McAfee, Inc. (MFE) Q4 2008 Earnings Call February 12, 2009 4:30 PM ET
Kelsey Doherty – Director of Investor Relations
Dave DeWalt – President and Chief Executive Officer
Rocky Pimentel – Chief Operating Officer and Chief Financial Officer
John DiFucci – JP Morgan
Phil Winslow – Credit Suisse
Heather Bellini – UBS
[Michael Turrets – Raymond James]
Rob Owens – Pacific Crest Securities
Daniel Ives – Friedman Billings Ramsay Group
Adam Holt – Morgan Stanley
[Steve Ashby – Robert W. Baird]
[Walter Pritchett – Calid]
Fred Greeb - Goldman Sachs
Philip Rueppel – Wachovia Securities
Good afternoon, ladies and gentlemen. My name is Rachel and I will be your conference operator today. At this time, I would like to welcome everyone for the McAfee fourth quarter and full year 2008 earnings conference call. (Operator instructions) Thank you. Ms. Doherty, you may begin your conference.
Great! Thank you, Rachel. Good afternoon and thank you for joining us today. This afternoon’s conference call is being recorded and will be available for replay on McAfee's Investor Relations homepage at investor.mcafee.com. On today's call with me are our Chief Executive Officer and President, Dave DeWalt, and our Chief Operating Officer and Chief Financial Officer, Rocky Pimentel. Dave will open the call with an overview of the year and an update on the integration of Secure Computing; then Rocky will provide the financial details of the quarter and guidance. Dave will close the call and we will be pleased to take your questions.
You will find in our press release and on the Investor Relations section of our website a GAAP to non-GAAP reconciliation of the fourth quarter and full year 2008 financial results discussed in this conference call. The link is investor.mcafee.com and our results are posted under quarterly results. We will post our prepared remarks to the website following the conclusion of today's call. This conference call, including the question-and-answer session, will contain forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements, including among others, those regarding market trends, our strategic positioning, guidance on revenue, operating income margins and earnings levels for the first quarter of 2009, the same (ph) tax rate for 2009; expectations regarding the benefits of our recent acquisitions including those regarding the contribution from integration cost synergies and future plans for the Secure Computing business; the expected level and scope of security threats in future periods; expectations regarding the industry shift to security suites; expected industry growth rates of the market segments in which McAfee participates; expected new and future product introductions and the revenue opportunity associated with them; expected integrations of products from our acquisition of Secure Computing and recent acquisitions with McAfee’s existing product lines; expectations regarding McAfee's business momentum, market position, business segments, statements regarding future partnership opportunities and our future growth opportunities; expectations about specific growth initiatives, cost savings, and cost avoidance; productivity improvements and other benefits from initiatives and strategies outlined for 2009; plans and benefits from our investment in our global systems and infrastructure, and future strategic acquisitions and other uses of cash by McAfee.
Forward-looking statements are based on management's current expectations and are subject to risks and uncertainties. We caution listeners that actual results may vary perhaps materially from the forward-looking statements referenced in this call including any forward-looking statements made during the question-and-answer session. We encourage listeners to view the risk factors contained in today’s press release as well as the company's filings with the SEC, including the annual report on form 10-K filed February 27, 2008 and most recently filed for quarterly report on form 10-Q filed November 7, 2008 for more detailed information on the risks and uncertainties related to the company and its business. We do not undertake to update any forward-looking statements.
And with that, it’s my pleasure to turn the call over to our CEO and President Dave Dewalt.
Okay. Thank you, Kelsey, and good afternoon and welcome everyone. Thanks for joining us today. 2008 was a year of market leaving results for McAfee. We delivered double digit year-over-year growth in key financial metrics. We increased our market share on all four quarters and we built the foundation for the future of our company. I want to say thank you to the entire McAfee team and our worldwide partners for their commitment to our vision and their dedication to providing our customers around the world the best security solutions for tech (ph) what is important for them. We’re building up best-in-class organization and I’m proud to be part of the team.
There are three key points I want to convey this afternoon. First, McAfee has come a long way and 2008 was a transformation all year during which we invested in our business to drive future growth and had its opportunity to really help enhance the company. Our sales grew 20% year-over-year for 2008; revenue grew 22% year-over-year to 1.6 billion. Deferred revenue ended the year at 1.3 billion, up 24% year-over-year. GAAP earnings per share on a diluted basis reached $1.08. Non-GAAP earnings per share reached $2.01, an increase of 15% year-over-year. We also closed four acquisitions enhancing our data protection, network, and web security solutions. McAfee is the market leading solution in almost every category in which we compete. We launched innovative new technologies including Artemis, our always on in-the-cloud threat prevention technology, which has been deployed to tens of millions of users now. We invested in our go-to-market capabilities, upgrading our field sales talent and strengthening our channel relationships. We created the industry’s first open platform, now including 40 new strategic innovation partners. We more than doubled our consumer distribution capacity. In the fourth quarter alone, we had 127% year-over-year increase in new registered trial subscriptions. This is a leading indicator of our consumer growth strategies. We significantly extended our brand reach and our recognition to innovative marketing actions and through new channels such as our web security business. We generated more than 23 billion impressions of McAfee’s secure trust mark in the fourth quarter alone and more than 82 billion impressions in 2008. And the year culminated with our addition to the S&P 500 in late December.
But we’re not done, which takes me to my second point: taking market share. For seven consecutive quarters we’ve taken market share. And I’m convinced we can continue to do so. Our investments resulted in four-year 2008 double digit year-over-year growth in sales and revenue across all of McAfee’s product segments, geographies and market segments. For example, four of the largest employers in the world have now standardized with McAfee. We shipped on over 50% of the PCs distributed by the top 10 PC OEM manufacturers and we partnered with more than 200 of the best known consumer brands, a 51% increase over last year. I’m also pleased to announce that this week we find a multi-year exclusive contract with Lenovo to ship on their consumer PCs and notebooks worldwide. This new partnership is expected to help drive growth in the emerging markets.
This is a time for McAfee to grow and take market share. We believe we have the financial resources, the team, the product leadership, the go-to-market strategy, the partner ecosystem, and the global brand to compete effectively and win, which brings me to my third and final point: to drive growth in shareholder value by optimizing our business models. We are consciously driving growth at the same time we’re focusing in on continuing to optimize the model that delivers sustainable shareholder value. We delivered non-GAAP operating margins of 26.7% in the fourth quarter; excluding the impact of Secure, our best performance in almost three years. And our guidance for the first quarter of 2009 will show that we expect a 200 basis point improvement in non-GAAP operating margins year-over-year for that core business.
In 2009, we expect to achieve continued improvement in non-GAAP operating margins by successfully executing two initiatives. First, we invested in 2008 and 2009 is the year to harvest those investments. We expect to leverage our consumer model as our PC OEM relationships grow. We plan to take our acquisitions to the next level leveraging revenue growth, cost synergies, and expanded cross-sell and up-sell opportunities. And we plan to deliver our vision of an integrated security environment across the endpoint, the network, and the cloud. Our second initiative is to continue improved cost efficiencies. We will achieve acquisition-related cost savings, do personnel reductions, applications of McAfee’s best-in-class processes, and facilities consolidations; employee cost savings from actions we’ve already taken and plan to take such as travel restrictions and a hiring freeze; an ongoing optimization in our go-to-market model to maximize sales force yields. We believe these initiatives are the foundation for profitable growth and market share opportunities in 2009.
Turning to Secure Computing, I’d like to provide you an update on the acquisition of Secure which closed in November 2008. I want to start by formally welcoming the Secure team to McAfee. The combination of these two organizations from the people to the technology creates nearly $0.5 billion network security business. This is a segment we believe is well-positioned to grow significantly over the next few years. Our product strategy emphasizes integration and interlock between the endpoint and the network. We firmly believe that McAfee’s network solutions offer the best threat detection and prevention across all protocols and products.
Fourth quarter 2008 results include stop (ph) period for the acquisition of Secure Computing which closed on November 18, 2008. Sales for that period were $46 million. Revenue was $19 million. Approximately 77% of fourth quarter for Secure came off the balance sheet from prior periods. As part of the closed process, we completed our (inaudible) study of Secure’s product portfolio, the results of which counted for in today’s reported results and guidance. The total deferred revenue right down for Secure derived using the fair value method in accordance with GAAP was 46 million, leaving a deferred revenue beginning balance of approximately 119 million at November 18th. During the fourth quarter, Secure Computing contributed an additional net increase of 27 million to deferred revenue for December 31, 2008 deferred revenue balance of 146 million. We effect that approximately 70% of this balance will amortirize into 2009 revenue. Consistent with our expectation, Secure was $0.01 dilutive to our fourth quarter non-GAAP results. Integration continues to progress well and we’ve already realized initial cost synergies. Plans for 2009 include a more than 50% consolidation of Secure’s back office resources and integration of sales teams. At the same time, we’re closing more than two-thirds of Secure’s facilities. By the end of the second quarter, we expect to have completed the integration of sales, customer support, administrative function, and IT infrastructure. We expected these initiatives and many others like it will improve the profitability in the combined businesses moving toward accretion in the back half of 2009. We continue to expect that Secure’s acquisition will prove neutral to slightly accretive to the full year of 2009, non-GAAP results. And with that, let me hand it over to Rocky for the quarter-over-quarter and guidance. Rocky?
Thank you, Dave. Good afternoon, everyone. We’re very pleased to report that sales grew 20% year-over-year during the fourth quarter even factoring out at approximately 3% negative impact from foreign currency. Fourth quarter 2008 revenue was $424 million, up 19% year-over-year, a record revenue quarter for McAfee in our twelve straight quarter of double digit year-over-year revenue growth. Currency fluctuations negatively impacted revenue by $11 million year-over-year and $22 million sequentially, while Secure Computing contributed $19 million to revenue in the fourth quarter. Of the $424 million in revenue during the quarter, $209 million with service and support, up 18% year-over-year, and $170 million with subscription, up 13% year-over-year. This equates to $379 million, just over 89% of total revenue for the quarter.
North America revenue was $233 million, an increase of 25% from last year’s fourth quarter and accounted for 55% of the business. This was a record revenue quarter for North America. International revenue was $191 million, an increase of 12% from last year’s fourth quarter and accounted for 45% of the business. We had double digit revenue growth across each of our international segments and local currency. As reported in U.S. dollars, revenue grew in all international geographies: up 1% in Europe, Middle East, and Africa, even where the intra-quarter strengthening of the dollar most negatively impacted year-over-year results; up 49% in Asia Pacific; up 39% in Latin America; and up 26% in Japan. This is our 12th straight quarter of double digit year-over-year growth in international revenue.
For the fourth quarter, 76% of total revenue came from deferred revenue off the balance sheet. Sequentially, we saw a slight decrease in the percentage of revenue off the balance sheet due to the impact of foreign exchange, a shift in product mix favoring our network solutions, and improving in period revenue realization related to our systems business. During the fourth quarter, we closed 576 deals having a value greater than $100,000; 66 deals with value over $500,000; and 28 deals with value over $1 million. This represents an increase of 69% quarter-over-quarter and 27% year-over-year for deals over $100,000. Corporate revenue was $261 million, up 21% year-over-year, and another record revenue quarter.
We had double digit year-over-year revenue growth in each of our corporate product segments. Highlights from our fourth quarter corporate business include record sales of Total Protection or ToPS. Sales of ToPS grew 11% year-over-year driving many of our large deals over $1 million and many new license sales and competitive displacements. Sales of our data protection solutions grew more than 70% year-over-year. Finally, we had a very strong quarter in Risk and Compliance where we closed three deals exceeding $1 million including the largest Risk and Compliance deal in McAfee’s history. Risk and Compliance sales grew more than 60% year-over-year.
On the consumer side, revenue grew 16% year-over-year for the fourth quarter to $163 million. This was a record quarter for our consumer business. Additional highlights from our fourth quarter consumer business include designing or extending 22 new consumer partnerships and launching 51 new or enhanced online partnerships during the quarter. We recorded the highest overall addition of online net new subscribers in more than 11 quarters. Our results reflected record worldwide sales for both our direct and partner consumer businesses. During the fourth quarter, Total Protection remained our fastest consumer product where sales of Total Protection grew approximately 80% year-over-year. We added approximately 3,000 new McAfee Secure customers in the fourth quarter, bringing the total number of customers who trust McAfee with their website certification to approximately 14,000. Full year 2008 revenue of $1.6 billion was up 22% over 2007. This total reflected double digit year-over-year growth across all geographies. For the full year 2008, we closed 85 deals exceeding $1 million and 1,533 deals over $100,000 compared with 39 deals exceeding $1 million and 1,216 deals over $100,000 in 2007.
Reviewing the rest of the income statement, GAAP gross profit margin for the fourth quarter was 75.2% compared with the third quarter 2008 of 76% and fourth quarter 2007 of 75.8%. Non-GAAP gross profit margins for the fourth quarter was 79.3% compared with last quarter’s 79.6% and a year ago quarter gross profit margin of 79%. Total GAAP operating expenses in the fourth quarter 2008 were $286 million compared with $237 million for fourth quarter 2007. Total operating expenses on a non-GAAP basis in the fourth quarter 2008 were $229 million compared with $195 million for the fourth quarter 2007, and $230 million for the third quarter of 2008. GAAP sales and marketing expenses for the fourth quarter 2008 were $142 million. Sales and marketing expenses on a non-GAAP basis in the fourth quarter 2008 were $132 million or 31% of revenue. This was an increase of $4 million sequentially on a non-GAAP basis and was driven primarily by the acquisition of Secure Computing.
Fourth quarter 2008 GAAP research and development cost were $67 million. Fourth quarter 2008 research and development cost on a non-GAAP basis were $61 million or 14.4% of revenue compared to $57 million for the third quarter, reflecting additional headcount from Secure Computing. We were granted seven new patents in the fourth quarter, bringing our total patent portfolio to 420. GAAP general and administrative expenses for the fourth quarter of 2008 were $43 million. On a non-GAAP basis, G&A expenses for the fourth quarter were $36 million or 8.5% of revenue compared to $46 million for the third quarter. This sequential decrease on a non-GAAP basis was primarily associated with reduced legal expenses during the quarter. GAAP operating income for the fourth quarter was $33 million resulting in a GAAP operating margin for the period of 7.7%. The year-over-year decrease in GAAP operating margin percentage is driven primarily by the acquisitions of Secure Computing and SafeBoot. Operating income on a non-GAAP basis for the fourth quarter was $107 million, the highest we have reported in three years resulting in a non-GAAP operating margin of 25.3%. Excluding the effect of the Secure Computing acquisition, McAfee’s core non-GAAP operating margin was 26.7% for the fourth quarter. For the full year 2008, we finished with a non-GAAP operating margin of 24% reflecting the dilution of initiative design to drive future growth including acquisitions and investments made in PC OEM partnerships.
GAAP other income for the quarter was $2 million. This GAAP figure includes a $4 million in paramount loss on our marketable securities portfolio resulting primarily from the recent credit market crisis. By policy, we invest in high quality investment grade securities. Non-GAAP other income was $6 million compared with $17 million in the third quarter 2008 and $16 million in the fourth quarter 2007. This decrease in other income reflected lower foreign currency exchange gains as compared to the third quarter and lost interest income associated with use of cash for our acquisitions.
Total employee headcount at the end of the quarter increased to 5,563 employees. The sequential increase was driven primarily by the acquisition of Secure Computing. For the quarter, we had a GAAP tax benefit of 31% as noted when we announced third quarter results. The GAAP tax benefit reflects the impact of receiving administrative relief for incremental taxes previously accrued related to certain acquisition integration activities. On a non-GAAP basis, our tax rate was unchanged from a year ago at 27%.
In the fourth quarter of 2008, we reported net income on a GAAP basis of $45 million or $0.29 per share on a diluted basis. For the year, GAAP net income was $172 million or $1.08 per share on a diluted basis. This compares with our 2007 results of $167 million or $1.02 per share on a diluted basis. Our fourth quarter net income on a non-GAAP basis was $83 million or $0.53 per diluted share, up 17% year-over-year. This includes approximately one penny of non-GAAP earnings per share dilution from the acquisition of Secure Computing. Full year net income on a non-GAAP basis was $320 million and non-GAAP earnings per share on a diluted basis was $2.01. This compares with our 2007 result of $287 million or $1.75 per share on an increase in full year earnings per share of 15%.
Investors and potential investors are encouraged to review the complete reconciliation of GAAP to non-GAAP financial measures set forth in the attachment to our press release issued this afternoon. Turning to the balance sheet, our net accounts receivable balance at the end of the fourth quarter 2008 was $323 million compared with $232 million for the same period last year. Days sales outstanding were 69 days for the fourth quarter 2008 compared to 59 days for the fourth quarter of last year. Nine days of the increase in days sales outstanding is related to the acquisition of Secure Computing’s accounts receivable without offsetting full period revenue.
Deferred revenue at the end of the fourth quarter 2008 was $1,293 million, up 24% year-over-year and included deferred revenue of $146 million related to Secure Computing. We ended the fourth quarter with $989 million in short-term deferred revenue, up $171 million when compared with the third quarter 2008. Long-term deferred revenue was up by $65 million in the fourth quarter compared to the third quarter 2008, ending the quarter at $304 million. We did not see unusual contract extensions during the quarter nor unusual discounting. We ended the quarter with cash and marketable securities of $594 million. Please note that this total reflected a net cash outlay of $447 million for the acquisition of Secure Computing which closed in November 2008. At the end of December 2008, McAfee announced that we entered into a credit agreement providing for a $100 million unsecured term loan and $100 million unsecured revolving credit facility. The term loan was drawn down in early January and provides for extra financial flexibility. We have $250 million in stock with purchase authorization remaining through July 2009.
In the fourth quarter 2008, we generated a total GAAP operating cash flow of $70 million. Operating cash flow was down compared to last year due to the use of cash for a one-time, non-U.S. tax payment of approximately $30 million related to 2004 and 2005 which we highlighted earlier this year. During the first quarter of 2009, we expect to make a payment of approximately $14 million related to our recently concluded derivative lawsuit.
Now, I would like to turn to the guidance. We will be providing guidance for the first quarter of 2009, but first I would like to give you a sense of how we are managing the business in this challenging macro-environment. We are pursuing operational efficiencies and have initiated numerous actions to keep operating expenses in line. We executed disciplined forecasting process. At the heart of this are frequent intra-quarter forecast cycles where we review and interrogate each geography and subregion’s pipeline, deal structures, and sales closed plan. We believe our process provides us the ability to dynamically align those resources necessary to assist our field sales representatives in securing orders and closing deals with our customers. At the same time, we are scrutinizing the cost profile of our business, as David said, balancing investments to grow with prudent expense management. In the short term, we have effectively imposed a hiring freeze, keeping headcount flat. We have instituted mandatory time-off. We have frozen salaries. We are suspending certain compensation benefits. We have imposed business travel restrictions limiting the team to primarily customer-facing travels, and cut discretionary marketing spend. We also have integration plans in place to deliver cost synergies from Secure Computing acquisition. Additionally, we are making progress on longer term expense levers. We’re consolidating facilities associated with acquired companies as well as rationalizing our own current facilities profile. At the same time, we are upgrading our infrastructure and enhancing our systems to maximize productivity of the sales team and create efficiency and other functional organizations involved in those related sales processes. The company anticipates these initiatives will result in more than $50 million in savings and cost avoidance over the course of 2009.
The following updated guidance replaces and supersedes any previous guidance with respect to future periods and is valid as of today only. I would like to remind our listeners that guidance is based upon management’s current judgments and that actual results may vary; perhaps, materially from those results anticipated in this guidance. Please see the footnotes to our press release for further details.
For the first quarter of 2009, we expect a revenue range of $440 million to $460 million. We expect a GAAP operating income margin of 5% to 9%. We expect an operating income margin on a non-GAAP basis of 20.5% to 22.5%. We expect a diluted share count in the range of 156 to 158 million shares. We assume an annual 8% GAAP tax rate and a non-GAAP tax rate of 24% for 2009. Also for the first quarter of 2009, we expect GAAP earnings per share of between $0.20 and $0.24 per share on a diluted basis. On a non-GAAP basis, we expect earnings per share in a range of $0.46 to $0.50 per share on a diluted basis. Our expectations for the first quarter include double digit year-over-year revenue growth for the core McAfee business. In addition, we expect approximately 70% of the revenue contribution from Secure Computing in the first quarter to come from the balance sheet. This guidance also includes $0.05 to $0.07 dilution to non-GAAP earnings per share related to the Secure Computing acquisition. We continue to expect the transaction to be neutral to slightly accretive for the full year 2009 results, with profitability improving as we progress throughout the year. Non-GAAP operating margin guidance for the first quarter excluding the dilutive impact of Secure Computing is expected to be between 23.5% and 25.5%. In addition, guidance does not include any impact from future stock repurchases. At this point, I will turn the call back over to Dave.
Okay, Rocky. Take a breath. Thank you. As evidenced by the results you just heard from Rocky, our strategy is working. While no company is recession-proof, we believe that a challenging macro-economic environment presents well-positioned companies like ours with opportunities to grow. Our customers are focused on cost reduction, better resource utilization, and business optimization as we struggle to manage the increasing level of security threats. There has been an exponential growth in cyber-crime over the last few years. In 2008 alone, we saw more than five times the amount of malware we saw in 2007. In addition, organizations worldwide are coping with increased compliance and reporting end requirements.
This complexity is driving buying trends, consolidation of vendors, a focus on efficiency, the necessity of integration and management, all of which trend in the favor of MacAfee. At the same time, security is becoming increasingly ubiquitous. In today’s world, the sophisticated malware targeted threats and multistage attacks, security needs to be everywhere. In the (inaudible), in the operating system, including virtual environments, in the database and storage, and in all endpoint devices like mobile phones.
Our business, once limited to a focus on operating systems and antivirus, today secures virtually all layers of the IT stack as well as our customer’s digital lifestyles. So, to conclude, challenging times create opportunities for companies that are positioned to take advantage of them. And, as we enter 2009, we believe McAfee is very well-positioned. We have been growing our business and taking market share and we expect this trend to continue. Thank you for joining us this afternoon. We look forward to answering your questions in a moment. And, I’ll turn it back over to Kelsey.
Great. Thanks, Dave. Thanks, Rocky. As the operator polls for questions, I’d like to inform you that McAfee plans to attend the Goldman Sachs conference on Thursday, February 26th, and the Morgan Stanley conference on Tuesday, March 3rd. In addition, please mark your calendar for McAfee’s Investor Day on Friday, May 15th. Investor Day this year will be held at the Grand Hyatt in New York City. This is an invitation-only event and information will be forthcoming.
Please poll for questions. In the interest of time, please limit yourself to one question per person. Thank you very much. (Operator Instructions)
Your first question comes from the line of John DiFucci with JP Morgan.
John DiFucci – JP Morgan
It has to do with the consumer business here. You guys seem to have positioned yourself well for what looks to be a tough environment, especially for the consumer right now. And, I’m just curious if you could tell us – I’m just trying to get a gauge on the underlying market fundamentals. How much of your success this quarter had to do with access to more subscribers versus what’s really happening out there if you didn’t have that incremental access?
Yeah, thanks, John. It’s a good question and an important one. You know, certainly the economic environment is challenging out there, but we’ve said for a number of quarters we’ve made a lot of investments in our consumer business and I can't thank the team enough. We have laid down a heck of a foundation.
We talked about doubling our capacity, meaning the amount of computers that we ship on or the real estate that we’re involved with. Our strategy of downloading, embedding, preloading has paid off quite well. The back end infrastructure model that we’ve got continues to optimize and we’ve been diversifying our business. We ship on a lot more computers, as I just mentioned.
Our conversion rates are strong. We’ve gotten into the web markets. And, frankly, you know, we’ve been able to leverage our high end suites, which we’ve called out again growing 80% year-over-year. So, when you start to look at some of these numbers, it’s a tough climate, but when you start to connect the doubling of our capacity, i.e., what we ship on, with now, this quarter particularly we had 127% increase in registrations. 127% increase. I called that out earlier. That’s a pretty impressive number for us.
We may see some conversion erosion over time as the year goes on, but when you start to connect capacity with registrations, with the model that we’ve got, it creates some underlying opportunity for us and the consumer. And that was the pillar that we were really trying to also stand on as we built our corporate model, couple it now with the consumer model and kudos to our team and what they’ve done.
Your next question comes from the line of Phil Winslow with Credit Suisse.
Phil Winslow – Credit Suisse
You mentioned some expense rationalization, looking at your infrastructure, facilities, etc. Wondering if you could give us just a sense for what your headcount expectations might be over the course of the year. And, if we’d see any sort of a shift in sort of the headcount between the sales marketing, R&D, etc.
As we said, we’re very focused on worst case scenario maintaining a headcount type restriction. I think if we see any investments, it’s going to be in the area of go to market the sales force. We’ve made some upgrades or changes in personnel that we think are going to be very effective that were in our press release and so we’re, as Dave mentioned, I think we feel this is certainly a tough macro environment, but we continue to see more green lights than not in the elements of our business and I think we’re prepared to continue to take advantage of those opportunities for us to gain market share and advance our interests.
Just to add on there too, we called out specifically today a lot of the actions we’ve been taking, we see a big growth opportunity in terms of market share, but we’ve also really been mindful of the cost environments, optimizing – Rocky’s been moving this effort. It’s been everything from travel restrictions to some of the soft discretionary spends to some of the leverage that we can create on G&A. We’ve seen improvements in those areas. Facility consolidation.
One of the most important assets the company has is its headcount and its employee base. We’re trying to preserve that. We’re trying to optimize it. And, we’re trying to load balance it wherever proper to make sure we’ve got the right capacity and the right investments that continue to grow. But, we’ve done a lot of things now in our maturing consumer model I think has opportunities as well as we get into year two and beyond with some of the contracts we’ve had in the past and we hope that the combination of these investments and our expense controls really created an opportunity for us this year.
Your next question comes from the line of Heather Bellini with UBS.
Heather Bellini – UBS
Hi. Thanks guys. Two questions for you. The first one is real quick, just the VSOE of Safeboot, I’m not sure if you mentioned this, but when should we be expecting it? I know there were some people saying that you could have gotten it in Q4, but if you could give us an update there.
And, then, the second question would be on cash flow in 2009. Obviously, 2008 was an investment year for you all, especially on the consumer side. I was just wondering if we should start to see cash flow in 2009 start to track growth in net income.
I’ll do the VSOE on Safeboot, Heather. And, we’ve talked about that over the past year. I mean, actually we’re already starting to see benefits be reflected in our in-period revenue. It’s really a SKU by SKU basis. We had some improvements in North America already in the fourth quarter. We’ll continue to be adding SKUs in North America as we go into 2009. We’ll start to see SKUs qualified for VSOE internationally as we go through the first quarter and into the back half of 2009. So, we’ll see a rolling sequential benefit from qualified SKUs reaching VSOE on Safeboot.
Just to add onto that, Heather, it’s a good comment because certainly as we acquired Safeboot, we saw not just good growth in Safeboot in terms of our bookings but really our whole data protection line Rocky called out. You know, we have 70-plus percent growth in our data protection business. This was a strong area for the company. We’re not completely optimized from a a bookings to revenue point of view yet, but we’re working on it. I wouldn't think of this as a big waterfall in a single quarter. As Rocky is pointing out, this is a steady improvement over the next few quarters as we establish VSOE and all the other SKUs that we’ve got and we’ll be continuing to drive that. We’ve come up with ways to make sure we’re optimizing in that environment.
The cash flow comment too, Heather, is a good one. We’re very mindful of that. We think this is an important metric. We did call out particularly again operating income was some of the best we’ve seen in years from the company. We tend to keep driving at that. We’ve been trying to work our way through some of the one-time kinds of cash impact that the company has had.
We’ve called out specifically in Q4 our settlement with the Dutch authorities, particularly on a $30 million payment that we had to make. We’re also making sure you note that we have a $14 million payment in Q1 related to the settlement and conclusion of the derivative lawsuit the company had a few years back.
So, these are just things that we’re using to clean up. But, when you normalize things with some of the investments that we made as well as these one times, you continue to see very strong cash flow results from the company and we’re continuing to build up our balance sheet for all the areas of investments we can.
Your next question comes from the line of Michael Turrets with Raymond James (ph).
[Michael Turrets – Raymond James]
Can you talk a little bit about what you think the contributions of revenue in the first quarter might be from Secure It. And, also, it was a pretty strong write down of the secure bookings this quarter. Do you expect that level of write down in the next quarter.
Actually, I think we felt relatively satisfied with the adjustment that we made for secure bookings as we carried over to our balance sheet upon the completion of the acquisition in November. We actually I think as we mentioned brought over approximately $120 million out of 160 million or so of available deferred revenue. So, actually, we felt that was a very positive outcome as it relates to future revenue.
We don't expect any events that would cause us to write off deferred revenue going forward for secure computing. What we’ll be focused on is qualifying more and more of their SKUs for our VSOE criteria. So, really, there should be no negative events on deferred revenue relative to Secure Computing going forward.
I think your second question was relative to the dollar contribution for Safe Bait for the first quarter too?
I think one of the things for just color to add on to Rocky from a Secure point of view, we made note to call out a lot of the numbers for you so you could put it all together, the organic business, the core business, the McAfee strength without standing again sales, bookings, quarter for the company. We’re pleased with that. We called out the Secure Computing sales of 46 million in the quarter and the stub quarter. The revenue of 19 million that resulted from that. And, then of course we’ll go through a little bit of what we went through with Safe Boot prior, which is the establishment of VSOE to McAfee standards and consistencies for taking revenue accounting. And, we’ll be building that back up.
We talked about a $0.05 to $0.07 dilute of impact of Secure in the first quarter, which then overall will become break even of slightly accretive for the company for the full year, which was again similar to what we saw with Safe Boot last year and how we established that. So, hopefully, you are able to see a lot of the color, but we’re excited about the opportunity with Secure. It fills a lot of the gaps that we had in the network security business. We see a similar opportunity that we saw in the endpoint now in the security side for the network. And, the combination of the endpoint and the network should provide the company with some more economies of scale.
Your next question comes from the line of Rob Owens with Pacific Crest.
Rob Owens – Pacific Crest Securities
Dave, could you talk a little bit about the Fed opportunities specifically with CMCI, maybe what you saw in the fourth quarter indications of what the pipeline’s looking like? Do you have the right avenues to market? And, then what potential leverage does Secure bring?
For those of you who don't know that, CMCI is a critical cyber security infrastructure program the United States Federal Department of Defense has. McAfee has been working earnestly over the last few years now and especially the last few quarters on being well-positioned for some of these new programs. Certainly, one of the variables we have seen, which was just amazing to me quite honestly has come into McAfee was just the increase in malware and threats we’ve seen worldwide. It’s just astonishing to see a five times a 500% increase year-over-year in malware and targeted attacks, many of which are government related. Obviously, governments worldwide are now putting up their cyber shields, their cyber security initiatives and the U.S. government is one of those.
On the fourth quarter, we saw a number of programs that put forth that we were able to capitalize on. We continue to see this year as another year for us to leverage that. And, it’s not just on the end point. It’s on the network side. But, also, it’s across many governments. The U.S. Fed was one of Secure Computing strongest areas, one of the strategic rationales that I had for the acquisition of Secure Computing was some of the defense opportunities they gave us, particularly with the U.S. Federal side, the intelligence community side. So, again, we feel like one of the greatest inertias that we have from a security area is in government. Government’s worldwide, CMCI is a nice program for that. We think we’re getting ourselves positioned to drive that.
Your next question comes from the line of Daniel Ives from Friedman Billings Ramsay Group.
Daniel Ives – Friedman Billings Ramsay Group
Could you talk about maintenance renewals here and just given the environment? Are you doing anything different with maintenance renewals to make sure they continue to have high renewal rates or anything different in the channel with programs?
Absolutely we are. Maintenance, maintenance, service revenues are really important. Rocky called out a couple of numbers for you that I thought were very insightful to our business. He had talked a little bit about a number upwards to 89%, which really showed subscriptions, renewal, subscriptions for service-revenue related numbers as really the core genesis of what McAfee has to offer. You can just see how sticky those numbers are and that’s 89% of revenues. And, so, certainly we are seeing a strong consistency of people renewing. We focused on that in one of our successes in consumer has been and continues to be our success of renewing that business segment. We continue to drive at programs. Premium support and services programs for our customers.
We’ve had a very nice uptake this past year in our premium SKUs for services. These are things like onsite resources for our customers, the ability to help them with their security vulnerabilities and this continues to be a strong area of focus for McAfee as well as I think helping to prove one of the support companies in security. So, this will continue to be one of my strategic imperatives, Rocky’s as well, and we’re driving that. And, renewals and maintenance is a key tracking element for the company.
Your next question comes from the line of Adam Holt with Morgan Stanley.
Adam Holt – Morgan Stanley
Thanks very much. I understand that we’ve got limited visibility given the environment and you're obviously not giving specific revenue guidance for next year. Can we at least use 2008 on an organic basis as a proxy for what we might see seasonally, from a quarter-to-quarter perspective for 2009? And, then secondly on the forward-looking margins, if you look at Q1 as well as some of the cost savings initiatives that you talked about and some of the one-time oriented costs from last year that are not going to recur this year, it would seem margins could be up at least 50 to 100 basis points. Any general thoughts about where you think margins can go over the longer term?
Certainly our goal is to continue the momentum that we had in 2007 and 2008 and continue that in 2009. We were proud that we were able to get double-digit growth across really all of our product segments, market segments and product lines. Certainly, as we go into 2009, all the visibility isn't as great as it once was, certainly we feel like we’ve got the foundation to continue a lot of that momentum and frankly, to your point, leverage a lot of what we put in place here at the company.
And, we hope to do that. I made particular note to say that we had seen our guidance, our 200-basis point improvement into Q1 on the core components of McAfee. And, remember we’ve got some components, moving parts with secure computing affecting that just because we have establishment of VSOE and getting the revenue in period, it takes us a few quarters to get all that flushed through. So, again core business and the basis point improvements are clearly there and we continue to see the consumer model maturing for us over time. And, again, our goal here is to leverage a lot of what we’ve put in place over the next period of time quarters and even years to really leverage McAfee into a premier spot in the market.
Your next question comes from the line of Steve Ashby with Robert W. Baird (ph).
[Steve Ashby – Robert W. Baird]
Just like to talk about the corporate business a little bit. The tops run point grew 11% year-over-year. I was wondering, did you see any customers renew for a lower amount or because of layoffs or just downsizing as part of that business and what kind of growth expectations or just maybe subjective color can you give us on what we might expect there?
11% was the number we called out. This was our tops for endpoint SKUs. Although we did call out a couple other SKUs that’s timed for you. This was our data protection area, which we had over 70% growth. Our risk in compliance area, which is over 60% growth. So you can look at a lot of those components as endpoint pies as well. And, so don't just draw the conclusion to endpoint. We’ve got a number of SKUs that we break apart now and we’ve had a lot of success here in converting kind of our classic AV business to a top SKU and that being a full protection suite SKU.
Sometimes it’s just the tops that we had been calling out that was 11% and then others like data protection and risk and compliance which has all had good growth. But, to answer your question directly, we did not see discounting changes. We did not see a lot of effect. Rocky called that out. We really had consistency across the fourth quarter in this area. I think that calls out some of the value proposition that McAfee has, all while we believe we’re saving customers a tremendous amount of money as they go with MacAfee and I think this is what’s played well for us is the fact that our value proposition if saving costs for companies while giving higher protection is really what’s playing out well for us.
Rocky, do you want to comment on this?
Yeah, and I would add we continue to see typical high renewal rates so it showed the customers they continue to endorse the product. I think the breadth of our product line tens to offset any isolated incidents of reductions in numbers of nodes but as we’ve talked about before, very large deals are really structured on band pricing. So, five to ten percent reduction in headcount really doesn’t fundamentally change some of our big enterprise deals which we’ve talked about most recently. So, we feel that we are somewhat more resistant than others in this situation.
And, Steve, last comment for you on that note is we have another major release of our EPO product, this is our e-policy orchestrator for those who don't know that name, this is our general security management console. We have another major release. This was dubbed our Catana release. And, another major innovation area for us, which again unites a lot of our acquisition areas into our end point suite and even on our network security side. We’re going into beta with that now. We have a joint development program with a lot of our customers. We’re just releasing that into the market. And, again, that should give us opportunity for cross selling and upselling as we move into the first part of 2009.
Your next question comes from the line of Walter Pritchett with Calid (ph).
[Walter Pritchett – Calid]
My question was on uses of cash. And, you've been pretty aggressive in the last year or so on uses of cash for growth both on the OEM side with some of the payments up front to drive some growth as well as on acqusitions. Just wondering if you look at this year , the market’s obviously changed quite a bit from where it was a year ago, how are you looking either similarly or differently at the potential uses of cash in the next 12 months?
Well, I think, Walter, we’re very focused generating operating cash flow from operating earnings. You know, I think we look at it on an opportunistic basis at OEM opportunities as well as acuqisionts. I mean, I think Dave’s been very consistant. I mean, in this environment, we’re going to continue to look for opportunities to do more acquisitions that fortify and broaden the product line.
As it related to OEM relationship s and payments, we continue to watch for the right opportunities. But, I think we feel that – and Dave mentioned this I believe eearlier – 2009 we’re very optimistic about our cash flow and we will share - I think the results will speak for themselves. But, clearly without one time payments and things, we have the potential to get great cash flow leverage out of the business.
Walter, I’d just add on part of what felt we had to do at least in my time here at MacAfee was really put some foundational elements, investment into the business, some of which occurred through acquisitions, some cam through consumer models. You know, largely that’s behind us now, we felt like we put a lot of those building blocks in place. We’re starting to see some of the results of that. And, that’s been positive. Consumer has been doing well in this climate. We’ve get some other indicators that it can continue to do well. And, we’ll continue to be opportunistic as we move forward.
But, I’m not sitting there with a specific plan every quarter to do more of these things as they come up and there’s opportunities to do so, we will. Where they make sense, we feel like we have the best and most [profitable model for doing investments, particularly in the consumer model. We feel we’re very effectively positioned against our competitors who can't get profitability off these models and we can.
And, that creates a tremendous advantage for us as we move forward. So, we’ll look for opportunities, we’ll continue to drive things, and we’ll make sure that we’re very prudent in harvesting our cash model as we go through the next cycle of time.
Your next question comes from the line of Sara Fryer with Goldman Sachs.
Fred Greeb - Goldman Sachs
Hey guys, this is Fred Greeb for Sara. Another quick question on cash flow. Even including the impact from the tax payment, it looks like cash flow is down year-over-year in the quarter. Is there anything else maybe that impacted this like payment terms getting extended?
No, actually, we’ve settled on some outstanding payables when we acquired Secure Computing, so we actually paid down a greater than normal amount of accounts payables in the fourth quarter, which is actually a positive effect that we had such solid cash flow, even paying down payables. So, I don't think there was really anything more unusual than that added onto the tax payment.
And, remember, you still have just residual things we’re doing on the consumer model, nothing major that are happening there, but just year over year from a cash flow basis you are seeing some consumer investment models continuing to carry on. So, again the majority of that was a tax payment, a onetime tax payment.
And, as we’ve talked about, our DSO was 69 days, nine days of which was the acquisition impact of Secure Computing receivable on us.
Your final question comes from the line of Philip Rueppel with Wachovia Securities.
Philip Rueppel – Wachovia Securities
As you head into 2009, have you made any significant changes to the sales force, either from a territory perspective, comp plans, product focus or your channel programs and how you're dealing with the channel? And, as a corollary to that, did you sense that on the corporate, through your sales force if there was any kind of budget flush that may have drawn down the e pipeline heading into Q1?
You know, the one thing that we’ve really done well and a credit to our sales operation teams and Mike DeCesar runs that organization is we’re incurably focused getting out of the gate earlier this year. Last year, it took us quite some time to get compensating plans, quotas, territories, everything organized. This year, we were like clockwork. We had all of the compensation plans delivered by week two. We had a sales kickoff high focus on training. Certifications on all of our product lines. All of our sales force was required to get those certifications. And, we were very focused. So, we’re off and running very early here in the quarter. I’m happy to report that we have closed several deals over a million already. We mentioned this one other contract as well, which was a strong win for us. So, we have gotten out of the gate, you know, very effectively. I don't think we saw any abnormal budget flush in Q4 at all. You know, certainly, it was a normal quarter for us and we’re continuing to focus and execute here. And, in the first quarter we know what we have to achieve.
So, why don’t I wrap up, just say thank you to everybody for joining us this afternoon. I really appreciate your time. Hopefully, everything was clear. We’re certainly excited about our opportunity here at McAfee.
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