s five-day average common stock
price was equal to $22.59. The Company recorded a loss of
$3.2 million in 2004 for the period of time from the
repayment of the Notes through the termination of the
Transactions.
To test effectiveness of the hedge, regression analysis was
performed at least quarterly comparing the change in fair value
of the Transactions and the Notes. The fair values of the
Transactions and the Notes were calculated at least quarterly as
the present value of the contractual cash flows to the expected
maturity date, where the expected maturity date is based on
probability-weighted analysis of interest rates relating to the
five-year LIBOR curve and the Company’s stock prices. For
2004 and 2003, the hedge was highly effective until the
repayment of the Notes and therefore, the ineffective portion
did not have a material impact on earnings.
In support of the Company’s obligation under the
Transactions, the Company was required to maintain with the
Banks a minimum level of cash and investment collateral of
$20.0 million and periodically adjust the overall level of
collateral depending on the fair market value of the
Transactions. This minimum amount of collateral is presented as
restricted cash in the consolidated balance sheet as of
December 31, 2003. The swap agreement terminated in October
2004, consequently, there is no restricted cash balance at
December 31, 2004 for the Transactions.
In March 2002, the Company purchased a one-year collar
consisting of 300,354 purchased put options with a strike price
of $17.31 and the same number of written call options with a
strike price of $22.04.
94
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Underlying both the put and call options were the Secure
Computing shares. The Company designated the purchased collar as
a fair value hedge of the Secure Computing available-for-sale
securities received in the sales of Gauntlet assets (see
Note 5) in accordance with SFAS 133. At the inception
of the hedge, the Company assessed that the collar was highly
effective based upon expected changes in the collar’s
intrinsic value. In July 2002, the Company sold its shares in
Secure Computing and closed its collar. As a result the Company
recorded a net gain of $0.3 million, which is recorded as a
gain of $0.4 million from the sale of the collar offset by
a loss of $0.1 million from the sale of Secure Computing
securities for 2002.
8. Consolidated Balance Sheet
Detail (in thousands):
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Property and equipment:
|
|
|
|
|
|
|
|
|
| |
Building
|
|
$ |
19,828 |
|
|
$ |
19,822 |
|
| |
Furniture and fixtures
|
|
|
18,728 |
|
|
|
27,469 |
|
| |
Computers and equipment
|
|
|
154,005 |
|
|
|
198,737 |
|
| |
Leasehold improvements
|
|
|
21,421 |
|
|
|
26,179 |
|
| |
Construction in progress
|
|
|
2,034 |
|
|
|
23,505 |
|
| |
|
|
|
|
|
|
| |
|
|
216,016 |
|
|
|
295,712 |
|
| |
Accumulated depreciation
|
|
|
(129,363 |
) |
|
|
(189,102 |
) |
| |
|
|
|
|
|
|
| |
|
|
86,653 |
|
|
|
106,610 |
|
|
Land
|
|
|
5,062 |
|
|
|
5,062 |
|
| |
|
|
|
|
|
|
|
Total property and equipment, net
|
|
$ |
91,715 |
|
|
$ |
111,672 |
|
| |
|
|
|
|
|
|
Depreciation expense for 2004, 2003, and 2002 was
$39.3 million, $35.8 million, and $39.8 million,
respectively.
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Accrued liabilities:
|
|
|
|
|
|
|
|
|
| |
Accrued income taxes, short term
|
|
$ |
70,778 |
|
|
$ |
10,123 |
|
| |
Accrued compensation
|
|
|
53,146 |
|
|
|
51,183 |
|
| |
Accrued marketing costs
|
|
|
2,806 |
|
|
|
3,622 |
|
| |
Accrued legal and accounting fees
|
|
|
9,231 |
|
|
|
6,946 |
|
| |
Accrued interest
|
|
|
— |
|
|
|
6,843 |
|
| |
Other accrued expenses
|
|
|
61,407 |
|
|
|
68,564 |
|
| |
|
|
|
|
|
|
| |
|
$ |
197,368 |
|
|
$ |
147,281 |
|
| |
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Accrued income taxes and other long-term liabilities:
|
|
|
|
|
|
|
|
|
| |
Accrued income taxes, long term
|
|
$ |
188,734 |
|
|
$ |
209,287 |
|
| |
Other
|
|
|
16,062 |
|
|
|
13,478 |
|
| |
|
|
|
|
|
|
| |
|
$ |
204,796 |
|
|
$ |
222,765 |
|
| |
|
|
|
|
|
|
95
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Long-term accrued income taxes represent tax accruals for which
the Company believes any related cash flows would occur after
December 31, 2005.
During 2004, the Company recorded several restructuring charges
related to the reduction of employee headcount. In the first
quarter of 2004, the Company 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 the Company’s North
America and EMEA operating segments, respectively. The workforce
size was reduced primarily due to the Company’s sale of
Magic in January 2004 (see Note 5). In the second quarter
of 2004, the Company recorded a restructuring charge of
approximately $1.6 million related to the severance of
approximately 80 employees in the Company’s 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, the Company 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,
the Company 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 have been terminated at December 31, 2004.
The reductions in the second, third and fourth quarters are part
of the previously announced cost-savings measures being
implemented by the Company.
In September 2004, the Company announced the move of the
European headquarters to Ireland, which is expected to be
substantially completed by the first quarter of 2005. In the
third and fourth quarters of 2004, the Company recorded
restructuring charges of $0.2 million and
$2.2 million, respectively, related to the severance of
approximately 80 employees, all of which was related to the EMEA
operating segment. The costs will be substantially paid in the
first half of 2005.
Also in September 2004, the Company permanently vacated an
additional two floors in its Santa Clara headquarters
building. The Company 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. The Company also recorded a non-cash
charge of approximately $0.8 million related to disposals
of certain leasehold improvements. The restructuring charge of
$6.5 million and related cash outlay are based on
management’s current estimates.
In the fourth quarter of 2004, the Company 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, the Company adjusted the restructuring accruals
related to severance costs and lease termination costs recorded
in 2004. The Company 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. The Company 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 its Santa Clara
headquarters building.
96
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table summarizes the Company’s restructuring
accruals established in 2004 (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 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2004, $5.8 million of the
restructuring accrual is due within 12 months and has been
classified as current accrued liabilities, while the remaining
balance of $6.1 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
$5.2 million at December 31, 2004.
In January 2003, as part of a restructuring effort to gain
operational efficiencies, the Company consolidated operations
formerly housed in three leased facilities in the Dallas, Texas
area into its regional headquarters facility in Plano, Texas.
The facility houses employees working in finance, information
technology, and the customer support and telesales groups
servicing the McAfee System Protection Solutions and McAfee
Network Protection Solutions businesses.
As part of the consolidation of activities into the Plano
facility, the Company relocated employees from the
Santa Clara, California headquarters site. As a result of
this consolidation, in March 2003, the Company 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. The Company 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. The total
restructuring charge of $15.8 million and related cash
outlay are based on management’s current estimates. This
restructuring charge was allocated to the Company’s North
American segment.
During the second and third quarters of 2003, the Company
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 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 the Company’s North American and EMEA
operating segments, respectively. The employees were located in
the Company’s domestic and international locations and were
primarily in the sales, product development and customer support
areas. In the third and fourth quarters of 2003, the Company
reversed a total of $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 and 2003, the Company adjusted the restructuring accrual
related to lease termination costs previously recorded in 2003.
The adjustments decreased the liability by approximately
$0.6 million and $0.3 million in 2004 and 2003,
respectively, due to changes in estimates related to the
sublease income to be
97
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
received over the remaining lease term. Also in 2004, the
Company recorded a $0.1 million adjustment to reduce the
restructuring accrual for severance and benefits from its EMEA
operating segment that would not be utilized.
The following table summarizes the Company’s restructuring
accrual established in 2003 and activity through
December 31, 2004 (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 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2004, $1.3 million of the
restructuring accrual is due within 12 months and has been
classified as current accrued liabilities, while the remaining
balance of $11.0 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
$10.9 million at December 31, 2004.
The Company’s estimate of the excess facilities charges
recorded during 2003 and 2004 may vary significantly depending,
in part, on factors which may be beyond the Company’s
control, such as the Company’s success in negotiating with
its lessor, the time periods required to locate and contract
suitable subleases and the market rates at the time of such
subleases. Adjustments to the facilities accrual will be made if
actual lease exit costs or sublease income differ from amounts
currently expected.
As part of the plan to integrate certain activities of the
Company’s PGP product group into its other product groups
and to dispose of other product lines, the Company sold its
Gauntlet business during the first quarter of 2002. In
connection with this process, a restructuring charge of
approximately $1.1 million was recorded. The restructuring
charge consists of costs of severance packages for 44 employees
as well as related legal and outplacement services. All amounts
were paid at December 31, 2002.
|
|
| 10. |
Goodwill and Intangible Assets |
The Company accounts for goodwill and other intangible assets in
accordance with SFAS No. 142, “Goodwill and
Other Intangible Assets.” In lieu of amortization, the
Company performs an impairment review of its goodwill on at
least an annual basis. The impairment review requires a two-step
process.
The Company performs its annual goodwill impairment review as of
October 1, of its fiscal year. In 2004, 2003, and 2002,
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. The Company will continue to test
for impairment on an annual basis and on an interim basis if an
event occurs or circumstances change that would more likely than
not reduce the fair value of the Company’s reporting units
below their carrying amounts. An interim impairment analysis was
performed in the second quarter of 2004 to coincide with the
sale of the Company’s Sniffer product line.
98
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Goodwill information is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
Effects of | |
|
|
|
|
|
|
|
Effects of | |
|
|
| |
|
|
|
|
|
|
|
Foreign | |
|
|
|
|
|
|
|
Foreign | |
|
|
| |
|
January 1, | |
|
Goodwill | |
|
|
|
Currency | |
|
December 31, | |
|
Goodwill | |
|
|
|
Currency | |
|
December 31, | |
| |
|
2003 | |
|
Acquired | |
|
Adjustments | |
|
Exchange | |
|
2003 | |
|
Acquired | |
|
Adjustments | |
|
Exchange | |
|
2004 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
North America
|
|
$ |
232,122 |
|
|
$ |
137,636 |
|
|
$ |
(6,671 |
) |
|
$ |
1,238 |
|
|
$ |
364,325 |
|
|
$ |
59,235 |
|
|
$ |
(59,007 |
) |
|
$ |
571 |
|
|
$ |
365,124 |
|
|
EMEA
|
|
$ |
25,424 |
|
|
$ |
21,477 |
|
|
$ |
(2,830 |
) |
|
$ |
289 |
|
|
$ |
44,360 |
|
|
$ |
— |
|
|
$ |
(2,930 |
) |
|
$ |
221 |
|
|
$ |
41,651 |
|
|
Japan
|
|
$ |
12,071 |
|
|
$ |
4,678 |
|
|
$ |
(1 |
) |
|
$ |
— |
|
|
$ |
16,748 |
|
|
$ |
— |
|
|
$ |
(351 |
) |
|
$ |
— |
|
|
$ |
16,397 |
|
|
Asia-Pacific (excluding Japan)
|
|
$ |
2,301 |
|
|
$ |
3,814 |
|
|
$ |
(28 |
) |
|
$ |
— |
|
|
$ |
6,087 |
|
|
$ |
— |
|
|
$ |
(520 |
) |
|
$ |
— |
|
|
$ |
5,567 |
|
|
Latin America
|
|
$ |
2,016 |
|
|
$ |
3,905 |
|
|
$ |
5,454 |
|
|
$ |
698 |
|
|
$ |
12,073 |
|
|
$ |
— |
|
|
$ |
(1,724 |
) |
|
$ |
92 |
|
|
$ |
10,441 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
273,934 |
|
|
$ |
171,510 |
|
|
$ |
(4,076 |
) |
|
$ |
2,225 |
|
|
$ |
443,593 |
|
|
$ |
59,235 |
|
|
$ |
(64,532 |
) |
|
$ |
884 |
|
|
$ |
439,180 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill was acquired during 2004 as a result of the purchase of
Foundstone, and during 2003 as part of the purchases of
Entercept and Intruvert (see Note 4).
For 2004, the adjustments column consists primarily of a
reduction of $50.5 million due to the sale of Sniffer in
2004 (see Note 5), $13.6 million in adjustments
related to the realization of net deferred tax assets from the
Cybermedia, BySupport and IntruVert acquisitions and
$0.4 million related to purchase price adjustments. For
2003, the adjustments column reflects a $6.2 million
increase due to purchase price adjustments related to the
BySupport acquisition in 2002, and a $9.8 million decrease
due to the reclassification of Magic goodwill to assets held for
sale. The goodwill adjustments related to each of the businesses
were allocated based on the relative percentage of their
respective estimated fair values to the Company’s fair
value by reporting unit.
The components of intangible assets are as follows (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, 2004 | |
|
December 31, 2003 | |
| |
|
| |
|
| |
| |
|
|
|
Accumulated | |
|
|
|
|
|
Accumulated | |
|
|
| |
|
|
|
Amortization | |
|
|
|
|
|
Amortization | |
|
|
| |
|
Weighted | |
|
|
|
(Including Effects | |
|
|
|
|
|
(Including Effects | |
|
|
| |
|
Average | |
|
Gross | |
|
of Foreign | |
|
Net | |
|
Gross | |
|
of Foreign | |
|
Net | |
| |
|
Useful | |
|
Carrying | |
|
Currency | |
|
Carrying | |
|
Carrying | |
|
Currency | |
|
Carrying | |
| |
|
Life | |
|
Amount | |
|
Exchange) | |
|
Amount | |
|
Amount | |
|
Exchange) | |
|
Amount | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Other Intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Purchased technologies
|
|
|
6.0 years |
|
|
$ |
139,509 |
|
|
$ |
(74,400 |
) |
|
$ |
65,109 |
|
|
$ |
116,037 |
|
|
$ |
(64,439 |
) |
|
$ |
51,598 |
|
| |
Trademarks, patents customer base, and other intangibles
|
|
|
6.4 years |
|
|
|
90,335 |
|
|
|
(48,311 |
) |
|
|
42,024 |
|
|
|
103,431 |
|
|
|
(49,077 |
) |
|
|
54,354 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
6.1 years |
|
|
$ |
229,844 |
|
|
$ |
(122,711 |
) |
|
$ |
107,133 |
|
|
$ |
219,468 |
|
|
$ |
(113,516 |
) |
|
$ |
105,952 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
99
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The aggregate amortization expenses for the intangible assets
listed above totaled $27.4 million, $27.0 million, and
$13.9 million for 2004, 2003, and 2002, respectively.
| |
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(In thousands) | |
|
Intangible assets, beginning of year
|
|
$ |
219,468 |
|
|
$ |
177,255 |
|
| |
Add: Purchased technologies (amortized over one to seven years)
|
|
|
27,000 |
|
|
|
40,523 |
|
| |
Add: Trademarks, patents and other intangibles (amortized over
one to seven years)
|
|
|
1,600 |
|
|
|
4,704 |
|
| |
Add: Change in value due to foreign exchange
|
|
|
2,122 |
|
|
|
2,738 |
|
| |
|
|
|
|
|
|
| |
|
|
250,190 |
|
|
|
225,220 |
|
| |
Less: Transfers to goodwill
|
|
|
— |
|
|
|
(5,752 |
) |
| |
|
|
|
|
|
|
| |
|
Dispositions
|
|
|
(20,346 |
) |
|
|
— |
|
|
Intangible Assets, end of year
|
|
$ |
229,844 |
|
|
$ |
219,468 |
|
| |
|
|
|
|
|
|
The additions in 2004 are a result of the Foundstone
acquisition. The dispositions consist of the sale of the Magic
and Sniffer product lines in 2004. The additions in 2003 consist
of the IntruVert and Entercept acquisitions. The transfers to
goodwill in 2003 are a result of purchase accounting adjustments
for BySupport.
Expected future intangible asset amortization expense is as
follows (in thousands):
| |
|
|
|
|
|
|
Fiscal Years:
|
|
|
|
|
| |
2005
|
|
$ |
27,585 |
|
| |
2006
|
|
|
24,896 |
|
| |
2007
|
|
|
21,954 |
|
| |
2008
|
|
|
16,586 |
|
| |
2009
|
|
|
10,727 |
|
| |
Thereafter
|
|
|
5,385 |
|
| |
|
|
|
| |
|
$ |
107,133 |
|
| |
|
|
|
The Company leases most of its operating facilities under
non-cancelable operating leases, which expire at various times
ranging from the year 2005 through 2017. The Company’s
operating leases for facilities typically include renewal
periods which are at the option of the Company, and contractual
escalations in monthly payments. The Company owns its regional
office in Plano, Texas. A description of the Company’s
significant operating leases is as follows:
| |
|
|
|
|
|
|
| |
|
Lease Expiration | |
|
Renewal Option |
| |
|
| |
|
|
|
Corporate Headquarters, Santa Clara, California
|
|
March 2013 |
|
|
None |
|
European Headquarters, Cork, Ireland
|
|
December 2014 |
|
|
Two 5 year renewals |
|
Amsterdam, The Netherlands
|
|
June 2008 |
|
|
5 year renewal |
|
Slough, England
|
|
December 2017 |
|
|
None |
|
Paris, France
|
|
April 2012 |
|
|
None |
|
Tokyo, Japan
|
|
February 2006 |
|
|
None |
100
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In addition, the Company has leased certain office equipment
with various lease expiration dates through 2007.
Future minimum payments, including contractual and reasonably
assured escalations in future lease payments, and sublease
rental income under non-cancelable operating leases are as
follows for the years ended December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Sublease | |
| |
|
Payments | |
|
Income | |
| |
|
| |
|
| |
|
2005
|
|
$ |
24,197 |
|
|
$ |
1,294 |
|
|
2006
|
|
|
20,643 |
|
|
|
737 |
|
|
2007
|
|
|
16,558 |
|
|
|
— |
|
|
2008
|
|
|
15,392 |
|
|
|
— |
|
|
2009
|
|
|
14,889 |
|
|
|
— |
|
|
Thereafter
|
|
|
61,810 |
|
|
|
— |
|
| |
|
|
|
|
|
|
| |
Total
|
|
$ |
153,489 |
|
|
$ |
2,031 |
|
| |
|
|
|
|
|
|
Rent expense for 2004, 2003, and 2002 was $21.2 million,
$21.3 million, and $25.2 million, respectively.
Sublease rental income under non-cancelable subleases was
$1.5 million, $0.4 million, and $0.1 million for
2004, 2003, and 2002, respectively.
|
|
| 12. |
Warranty Provision and Guarantees |
The Company offers warranty on its hardware and software
products and records a liability for the estimated future costs
associated with warranty claims, which is based upon historical
experience and the Company’s estimate of the level of
future costs. A reconciliation of the change in the
Company’s warranty obligation for the years ended
December 31 follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Warranty provision, beginning of year
|
|
$ |
1,103 |
|
|
$ |
1,153 |
|
|
$ |
982 |
|
|
Additional accruals
|
|
|
8,037 |
|
|
|
3,881 |
|
|
|
4,624 |
|
|
Disposition of Sniffer
|
|
|
(807 |
) |
|
|
— |
|
|
|
— |
|
|
Expenses incurred during the period
|
|
|
(6,515 |
) |
|
|
(3,931 |
) |
|
|
(4,453 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Warranty provision, end of year
|
|
$ |
1,818 |
|
|
$ |
1,103 |
|
|
$ |
1,153 |
|
| |
|
|
|
|
|
|
|
|
|
In November 2002, the FASB issued Interpretation No. 45
(“FIN 45”), “Guarantor’s Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others.” FIN 45
requires that a guarantor recognize, at the inception of a
guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee or indemnification.
FIN 45 also requires additional disclosure by a guarantor
in its interim and annual consolidated financial statements
about its obligations under certain guarantees and
indemnifications. The following is a summary of the agreements
that the Company has determined are within the scope of
FIN 45 as of December 31, 2004:
|
|
|
| |
• |
Under the terms of the Company’s software license
agreements with its customers, the Company agrees that in the
event the software sold infringes upon any patent, copyright,
trademark, or any other proprietary right of a third party, it
will indemnify its customer licensees against any loss, expense,
or liability from any damages that may be awarded against its
customer. The Company includes this infringement indemnification
in all of its software license agreements and selected managed
service arrangements. In the event the customer cannot use the
software or service due to infringement and the Company can not
obtain the right to use, replace or modify the license or
service in a commercially |
101
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
|
|
|
| |
|
feasible manner so that it no longer infringes then the Company
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. The Company has recorded no liability
associated with this indemnification, as it is not aware of any
pending or threatened infringement actions that are probable
losses. The Company believes the estimated fair value of these
intellectual property indemnification clauses is minimal. |
| |
| |
• |
Under the terms of certain vendor agreements, in particular,
vendors used as part of the Company’s managed services, the
Company has agreed that in the event the service provided to the
customer by the vendor on behalf of the Company infringes upon
any patent, copyright, trademark, or any other proprietary right
of a third party, it will indemnify its vendor, against any
loss, expense, or liability from any damages that may be awarded
against its customer. No maximum liability is stipulated in
these vendor agreements. The Company has recorded no liability
associated with this indemnification, as it is not aware of any
pending or threatened infringement actions or claims that are
probable losses. The Company believes the estimated fair value
of these indemnification clauses is minimal. |
| |
| |
• |
The Company has agreed to indemnify members of the board of
directors, as well as officers of the Company, if they are made
a party or are threatened to be made a party to any proceeding
(other than an action by or in the right of the Company) by
reason of the fact that they are an agent of the Company, or by
reason of anything done or not done by them in any such
capacity. The indemnity is for any and all expenses and
liabilities of any type whatsoever (including judgments, fines
and amounts paid in settlement) actually and reasonably incurred
by the directors or officers in connection with the
investigation, defense, settlement or appeal of such proceeding,
provided they acted in good faith. The Company maintains
insurance coverage for directors and officers liability
(“D&O insurance”). No maximum liability is
stipulated in these agreements that include indemnifications of
members of the board of directors and officers of the Company.
The Company has recorded no liability associated with these
indemnifications as it is not aware of any pending or threatened
actions or claims against its members of the board of directors
or officers that are probable losses in excess of amounts
covered by its D&O insurance. As a result of the insurance
policy coverage, the Company believes the estimated fair value
of these indemnification agreements is minimal. |
| |
| |
• |
Under the terms of the Company’s agreement to sell Magic in
January 2004, the Company 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, the Company has paid no amounts
under the representations and warranties indemnification. The
Company has not recorded any accruals related to these
agreements. |
| |
| |
• |
Under the terms of the Company’s agreement to sell Sniffer
in July 2004, the Company 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, the Company has paid no amounts
under the representations and warranties indemnification. The
Company has not recorded any accruals related to these
agreements. |
| |
| |
• |
Under the terms of the Company’s agreement to sell McAfee
Labs assets in December 2004, the Company 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. The Company has not
recorded any accruals related to these agreements. |
102
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
|
|
|
| |
• |
Under the terms of the Company’s agreements to sell the PGP
and Gauntlet assets in 2002, the Company agreed to indemnify the
purchasers for any breach of representations or warranties in
the agreement as well as for any liabilities related to the
assets prior to sale that are not included in the purchaser
assumed liabilities (undiscovered liabilities). The maximum
potential loss related to the indemnification for breach of
representations or warranties is $2.4 million. No maximum
liability is stipulated in the agreement related to any
undiscovered liabilities. To date, the Company has paid
$0.4 million under the representations and warranties
indemnification. |
If the Company believes a liability associated with any of the
aforementioned indemnifications becomes probable and the amount
of the liability is reasonably estimable or the maximum amount
of a range of loss is reasonably estimable, then an appropriate
liability will be established.
|
|
| 13. |
Convertible Debt and Line of Credit |
The convertible debt balance was $0 and $347.4 million, net
of accumulated fair value adjustment of $0 and $2.4 million
(see Note 7), at December 31, 2004 and 2003,
respectively.
|
|
|
Zero Coupon Convertible Debentures Due 2018 |
In February 1998, the Company completed a private placement of
zero coupon convertible subordinated debentures due in 2018 (the
“Debentures”). The Debentures, with an aggregate face
amount at maturity of $885.5 million, generated net
proceeds to the Company of approximately $337.6 million.
The initial price to the public for the debentures was
$391.06 per $1,000 of face amount at maturity, which
equates to a yield to maturity over the term of the Debentures
of 4.75% (on a semi-annual Debentures equivalent basis). The
Debentures were convertible into common stock at the rate of
8.538 shares per $1,000 of face amount at maturity, which
equated to an initial conversion price of $45.80 per share.
The Debentures were subordinated in right of payment to all
existing and future Senior Indebtedness (as defined in the
related indenture) and effectively subordinated in right of
payment to all indebtedness and other liabilities of the
Company’s subsidiaries.
In accordance with the indenture, in 2002, the Company redeemed
a portion of the Debentures, which had an aggregate face amount
at maturity of $140.0 million, at a net price of
$66.2 million, which was financed from the Company’s
investment portfolio. In connection with this repurchase, the
Company recognized a net gain of approximately $26,000 in 2002.
The gain was calculated as the difference between the accreted
value of the debt, net of unamortized issuance costs and the
cost of repurchase.
In February 2003, outstanding Debentures, with an aggregate face
amount at maturity of $358.5 million, became redeemable for
cash at the option of the holders thereof, at which time the
Company repurchased Debentures which had an aggregate face
amount at maturity of $358.0 million for a net price of
$177.1 million. In June 2003, the Company repurchased the
remaining Debentures with an aggregate face amount at maturity
of $0.5 million for a net price of $0.2 million. The
Company recognized a loss of $2.7 million on the repurchase
of Debentures during 2003.
|
|
|
5.25% Convertible Subordinated Note Due
2006 |
In August 2001, the Company issued 5.25% convertible
subordinated notes (“Notes”) due 2006 with an
aggregate principal amount of $345.0 million. The issuance
generated net proceeds (after deducting fees and expenses) of
$335.1 million. The amortization of the issuance costs
related to the Notes has been calculated using the effective
interest method and recorded as additional interest expense in
the statements of income. The Notes were unsecured and were
subordinated to all existing and future Senior Indebtedness (as
defined in the related indenture). The Notes had no restrictive
financial covenants.
103
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Notes had a maturity date of August 15, 2006, unless
earlier redeemed by the Company at its option or converted at
the holder’s option. At the option of the holder, the Notes
were convertible into the Company’s common stock at any
time, unless previously redeemed, at a conversion price of
$18.07 per share. The Notes could also be redeemed at the
option of the holder in the event of a Change of Control (as
defined in the related indenture). At any time between
August 20, 2004 and August 14, 2005, the Company would
be able to redeem all or a portion of the Notes for cash at a
repurchase price of 101.3125% of the principal amount. After
August 14, 2005, the repurchase price would be 100.0% of
the principal amount.
In August 2004, the Company redeemed all of the outstanding
Notes at a net price of $265.6 million. Prior to the
redemption date, approximately $83.4 million in aggregate
principal amount of the Notes converted into approximately
4.6 million shares of the Company’s common stock. The
Company recorded a loss on redemption of approximately
$15.1 million, which represented the write-off of
unamortized debt issuance costs, fair value adjustment and the
1.3125% premium paid for redemption.
In July 2002, the Company entered into an interest rate swap
transaction with two investment banks, which resulted in the
convertible notes being carried at fair value (see Note 7).
The estimated fair value of the Company’s long-term debt
outstanding at December 31, 2003, which consisted of Notes
with a carrying amount of $347.4, was $373.1 million.
The Company has 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 the Company 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 December 31, 2004.
|
|
| 14. |
Employee Benefit Plans |
|
|
|
Company 401(k) and Profit Sharing Plan |
The Company’s 401(k) and Profit Sharing Plan cover
substantially all full-time employees. Employees can elect to
defer the lesser of 40% of their compensation or
$13,000 per year. The board of directors, at its
discretion, can match employee contributions in an amount not to
exceed a maximum of $4,000 per year. The number of plan
participants was impacted by headcount reductions resulting from
the Magic and Sniffer dispositions, as well as general headcount
reductions. Annual amounts contributed by the Company under the
plan were $4.0 million, $4.7 million, and
$4.3 million in 2004, 2003 and 2002, respectively.
|
|
|
Company Employee Stock Purchase Plan |
In April 2002, the Company’s board of directors adopted
McAfee’s 2002 Employee Stock Purchase Plan (“2002
Purchase Plan”) and an initial 2.0 million shares of
the Company’s common stock were reserved for issuance. In
December 2003, the Company’s stockholders approved an
additional 2.0 million shares for issuance under the 2002
Purchase Plan for a total of 4.0 million shares. All
employees are eligible to participate in the 2002 Purchase Plan.
The 2002 Purchase Plan is comprised of two year offering periods
with four six-month purchase periods. Purchase periods occur
twice yearly and each offering effectively contains a six,
twelve, eighteen and twenty-four month option. Shares are
purchased through employees’ contributions at exercise
prices equal to 85% of the lesser of the fair market value of
the Company’s common stock at either the first day of an
offering period or the last day of the purchase period. No
participant may purchase more than $25,000 of common stock in
any one calendar year and the maximum number of shares a
participant may purchase during a single offering period is
10,000 shares. In 2004 and 2003, approximately
0.8 million and
104
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
1.6 million shares were issued under the 2002 Purchase Plan
at a weighted average purchase price of $10.41 and $9.89,
respectively.
Under the 1994 Employee Qualified Stock Purchase Plan
(“1994 Purchase Plan”), the Company could grant stock
purchase rights to all eligible employees during one year
offering periods with exercise dates approximately every six
months (beginning each August and February). The Company had
reserved 3.8 million shares of common stock for issuance
under the plan. Shares were purchased through employees’
payroll deductions at exercise prices equal to 85% of the lesser
of the fair value of the Company’s common stock at either
the first day of an offering period or the last day of such
offering period. No participant could purchase more than $25,000
of common stock in any one calendar year. After the purchase on
January 31, 2002, the 1994 Purchase Plan was terminated. In
2002, approximately 0.7 million shares were issued under
the 1994 Purchase Plan at a weighted average purchase price of
$7.24.
|
|
|
McAfee.com Employee Stock Purchase Plan |
In September 1999, McAfee.com’s board of directors adopted
McAfee.com’s Employee Stock Purchase Plan (the “1999
Purchase Plan”). A total of 0.5 million shares of
McAfee.com Class A common stock were initially reserved for
issuance under the 1999 Purchase Plan. All McAfee.com full-time
employees were eligible to participate in the 1999 Purchase
Plan. The 1999 Purchase Plan was comprised of two-year offering
periods with exercise dates approximately every six months
(beginning each August and February), with the exception of the
first offering period, which commenced on December 2, 1999,
with the first exercise date on January 31, 2000. Shares
were purchased through McAfee.com employees’ payroll
deductions at exercise prices equal to 85% of the lesser of the
fair market value of McAfee.com’s Class A common stock
at either the first day of an offering period or the last day of
such offering period. No participant could purchase more than
$25,000 worth of Class A common stock in any one calendar
year and the maximum number of shares a participant could
purchase during a single purchase period was 2,500 shares.
Purchase periods occurred twice yearly and each offering
effectively contained a six, twelve, eighteen and twenty-four
month option. On September 13, 2002, the Company acquired
the minority interest in McAfee.com and therefore the McAfee.com
employee stock purchase plan was terminated. In 2002,
approximately 0.2 million of McAfee.com shares were issued
under the 1999 Purchase Plan at weighted average purchase price
of $6.66. There was no activity under this plan in 2004 and 2003.
In November 2003, the Company’s board of directors
authorized the repurchase up to $150.0 million of the
Company’s common stock in the open market. In August 2004,
the board of directors authorized the repurchase of an
additional $200.0 million of common stock through August
2006. The Company repurchased approximately 12.6 million
and 0.4 million shares of its common stock in 2004 and 2003
for $221.8 million and $4.7 million, respectively. As
of December 31, 2004, the Company may repurchase an
additional $123.6 million of its common stock. The timing
and size of future repurchases are subject to market conditions,
stock prices, the Company’s cash position and other cash
requirements.
In 2004, the Company retired approximately 13.0 million
shares of its common stock which had been purchased on the open
market in 2003 and 2004.
In 1998, the Company deposited approximately 1.7 million
shares of common stock with a trustee for the benefit of the
employees of the Dr. Solomon’s acquisition to cover
the stock options assumed in the acquisition of this company.
These shares, which have been included in the outstanding share
balance, were to be issued upon the exercise of stock options by
Dr. Solomon’s employees. The Company determined in
June 2004 that Dr. Solomon’s employees had exercised
approximately 1.6 million options, and that it had issued
new shares in
105
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
connection with these exercises rather than the trust shares.
The trustee returned the 1.6 million shares to the Company
in June 2004, at which time they were retired and were no longer
included in the outstanding share balance. In December 2004, the
trustee sold the remaining 133,288 shares in the trust for
proceeds of $3.8 million, and remitted the funds to the
Company. The terms of the trust prohibited the trustee from
returning the shares to the Company and stipulated that only
employees could benefit from the shares. The Company paid out
the $3.8 million to its employees as a bonus in 2004.
The Company has authorized 5.0 million shares of preferred
stock, par value $0.01 per share. The Company’s board
of directors has authority to provide for the issuance of the
shares of preferred stock in series, to establish from time to
time the number of shares to be included in each such series and
to fix the designation, powers, preferences and rights of the
shares of each such series and the qualifications, limitations
or restrictions thereof, without any further vote or action by
the shareholders.
|
|
|
Company Stock Option Plans |
Under the amended 1997 Plan, the Company has reserved
32.5 million shares for issuance to employees, officers,
directors, third party contractors and consultants. The plan
provides for an option price no less than 100% of the fair value
of the Company’s common stock on the date of grant for
incentive stock options granted to employees and officers
(including directors who are also employees) or 85% of the fair
value on the date of grant for all others. The options may be
exercisable immediately, or over time, but generally become
exercisable 25% one year after commencing employment or from
date of grant and thereafter in monthly increments over three
years. All options under the option plan expire ten years after
grant.
Under the Stock Option Plan for Outside Directors, the Company
has reserved 1.1 million shares of its common stock for
issuance to certain members of its board of directors who are
not employees of the Company or any affiliated corporation. The
plan provides for an option price at fair value of the
Company’s common stock on the date of grant. The initial
grant to each outside director generally vests ratably over a
three-year period. Subsequent option grants will become
exercisable after three years from the date of grant. All
options under the option plan expire ten years after grant.
The Company assumed the Foundstone, Inc. 2000 Stock Plan as part
of the acquisition of Foundstone in October 2004 (see
Note 4). The Company has reserved 747,144 shares of
its common stock for issuance under this plan. The plan provides
for an option price no less than 85% of the fair value of the
Company’s common stock on the date of grant. The options
generally become exercisable 25% one year after commencing
employment or from the date of grant and thereafter in monthly
increments over three years. All options under the plan expire
ten years after grant. The Company assumed 428,696 options to
purchase its common stock as a result of the acquisition.
In September 2002, the Company acquired the minority interest in
McAfee.com. At that time, all outstanding options under
McAfee.com’s 1999 Stock Plan and 1999 Director Option
Plan were converted and transferred into the Company’s
option plans and the McAfee.com stock option plans were
terminated.
106
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Aggregate activity under the Company’s stock option plans
is as follows (in thousands, except per share data):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Outstanding Options | |
| |
|
|
|
| |
| |
|
|
|
|
|
Weighted | |
| |
|
Shares | |
|
|
|
Average | |
| |
|
Available | |
|
Number of | |
|
|
|
Aggregate | |
|
Exercise | |
| |
|
for Grant | |
|
Shares | |
|
Price per Share | |
|
Price | |
|
Price | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Balances, January 1, 2002
|
|
|
9,104 |
|
|
|
31,771 |
|
|
|
$ 0.23-$48.72 |
|
|
$ |
421,493 |
|
|
$ |
13.27 |
|
|
Additional options reserved
|
|
|
5,000 |
|
|
|
— |
|
|
|
|
|
|
|
— |
|
|
|
— |
|
|
Option plan expirations
|
|
|
(984 |
) |
|
|
— |
|
|
|
|
|
|
|
— |
|
|
|
— |
|
|
Options granted
|
|
|
(8,302 |
) |
|
|
8,302 |
|
|
|
$ 0.01-$30.26 |
|
|
|
190,401 |
|
|
$ |
22.93 |
|
|
Options issued in exchange of McAfee.com outstanding stock
options
|
|
|
— |
|
|
|
2,761 |
|
|
|
$ 4.63-$71.26 |
|
|
|
46,748 |
|
|
$ |
16.93 |
|
|
Options exercised
|
|
|
— |
|
|
|
(8,197 |
) |
|
|
$ 0.01-$28.50 |
|
|
|
(107,454 |
) |
|
$ |
13.11 |
|
|
Options canceled
|
|
|
6,335 |
|
|
|
(6,335 |
) |
|
|
$ 4.19-$34.69 |
|
|
|
(124,025 |
) |
|
$ |
19.58 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2002
|
|
|
11,153 |
|
|
|
28,302 |
|
|
|
$ 0.01-$71.26 |
|
|
$ |
427,163 |
|
|
$ |
15.09 |
|
|
Option plan expirations
|
|
|
(1,326 |
) |
|
|
— |
|
|
|
|
|
|
|
— |
|
|
|
— |
|
|
Options granted
|
|
|
(7,807 |
) |
|
|
7,807 |
|
|
|
$10.80-$20.28 |
|
|
|
118,364 |
|
|
$ |
15.16 |
|
|
Options exercised
|
|
|
— |
|
|
|
(2,548 |
) |
|
|
$ 1.78-$29.82 |
|
|
|
(20,532 |
) |
|
$ |
8.06 |
|
|
Options canceled
|
|
|
3,821 |
|
|
|
(3,821 |
) |
|
|
$ 4.19-$65.38 |
|
|
|
(69,982 |
) |
|
$ |
18.32 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2003
|
|
|
5,841 |
|
|
|
29,740 |
|
|
|
$ 0.01-$71.26 |
|
|
$ |
455,013 |
|
|
$ |
15.30 |
|
|
Additional options of acquired company reserved
|
|
|
747 |
|
|
|
— |
|
|
|
|
|
|
|
— |
|
|
|
— |
|
|
Option plan expirations
|
|
|
(1,993 |
) |
|
|
— |
|
|
|
|
|
|
|
— |
|
|
|
— |
|
|
Options granted
|
|
|
(5,674 |
) |
|
|
5,674 |
|
|
|
$14.96-$33.39 |
|
|
|
102,131 |
|
|
$ |
18.00 |
|
|
Options assumed in conjunction with acquisition
|
|
|
(429 |
) |
|
|
429 |
|
|
|
$ 1.11-$ 3.68 |
|
|
|
1,153 |
|
|
$ |
2.69 |
|
|
Options exercised
|
|
|
— |
|
|
|
(9,152 |
) |
|
|
$ 0.65-$38.23 |
|
|
|
(106,235 |
) |
|
$ |
11.61 |
|
|
Options canceled
|
|
|
7,262 |
|
|
|
(7,262 |
) |
|
|
$ 2.80-$58.71 |
|
|
|
(139,753 |
) |
|
$ |
19.24 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2004
|
|
|
5,754 |
|
|
|
19,429 |
|
|
|
$ 0.01-$71.26 |
|
|
$ |
312,309 |
|
|
$ |
16.08 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net proceeds from exercise of stock options was
$105.7 million, $19.6 million and $99.7 million
for 2004, 2003 and 2002, respectively, which is net of a
reduction in stock option exercise proceeds of
$0.5 million, $0.9 million and $7.8 million,
respectively. This reduction is for the payment of the
Company’s cash obligation, not exceeding the full exercise
price, which is triggered upon exercise of the Company stock
options that were granted in exchange for the McAfee.com options
(see Note 16).
During 2004 the Company granted 1.1 million stock options
to employees for which the exercise price was below the fair
value of its common stock on the date of grant. The Company is
recognizing approximately $0.1 million in compensation
expense over the vesting period of the options. During 2002, the
Company exchanged approximately 2.3 million options in the
McAfee.com acquisition at exercise prices below fair value as of
the acquisition date (see Note 16). No options were granted
to employees below or above fair value during 2003.
107
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
For various price ranges, weighted average characteristics of
outstanding stock options of the Company at December 31,
2004 were as follows (in thousands, except per share data):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Options Outstanding | |
|
Options Exercisable | |
| |
|
| |
|
| |
| |
|
|
|
Weighted | |
|
|
|
|
| |
|
|
|
Average | |
|
Weighted | |
|
|
|
Weighted | |
| |
|
|
|
Remaining | |
|
Average | |
|
|
|
Average | |
| |
|
Number | |
|
Contractual | |
|
Exercise | |
|
Number | |
|
Exercise | |
| Range of Exercise Prices |
|
Outstanding | |
|
Life (Yrs) | |
|
Price | |
|
Exercisable | |
|
Price | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
$ 0.01-$ 1.98
|
|
|
98 |
|
|
|
4.3 |
|
|
$ |
0.63 |
|
|
|
51 |
|
|
$ |
1.21 |
|
|
$ 1.99-$ 4.12
|
|
|
359 |
|
|
|
5.1 |
|
|
$ |
2.88 |
|
|
|
237 |
|
|
$ |
2.80 |
|
|
$ 4.13-$ 6.19
|
|
|
2,370 |
|
|
|
5.1 |
|
|
$ |
4.66 |
|
|
|
2,269 |
|
|
$ |
4.67 |
|
|
$ 6.20-$ 9.30
|
|
|
534 |
|
|
|
5.5 |
|
|
$ |
7.63 |
|
|
|
421 |
|
|
$ |
7.58 |
|
|
$ 9.31-$13.97
|
|
|
2,926 |
|
|
|
7.2 |
|
|
$ |
12.22 |
|
|
|
1,399 |
|
|
$ |
11.98 |
|
|
$13.98-$20.97
|
|
|
9,169 |
|
|
|
8.1 |
|
|
$ |
17.27 |
|
|
|
2,339 |
|
|
$ |
17.09 |
|
|
$20.98-$31.47
|
|
|
3,817 |
|
|
|
6.3 |
|
|
$ |
25.17 |
|
|
|
2,432 |
|
|
$ |
24.98 |
|
|
$31.48-$47.22
|
|
|
133 |
|
|
|
6.0 |
|
|
$ |
35.47 |
|
|
|
99 |
|
|
$ |
36.13 |
|
|
$47.23-$74.00
|
|
|
23 |
|
|
|
3.7 |
|
|
$ |
57.39 |
|
|
|
23 |
|
|
$ |
57.53 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
19,429 |
|
|
|
7.1 |
|
|
$ |
16.08 |
|
|
|
9,270 |
|
|
$ |
14.76 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2003 and 2002, the Company had
14.1 million and 10.0 million options that were
exercisable with weighted average exercise prices of $15.33 and
$14.27, respectively.
|
|
|
Proforma Stock Compensation Disclosure |
The fair value of options granted by the Company and McAfee.com
has been calculated using the Black-Scholes option-pricing model
using the single option approach. A typical option grant vests
over a four-year period. Parameters for the option analysis are
listed below.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
The Company:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Risk free interest rate
|
|
|
3.07 |
% |
|
|
2.44 |
% |
|
|
3.46 |
% |
| |
Expected life (years)
|
|
|
4 |
|
|
|
4 |
|
|
|
4 |
|
| |
Volatility
|
|
|
63 |
% |
|
|
96 |
% |
|
|
84 |
% |
| |
Dividend yield
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
The weighted average grant date fair value of options granted by
the Company in 2004, 2003 and 2002 was $9.08, $10.38 and $10.07,
respectively.
The weighted average fair value of restricted stock granted by
the Company in 2002 was $27.19.
| |
|
|
|
|
|
|
|
|
| |
|
|
|
Options | |
| |
|
Options | |
|
Granted to | |
| |
|
Granted to | |
|
Non- | |
| |
|
Employees | |
|
Employees | |
| |
|
2002 | |
|
2002 | |
| |
|
| |
|
| |
|
Risk free interest rate
|
|
|
3.82 |
% |
|
|
3.82 |
% |
|
Expected life (years)
|
|
|
5 |
|
|
|
10 |
|
|
Volatility
|
|
|
110 |
% |
|
|
110 |
% |
|
Dividend yield
|
|
|
— |
|
|
|
— |
|
108
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The weighted average expected life of the option grants was
estimated based on historical exercise patterns.
The weighted average grant date fair value of options granted by
McAfee.com to employees in 2002 was $7.76.
The Company and McAfee.com have also estimated the fair value of
purchase rights issued under their employee stock purchase
plans. Rights under these plans were also valued using the
Black-Scholes option pricing model. Parameters for the purchase
rights analysis are listed below:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Risk free interest rate
|
|
|
2.03 |
% |
|
|
1.43 |
% |
|
|
2.05 |
% |
|
Expected life (years)
|
|
|
1.25 years |
|
|
|
1.25 years |
|
|
|
6 months |
|
|
Volatility
|
|
|
48 |
% |
|
|
72 |
% |
|
|
84 |
% |
|
Dividend yield
|
|
|
|
|
|
|
— |
|
|
|
— |
|
The weighted average fair value of rights issued pursuant to the
Company’s employee stock purchase plans in 2004, 2003 and
2002, was $6.58, $13.75, and $14.62, respectively.
| |
|
|
|
|
| |
|
2002 | |
| |
|
| |
|
Risk free interest rate
|
|
|
1.72 |
% |
|
Expected life (years)
|
|
|
6 months |
|
|
Volatility
|
|
|
110 |
% |
|
Dividend yield
|
|
|
— |
|
The weighted average fair value of rights issued by McAfee.com
pursuant to its employee stock purchase plan until
September 13, 2002 was $39.60.
|
|
|
Preferred Shares Rights Agreement |
On October 19, 1998, pursuant to a Preferred Shares Rights
Agreement between the Company and BankBoston, N.A. as Rights
Agent, the board of directors of the Company announced that it
had declared a dividend distribution of one preferred share
purchase right (a “Right”) on each outstanding share
of the Company’s common stock. Each Right will entitle
stockholders to buy one one-thousandth of a share of the
Company’s Series B Participating Preferred Stock at an
exercise price of $200.00. The Rights will become exercisable
following the tenth day after a person or group announces the
acquisition of 15% or more of the Company’s common stock or
announces commencement of a tender or exchange offer, the
consummation of which would result in ownership by the person or
group of 15% or more of the common stock of the Company. The
Company will be entitled to redeem the Rights at $0.01 per
Right at any time on or before the tenth day following
acquisition by a person or group of 15% or more of the
Company’s common stock. The dividend distribution was made
on November 3, 1998, payable to the stockholders of record
on November 3, 1998. The Rights expire on October 20,
2008.
|
|
| 16. |
Stock-Based Compensation |
The Company recorded $14.3 million, $12.5 million, and
$22.4 million in 2004, 2003 and 2002, respectively, of
stock-based compensation. Stock-based compensation charges
relate primarily to the exchange of McAfee.com options in
connection with the Company’s acquisition of the publicly
traded minority
109
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
interest in McAfee.com, non-recurring stock compensation charges
related to executive compensation and the repricing of employee
stock options. The Company expects significant future
stock-based compensation charges related to the exchange of
McAfee.com options, repriced employee stock options and the
adoption of SFAS 123R (see Note 2).
The following is a summary of the Company’s compensation
charges for the years presented (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Exchange of McAfee.com options
|
|
$ |
6,669 |
|
|
$ |
3,369 |
|
|
$ |
16,101 |
|
|
Former employees
|
|
|
1,216 |
|
|
|
1,125 |
|
|
|
10,118 |
|
|
New and existing executives and employees
|
|
|
1,928 |
|
|
|
424 |
|
|
|
1,478 |
|
|
Extended life of vested options of terminated employees
|
|
|
1,164 |
|
|
|
3,720 |
|
|
|
— |
|
|
Extended vesting term of options
|
|
|
— |
|
|
|
— |
|
|
|
193 |
|
|
Extended period of Employee Stock Purchase Plan
|
|
|
— |
|
|
|
3,869 |
|
|
|
— |
|
|
Shares purchased outside Employee Stock Purchase Plan and other
|
|
|
— |
|
|
|
— |
|
|
|
62 |
|
|
Repriced options
|
|
|
3,343 |
|
|
|
— |
|
|
|
(5,548 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Total stock-based compensation
|
|
$ |
14,320 |
|
|
$ |
12,507 |
|
|
$ |
22,404 |
|
| |
|
|
|
|
|
|
|
|
|
Exchange of McAfee.com options. On September 13,
2002, the Company acquired the minority interest in McAfee.com.
McAfee.com option holders received options for 0.675 of a share
of the Company’s 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.
McAfee.com options to purchase 4.1 million shares were
converted into options to purchase 2.8 million shares
of the Company’s common stock. The assumed options have
been accounted for under the guidance in EITF Issue
No. 00-23, “Issues Related to the Accounting for
Stock Compensation under APB Opinion No. 25,” and
FASB Interpretation No. 44 (“FIN 44”),
“Accounting for Certain Transactions Involving Stock
Compensation — an Interpretation of APB Opinion
No. 25.” Accordingly, these options are subject to
variable accounting treatment, which means that a compensation
charge has been measured initially at the date of the closing of
the acquisition and then remeasured at the end of each reporting
period.
The initial charge was based on the excess of the closing price
of the Company’s common stock over the exercise price of
the options plus the $11.85 per share payable in cash. This
compensation charge has been and will be remeasured using the
same methodology until the earlier of the date of exercise,
forfeiture or cancellation without replacement. This
compensation charge is recorded as an expense over the remaining
vesting period of the options using the accelerated method of
amortization under FASB Interpretation No. 28,
“Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans.” For those
options that were fully vested at the date of the closing of the
acquisition, the Company immediately recorded compensation
expense of $10.5 million. Charges related to unvested
options are recorded as deferred stock-based compensation in
stockholders equity in the consolidated balance sheet, and
recognized as expense as the options vest.
During 2004, 2003 and 2002, the Company recorded charges of
approximately $6.7 million, $3.4 million and
$16.1 million, including the $10.5 million described
above, respectively, related to exchanged options subject to
variable accounting. These stock-based compensation charges were
based on the Company’s closing stock prices of $28.93,
$15.04 and $16.09 on December 31, 2004, 2003 and 2002,
respectively. As of December 31, 2004, the Company had
outstanding exchanged options to acquire approximately
0.4 million
110
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
shares subject to this variable accounting. Further fluctuations
in the stock price may result in significant additional stock
based compensation charges in future periods.
Former Employees. In November and December 2003, the
Company extended the vesting period of two employees and also
extended the period after which vesting ends to exercise their
options. These employees’ options continued to vest after
termination and their exercise period was extended an additional
90 days. The Company recorded a one time stock-based
compensation charge of approximately $0.1 million in 2004.
As a result of the sale of the Company’s Sniffer product
line in July 2004, the Company modified the stock option
agreements of several Sniffer executives by accelerating the
vesting of their unvested outstanding options. The Company
recorded a stock-based compensation charge of approximately
$1.0 million in 2004.
In October 2002, the Company terminated the employment of four
former McAfee.com executives. These executives held McAfee.com
exchanged options, which are subject to variable accounting as
discussed above. Upon termination, the options were modified in
accordance with a change in control provision. As a result, the
Company recorded a stock compensation charge of approximately
$1.1 million and $9.9 million in 2003 and 2002,
respectively.
In July 2002, one of the Company’s employees became a
non-employee, but continued to provide services to the Company.
As he was allowed to continue to vest his options, the Company
recorded a stock-based compensation charge corresponding to the
fair market value of his vested options. The Company recorded
stock-based compensation of $0.2 million in 2002.
New and Existing Executives and Employees. In January
2002, the Company’s board of directors approved a grant of
50,000 shares of restricted stock to its chief executive
officer. The price of the underlying shares is $0.01 per
share. The shares will vest and the Company’s right to
repurchase such shares will lapse as follows: 3,000 vested as of
the grant date and 47,000 are restricted until January 15,
2005. 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 January 15,
2002. During 2004, 2003 and 2002, the Company recorded
approximately $0.4 million, $0.4 million and
$0.5 million related to stock-based compensation associated
with the chief executive officer’s 2002 restricted stock
grant.
In September 2004, the Company’s chief financial officer
and chief operating officer announced that he was retiring from
the Company effective December 31, 2004. Under the terms of
his transition agreement, his options were modified such that
all remaining unvested outstanding stock options would
immediately vest on December 31, 2004 under specified
conditions. The total stock based compensation charge related to
this modification was approximately $1.3 million, which was
recorded as expense in 2004.
In connection with the acquisition of Foundstone in October
2004, the Company exchanged options to purchase shares of its
common stock for Foundstone stock options. The fair value of the
Company’s stock options was included in the Foundstone
purchase price. In accordance with FIN 44, the Company
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 by the former Foundstone employees. The unvested stock
options granted to Foundstone employees vest over periods
ranging through 2008. The Company recorded stock-based
compensation of $0.2 million in 2004 related to the
unvested stock options exchanged in the Foundstone acquisition.
On January 3, 2001, the Company entered into an employment
agreement with its current chief executive officer. In
accordance with the terms of the agreement, the Company issued
400,000 shares of restricted stock to its chief executive
officer. The price of the underlying shares was $0.01 per
share. The shares vested and the Company’s right to
repurchase such shares lapsed as follows: 12.5% on the first
four quarterly anniversaries of employment and the remaining 50%
on the second year anniversary of employment. The fair value of
the
111
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
restricted stock was determined to be approximately
$2.0 million and was estimated based on the difference
between the exercise price of the restricted stock and the fair
value of the Company’s common stock on the employment
commencement date. During 2002, the Company recorded
approximately $1.0 million in stock-based compensation.
Extended life of vested options held by terminated
employees. In connection with the Foundstone acquisition,
the Company exchanged vested options to purchase shares of its
common stock for vested Foundstone options. Certain Foundstone
employees terminated their employment in October 2004 subsequent
to the acquisition. Under the terms of their options, the
terminated employees had 90 days to exercise their options
before they would expire. The Company determined prior to the
end of 2004 that it would not be able to file the required
public company reports with the SEC that would allow the
terminated Foundstone employees to exercise their options within
the 90 day period. On December 7, 2004, the Company
extended the expiration date of the options through the end of
January 2005. In accordance with FIN 44, this modification
was considered to result in a new measurement of compensation
cost as if the options were newly granted. The compensation
charge was calculated based on the difference between the
Company’s closing stock price on December 7, 2004, the
date of modification, and the closing stock price on the date of
the Foundstone acquisition. The Company recorded a stock-based
compensation charge of $1.0 million in 2004.
In March 2003, the Company announced that the filing of its
Form 10-K for 2002 would be postponed in order to restate
prior financial results for 2000, 1999 and 1998. As a result,
effective April 9, 2003, the Company suspended all
exercises of stock options until the 2002 Form 10-K and all
required quarterly reports on Form 10-Q were filed with the
SEC, as these reports are incorporated by reference into the
securities registration statements for each of the stock option
plans. The period during which all stock option exercises were
suspended was known as the blackout period. Due to the blackout
period, the Company extended the exercisability of any options
that would otherwise terminate during the blackout period for a
period of time equal to a specified period after termination of
the blackout period. Accordingly, the Company recorded a
stock-based compensation charge on the date the options should
have terminated based on the intrinsic value of the option on
the modification date and the option price. The Company recorded
stock-based compensation charges of approximately
$0.1 million and $3.7 million for 2004 and 2003.
Extended Vesting Term of Options. In the second quarter
of 2002, the Company recorded a one-time stock-based
compensation charge of approximately $0.2 million as a
result of the modification of the terms of the options
previously granted to certain employees.
Extended period of Employee Stock Purchase Plan. In March
2003, the Company announced that the filing of its
Form 10-K for 2002 would be postponed in order to restate
prior financial results for 2000, 1999 and 1998. As a result,
effective April 9, 2003, the Company suspended all stock
purchases until the 2002 Form 10-K and all required
quarterly reports on Form 10-Q were filed with the SEC, as
these reports are incorporated by reference into the securities
registration statements for the 2002 Employee Stock Purchase
Plan (“2002 Purchase Plan”). The period during which
all stock purchases were suspended was known as the blackout
period. Due to the blackout period, the Company extended the
purchase period of the 2002 Purchase Plan that would otherwise
had been purchased on July 31, 2003. Accordingly, during
2003, the Company recorded a stock-based compensation charge of
approximately $3.9 million for the extended period of the
2002 Purchase Plan. The blackout period ended in November 2003,
and therefore no additional stock-based compensation will be
recorded.
Shares Purchased Outside Employee Stock Purchase Plan. On
January 31, 2002, the Company experienced a shortfall in
the number of shares available under the 1994 Employee Qualified
Stock Purchase Plan to meet the requirements of the open
purchase period. Although the Company reduced the number of
shares plan participants could purchase by a pro rata amount,
additional shares were required to be purchased outside of the
plan in order to meet this shortfall. As a result, the Company
recorded a one-time stock-based compensation charge of
approximately $0.1 million in 2002. The charge was based on
the difference between
112
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
the fair value of the shares purchased outside of the plan and
the price the shares were sold to plan participants.
Repriced Options. On April 22, 1999, the Company
offered to substantially all of its employees, excluding
executive officers, the right to cancel certain outstanding
stock options and receive new options with an exercise price of
$11.063, the then current fair value of the stock. Options to
purchase a total of 9.5 million shares were cancelled and
the same number of new options were granted. These new options
vest at the same rate that they would have vested under previous
option plans and are subject to variable accounting.
Accordingly, the Company has and will continue to remeasure
compensation cost for these repriced options until these options
are exercised, cancelled, or forfeited without replacement. The
first valuation period began July 1, 2000.
The amount of stock-based compensation recorded was and will be
based on any excess of the closing stock price at the end of the
reporting period or date of exercise, forfeiture or cancellation
without replacement, if earlier, over the fair value of the
Company’s common stock on July 1, 2000, which was
$20.375. The resulting compensation charge to earnings is
recorded over the remaining vesting period, using the
accelerated method of amortization required by FASB
Interpretation 28, “Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award
Plans — an Interpretation of APB Opinions No. 15
and 25.” At December 31, 2004, these options were
fully vested. Depending upon movements in the market value of
the Company’s common stock, this variable accounting
treatment can result in additional stock-based compensation
charges in future periods until the options are exercised,
forfeited or cancelled.
During 2004, the Company recorded a stock-based compensation
charge of $3.3 million, and during 2002, the Company
recorded a credit to earnings of approximately
$6.5 million. For 2004 and 2002, the Company’s
stock-based compensation charge (credit) was based on
year-end per share prices of its stock of $28.93 and $16.09,
respectively. There was no charge or credit recorded by the
Company in 2003 as the stock price was below $20.375 as of
December 31, 2002 and throughout 2003. As of
December 31, 2004, the Company had 0.3 million options
outstanding subject to variable accounting.
The Company also incurred an initial stock-based compensation
charge in connection with the initial issuance of the repriced
options. This charge was calculated based on the difference
between the exercise price of the new options and their market
value on the date of acceptance by employees. Approximately
$1.0 million was expensed during 2002.
|
|
| 17. |
Provision for Income Taxes |
The domestic and foreign components of income before provision
for income taxes were as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Domestic
|
|
$ |
180,462 |
|
|
$ |
17,303 |
|
|
$ |
278 |
|
|
Foreign
|
|
|
136,009 |
|
|
|
69,752 |
|
|
|
129,655 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
316,471 |
|
|
$ |
87,055 |
|
|
$ |
129,933 |
|
| |
|
|
|
|
|
|
|
|
|
113
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Significant components of the provision (benefit) for income
taxes attributable to continuing operations are as follows (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Federal:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Current
|
|
$ |
2,630 |
|
|
$ |
18,148 |
|
|
$ |
39,916 |
|
| |
Deferred
|
|
|
68,370 |
|
|
|
(23,332 |
) |
|
|
(61,674 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
Total Federal
|
|
|
71,000 |
|
|
|
(5,184 |
) |
|
|
(21,758 |
) |
|
State:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Current
|
|
|
(1,834 |
) |
|
|
5,863 |
|
|
|
5,189 |
|
| |
Deferred
|
|
|
8,439 |
|
|
|
(4,802 |
) |
|
|
(2,362 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
Total State
|
|
|
6,605 |
|
|
|
1,061 |
|
|
|
2,827 |
|
|
Foreign:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Current
|
|
|
21,648 |
|
|
|
18,167 |
|
|
|
19,829 |
|
| |
Deferred
|
|
|
(7,847 |
) |
|
|
2,766 |
|
|
|
(1,172 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
Total Foreign
|
|
|
13,801 |
|
|
|
20,933 |
|
|
|
18,657 |
|
| |
|
|
|
|
|
|
|
|
|
|
Provision for (benefit from) income taxes
|
|
$ |
91,406 |
|
|
$ |
16,810 |
|
|
$ |
(274 |
) |
| |
|
|
|
|
|
|
|
|
|
Approximately $3.6 million of the provision for income
taxes in 2003 was reflected as part of the cumulative effect of
a change in accounting principal in the consolidated statement
of income.
Significant components of net deferred tax assets are as follows
(in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
ASSETS |
|
Deferred revenue
|
|
$ |
154,910 |
|
|
$ |
124,932 |
|
|
Accrued liabilities and allowances
|
|
|
74,627 |
|
|
|
61,802 |
|
|
Depreciation and amortization
|
|
|
165,279 |
|
|
|
137,554 |
|
|
Tax credits
|
|
|
107,871 |
|
|
|
117,998 |
|
|
Deferred stock compensation
|
|
|
7,870 |
|
|
|
4,116 |
|
|
Net operating loss carryover
|
|
|
27,948 |
|
|
|
51,332 |
|
| |
|
|
|
|
|
|
| |
|
|
538,505 |
|
|
|
497,734 |
|
|
Valuation allowance
|
|
|
(65,820 |
) |
|
|
(88,283 |
) |
| |
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
472,685 |
|
|
|
409,451 |
|
| |
|
|
|
|
|
|
| |
|
LIABILITIES |
|
Intangibles not amortizable for tax purposes
|
|
|
39,677 |
|
|
|
40,178 |
|
|
Accrued liabilities and allowances
|
|
|
11,947 |
|
|
|
9,527 |
|
| |
|
|
|
|
|
|
|
Total deferred tax liability
|
|
|
51,624 |
|
|
|
49,705 |
|
| |
|
|
|
|
|
|
|
Net deferred tax asset
|
|
$ |
421,061 |
|
|
$ |
359,746 |
|
| |
|
|
|
|
|
|
|
Current portion
|
|
$ |
200,459 |
|
|
$ |
160,550 |
|
|
Noncurrent portion
|
|
|
220,602 |
|
|
|
199,196 |
|
| |
|
|
|
|
|
|
| |
|
$ |
421,061 |
|
|
$ |
359,746 |
|
| |
|
|
|
|
|
|
114
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
At December 31, 2004, the Company has net operating loss
carryovers for federal income tax purposes of approximately
$74.2 million. These net operating loss carryovers relate
to acquisitions and are limited in the amount that can be
recognized in any one year, and have expiration dates ranging
from 2008 to 2024. The net decrease in the valuation allowance
primarily relates to the utilization of foreign tax credits and
net operating loss carryforwards from acquisitions for which
there was uncertainty of future utilization prior to 2004. This
decrease was partially offset by approximately a
$2.2 million valuation allowance recorded related to
deferred tax assets of Foundstone. Management believes that it
is more likely than not that the results of future operations
will generate sufficient taxable income to realize the net
deferred tax assets, other than certain acquired net operating
loss and credit carryforwards and certain other foreign tax
credits for which a valuation allowance has been provided.
United States income taxes have not been provided for on a
cumulative total of approximately $341.3 million of
earnings of certain non-U.S. subsidiaries, as the
Company’s historical intent has been to reinvest these
earnings indefinitely in operations outside the U.S. See
“Recent Accounting Pronouncements and Guidance”
in Note 2 of the Consolidated Financial Statements
for discussion of recent legislation regarding the repatriation
of foreign earnings.
The Company’s effective tax rate on income before income
taxes differs from the U.S. Federal statutory tax rate as
follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
U.S. Federal income tax provision at statutory rate
|
|
$ |
110,765 |
|
|
$ |
30,470 |
|
|
$ |
45,469 |
|
|
State provision
|
|
|
8,979 |
|
|
|
1,258 |
|
|
|
2,725 |
|
|
Non deductible acquisition and other costs
|
|
|
— |
|
|
|
2,310 |
|
|
|
5,343 |
|
|
Foreign earnings taxed at rates different than the U.S. Rate
|
|
|
(10,266 |
) |
|
|
(3,480 |
) |
|
|
(26,724 |
) |
|
Other permanent differences
|
|
|
(2,335 |
) |
|
|
867 |
|
|
|
(957 |
) |
|
Tax credits
|
|
|
(12,183 |
) |
|
|
(2,532 |
) |
|
|
(26,096 |
) |
|
Difference between book and tax basis of businesses sold
|
|
|
22,840 |
|
|
|
— |
|
|
|
— |
|
|
Benefit from accruals for tax exposures no longer required
|
|
|
(25,036 |
) |
|
|
(12,083 |
) |
|
|
— |
|
|
Other
|
|
|
(1,358 |
) |
|
|
— |
|
|
|
(34 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
91,406 |
|
|
$ |
16,810 |
|
|
$ |
(274 |
) |
| |
|
|
|
|
|
|
|
|
|
In 2004, the Company realized the benefit of certain tax
deductions related to a prior period acquisition. The
$27.0 million benefit has been recorded as a credit to
additional paid in capital in the consolidated statement of
stockholders’ equity in 2004 as the acquisition was
accounted for under the “pooling of interests” method.
A reconciliation of the numerator and denominator of basic and
diluted net income per share is provided as follows (in
thousands, except per share amounts):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Numerator — Basic
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income before cumulative effect of change in accounting principle
|
|
$ |
225,065 |
|
|
$ |
59,905 |
|
|
$ |
128,312 |
|
| |
Cumulative effect of change in accounting principle, net of tax
|
|
|
— |
|
|
|
10,337 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Net income
|
|
$ |
225,065 |
|
|
$ |
70,242 |
|
|
$ |
128,312 |
|
| |
|
|
|
|
|
|
|
|
|
115
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Numerator — Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income before cumulative effect of change in accounting principle
|
|
$ |
225,065 |
|
|
$ |
59,905 |
|
|
$ |
128,312 |
|
| |
Cumulative effect of change in accounting principle, net of tax
|
|
|
— |
|
|
|
10,337 |
|
|
|
— |
|
| |
Interest on convertible debentures(1)
|
|
|
7,556 |
|
|
|
— |
|
|
|
12,042 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Net income, adjusted
|
|
$ |
232,621 |
|
|
$ |
70,242 |
|
|
$ |
140,354 |
|
| |
|
|
|
|
|
|
|
|
|
|
Denominator — Basic
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Weighted average shares of common stock outstanding
|
|
|
160,714 |
|
|
|
160,338 |
|
|
|
149,641 |
|
| |
Less: weighted average shares of common stock subject to
repurchase
|
|
|
— |
|
|
|
— |
|
|
|
(200 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
Basic weighted average common shares outstanding
|
|
|
160,714 |
|
|
|
160,338 |
|
|
|
149,441 |
|
| |
|
|
|
|
|
|
|
|
|
|
Denominator — Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic weighted average common shares outstanding
|
|
|
160,714 |
|
|
|
160,338 |
|
|
|
149,641 |
|
| |
Effective of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Convertible debentures(1)
|
|
|
12,154 |
|
|
|
— |
|
|
|
19,092 |
|
| |
|
Common stock options(2)
|
|
|
4,207 |
|
|
|
3,992 |
|
|
|
7,333 |
|
| |
|
Warrants
|
|
|
24 |
|
|
|
159 |
|
|
|
183 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Diluted weighted average shares
|
|
|
177,099 |
|
|
|
164,489 |
|
|
|
176,249 |
|
| |
|
|
|
|
|
|
|
|
|
|
Basic net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income before cumulative effect of change in accounting principle
|
|
$ |
1.40 |
|
|
$ |
0.37 |
|
|
$ |
0.86 |
|
| |
Cumulative effect of change in accounting principle, net of tax
|
|
|
— |
|
|
|
0.07 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Net income per share — Basic
|
|
$ |
1.40 |
|
|
$ |
0.44 |
|
|
$ |
0.86 |
|
| |
|
|
|
|
|
|
|
|
|
|
Diluted net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income before cumulative effect of change in accounting principle
|
|
$ |
1.31 |
|
|
$ |
0.36 |
|
|
$ |
0.80 |
|
| |
Cumulative effect of change in accounting principle, net of tax
|
|
|
— |
|
|
|
0.07 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Net income per share — Diluted
|
|
$ |
1.31 |
|
|
$ |
0.43 |
|
|
$ |
0.80 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
| (1) |
Convertible debt interest and related 19.1 million as-if
converted shares were excluded from the calculation since the
effect was anti-dilutive in 2003. The total number of shares
excluded from the calculation related to as-if converted shares
was 3.1 million for 2002. |
| |
| (2) |
At December 31, 2004, 2003 and 2002, 5.1 million,
15.6 million, and 9.9 million options to purchase
common stock, respectively, were excluded from the calculation
since the effect was anti-dilutive. |
|
|
| 19. |
Business Segment and Major Customer Information |
The Company has concluded that it has one business and operates
in one industry, developing, marketing, distributing and
supporting computer security solutions for large enterprises,
governments, small and medium sized business and consumer users,
as well as resellers and distributors. Management measures
profitability based on the Company’s five geographic
regions: North America; EMEA; Japan; Asia-Pacific (excluding
Japan) and Latin America. The regions are evidence of the
operating structure of the Company’s internal organization.
116
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The Company markets and sells, through its geographic regions,
anti-virus and security software, hardware and services; network
management software, hardware and services; and help desk
software and services. These products and services are marketed
and sold worldwide primarily through resellers, distributors,
systems integrators retailers, and directly by the Company. In
addition, the Company offers web sites, which provide suites of
on-line products and services personalized for the user based on
the users’ PC configuration, attached peripherals and
resident software. The Company also offers managed security and
availability applications to corporations and governments on the
Internet.
The accounting policies of the businesses and geographic
segments are the same as disclosed in Note 2. To reconcile
to the consolidated financial statements, where applicable,
“Corporate” represents costs and expenses associated
with corporate activities. Corporate activities include general
and administrative expenses and corporate marketing expenses of
$65.0 million, $61.9 million, and $37.3 million
in 2004, 2003 and 2002, respectively; stock-based compensation
charges; and acquisition, restructuring and other related costs.
These corporate expenses are not considered attributable to any
specific geographic region. The $25.0 million litigation
reimbursement received in 2004 and the $70.0 million
litigation charge incurred in 2002 were recorded in North
America. Summarized financial information concerning the
Company’s net revenue and operating income by geographic
region is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Years Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Net revenue by region:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America
|
|
$ |
554,641 |
|
|
$ |
606,685 |
|
|
$ |
653,532 |
|
|
EMEA
|
|
|
241,724 |
|
|
|
240,616 |
|
|
|
298,659 |
|
|
Japan
|
|
|
54,609 |
|
|
|
40,519 |
|
|
|
39,369 |
|
|
Asia-Pacific (excluding Japan)
|
|
|
38,494 |
|
|
|
29,014 |
|
|
|
33,595 |
|
|
Latin America
|
|
|
21,074 |
|
|
|
19,502 |
|
|
|
17,889 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net revenue
|
|
$ |
910,542 |
|
|
$ |
936,336 |
|
|
$ |
1,043,044 |
|
| |
|
|
|
|
|
|
|
|
|
|
Operating income (loss) by region:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America
|
|
$ |
195,195 |
|
|
$ |
215,027 |
|
|
$ |
156,080 |
|
|
EMEA
|
|
|
90,612 |
|
|
|
88,884 |
|
|
|
135,629 |
|
|
Japan
|
|
|
18,650 |
|
|
|
11,061 |
|
|
|
8,710 |
|
|
Asia-Pacific (excluding Japan)
|
|
|
11,903 |
|
|
|
5,962 |
|
|
|
6,682 |
|
|
Latin America
|
|
|
4,188 |
|
|
|
1,338 |
|
|
|
2,436 |
|
|
Corporate
|
|
|
2,123 |
|
|
|
(257,870 |
) |
|
|
(185,509 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Operating income
|
|
$ |
322,671 |
|
|
$ |
64,402 |
|
|
$ |
124,028 |
|
| |
|
|
|
|
|
|
|
|
|
117
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Following is a summary of the Company’s total assets by
geographic region. Assets purchased to support infrastructure
and general and administrative activities, including land
purchases, are included in “Corporate” in the table
below. These corporate assets are not assigned to any specific
geographic region. Summarized financial information concerning
the Company’s total assets by business and geographic
region is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
North America
|
|
$ |
1,579,401 |
|
|
$ |
1,452,407 |
|
|
EMEA
|
|
|
533,987 |
|
|
|
485,613 |
|
|
Japan
|
|
|
64,736 |
|
|
|
51,331 |
|
|
Asia-Pacific (excluding Japan)
|
|
|
25,794 |
|
|
|
25,479 |
|
|
Latin America
|
|
|
19,729 |
|
|
|
17,839 |
|
|
Corporate
|
|
|
14,029 |
|
|
|
87,829 |
|
| |
|
|
|
|
|
|
| |
Total assets
|
|
$ |
2,237,676 |
|
|
$ |
2,120,498 |
|
| |
|
|
|
|
|
|
Property and equipment based on the physical location of the
assets is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
United States
|
|
$ |
72,769 |
|
|
$ |
89,857 |
|
|
$ |
73,990 |
|
|
Japan
|
|
|
4,038 |
|
|
|
5,484 |
|
|
|
4,560 |
|
|
India
|
|
|
3,667 |
|
|
|
4,261 |
|
|
|
1,506 |
|
|
The Netherlands
|
|
|
2,354 |
|
|
|
3,991 |
|
|
|
1,835 |
|
|
Other countries
|
|
|
8,887 |
|
|
|
8,079 |
|
|
|
7,386 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
91,715 |
|
|
$ |
111,672 |
|
|
$ |
89,277 |
|
| |
|
|
|
|
|
|
|
|
|
Net revenues attributed to countries based on the location of
the customer for the years ended December 31 is as follows
(in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
United States
|
|
$ |
520,211 |
|
|
$ |
573,263 |
|
|
$ |
618,936 |
|
|
United Kingdom
|
|
|
67,443 |
|
|
|
67,229 |
|
|
|
87,010 |
|
|
Germany
|
|
|
41,910 |
|
|
|
43,717 |
|
|
|
50,533 |
|
|
Japan
|
|
|
54,609 |
|
|
|
40,519 |
|
|
|
39,369 |
|
|
Other countries
|
|
|
226,369 |
|
|
|
211,608 |
|
|
|
247,196 |
|
| |
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
910,542 |
|
|
$ |
936,336 |
|
|
$ |
1,043,044 |
|
| |
|
|
|
|
|
|
|
|
|
118
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Net revenue information on a business unit basis is as follows
for the years ended December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
McAfee
|
|
$ |
766,696 |
|
|
$ |
634,812 |
|
|
Sniffer
|
|
|
90,878 |
|
|
|
210,176 |
|
|
Magic
|
|
|
2,850 |
|
|
|
63,164 |
|
|
IntruShield
|
|
|
43,707 |
|
|
|
15,510 |
|
|
McAfee Labs
|
|
|
6,411 |
|
|
|
11,023 |
|
|
PGP
|
|
|
— |
|
|
|
1,651 |
|
| |
|
|
|
|
|
|
|
Total net revenue
|
|
$ |
910,542 |
|
|
$ |
936,336 |
|
| |
|
|
|
|
|
|
Net revenue information on a business unit basis is not
available for 2002.
Net revenue information on a product and service basis is as
follows for the years ended December 31 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Software licenses
|
|
$ |
157,983 |
|
|
$ |
341,188 |
|
|
$ |
459,707 |
|
|
Support and maintenance
|
|
|
436,299 |
|
|
|
313,731 |
|
|
|
310,473 |
|
|
Hardware
|
|
|
79,828 |
|
|
|
99,502 |
|
|
|
93,359 |
|
|
Retail
|
|
|
27,787 |
|
|
|
45,993 |
|
|
|
63,236 |
|
|
Consulting
|
|
|
19,157 |
|
|
|
27,421 |
|
|
|
36,740 |
|
|
Training
|
|
|
8,394 |
|
|
|
9,486 |
|
|
|
12,527 |
|
|
On-line subscription arrangements
|
|
|
152,529 |
|
|
|
72,088 |
|
|
|
51,754 |
|
|
Other
|
|
|
28,565 |
|
|
|
26,927 |
|
|
|
15,248 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Total
|
|
$ |
910,542 |
|
|
$ |
936,336 |
|
|
$ |
1,043,044 |
|
| |
|
|
|
|
|
|
|
|
|
At December 31, 2004 and 2003, one customer had an accounts
receivable balance which comprised 23% and 22%, respectively, of
the Company’s total accounts receivable balance. During
2004, 2003 and 2002, one customer accounted for 22%, 24% and
25%, respectively, of the total net revenue for each year.
During 2004 and 2002, another customer accounted for 11% and
10%, respectively, of the net revenue. The net revenue derived
from these customers is reported primarily in the Company’s
North American and EMEA geographic segments.
From time to time, the Company has been subject to litigation
including the pending litigation described below. The
Company’s current estimated range of liability related to
some of the pending litigation below is based on claims for
which management can estimate the amount and range of loss. The
Company has recorded the minimum estimated liability related to
those claims, where there is a range of loss. Because of the
uncertainties related to the range of loss on the remaining
pending litigation, management is unable to make a reasonable
estimate of the liability that could result from an unfavorable
outcome. As additional information becomes available, the
Company will assess its potential liability and revise its
estimates. Pending or future litigation could be costly, could
cause the diversion of management’s attention and could
upon resolution, have a material adverse effect on the business,
results of operations, financial condition and cash flow.
119
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In addition, the Company is engaged in certain legal and
administrative proceedings incidental to its normal business
activities and believes that these matters will not have a
material adverse effect on the Company’s financial
position, results of operations or cash flows.
In September 2003, the Company entered into a settlement
agreement with the plaintiffs in the In re Network
Associates, Inc. II Securities Litigation, which was
originally filed in September 2001. Under the settlement
agreement the Company paid $70.0 million, which was
recorded as litigation settlement in the consolidated statement
of income for 2002. The settlement was approved by the court in
February 2004, and the case was dismissed with prejudice to all
parties and claims. In 2004, the Company received approximately
$25.0 million from its insurance carriers related to this
litigation, which was recorded as litigation reimbursement in
the consolidated statement of income for 2004.
Certain investment bank underwriters, the Company, and certain
of its directors and officers have been named in a putative
class action for violation of the federal securities laws in the
United States District Court for the Southern District of New
York, captioned In re McAfee.com Corp. Initial Public
Offering Securities Litigation, 01 Civ. 7034 (SAS).
This is one of a number of cases challenging underwriting
practices in the initial public offerings (“IPOs”) of
more than 300 companies. These cases have been coordinated
for pretrial proceedings as In re Initial Public Offering
Securities Litigation, 21 MC 92 (SAS). Plaintiffs
generally allege that certain underwriters engaged in
undisclosed and improper underwriting activities, namely the
receipt of excessive brokerage commissions and customer
agreements regarding post-offering purchases of stock in
exchange for allocations of IPO shares. Plaintiffs also allege
that various investment bank securities analysts issued false
and misleading analyst reports. The complaint against the
Company claims that the purported improper underwriting
activities were not disclosed in the registration statements for
McAfee.com’s IPO and seeks unspecified damages on behalf of
a purported class of persons who purchased the Company’s
securities or sold put options during the time period from
December 1, 1999 to December 6, 2000. On
February 19, 2003 the Court issued an Opinion and Order
dismissing certain of the claims against the Company with leave
to amend. A settlement proposal was accepted by the Company on
July 15, 2003 and is awaiting Court approval. Under this
settlement proposal, the Company may assign its claims against
certain underwriters to the plaintiffs, and the Company would be
dismissed from the lawsuit without paying any monetary damages.
On June 6, 2002, Paul Cozza filed a Complaint in the United
States District Court, District of Massachusetts alleging breach
of contract, fraud and bad faith arising out of a dispute
concerning the licensing of certain technology used in the
Company’s Virex 6.1 product. The Complaint seeks royalties
on the Company’s sale of Virex 6.1 products from
January 1, 2002 to the present. The Company filed papers in
opposition to the Complaint and asserted various defenses. The
Company also moved to compel arbitration, which was denied by
the District Court and the First Circuit Court of Appeals. In
September 2004 the parties filed cross-motions for partial
summary judgment on liability, but not damages, issues relating
to whether the contract claims extend beyond the Virex 6.1
product. The District Court has heard argument on the pending
cross-motions for partial summary judgment but has not yet
issued any decision.
On March 22, 2002, the Securities and Exchange Commission
notified the Company that it has commenced a “Formal Order
of Private Investigation” into the Company’s
accounting practices. The SEC investigation is continuing, and
the Company continues to provide documents and information to
the SEC.
|
|
| 21. |
Related Party Transactions |
Under the terms of the amended and restated employment agreement
for Mr. George Samenuk, Chairman of the Board and Chief
Executive Officer, the Company agreed to loan Mr. Samenuk
the funds
120
MCAFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
necessary to pay the taxes due on each vesting date for the
400,000 shares of restricted stock granted to
Mr. Samenuk on January 3, 2001. In addition, the
Company agreed to loan Mr. Samenuk the funds necessary to
pay the taxes due on the 3,000 shares of stock granted to
Mr. Samenuk on January 15, 2002. In accordance with
the provisions of the Sarbanes-Oxley Act of 2002, no additional
loans were made to Mr. Samenuk after July 30, 2002 and
no material modifications were made to any loan outstanding on
that date.
In total, the Company extended five separate loans to
Mr. Samenuk. As of December 31, 2002, four loans in an
aggregate amount of approximately $955,000 were outstanding. The
loans each had a two-year maturity and bore interest at the
applicable federal rate. The loans were full recourse and
secured by Mr. Samenuk’s restricted stock and
3,000 shares of stock. The last remaining loan was fully
repaid in October 2003.
In March 2005, the Company repurchased approximately
2.0 million shares of its common stock in the open market
for approximately $47.4 million.
121
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, as amended, the Registrant has
duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of
Santa Clara, State of California, on the 31st day of
March, 2005.
|
|
| |
|
| |
George Samenuk |
| |
Chairman of the Board and |
| |
Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of
1934, as amended, this report has been signed below on
March 31st, 2005 by the following persons on behalf of the
Registrant and in the capacities indicated.
| |
|
|
|
|
|
|
| Signature |
|
Title |
|
Date |
| |
|
|
|
|
| |
/s/ George Samenuk
(George
Samenuk) |
|
Chairman of the Board and Chief Executive Officer |
|
March 31, 2005 |
| |
/s/ Eric F. Brown
(Eric
F. Brown) |
|
Chief Financial Officer |
|
March 31, 2005 |
| |
/s/ Robert B. Bucknam
(Robert
B. Bucknam) |
|
Director |
|
March 31, 2005 |
| |
/s/ Leslie G. Denend
(Leslie
G. Denend) |
|
Director |
|
March 31, 2005 |
| |
/s/ Robert Dutkowsky
(Robert
Dutkowsky) |
|
Director |
|
March 31, 2005 |
| |
/s/ Denis J.
O’Leary
(Denis
J. O’Leary) |
|
Director |
|
March 31, 2005 |
| |
/s/ Robert Pangia
(Robert
Pangia) |
|
Director |
|
March 31, 2005 |
| |
/s/ Liane Wilson
(Liane
Wilson) |
|
Director |
|
March 31, 2005 |
122
EXHIBIT INDEX
| |
|
|
|
|
|
|
| Exhibit |
|
|
|
|
| Number |
|
|
|
Description |
| |
|
|
|
|
| |
2 |
.1 |
|
— |
|
Asset Purchase Agreement made and entered into as of
April 22, 2004, by and among, Network General Corporation
(formerly named Starburst Technology Holdings, Inc.), on the one
hand; and (ii) McAfee, Inc. (formerly named Networks
Associates, Inc.), Network Associates Technology, Inc., Network
Associates International BV, Network Associates (India) Private
Limited, McAfee Japan Co., Ltd. (formerly named Network
Associates Japan Co., Ltd.), on the other hand, as amended by
Amendment No. 1 thereto dated as of July 15, 2004.(1) |
| |
| |
3 |
.1 |
|
— |
|
Second Restated Certificate of Incorporation of the Registrant,
as amended on December 1, 1997.(3) |
| |
| |
3 |
.2 |
|
— |
|
Certificate of Ownership and Merger between Registrant and
McAfee, Inc.(2) |
| |
| |
3 |
.3 |
|
— |
|
Amended and Restated Bylaws of the Registrant.(2) |
| |
| |
3 |
.4 |
|
— |
|
Certificate of Designation of Series A Preferred Stock of
the Registrant.(5) |
| |
| |
3 |
.5 |
|
— |
|
Certificate of Designation of Series B Participating
Preferred Stock of the Registrant.(6) |
| |
| |
4 |
.3 |
|
— |
|
Indenture dated as of August 17, 2001 between the
Registrant and State Street Bank and Trust Company of
California.(7) |
| |
| |
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.(8) |
| |
| |
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.(8) |
| |
| |
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.(8) |
| |
| |
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.(8) |
| |
| |
10 |
.5* |
|
— |
|
2002 Employee Stock Purchase Plan.(9) |
| |
| |
10 |
.6* |
|
— |
|
1997 Stock Incentive Plan, as Amended.(9) |
| |
| |
10 |
.7* |
|
— |
|
Amended and Restated 1993 Stock Option Plan for Outside
Directors.(4) |
| |
| |
10 |
.8* |
|
— |
|
2000 Nonstatutory Stock Option Plan.(10) |
| |
| |
10 |
.9* |
|
— |
|
Amended and Restated Employment Agreement between George Samenuk
and the Registrant, dated October 9, 2001.(11) |
| |
| |
10 |
.10* |
|
— |
|
Employment agreement between Stephen C. Richards and the
Registrant, dated April 3, 2001.(12) |
| |
| |
10 |
.11 |
|
— |
|
1st Amendment to Lease dated March 20, 1998 between
Birk S. McCandless, LLC and the Registrant.(13) |
| |
| |
10 |
.12 |
|
— |
|
Confirmation, Amendment and Notice of Security Agreement dated
March 20, 1998 among Informix Corporation, Birk S.
McCandless, LLC and the Registrant.(13) |
| |
| |
10 |
.13 |
|
— |
|
Second Amendment to Lease dated September 1, 1998 among
Informix Corporation, Birk S. McCandless, LLC and the
Registrant.(13) |
| |
| |
10 |
.14 |
|
— |
|
Subordination, Nondisturbance and Attornment Agreement dated
June 21, 2000, among Column Financial, Inc., Informix
Corporation, Birk S. McCandless, LLC, and the Registrant.(13) |
| |
| |
10 |
.15 |
|
— |
|
Lease Agreement dated November 14, 1996 between Blue Lake
Partners and McAfee Associates, Inc.(13) |
| |
| |
10 |
.16 |
|
— |
|
Lease Amendment dated November 24, 1997 between Blue Lake
Partners and McAfee Software, Inc.(13) |
| |
| |
10 |
.17 |
|
— |
|
Lease Amendment dated March 17, 1998 between Blue Lake
Partners and McAfee Software, Inc.(13) |
| |
| |
10 |
.18 |
|
— |
|
Lease Amendment dated March 27, 1998 between Blue Lake
Partners and McAfee Software, Inc.(13) |
123
| |
|
|
|
|
|
|
| Exhibit | |
|
|
|
|
| Number | |
|
|
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Description |
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10 |
.19 |
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— |
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Lease Amendment dated June 4, 1998 between Blue Lake
Partners and McAfee Software, Inc.(13) |
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10 |
.20 |
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— |
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Lease Amendment dated July 21, 1998 between Blue Lake
Partners and McAfee Software, Inc.(13) |
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10 |
.21 |
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— |
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Lease Amendment dated November 20, 1998 between Blue Lake
Partners and McAfee Software, Inc.(13) |
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10 |
.22 |
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— |
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Lease Amendment dated March 18, 1999 between Blue Lake
Partners and McAfee Software, Inc.(13) |
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10 |
.23 |
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— |
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Lease Amendment dated June 3, 1999 between Blue Lake
Partners and McAfee Software, Inc.(13) |
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10 |
.24 |
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— |
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Lease Amendment dated October 7, 1999 between Blue Lake
Partners and McAfee Software, Inc.(13) |
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10 |
.25 |
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— |
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Lease Amendment dated March 25, 2000 between Daltex Centre
LP and the Registrant.(13) |
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10 |
.26 |
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— |
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Lease Amendment dated July 31, 2000 between Daltex Centre
LP and the Registrant.(13) |
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10 |
.27 |
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— |
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Lease Amendment dated January 24, 2001 between Daltex
Centre LP and the Registrant.(13) |
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10 |
.28 |
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— |
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Lease Amendment dated May 31, 2001 between Daltex Centre LP
and the Registrant.(13) |
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10 |
.29* |
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— |
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Employment Agreement between Kent H. Roberts and the Registrant,
dated October 9, 2001.(14) |
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10 |
.30* |
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— |
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Employment Agreement between Vernon Gene Hodges and the
Registrant, dated December 3, 2001.(14) |
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10 |
.31* |
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— |
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Employment Agreement between Raymond J. Smets and the
Registrant, dated October 7, 2002(14) |
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10 |
.32* |
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— |
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Employment Agreement between Kevin M. Weiss and the Registrant
Dated October 15, 2002.(17) |
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10 |
.33 |
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— |
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Form of Indemnification Agreement between the Registrant and its
Executive Officers(17) |
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10 |
.34* |
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— |
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Summary of Pay for Performance Plan.(4) |
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10 |
.35* |
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Network Associates, Inc. Tax Deferred Savings Plan.(16) |
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10 |
.36 |
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Umbrella Credit Facility of Registrant dated April 15,
2004.(18) |
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10 |
.37 |
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Fifth Amendment to Network Associates, Inc. Tax Deferred Savings
Plan.(18) |
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10 |
.38 |
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Amendment to Employment Agreement of George Samenuk effective as
of January 20, 2004.(18) |
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10 |
.39 |
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Amendment to Employment Agreement of Stephen C. Richards
effective as of January 20, 2004.(18) |
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10 |
.40 |
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— |
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Sniffer Bonus Plan.(18) |
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10 |
.41 |
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Form of Sniffer Bonus Plan Participation Agreement (Ray
Smets).(18) |
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10 |
.42 |
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Addendum to Raymond J. Smets Employment Agreement.(20) |
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10 |
.43 |
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Sixth Amendment to Network Associates, Inc. Tax Deferred Savings
Plan.(20) |
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10 |
.44 |
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Transition Agreement by and between Registrant and Stephen C.
Richards.(19) |
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10 |
.45 |
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Employment Agreement between Registrant and Eric F. Brown dated
December 10, 2004 (22) |
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10 |
.46* |
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2005 Independent Director Cash Compensation Plan |
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21 |
.1 |
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Subsidiaries of the Registrant |
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23 |
.1 |
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Consent of Deloitte & Touche LLP, Independent
Registered Public Accounting Firm |
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23 |
.2 |
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Consent of PricewaterhouseCoopers LLP, Independent Registered
Public Accounting Firm |
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31 |
.1 |
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— |
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Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 |
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32 |
.1 |
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— |
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Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 |
124
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| (1) |
Incorporated by reference from the Registrant’s Report on
Form 8-K filed with the Commission on July 16, 2004. |
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| (2) |
Incorporated by reference from the Registrant’s Report on
Form 10-Q for the quarter ended September 30, 2004,
filed with the Commission on November 8, 2004. |
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| (3) |
Incorporated by reference from the Registrant’s
Registration Statement on Form S-4 filed with the
Commission on March 25, 1998. |
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| (4) |
Incorporated by reference from the Registrant’s Annual
Report on Form 10-K for the year ended December 31,
2002, filed with the Commission on October 31, 2003. |
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| (5) |
Incorporated by reference from the Registrant’s Report on
Form 10-Q for the quarter ended September 30, 1996,
filed with the Commission on November 14, 1996. |
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| (6) |
Incorporated by reference from the Registrant’s Report on
Form 8-A filed with the Commission on October 22, 1998. |
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| (7) |
Incorporated by reference from the Registrant’s
Registration Statement on Form S-3 filed with the
Commission on November 9, 2001. |
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| (8) |
Incorporated by reference from the Registrant’s
Registration Statement on Form S-3, filed with the
Commission on February 11, 1998. |
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| (9) |
Incorporated by reference from the Registrant’s
Registration Statement on Form S-8 filed with the
Commission on June 28, 2002. |
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| (10) |
Incorporated by reference from the Registrant’s report on
Form 10-K for the year ended December 31, 2000, filed
with the Commission on April 2, 2001. |
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| (11) |
Incorporated by reference from the Registrant’s report on
Form 10-K for the year ended December 31, 2001, filed
with the Commission on February 8, 2002. |
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| (12) |
Incorporated by reference from the Registrant’s report on
Form 10-Q for the quarter ended March 31, 2001, filed
with the Commission on May 15, 2001. |
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| (13) |
Incorporated by reference from the Registrant’s report on
Form 10-Q for the quarter ended September 30, 2001,
filed with the Commission on November 13, 2001. |
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| (14) |
Incorporated by reference from the Registrant’s report on
Form 10-K for the year ended December 31, 2001, filed
with the Commission on February 8, 2002. |
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| (15) |
Incorporated by reference from the Registrant’s report on
Form 10-Q for the quarter ended September 30, 2002,
filed with the Commission on November 12, 2002. |
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| (16) |
Incorporated by reference from the Registrant’s
Registration Statement on Form S-8 filed with the
Commission on November 5, 2003. |
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| (17) |
Incorporated by reference from the Registrant’s report on
Form 10-K for the year ended December 31, 2003, filed
with the Commission on March 9, 2004. |
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| (18) |
Incorporated by reference from the Registrant’s report on
Form 10-Q for the quarter ended March 31, 2004, filed
with the Commission on May 10, 2004. |
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| (19) |
Incorporated by reference from the Registrant’s report on
Form 8-K filed with the Commission on September 7,
2004. |
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| (20) |
Incorporated by reference from the Registrant’s report on
Form 10-Q for the quarter ended June 30, 2004, filed
with the Commission on August 9, 2004. |
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| (21) |
Incorporated by reference from the Registrant’s report on
Form 10-Q for the quarter ended September 30, 2004,
filed with the Commission on November 8, 2004. |
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| (22) |
Incorporated by reference from the Registrant’s report on
Form 8-K filed with the Commission on December 14,
2004. |
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* |
Management contracts or compensatory plans or arrangements
covering executive officers or directors of McAfee, Inc. |
125
SCHEDULE II
NETWORKS ASSOCIATES, INC.
VALUATION AND QUALIFYING ACCOUNTS
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Provision for | |
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Doubtful | |
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Accounts, | |
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Write-Offs of | |
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Balance at | |
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Additions Charged | |
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Previously | |
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Balance at | |
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Beginning of | |
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to Expense or | |
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Provided | |
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End of | |
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Period | |
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Revenue Net(1) | |
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Accounts | |
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Period | |
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(In thousands) | |
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Year Ended December 31, 2004
Allowance for Doubtful Accounts
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$ |
3,070 |
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$ |
1,716 |
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$ |
(2,250 |
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$ |
2,536 |
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Year Ended December 31, 2003
Allowance for Doubtful Accounts(2)
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$ |
6,638 |
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$ |
(1,216 |
) |
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$ |
(2,352 |
) |
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$ |
3,070 |
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Year Ended December 31, 2002
Allowance for Doubtful Accounts
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$ |
8,394 |
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$ |
(219 |
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$ |
(1,537 |
) |
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$ |
6,638 |
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| (1) |
Provision for Doubtful Accounts, Net. The provision for
doubtful accounts, net consists of our estimates with respect to
the uncollectibility of our receivables, net of recoveries of
amounts previously written off. Our management must make
estimates of the uncollectibility of our accounts receivables.
Management specifically analyzes accounts receivable and
analyzes historical bad debts, customer concentrations, customer
credit-worthiness, current economic trends and changes in our
customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. |
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| (2) |
The allowance for doubtful accounts in the consolidated balance
sheet as of December 31, 2003 is net of the
$0.2 million allowance for Magic, which is included in
assets held for sale. |
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Provision for | |
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Balance at | |
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Sales Returns | |
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Actual | |
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Balance at | |
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Beginning of | |
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and Other | |
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Returns and | |
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End of | |
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Period | |
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Allowances(3) | |
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Allowances | |
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Period | |
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(In thousands) | |
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Year Ended December 31, 2004
Sales Returns and Allowances
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$ |
39,599 |
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$ |
65,350 |
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$ |
(75,725 |
) |
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$ |
29,224 |
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Year Ended December 31, 2003
Sales Returns and Allowances
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$ |
32,337 |
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$ |
85,612 |
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$ |
(78,350 |
) |
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$ |
39,599 |
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Year Ended December 31, 2002
Sales Returns and Allowances
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$ |
32,586 |
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$ |
130,163 |
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$ |
(130,412 |
) |
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$ |
32,337 |
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| (3) |
Provision for Sales Returns and Allowances. The provision
for sales returns and allowances consists of our estimates of
potential future product returns related to current period
product revenue, and specific provisions for distributor,
reseller, and retailer sales incentives (“allowances”)
that are reductions in the revenue to be realized. Management
analyzes historical returns, current economic trends, and
changes in customer demand and acceptance of our products when
evaluating the adequacy of the sales returns and allowances.
Significant management judgments and estimates must be made and
used in connection with establishing the sales returns and
allowances in any accounting period. Material differences may
result in the amount and timing of our revenue for any period if
management made different judgments or utilized different
estimates. |
126