UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission file number: 001-31216

McAfee, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(408) 988-3832

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

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

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o          No þ

      As of October 31, 2005, 167,765,011 shares of the registrant’s common stock, $0.01 par value, were outstanding.

MCAFEE, INC.

FORM 10-Q

September 30, 2005

CONTENTS

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND

COMPREHENSIVE INCOME

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

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

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

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

      We and our wholly owned subsidiaries are a leading supplier of computer security solutions designed to prevent intrusions on networks and protect computer systems from the next generation of blended attacks and threats. We offer two families of products, McAfee System Protection Solutions and McAfee Network Protection Solutions. Our computer security solutions are offered primarily to large enterprises, governments, small and medium-sized businesses and consumers. We operate our business in five geographic regions: North America; Europe, Middle East and Africa (“EMEA”); Japan; Asia-Pacific, excluding Japan; and Latin America.

      In January 2004, we sold our Magic Solutions product line (“Magic”), and in July 2004, we sold our Sniffer product line (“Sniffer”). In April 2005, we sold our McAfee Labs assets.

      In October 2004, we acquired Foundstone, Inc. (“Foundstone”), a provider of risk assessment and vulnerability services and products, and in June 2005, we acquired Wireless Security Corporation, a provider of home and small business wireless network security products.

      The accompanying condensed consolidated financial statements include our accounts as of September 30, 2005 and December 31, 2004 and for the three and nine months ended September 30, 2005 and September 30, 2004. All significant intercompany accounts and transactions have been eliminated in consolidation. These condensed consolidated financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The December 31, 2004 Consolidated Balance Sheet was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. However, we believe that all disclosures are adequate to make the information presented not misleading. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2004.

      In the opinion of our management, all adjustments (which consist of normal recurring adjustments, except as disclosed herein) necessary to fairly present our financial position as of September 30, 2005, results of operations for the three and nine months ended September 30, 2005 and September 30, 2004 and cash flows for the nine months ended September 30, 2005 and September 30, 2004 have been included. The results of operations for the three and nine months ended September 30, 2005 are not necessarily indicative of the results to be expected for the full fiscal year or for any future periods.

      Approximately $5.9 million and approximately $14.6 million were reclassified from cost of product net revenue to cost of services and support net revenue in the three and nine months ended September 30, 2004, respectively, to be consistent with current-period presentation. This reclassification did not have an impact to total cost of net revenue. Approximately $8.9 million of reseller and retail rebates was reclassified from a reduction to accounts receivable to accrued liabilities on the December 31, 2004 balance sheet to be consistent with current-period presentation. This reclassification did not have an impact on our working capital as of December 31, 2004. Certain other immaterial prior-period amounts have been reclassified to conform to current-period presentation.

      As permitted by Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and as amended by SFAS No. 148, “Accounting for Stock-

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Based Compensation — Transition and Disclosure,” (“SFAS 148”), we account for employee stock-based compensation in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”), and related interpretations. Under APB 25, if the exercise price of an employee’s stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. Stock-based compensation is based on the excess of the market price on the grant date over the exercise price and is recognized ratably over the vesting period. Stock-based compensation related to non-employees is based on the fair value price of the options and is recognized ratably over the vesting period in accordance with SFAS 123.

      In calculating the estimated fair value of the stock options granted in the period and for our employee stock purchase plan (“ESPP”), we utilized the Black-Scholes option-pricing model with the following weighted-average assumptions:

      The following table illustrates the effect on net income and net income per share if we had applied the fair value recognition provision of SFAS 123 to all of our stock-based compensation plans:

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The impact on pro forma income per share and pro forma net income in the table above may not be indicative of the effect in future periods as options vest over several years and we continue to grant stock options to employees.

      At the end of each interim period we make our best estimate of the effective tax rate expected to be applicable for the full fiscal year. This effective tax rate is used to determine income taxes on a current year-to-date basis. The effective tax rate may consider, as applicable, tax credits, foreign tax rates, and other available tax planning alternatives. It also includes the effect of any valuation allowance expected to be necessary at the end of the period for deferred tax assets related to originating deductible temporary differences and carryforwards. In arriving at this effective tax rate applied to interim periods no effect is included for the tax related to significant, unusual, or extraordinary items that may be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year. The rate is revised, if necessary, as of the end of each successive interim period during the fiscal year to our best current estimate of our expected annual effective tax rate.

      The effective tax rate is our best estimate of the tax expense (or benefit) that will be provided for the fiscal year, stated as a percentage of our estimated annual ordinary income (or loss). The tax expense (or benefit) related to ordinary income (or loss) for the interim period is determined using this estimated annual effective tax rate. The tax expense (or benefit) related to other items is individually computed and recognized when the items occur. The estimated tax rate applied to interim ordinary income (or loss) is reliant on our estimates of expected annual operating income (or loss) for the year as well as our projections of the proportion of income (or loss) earned in foreign jurisdictions which may have statutory tax rates significantly lower than tax rates applicable to our earnings in the United States. In each successive interim period, to the extent our operating results year to date and our estimates for the remainder of the fiscal year change from our original expectations regarding the proportion of earnings in various tax jurisdictions we expect that our effective tax rate will change accordingly, affecting tax expense (or benefit) for both that successive interim period as well as year-to-date interim results.

      Tax returns are subject to audit by various taxing authorities. Although we believe that adequate accruals have been made each period for unsettled issues, additional benefits or expenses could occur in future years from resolution of outstanding matters. We record additional expenses each period on unsettled issues relating to the expected interest we would be required to pay a tax authority if we do not prevail on an unsettled issue. We continue to assess our potential tax liability included in accrued taxes in the consolidated financial statements, and revise our estimates. Such revisions in our estimates could materially impact our results of operations and financial position. We have classified a portion of our tax liability as non-current in the consolidated balance sheet based on the expected timing of cash payments to settle contingencies with taxing authorities.

      In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment” (“SFAS 123R”) which requires the measurement of all 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. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 expresses views of the SEC staff regarding the interaction between SFAS 123R and certain SEC rules. In April 2005, the SEC extended the effective date for SFAS 123R to fiscal years beginning after June 15, 2005. Therefore, we are required to adopt SFAS 123R in the first quarter of fiscal year 2006. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. See

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

“Pro forma Stock-based Compensation Disclosure” above for the pro forma net income and net income per share amounts, in the three and nine months ended September 30, 2005 and September 30, 2004, respectively, 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 our consolidated results of operations.

      In June 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143-1, “Accounting for Electronic Equipment Waste Obligations”, that provides guidance on how commercial users and producers of electronic equipment should recognize and measure asset retirement obligations associated with the European Directive 2002/96/ EC on Waste Electrical and Electronic Equipment. We adopted SFAS 143-1 during the three months ended June 30, 2005. The adoption of SFAS 143-1 did not have a material effect on our financial statements. Due to the fact that several major EU-member countries have not yet enacted country-specific laws, we cannot estimate the effect of applying this guidance in future periods, however, we do not believe SFAS 143-1 will have a material effect on our consolidated financial position, results of operations or cash flows.

      In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), a replacement of APB Opinion No. 20, “Accounting Changes”, and SFAS Statement 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition via a cumulative effect adjustment within net income of the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the Statement does not change the transition provisions of any existing accounting pronouncements. We do not believe the adoption of SFAS 154 will have a material effect on our consolidated financial position, results of operations or cash flows.

      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. We do not believe that the adoption of EITF 03-01 will have a material impact on our financial position, results of operations or cash flows; however, we will evaluate the impact of EITF 03-1 once final guidance is issued.

      We recorded stock-based compensation charges of $3.0 million and $2.3 million, before taxes, in the three months ended September 30, 2005 and 2004, respectively, and $2.1 million and $4.9 million, before

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

taxes, in the nine months ended September 30, 2005 and 2004, respectively. These charges are comprised of the following (in thousands):

      Exchange of McAfee.com options. On September 13, 2002, we acquired the minority interest in McAfee.com that we previously did not own. McAfee.com option holders received options for 0.675 of a share of our common stock plus $8.00 in cash, $11.85 after applying the option exchange ratio, which is paid to the option holder upon exercise of the option and without interest. McAfee.com options to purchase 4.1 million shares were converted into options to purchase 2.8 million shares of our common stock. The assumed options are subject to variable accounting treatment, which means that a compensation charge was measured initially at the date of the closing of the acquisition and is remeasured each reporting period based on our common stock fair market value at the end of each reporting period.

      The initial charge was based on the excess of the closing price of our common stock over the exercise price of the options less 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.” 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 the three months ended September 30, 2005 and 2004, we recorded a charge of approximately $1.6 million and $0.8 million, respectively, related to exchanged options subject to variable accounting. During the nine months ended September 30, 2005 and 2004, we recorded a charge of approximately $0.8 million and $3.0 million, respectively, related to exchanged options subject to variable accounting. This stock-based compensation was based on our closing stock price of $31.42 on September 30, 2005 and $20.10 on September 30, 2004. The charge in the nine months ended September 30, 2005 was due to an increase in our stock price from $28.93 at December 31, 2004 to $31.42 as of September 30, 2005, and the charge in the three months ended September 30, 2005 was due to an increase in our stock price from $26.18 on June 30, 2005. As of September 30, 2005, we had approximately 0.2 million outstanding options related to the acquisition of the minority interest in McAfee.com subject to variable accounting. Further fluctuations in the stock price may result in significant additional stock-based compensation charges or benefits in future periods.

      Repriced options. On April 22, 1999, we offered to substantially all of our employees, excluding executive officers, the right to cancel certain outstanding stock options and receive new options with an exercise price of $11.063 per share, 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 vested at the same rate that they would have vested under previous option plans and are subject to variable accounting. Accordingly, we have and will continue to remeasure compensation cost for these repriced options

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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 our common stock on July 1, 2000, which was $20.375. As these options are fully vested, the charge is recorded to earnings immediately. Depending upon movements in the market value of our common stock, this variable accounting treatment can result in additional stock-based compensation charges or benefits in future periods until the options are exercised, forfeited or cancelled.

      During the three months ended September 30, 2005, we recorded a charge of approximately $1.1 million, and did not record any charges or benefits in the three months ended September 30, 2004. During the nine months ended September 30, 2005, we recorded a charge of $0.2 million and did not record any charges or benefits in the nine months ended September 30, 2004. The stock-based compensation for these options was based on closing stock prices as of September 30, 2005 and 2004 of $31.42 and $20.10, respectively. The charge in the nine months ended September 30, 2005 was due to an increase in our stock price from $28.93 at December 31, 2004 to $31.42 as of September 30, 2005, and the charge in the three months ended September 30, 2005 was due to an increase in our stock price from $26.18 on June 30, 2005. There was no charge or benefit in the three months and nine months ended September, 2004 as our closing stock price from December 31, 2003 to September 30, 2004 was below $20.375. As of September 30, 2005, there were approximately 0.2 million options related to this repricing which were outstanding and subject to variable plan accounting.

      New and existing employees and executives. In the three months ended September 30, 2005, our compensation committee of our board of directors granted a total of 110,000 shares of restricted stock, which vest through September 2008, to key employees. The price of the underlying shares is $0.01 per share. In January 2005, our board of directors granted 75,000 shares of restricted stock, which vest through December 31, 2007, to our chief financial officer. The price of the underlying shares is $0.01 per share. We recorded expense of approximately $0.2 million in the three months ended September 30, 2005 and $0.6 million in the nine months ended September 30, 2005 related to the stock-based compensation associated with these restricted stock grants.

      In January 2002, our board of directors approved a grant of 50,000 shares of restricted stock, which vested through January 2005, to our chief executive officer. The price of the underlying shares is $0.01 per share. During the three months ended September, 2005, we recorded no stock-based compensation related to the chief executive officer’s 2002 restricted stock grant compared to $0.1 million in the three months ended September 30 2004. During the nine months ended September 30, 2005 and 2004, we recorded less than $0.1 million and approximately $0.3 million, respectively, 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, of which $0.3 million was recorded in the three and nine months ended September 30, 2004.

      In connection with the acquisition of Foundstone in October 2004, we assumed stock options to Foundstone employees which are subject to vesting provisions as the employees provide service to us. We recognized approximately $0.1 million in the three months ended September 30, 2005, and $0.4 million in the nine months ended September 30, 2005. An additional $0.6 million will be recognized through 2008, which is subject to reduction based on employees terminating prior to the full vesting of their options.

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Former employees. 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 options 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 during the nine months ended September 30, 2004.

      As a result of the sale of the Company’s Sniffer product line (“Sniffer”) in July 2004, the Company modified the stock option agreements of several Sniffer executives by accelerating the vesting of their unvested outstanding options. As a result, the Company recorded a stock-based compensation charge of approximately $1.0 million during the three and nine months ended September 30, 2004. Since the modification was directly related to the sale of Sniffer, the stock compensation charge was reflected in the calculation of the gain on the sale of Sniffer.

      Extended life of vested options held by terminated employees. During a significant portion of 2003, we suspended exercises of stock options until our required public company reports were filed with the SEC. The period during which stock options were suspended is known as the black-out period. Due to the black-out period, we extended the exercisability of any options that would otherwise terminate during the black-out period for a period of time equal to a specified period after termination of the black-out period. Accordingly, we recorded a stock-based compensation charge on the date the options should have terminated based on the intrinsic value of the option on the modification date and the option price. During the nine months ended September 30, 2004, we recorded a stock-based compensation charge of approximately $0.1 million.

      In June 2005, we acquired 100% of the outstanding shares of Wireless Security Corporation, a provider of home and small business wireless network security products, for approximately $20.0 million in cash and $0.3 million of direct expenses, totaling $20.3 million. We acquired Wireless Security Corporation to continue to develop their patent-pending technology, introduce a new consumer offering and to utilize the technology in our small business managed solutions. The results of operations of Wireless Security Corporation have been included in our results of operations since the date of acquisition.

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Our 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 Wireless Security Corporation as adjusted during the current period for resolution of ongoing purchase price valuation procedures:

      We recorded approximately $4.0 million for in-process research and development, which was fully expensed upon purchase because technological feasibility had not been achieved and there was no alternative use for the projects under development. The in-process research and development included the development of the consumer wireless security product that we introduced in the third quarter of 2005. In addition, the in-process research and development included existing wireless security offers that we plan to integrate in our small business managed solution. At the date of acquisition, we estimated that 60% of the development effort had been completed and that the remaining 40% of the development would take approximately three months to complete and would cost approximately $0.6 million. As of September 30, 2005, we had completed the remaining development efforts. The intangible assets, other than goodwill, are being amortized over their useful lives of 2.0 to 3.5 years or a weighted average period of 3.2 years. As part of the acquisition, we did not assume any outstanding stock options or warrants. A performance and retention plan, which provides for payment of up to $1.8 million, was established at the close of the acquisition. At September 30, 2005, approximately $0.3 million had been accrued and no amounts had been paid related to this performance plan. The results of operations for Wireless Security Corporation prior to the acquisition would not have a material impact on our results of operations.

      In October 2004, we acquired 100% of the outstanding 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 and 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 our results of operations since the date of acquisition.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      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, $57.4 million for goodwill (none of which is deductible for tax purposes), $0.5 million for net deferred tax liabilities and $4.9 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 2.0 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. As of September 30, 2005, we have paid all severance costs related to the acquisition.

      As part of the Foundstone acquisition, we assumed a portion of outstanding vested and unvested Foundstone stock options. The intrinsic value of the stock options will be recognized by us through 2008 as employment services are provided. In the three and nine months ended September 30, 2005, we expensed $0.1 million and $0.4 million, respectively, related to the Foundstone stock options. At September 30, 2005, unearned compensation to be recognized by us in future periods as services are provided was $0.6 million.

      We cancelled the Foundstone stock options we 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. We recorded the $5.6 million paid into Key Employee Escrow as prepaid compensation, which is being recognized as compensation expense over the vesting period. 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. In the three and nine months ended September 30, 2005, we recorded approximately $0.7 million and $2.5 million, respectively, in expense for escrow amounts vesting in the period.

      Our 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 as adjusted during the current period for resolution of ongoing purchase price valuation procedures:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following pro forma financial information presents our combined results with Foundstone, Inc., as if the acquisition had occurred at the beginning of 2004 (in thousands, except per share amounts):

      The above 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.

      In May 2003, we acquired 100% of the outstanding shares of IntruVert Networks, Inc., (“IntruVert”) a provider of network-based intrusion prevention solutions designed to proactively detect and stop system and network security attacks before they occur, for $98.1 million in cash and $5.2 million of direct expenses, totaling $103.3 million. We acquired IntruVert to enhance our intrusion detection product line, improve our position in the emerging intrusion prevention marketplace, embed the acquired technologies in our current product offering, and sell IntruVert products to our existing customer base.

      As part of the IntruVert acquisition, we 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 us based on the same vesting terms of their restricted stock or stock option agreements. The payments to former IntruVert employees are recorded as salary expense ratably over the vesting period since the employees are currently providing services to us. 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. For the restricted stock agreements, we recorded expense of approximately $0.1 million and $0.3 million in the three months ended September 30, 2005 and 2004, respectively. In the nine months ended September 30, 2005 and 2004, we recorded expense of approximately $0.3 million and $1.1 million, respectively. Payments under the stock option plan are being paid monthly through our payroll, and we currently expect the payments to total $3.4 million. For stock option agreements, we recorded expense of approximately $0.2 million and $0.3 million in the three months ended September 30, 2005 and 2004, respectively. In the nine months ended September 30, 2005 and 2004, we recorded expense of approximately $0.6 million and $1.1 million, respectively, and we anticipate that we will record an additional $0.7 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 us, unvested payment amounts will be returned to us.

      In April 2003, we acquired 100% of the outstanding 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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

expenses, totaling $125.8 million. We acquired Entercept to enhance our intrusion detection product line, achieve a leading position in the emerging intrusion prevention marketplace, embed the acquired technologies in our current product offering, and sell Entercept products to our existing customer base. At the acquisition date, we accrued $2.8 million for permanently vacated facilities. A summary of activity in the restructuring accrual related to Entercept during the nine months ended September 30, 2005 is as follows (in thousands):

      In April 2005, we completed the sale of our McAfee Labs assets to SPARTA, Inc. (“SPARTA”) for $1.5 million and recognized a gain on the sale of $1.3 million for the nine months ended September 30, 2005. The carrying value of McAfee Labs assets and liabilities, which were sold in this agreement, were not significant. The operations of McAfee Labs, which are not material to our consolidated results of operations, are included in income from operations.

      In the three months ended September 30, 2005, we had no revenue from McAfee Labs compared to $1.5 million in the three months ended September 30, 2004. Revenues related to McAfee Labs were approximately $1.9 million and $4.7 million in the nine months ended September 30, 2005 and 2004, respectively.

      In July 2004, we completed our sale of our Sniffer product line to Network General Corporation for $212.7 million in cash, net of approximately $4.0 million in direct costs. We recorded a gain on sale of $197.4 million in 2004. Revenues related to Sniffer were approximately $10.2 million and $90.9 million, respectively, in the three and nine months ended September 30, 2004.

      In conjunction with the sale of Sniffer, we entered into a transition services agreement with Network General Corporation. Under this agreement, we provided certain transition services, including initial order processing, use of facilities, transaction processing services and certain other back office functions for one year from the purchase date. We were reimbursed for our 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 and comprehensive income. We recorded $0.4 million of reimbursements under the transition services agreement in the nine months ended September 30, 2005. We recorded $3.7 million in the three and nine months ended September 30, 2004. We completed our requirements under the transition services agreement in July 2005.

      In January 2004, we completed our sale of our Magic Solutions product line to BMC Software for $47.1 million in cash. We recorded a gain of $46.2 million during the nine months ended September 30, 2004. In conjunction with the Magic sale, we paid a $1.4 million bonus to an executive related to the transaction in the nine months ended September 30, 2004. Revenues related to Magic were approximately $2.9 million in nine months ended September 30, 2004.

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      We account for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” In lieu of amortization, we perform an impairment review of our goodwill on at least an annual basis.

      We perform our annual goodwill impairment review as of October 1 of our fiscal year. We completed our annual goodwill review as of October 1, 2004 and concluded that goodwill was not impaired. The fair value of the reporting units was estimated using the average of the expected present value of future cash flows and of the market multiple value. As a result of the sale of Sniffer and Magic in 2004, we tested goodwill, excluding Sniffer and Magic. These impairment tests were performed during the three months ended March 31, 2004 and September 30, 2004, respectively, and no impairment was identified. We will continue to test for impairment on an annual basis and on an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting units below their carrying amounts.

      Goodwill information is as follows (in thousands):

      The adjustment to goodwill in the nine months ended September 30, 2005 related to the Foundstone, Wireless Security Corporation, McAfee.com and Traxess acquisitions.

      The components of other intangible assets are as follows (in thousands):

      The aggregate amortization expenses for the intangible assets listed above totaled $6.8 million and $6.3 million in the three months ended September 30, 2005 and 2004, respectively, and $21.8 million and $20.0 million in the nine months ended September 30, 2005 and 2004, respectively.

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      Expected future intangible asset amortization expense as of September 30, 2005 is as follows (in thousands):

      During the nine months ended September 30, 2005, we permanently vacated several leased facilities and recorded a $1.8 million accrual for estimated lease related costs associated with the permanently vacated facilities. The remaining costs associated with vacating the facilities are primarily comprised of the present value of remaining lease obligations, along with estimated costs associated with subleasing the vacated facility, net of estimated sublease rental income. We also recorded a restructuring charge of $0.2 million related to a reduction in headcount of approximately 14 employees.

      The following table summarizes our restructuring accrual established in 2005 and activity through September 30, 2005 (in thousands):

      As of September 30, 2005, $0.9 million of the restructuring accrual is due within 12 months and has been classified as current accrued liabilities, while less than $0.1 million has been classified as other long term liabilities, and will be paid through July 2007.

      During 2004, we recorded several restructuring charges related to the reduction of employee headcount. In the first quarter of 2004, we recorded a restructuring charge of approximately $2.2 million related to the severance of approximately 160 employees, of which $0.7 million and $1.5 million was related to our North America and EMEA operating segments, respectively. The workforce size was reduced primarily due to our sale of Magic in January 2004. In the second quarter of 2004, we recorded a restructuring charge of approximately $1.6 million related to the severance of approximately 80 employees in our sales, technical support and general and administrative functions. Approximately $0.6 million of the restructuring charge was related to the EMEA operating segment and the remaining $1.0 million was related to the North America operating segment. In the third quarter of 2004, we recorded a restructuring charge related to ten employees

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which totaled approximately $0.9 million, all of which related to the North America operating segment. In the fourth quarter of 2004, we recorded a restructuring charge of $1.3 million related to 111 employees, of which $0.7 million, $0.2 million, $0.2 million and $0.2 million related to the Latin America, North America, EMEA and Asia-Pacific, excluding Japan, operating segments, respectively. All employees were terminated as of December 31, 2004. The reductions in the second, third and fourth quarters were part of the previously announced cost-savings measures being implemented by us.

      In September 2004, we announced the move of our European headquarters to Ireland, which was substantially completed by the end of March 2005. In the third and fourth quarters of 2004, we recorded restructuring charges of $0.2 million and $2.2 million, respectively, related to the severance of approximately 80 employees. During the nine months ended September 30, 2005, we completed the move of our European headquarters to Ireland and vacated the remaining planned floors. We recorded an additional $1.4 million restructuring charge for estimated lease related costs associated with the permanently vacated facilities and a $1.4 million restructuring charge for severance costs. All of these restructuring charges were related to the EMEA operating segment

      Also in September 2004, we permanently vacated an additional two floors in our Santa Clara headquarters building. We recorded a $7.8 million accrual for the estimated lease related costs associated with the permanently vacated facility, partially offset by a $1.3 million write-off of deferred rent liability. The remaining costs associated with vacating the facility are primarily comprised of the present value of remaining lease obligations, net of estimated sublease income along with estimated costs associated with subleasing the vacated facility. The remaining costs will generally be paid over the remaining lease term ending in 2013. We also recorded a non-cash charge of approximately $0.8 million related to disposals of certain leasehold improvements. The restructuring charge of $6.5 million and related cash outlay were based our 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, along with estimated costs associated with subleasing the vacated facility.

      During 2004, we adjusted the restructuring accruals related to severance costs and lease termination costs recorded in 2004. We recorded a $0.3 million adjustment to reduce the EMEA severance accrual for amounts that were no longer necessary after paying out substantially all accrued amounts to the former employees. We also recorded a $0.2 million reduction in lease termination costs due to changes in estimates related to the sublease income to be received over the remaining lease term of our Santa Clara headquarters building.

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      The following table summarizes our restructuring accruals established in 2004 and activity through September 30, 2005 (in thousands):

      As of September 30, 2005, $1.9 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 2013.

      In January 2003, as part of a restructuring effort to gain operational efficiencies, we consolidated operations formerly housed in three leased facilities in the Dallas, Texas area into our regional headquarters facility in Plano, Texas. The facility houses employees working in finance, information technology, legal, human resources, field sales and the customer support and telesales groups servicing the McAfee System Protection Solutions and McAfee Network Protection Solutions businesses. The remaining costs will generally be paid over the remaining lease term ending in 2013.

      In 2004, we adjusted the restructuring accrual related to lease termination costs previously recorded in 2003. The adjustments decreased the liability by approximately $0.6 million in 2004, due to changes in estimates related to the sublease income to be received over the remaining lease term.

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      The following table summarizes our restructuring accrual established in 2003 and activity through September 30, 2005 (in thousands):

      As of September 30, 2005, $1.5 million of the restructuring accrual is due within 12 months and has been classified as current accrued liabilities, while the remaining balance of $10.3 million has been classified as other long term liabilities and will be paid through March 2013.

      Our estimate of the excess facilities charges recorded during 2005, 2004 and 2003 may vary significantly depending, in part, on factors which may be beyond our control, such as our success in negotiating with our lessor, the time periods required to locate and contract suitable subleases and the market rates at the time of such subleases. Adjustments to the facilities accrual will be made if actual lease exit costs or sublease income differ from amounts currently expected. The facility restructuring charges in 2005 were primarily allocated to the EMEA and Japan operating segments, and the facility restructuring charges in 2004 and 2003 were primarily allocated to the North America operating segment.

      We have a $17.0 million credit facility with a bank. The credit facility is available on an offering basis, meaning that transactions under the credit facility will be on such terms and conditions, including interest rate, maturity, representations, covenants and events of default, as mutually agreed between us and the bank at the time of each specific transaction. The credit facility is intended to be used for short-term credit requirements with terms of one year or less. The credit facility can be cancelled at any time. No balances were outstanding as of September 30, 2005 and December 31, 2004.

      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 our outstanding 5.25% Convertible Subordinated Notes (“Notes”) due 2006. The Notes were issued in August 2001 with an aggregate principal amount of $345.0 million.

      The Transactions had a termination date of August 15, 2006, 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 per share. Depending on the timing of the early termination event, the Banks would be obligated to pay us an amount equal to the repurchase premium called for under the terms of the Notes.

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      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 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, until the Transactions terminated in October 2004 when our common stock price exceeded $22.59 for a five-day period.

      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):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Our consolidated provision for income taxes for the three months ended September 30, 2005 and 2004 was $0.1 million and $81.3 million, respectively, reflecting an effective tax rate of less than 1% and 41%, respectively. Our consolidated provision for income taxes for the nine months ended September 30, 2005 and 2004 was $25.4 million and $106.5 respectively, reflecting an effective tax rate of 20% and 36%, 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. In each successive interim period, to the extent our operating results year to date and our estimates for the remainder of the fiscal year change from our original expectations regarding the proportion of earnings in various tax jurisdictions we expect that our effective tax rate will change accordingly, affecting tax expense (or benefit) for both that successive interim period as well as year-to-date interim results.

      Although we reported an effective tax rate of 20% for the nine months ended September 30, 2005, our total tax expense of $25.4 million is comprised of tax expense of $41.6 million on year to date ordinary income at an estimated 33% annual effective tax rate offset by a net tax benefit of $16.1 million from discrete items individually computed and recognized when the items occurred. The discrete items include an $18.7 million tax benefit relating to a valuation allowance release, changes in foreign, federal and state estimated tax provisions, and releases of tax reserves no longer required. Additionally, $2.6 million in tax expenses correlates to net incremental federal and state income tax expense related to our determination to repatriate no less than $350.0 million of foreign earnings, as discussed below.

      The American Jobs Creation Act of 2004 (the “Act”) provided for a deduction of 85% of certain foreign earnings that are repatriated in stipulated periods, including our year ending December 31, 2005. Certain criteria must be met to qualify for the deduction, including the establishment of a domestic reinvestment plan by the Chief Executive Officer, the approval of the plan by the Board of Directors, and the execution of the plan whereby the repatriated earnings are reinvested in the United States.

      In the third quarter of 2005, we decided to make a distribution of earnings from our foreign subsidiaries that would qualify for the repatriation provisions of the Act. We plan to repatriate no less than $350.0 million. As a result we recorded tax expense of $2.6 million, net of a $17.8 million tax benefit resulting from an expected lower tax rate under the Act on a portion of foreign earnings for which we previously in 2004 provided United States tax. We are continuing our assessment of the opportunity of the repatriation provisions for further repatriations under the Act, but do not expect to complete this assessment until the fourth quarter of 2005. The additional amount of unremitted foreign earnings that is being considered for possible repatriation and the related income tax expense is no more than $150.0 million and $9.0 million, respectively. Except for the distributions considered under the Act, we intend to indefinitely reinvest all other current and/or future earnings of our foreign subsidiaries.

      We have concluded that we have one business and operate in one industry, developing, marketing, distributing and supporting computer security solutions for large enterprises, governments, small and medium-sized business and consumer users, as well as resellers and distributors. Our management measures profitability based on our five geographic regions: North America; Europe, Middle East and Africa (“EMEA”); Japan; Asia-Pacific, excluding Japan; and Latin America. The regions are evidence of the operating structure of our internal organization. The Corporate business segment includes general and administrative expenses, amortization of purchased technology and other intangibles, the provision for doubtful accounts and other indirect charges, such as the proposed legal settlement charge, acquired in-process research and development, and restructuring charges.

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      We market and sell, through our geographic regions, anti-virus and security software, hardware and services. These products and services are marketed and sold worldwide primarily through resellers, distributors, systems integrators, retailers, original equipment manufacturers, internet service providers and directly by us. In addition, we offer web sites, which provide suites of on-line products and services personalized for the user based on the users’ personal computer (“PC”) configuration, attached peripherals and resident software. We also offer managed security and availability applications to corporations and governments on the Internet.

      Following is a summary of our net revenue from external customers and operating income by geographic region (in thousands):

      The difference between operating income and income before taxes is reflected on the face of our condensed consolidated statements of income.

      Net revenue information on a product and service basis is as follows (in thousands):

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      Net revenue information on a product family basis is as follows (in thousands):

      From time to time, we have been subject to litigation including the pending litigation described below. Our current estimated range of liability related to some of the pending litigation below is based on claims for which our management can estimate the amount and range of loss. We have recorded the minimum estimated liability related to those claims, where there is a range of loss. Because of the uncertainties related to both the range of loss on the remaining pending litigation, our management is unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, we will assess our potential liability and revise our estimates. Pending or future litigation could be costly, could cause the diversion of our management’s attention and could upon resolution, have a material adverse effect on the business, results of operations, financial condition and cash flows.

      In addition, we are engaged in certain legal and administrative proceedings incidental to our normal business activities and believe that these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

      In September 2003, we entered into a settlement agreement with the plaintiffs in the In re Network Associates, Inc. II Securities Litigation, which was originally filed in December 2000. Under the settlement agreement, we paid $70.0 million, which was recorded as litigation settlement in the consolidated statement of income for 2002. The settlement was approved by the court in February 2004, and the case was dismissed with prejudice to all parties and claims. In 2004, we received approximately $25.0 million from our insurance carriers related to this litigation, of which $19.1 million was received in the first quarter of 2004 and was recorded as litigation reimbursement in the consolidated statement of income. The remaining $5.9 million was received in the second quarter of 2004.

      Certain investment bank underwriters, our company, and certain of our directors and officers have been named in a putative class action for violation of the federal securities laws in the United States District Court for the Southern District of New York, captioned In re McAfee.com Corp. Initial Public Offering Securities Litigation, 01 Civ. 7034 (SAS). This is one of a number of cases challenging underwriting practices in the initial public offerings (“IPOs”) of more than 300 companies. These cases have been coordinated for pretrial proceedings as In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS). Plaintiffs generally allege that certain underwriters engaged in undisclosed and improper underwriting activities, namely the receipt of excessive brokerage commissions and customer agreements regarding post-offering purchases of stock in exchange for allocations of IPO shares. Plaintiffs also allege that various investment bank securities analysts issued false and misleading analyst reports. The complaint against us claims that the purported improper underwriting activities were not disclosed in the registration statements for McAfee.com’s IPO and seeks

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unspecified damages on behalf of a purported class of persons who purchased our securities or sold put options during the time period from December 1, 1999 to December 6, 2000. On February 19, 2003 the Court issued an Opinion and Order dismissing certain of the claims against us with leave to amend. We accepted a settlement proposal on July 15, 2003 and we are awaiting Court approval. Under this settlement proposal, we may assign our claims against certain underwriters to the plaintiffs, and we 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 Virex 6.1 product. The Complaint seeks treble damages, attorneys’ fees and costs for the alleged unauthorized sale of products Cozza claims contain or contained his technology from and after January 1, 2002, and an injunction against the alleged further use of Cozza’s technology. McAfee filed papers in opposition to the Complaint and asserted various defenses. A motion by McAfee to compel arbitration and a motion for partial summary judgment on liability (but not damages) issues relating to whether the contract claims extended beyond the Virex 6.1 product, have both been denied by the Court. In its order denying the McAfee motion for partial summary judgment, the Court also granted a motion for partial summary judgment filed by Cozza in which Cozza sought a declaration that the language of an agreement is unambiguous and enforceable against any McAfee product which might be proved to contain that same technology referenced in a 1993 License Agreement. No trial date has been set, and discovery continues in anticipation of a trial either at the end of the first quarter, or during the second quarter, of 2006.

      On March 22, 2002, the SEC notified us that it has commenced a “Formal Order of Private Investigation” into our accounting practices. We have been engaged in ongoing settlement discussions with the SEC. On September 29, 2005, we announced we had reserved $50.0 million in connection with a proposed settlement with the SEC and we have deposited $50.0 million in an escrow account with the SEC as the designated beneficiary. This amount is reflected as current restricted cash on our balance sheet. The proposed settlement would, among other things, require us to pay a $50.0 million penalty. No settlement with the SEC has been finalized and the amount and terms of such settlement, if any, are subject to change.

      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 we have determined are within the scope of FIN 45 as of September 30, 2005:

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