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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

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 30, 2009, 157,727,804 shares of the registrant’s common stock, $0.01 par value, were outstanding.

 

 

MCAFEE, INC. AND SUBSIDIARIES

 

FORM 10-Q

September 30, 2009

 

 

CONTENTS

 

 

 

MCAFEE, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

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

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

 

 

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

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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

 

MCAFEE, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

McAfee, Inc. and our wholly owned subsidiaries (“we”, “us” or “our”) are a global dedicated security technology company that secures systems and networks from known and unknown threats. We empower home users, businesses, government agencies, service providers and our partners with the ability to block attacks, prevent disruptions, and continuously track and improve their security and compliance. We operate our business in five geographic regions: North America; Europe, Middle East and Africa (“EMEA”); Japan; Asia-Pacific, excluding Japan; and Latin America.

 

 

The accompanying condensed consolidated financial statements include our accounts as of September 30, 2009 and December 31, 2008 and for the three and nine months ended September 30, 2009 and September 30, 2008. All 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, 2008 condensed 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 the disclosures are adequate to make the information presented not misleading. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto, included in our annual report on Form 10-K for the year ended December 31, 2008.

 

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, results of operations and cash flows for the interim periods presented have been included. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the full year or for any future periods.

 

Significant Accounting Policies

 

Marketable Securities

 

All marketable securities are classified as available-for-sale securities. Available-for-sale securities are carried at fair value with resulting unrealized gains and losses, including the non-credit component of other-than-temporary impairments, reported net of tax as a component of accumulated other comprehensive income (loss). 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. All proceeds received from the sale and maturity of our marketable securities are reflected in investing activities in the condensed consolidated statements of cash flows, including amounts related to discounts and premiums recorded at the time of purchase. Short-term marketable securities are those with remaining maturities at the balance sheet date of less than one year. Long-term marketable securities have remaining maturities at the balance sheet date of one year or greater. Realized gains and losses on sales of all such investments are reported in earnings and are computed using the specific identification cost method.

 

In April 2009, new accounting guidance was issued, which revised the existing impairment model for debt securities by modifying the current intent and ability indicator in determining whether a debt security is other-than-temporarily impaired. For debt securities in an unrealized loss position, we are required to assess whether (i) we have the intent to sell the debt security, or (ii) it is more likely than not that we will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an other-than-temporary

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

impairment on the security must be recognized in earnings equal to the entire difference between its fair value and amortized cost basis.

 

For debt securities in an unrealized loss position where neither of the criteria in the paragraph above are present, the difference between the security’s then-current carrying amount and its estimated fair value is separated into (i) the amount of the impairment related to the credit loss (i.e., the credit component) and (ii) the amount of the impairment related to all other factors (i.e., the non-credit component). The credit component is recognized in earnings. The non-credit component is recognized in accumulated other comprehensive income (loss). The credit loss component is the excess of the amortized cost of the security over the best estimate of the present value of the cash flows expected to be collected from the debt security. The non-credit loss component is the residual amount of the other-than-temporary impairment. Previously, in all cases, if an impairment was determined to be other-than-temporary, then an impairment loss was recognized in earnings in an amount equal to the entire difference between the security’s amortized cost basis and its fair value.

 

When calculating the present value of expected cash flows to determine the credit loss component of the other-than-temporary impairment, we estimate the amount and timing of projected cash flows on a security-by-security basis. These calculations reflect our expectations of the performance of the underlying collateral and the ability of the issuer to meet payment obligations as applicable. The expected cash flows are discounted using the effective interest rate of the security prior to any impairment. The amortized cost basis of a debt security is adjusted for credit losses recorded to earnings. The difference between the cash flows expected to be collected and the new cost basis is accreted to investment income over the remaining expected life of the security.

 

Pursuant to recently issued accounting guidance, we were required to separate other-than-temporary impairments recognized in earnings through April 1, 2009, between the credit loss and the non-credit components, and record a cumulative effect adjustment to retained earnings for the non-credit component. Upon adoption on April 1, 2009, we recorded a net after tax increase to retained earnings and a corresponding decrease to accumulated other comprehensive income of $2.5 million, net of $1.6 million in tax benefits. Periods prior to April 1, 2009, have not been restated for this new accounting policy and therefore, current period and prior period financial statements may not be comparable.

 

Inventory

 

Inventory, which consists of components and finished goods held at our warehouse and other fulfillment partner locations and finished goods sold to our channel partners but not yet sold through to the end-user, is stated at lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first in, first out basis. Inventory balances are included in other current assets on our condensed consolidated balance sheets and were $12.8 million as of September 30, 2009 and $10.2 million as of December 31, 2008, net of write-offs for inventory expected to be excess or obsolete.

 

Deferred Costs of Revenue

 

Deferred costs of revenue consist primarily of costs related to revenue-sharing and royalty arrangements, and the direct cost of materials that are associated with product and subscription revenues deferred over a service period, including arrangements that are deferred due to lack of vendor-specific objective evidence (“VSOE”) of fair value on an undelivered element. At September 30, 2009, our deferred costs were $284.4 million compared to $184.6 million at December 31, 2008. Of the $284.4 million of deferred costs at September 30, 2009, $250.2 million is included in the prepaid expenses line item and $34.2 million is included in the other assets line item on our condensed consolidated balance sheets. Of the $184.6 million of deferred costs at December 31, 2008, $152.7 million is included in the prepaid expenses line item and $31.9 million is included in the other assets line item on our condensed consolidated balance sheets. The prepaid line item includes revenue sharing costs that have been paid in advance of the anticipated renewal transactions. Costs associated with renewal transactions are classified as current

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

or non-current consistent with the associated deferred revenue. We recognize deferred costs ratably as revenue is recognized.

 

Reclassifications

 

In the condensed consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2008, we reclassified sales order operation department expenses to conform to our current period presentation. Expenses of $2.7 million and $8.3 million for the three and nine months ended September 30, 2008, respectively, including $0.1 million and $0.4 million, respectively, of stock-based compensation expense previously reported in general and administrative expenses are now included in sales and marketing expenses. This reclassification improves the transparency of the cost of our sales process and does not affect our total operating costs, income from operations or net income for the three and nine months ended September 30, 2008.

 

Fair Value Measurements

 

Carrying amounts of our financial instruments including accounts receivable, accounts payable, and accrued liabilities approximate fair value due to their short maturities. The carrying amount of our bank term loan approximates fair value as the interest rate is consistent with current rates on similar debt. The fair values of our investments in marketable securities and derivatives are disclosed in Note 5.

 

In August 2009, additional guidance provided clarification in measuring the fair value of liabilities in circumstances in which a quoted price in an active market for the identical liability is not available and in circumstances in which a liability is restricted from being transferred. This guidance required companies to determine the fair value of liabilities using market prices for similar or identical liabilities when traded as an asset, if available. This guidance is effective for us beginning October 1, 2009, and is not expected to have a significant impact on our financial statements.

 

The following table presents the types of fair value measurements for our marketable debt securities, foreign currency contracts and contingent purchase consideration liabilities as of September 30, 2009 (in thousands):

 

 

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

Market values were determined for each individual security in the investment portfolio. For marketable securities and foreign currency contracts reported at fair value, quoted market prices or pricing services that utilize observable market data inputs are used to estimate fair value. We utilize pricing service quotes to determine the fair value of our securities for which there are not active markets for the identical security. The primary input for the pricing service quotes are recent trades in the same or similar securities, with appropriate adjustments for yield curves, prepayment speeds, default rates and subordination level for the security being measured. Similar securities are selected based on the similarity of the underlying collateral for asset-backed and collateralized mortgage securities, and similarity of the issuer, including credit ratings, for corporate debt securities. Investments are held by a custodian who obtains investment prices from a third party pricing provider that uses standard inputs to models which vary by asset class. We corroborate the prices obtained from the pricing service against other independent sources and, as of September 30, 2009, have not found it necessary to make any adjustments to the prices obtained.

 

The fair values of the foreign exchange derivatives do not reflect any adjustment for nonperformance risk as the contract terms are three months or less and the counterparties have high credit ratings.

 

Recent Accounting Pronouncements

 

Revenue Recognition

 

In October 2009, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on revenue recognition that will become effective for us beginning January 1, 2011, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. We believe that when we adopt this new guidance our condensed consolidated financial statements will be impacted and we are currently assessing the magnitude of the impact.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Accounting for Uncertainty in Income Taxes

 

In September 2009, the FASB issued authoritative guidance which provides additional implementation guidance on accounting for uncertainty in income taxes. This guidance is effective beginning July 1, 2009. This guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

Subsequent Events

 

In May 2009, the FASB issued authoritative guidance which established general standards of accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, it established that we must evaluate subsequent events through the date the financial statements are issued, the circumstances under which a subsequent event should be recognized, and the circumstances for which a subsequent event should be disclosed. It also requires us to disclose the date through which we have evaluated subsequent events. This guidance was effective for us beginning April 1, 2009 and did not have an impact on our consolidated financial position, results of operations or cash flows.

 

Business Combinations

 

In December 2007, the FASB revised their guidance on business combinations. The new guidance requires an acquiring entity to measure and recognize identifiable assets acquired and liabilities assumed at the acquisition date fair value with limited exceptions. The changes also include the treatment of acquisition related transaction costs, the valuation of any noncontrolling interest at the acquisition date fair value, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals subsequent to the acquisition date and the recognition of changes in the acquirer’s income tax valuation allowance (see Note 4). In April 2009, the FASB further revised their guidance regarding the accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies. It amended the provisions in the December 2007 guidance for the recognition measurement and disclosures of asset and liabilities arising from contingencies in business combinations, and carries forward most of the previous provisions for acquired contingencies. This new guidance was effective for us beginning January 1, 2009.

 

 

We record compensation expense for stock-based awards issued to employees and outside directors in exchange for services provided based on the estimated fair value of the awards on their grant dates. Stock-based compensation expense is recognized over the required service or performance period of the awards. Our stock-based awards include stock options (“options”), restricted stock units (“RSUs”), restricted stock awards (“RSAs”), restricted stock units with performance-based vesting (“PSUs”) and employee stock purchase rights issued pursuant to our Employee Stock Purchase Plan (“ESPP grants”).

 

The following table summarizes stock-based compensation expense (in thousands):

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Amortization of fair value of options.  We recognize the fair value of options issued to employees and outside directors and assumed in acquisitions as stock-based compensation expense over the vesting period of the awards. The estimated fair value of options is based on the Black-Scholes pricing model.

 

Restricted stock awards and units.  We recognize the fair value of RSAs and RSUs issued to employees and outside directors and assumed in acquisitions as stock-based compensation expense over the vesting period of the awards. Fair value is determined as the difference between the closing price of our common stock on the grant date or acquisition date and the purchase price of the RSAs and RSUs.

 

Restricted stock units with performance-based vesting.  We recognize stock-based compensation expense for the fair value of PSUs issued to employees.

 

The PSUs can have performance-based vesting components that vest only if performance criteria are met for each respective performance period (“performance component”). Additionally, the PSUs can have service-based vesting components that have accelerated vesting provisions if performance criteria are met for each respective performance period (“service component”). The PSUs issued to employees have either performance components or service components or both.

 

If the performance criteria are not met for a performance period, then the related performance components that would have vested are forfeited and the related service components do not accelerate. Certain performance criteria allow for different vested amounts based on the level of achievement of the performance criteria.

 

For certain performance components, we do not communicate the performance criteria to the employees. For these awards, the accounting grant date does not occur until it is known whether the performance criteria are met, and such achievement or non-achievement is communicated to the employees. These awards are marked-to-market at the end of each reporting period through the accounting grant date, and recognized over the expected vesting period, provided we determine it is probable that the performance criteria will be met.

 

For performance components for which the performance criteria have been communicated to the employees, the accounting grant date is deemed to have occurred. Fair value has been measured on the grant date and is recognized over the expected vesting period, provided we determine it is probable that the performance criteria will be met.

 

For the service components, each tranche is accounted for as a separate award and the accounting grant date is the date the grant was communicated to the employees. Fair value is measured on the grant date, and is recognized over the expected vesting period for each tranche. The expected vesting period for each tranche is based on the service-based vesting period or the accelerated vesting period if the performance period has been set and we determine it is probable that the performance criteria will be met.

 

Employee Stock Purchase Plan.  We recognize stock-based compensation expense for the fair value of ESPP grants. The estimated fair value of ESPP grants is based on the Black-Scholes pricing model. Expense is recognized ratably based on contributions and the total fair value of the ESPP grants estimated to be issued.

 

Cash settlement of certain options.  We paid $6.1 million in June 2009 related to certain expired stock options.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table summarizes stock-based compensation expense recorded by condensed consolidated statements of income and comprehensive income line item (in thousands):

 

 

We had no stock-based compensation costs capitalized as part of the cost of an asset.

 

At September 30, 2009, the estimated fair value of all unvested options, RSUs, RSAs, PSUs and ESPP grants that have not yet been recognized as stock-based compensation expense was $143.4 million, net of expected forfeitures. We expect to recognize this amount over a weighted-average period of 2.3 years. This amount does not reflect stock-based compensation expense relating to 0.6 million PSUs for which the performance criteria had not been set as of September 30, 2009.

 

 

2009 Acquisitions

 

On September 1, 2009, we acquired 100% of the outstanding shares of MX Logic, Inc. (“MX Logic”), a Software-as-a-Service provider of on-demand email, web security and archiving solutions for $138.5 million. The MX Logic purchase agreement provides for earn-out payments totaling up to $30.0 million contingent upon the achievement of certain MX Logic revenue targets. The $24.6 million fair value of the earn-out payments has been accrued for a total purchase price of $163.1 million.

 

The MX Logic contingent consideration arrangement requires payments up to $30.0 million that will be due and payable if certain criteria in relation to revenue recognized on the sale of MX Logic products are met during the three-year period subsequent to the close of the acquisition. The fair value of the contingent consideration arrangement of $24.6 million was determined using the income approach with significant inputs that are not observable in the market. Key assumptions include discount rates consistent with the level of risk of achievement and probability adjusted revenue amounts. The expected outcomes were recorded at net present value. Subsequent changes in the fair value of the liability will be recorded in earnings. As of September 30, 2009 the range of outcomes and the assumptions used to develop the estimates had not changed significantly, and the amount accrued in the financial statements increased by $1.0 million. The increase in fair value was due to expected achievement of the earn-out payments at an earlier date than originally assumed and an increase in the net present value of the liability due to the passage of time.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

On June 1, 2009, we acquired 100% of the outstanding shares of Solidcore Systems, Inc. (“Solidcore”), a provider of whitelisting technology that controls and protects the applications installed on a computer, for $32.1 million. The Solidcore purchase agreement provides for earn-out payments totaling up to $14.0 million contingent upon the achievement of certain Solidcore financial and product delivery targets. The $8.4 million fair value of the earn-out payments has been accrued for a total purchase price of $40.5 million.

 

The Solidcore contingent consideration arrangement requires payments up to $14.0 million that will be due and payable if certain criteria in relation to amounts billed to customers for Solidcore products are met during the three-year period subsequent to the close of the acquisition and if certain criteria in relation to product development and integration are met within eighteen months of the acquisition. The fair value of the contingent consideration arrangement of $8.4 million was determined using the same approach described above for the MX Logic earn-out. As of September 30, 2009, the range of outcomes and the assumptions used to develop the estimates had not changed, and the amount accrued in the financial statements increased by $0.4 million. The increase in fair value was due to an increase in the net present value of the liability due to the passage of time.

 

The preliminary allocation of the purchase price was based upon preliminary estimates and assumptions that are subject to change within the purchase price allocation period (generally one year from the acquisition date). The primary areas of the purchase price allocation that are not yet finalized are related to certain tax elections for Solidcore, as well as the measurement of certain deferred tax assets and liabilities for both Solidcore and MX Logic. Our preliminary purchase price allocation for Solidcore and MX Logic are as follows (in thousands):

 

 

Our management determined the purchase price allocations for these acquisitions based on estimates of the fair values of the tangible and intangible assets acquired and liabilities assumed. We utilized recognized valuation techniques, including the income approach for intangible assets and earn-out liabilities and the cost approach for certain tangible assets, and we used a discount rate reflective of the risk of the respective cash flows. Goodwill for Solidcore resulted primarily from our expectation that we will now be able to provide our customers with an end-to-end compliance solution that includes whitelisting and application trust technology, antivirus, antispyware, host intrusion prevention, policy auditing and firewall technologies. We intend to incorporate Solidcore’s technologies into our vulnerability and risk management business, integrating it with our McAfee ePolicy Orchestrator in 2009. The goodwill for Solidcore may be deductible for tax purposes, depending on certain tax elections that have not been finalized. Goodwill for MX Logic resulted primarily from our expectation that we will be able to deliver a

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

comprehensive cloud-based security portfolio to our customers. The goodwill for MX Logic is not deductible for tax purposes.

 

In January 2009, we acquired 100% of the outstanding shares of Endeavor Security, Inc. (“Endeavor”), an intrusion prevention and detection company, for $2.5 million. The Endeavor purchase agreement provides for an earn-out payment totaling $1.0 million contingent upon the achievement of certain Endeavor financial targets during the two-year period subsequent to the close of the acquisition. The fair value of the earn-out of $0.7 million at acquisition was accrued, for a total purchase price of $3.2 million. As of September 30, 2009 the range of outcomes and the assumptions used to develop the estimates had not changed, and the amount recognized in the financial statements increased by $0.1 million. The increase in fair value was due to an increase in the net present value of the liability due to the passage of time. We recorded $1.4 million of goodwill, which is not deductible for tax purposes. We did not provide the purchase price allocation for Endeavor in the table above because the effect of this acquisition was not material to our condensed consolidated balance sheets.

 

The results of operations for these acquisitions have been included in our results of operations since their respective acquisition dates. The financial impact of these results is not material to our condensed consolidated statements of income and comprehensive income. In connection with the MX Logic acquisition, we recognized $1.0 million of acquisition related costs that were expensed in the current period and are included in general and administrative expenses in our condensed consolidated statements of income and other comprehensive income for the period ended September 30, 2009.

 

2008 Acquisitions

 

In 2008, we acquired ScanAlert, Inc. (“ScanAlert”) for $54.9 million, Reconnex Corporation (“Reconnex”) for $46.6 million and Secure Computing Corporation (“Secure Computing”) for $490.1 million. The results of operations for these acquisitions have been included in our results of operations since their respective acquisition dates.

 

Our management determined the purchase price allocations for these acquisitions based on estimates of the fair values of the tangible and intangible assets acquired and liabilities assumed. These estimates were developed utilizing recognized valuation techniques. We are continuing to assess uncertain tax positions as well as continuing to assess measurement of certain deferred tax assets and liabilities of Secure Computing. In the nine months ended September 30, 2009, we had purchase price adjustments totaling $5.2 million, primarily adjustments to preliminary deferred tax balances for Secure Computing.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Pro Forma Effect of Acquisitions

 

Pro forma results of operations have not been presented for Endeavor, MX Logic or ScanAlert because the effect of these acquisitions was not material to our results of operations. The following unaudited pro forma financial information presents our combined results with Solidcore as if the acquisition had occurred at the beginning of 2009 and our combined results with Solidcore, Secure Computing and Reconnex as if the acquisitions had occurred at the beginning of 2008 (in thousands, except per share data):

 

 

The above unaudited pro forma financial information includes adjustments for amortization of identifiable intangible assets that were acquired, adjustments to interest income, adjustments for incremental stock-based compensation expense related to the unearned portion of Secure Computing’s RSAs and RSUs assumed and converted, eliminations of intercompany transactions and related tax effects. The pro forma financial information excludes the effects of the SafeWord product line sold by Secure Computing in 2008, the effects of the in-process research and development charge for Secure Computing that was expensed immediately upon acquisition and the effects of the goodwill impairment charge recorded by Secure Computing in 2008. No effect has been given to cost reductions or synergies in this presentation. In management’s opinion, the unaudited pro forma combined results of operations are not indicative of the actual results that would have occurred had the acquisitions been consummated at the beginning of 2008 and 2009, nor are they indicative of future operations of the combined companies.

 

 

Marketable Securities

 

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

 

 

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

At September 30, 2009, $244.1 million of marketable debt securities had scheduled maturities of less than one year and are classified as current assets. Non-current marketable securities of $22.4 million have maturities greater than one year with most of the maturities being greater than ten years, and are classified as non-current assets.

 

The following table summarizes the fair value and gross unrealized losses, related to those available-for-sale securities that have unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at September 30, 2009 and December 31, 2008 (in thousands):

 

 

 

 

 

We do not intend to sell the securities with unrealized losses and other-than-temporary impairments recorded in accumulated other comprehensive income and it is not more likely than not that we will be required to sell the securities before recovery of their amortized cost bases, which may be maturity. When assessing other-than-temporary impairments, we consider factors including: the likely reason for the unrealized loss, period of time and extent to which the fair value was below amortized cost, changes in the performance of the underlying collateral,

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

changes in ratings, and market trends and conditions. We then evaluate whether amortized cost exceeds the net present value of expected future cash flows. We have recorded no other-than-temporary impairment since April 1, 2009. As of September 30, 2009, the amount of previously recognized credit losses remaining in retained earnings was $7.2 million.

 

Prior to April 1, 2009, any “other-than-temporary decline” in value was reported in earnings and a new cost basis for the marketable security was established. We had $0.7 million of other-than-temporary impairments in the nine months ended September 30, 2009 for impairments recorded in the first quarter of 2009. In the three and nine months ended September 30, 2008, we recorded other-than-temporary impairments on marketable securities totaling $12.4 million and $14.9 million, respectively.

 

We recognized gains (losses) upon the sale of investments using the specific identification cost method. The following table summarizes the gross realized gains (losses) for the periods indicated and does not reflect other-than-temporary impairments recognized within the interest and other income line item on our condensed consolidated statements of income and comprehensive income (in thousands):

 

 

Derivative Financial Instruments

 

We conduct business globally. As a result, we are exposed to movements in foreign currency exchange rates. From time to time we enter into forward exchange contracts to reduce exposures associated with certain nonfunctional monetary assets and liabilities such as accounts receivable and accounts payable denominated in the Euro, British Pound, and Canadian Dollar. The forward contracts typically range from one to three months in original maturity. We recognize derivatives, which are included in other current assets and other accrued liabilities on the condensed consolidated balance sheets, at fair value. On the condensed consolidated statements of cash flows, the derivatives offset the increase or decrease in cash related to the underlying asset or liability. In general, we do not hedge anticipated foreign currency cash flows, nor do we enter into forward contracts 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 interest and other income on our condensed consolidated statements of income and comprehensive income.

 

Forward contracts outstanding are presented below (in thousands):

 

 

In the three months ended September 30, 2009 and 2008, we recorded a $0.4 million and $10.3 million net realized gain, respectively, on derivatives. In the nine months ended September 30, 2009 and 2008, we recorded a

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

$1.3 million net realized loss and a $1.0 million net realized gain, respectively, on derivatives. These amounts are recognized in interest and other income on our condensed consolidated statements of income and comprehensive income along with the remeasurement of the assets and liabilities.

 

 

Goodwill by geographic region is as follows (in thousands):

 

 

The goodwill acquired during the nine months ended September 30, 2009 is due to the acquisitions of MX Logic, Solidcore and Endeavor. The adjustments to goodwill are primarily a result of purchase accounting adjustments to deferred taxes for the Secure Computing acquisition.

 

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

 

 

The aggregate amortization expenses for the intangible assets listed above totaled $29.9 million and $19.1 million in the three months ended September 30, 2009 and 2008, respectively, and $87.8 million and $57.0 million in the nine months ended September 30, 2009 and 2008, respectively.

 

MCAFEE, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Expected future intangible asset amortization expense as of September 30, 2009 is as follows (in thousands):

 

 

 

We have initiated certain restructuring actions to reduce our cost structure and enable us to invest in certain strategic growth initiatives to enhance our competitive position.

 

During 2009 (the “2009 Restructuring”), we continued our efforts to consolidate and took the following measures: (i) realigned our sales and marketing workforce and staffing across various departments, (ii) disposed of excess facilities and (iii) eliminated redundant positions related to acquisitions.

 

During 2008 (the “2008 Restructuring”), we took the following measures: (i) eliminated redundant positions related to the SafeBoot Holdings B.V. (“SafeBoot”) and Secure Computing acquisitions, (ii) realigned our sales force and (iii) realigned staffing across various departments.

 

During 2006 (the “2006 Restructuring”), we took the following measures: (i) reduced our workforce and (ii) continued our efforts to consolidate and dispose of excess facilities. We paid the remaining $0.2 million of lease termination costs and severance and other benefits related to the 2006 Restructuring during the nine months ended September 30, 2009.

 

During 2004 and 2003 (the “2004 and 2003 Restructurings”), we took the following measures: (i) reduced our workforce, (ii) consolidated and disposed of excess facilities, (iii) moved our European headquarters to Ireland and vacated a leased facility in Amsterdam, (iv) consolidated operations formerly housed in three leased facilities in Dallas, Texas into our regional headquarters facility in Plano, Texas, (v) relocated employees from the Santa Clara, California headquarters site to our Plano facility as part of the consolidation activities and (vi) sold our Sniffer and Magic product lines in 2004. During the nine months ended September 30, 2009, we recorded a $2.8 million decrease to the liability. We have no outstanding accrual balance related to the 2004 and 2003 Restructurings as of September 30, 2009 as we have occupied or plan to occupy the previously vacated space.

 

Restructuring charges in the nine months ended September 30, 2009 totaled $10.9 million, consisting of $10.2 million related to the 2009 Restructuring, a $3.0 million additional accrual over the service period for our 2008 elimination of certain positions at Secure Computing, including accretion on facility restructurings, partially offset by a $2.4 million restructuring benefit related to the 2004 and 2003 Restructurings.

 

Restructuring charges in the nine months ended September 30, 2008 totaled $0.5 million, consisting of a $5.5 million charge related to the 2008 Restructuring offset by a $5.0 million benefit, net of accretion, related to the 2004 and 2003 Restructuring.

 

MCAFEE, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2009 Restructuring

 

Activity and liability balances related to our 2009 Restructuring are as follows (in thousands):

 

 

Of the total 2009 restructuring charge, $3.3 million, $6.6 million, and $0.3 million was recorded in EMEA, North America and Asia-Pacific, respectively. Lease termination costs and severance and other benefits are expected to be paid through 2009. Accretion relates to lease termination costs.

 

2008 Restructuring

 

Activity and liability balances related to our 2008 Restructuring are as follows (in thousands):

 

 

Of the total 2009 restructuring charge for severance, $0.3 million and $2.7 million was recorded in EMEA and North America, respectively. In 2008, the $6.1 million accrual for lease termination costs was recorded on the opening balance sheet for Secure Computing for costs associated with permanently vacated facilities. In the nine months ended September 30, 2009, we recorded a $0.3 million purchase price adjustment for additional lease related costs associated with permanently vacated facilities. The 2009 accretion relates to these lease termination costs. Lease termination costs will be paid through 2015 and severance and other benefits will be paid in 2009. Accretion relates to lease termination costs.

 

MCAFEE, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

On December 22, 2008, we entered into a credit agreement with a group of financial institutions (“the Credit Facility”). The Credit Facility provides for a $100.0 million unsecured term loan and a $100.0 million unsecured revolving credit facility with a $25.0 million letter of credit sublimit. The Credit Facility also contains an expansion option permitting us to arrange up to an aggregate of $200.0 million in additional commitments from existing lenders and/or new lenders at the lenders’ discretion.

 

Loans may be made in U.S. Dollars, Euros or other currencies agreed to by the lenders. Loans will bear interest at our election at the prime rate or at an adjusted LIBOR rate plus a margin (ranging from 2.00% to 2.50%) that varies with our consolidated leverage ratio (a “eurocurrency loan”). Our interest rate was 2.3% as of September 30, 2009. Interest on the loans is payable quarterly in arrears with respect to prime rate loans and at the end of an interest period (or at each three month interval in the case of loans with interest periods greater than three months) in the case of eurocurrency loans. Commitment fees range from 0.25% to 0.45% of the unused portion on the credit facility depending on our consolidated leverage ratio.

 

In January 2009, we borrowed $100.0 million against the term loan in the Credit Facility. The principal together with any accrued interest on the term loan is due on December 22, 2009. No balances were outstanding under the Credit Facility as of December 31, 2008.

 

The Credit Facility, which is subject to certain quarterly financial covenants, terminates on December 22, 2011, on which date all outstanding principal of, together with accrued interest on, any revolving loans will be due. We may prepay the loans and terminate the commitments at any time, without premium or penalty, subject to reimbursement of certain costs in the case of eurocurrency loans. At September 30, 2009 and December 31, 2008, we were in compliance with all covenants in the Credit Facility.

 

In addition, we have a 14 million Euro credit facility with a bank (“the Euro Credit Facility”). The Euro Credit Facility is available on an offering basis, meaning that transactions under the Euro 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 Euro Credit Facility is intended to be used for short-term credit requirements, with terms of one year or less. The Euro Credit Facility can be canceled at any time. No balances were outstanding under the Euro Credit Facility as of September 30, 2009 and December 31, 2008.

 

MCAFEE, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

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):