McAfee Inc. Q3 2009 Earnings Call Transcript

| About: McAfee Inc. (MFE)

McAfee Inc. (MFE) Q3 2009 Earnings Call October 29, 2009 4:30 PM ET


Kate Scolnick – Vice President, Investor Relations

David G. DeWalt - President & Chief Executive Officer

Albert A. Pimentel - Chief Operating Officer & Chief Financial Officer


Michael Turits - Raymond James

Daniel Ives - FBR

Todd Raker - Deutsche Bank North America

Robert Breza - RBC Capital Markets

Steve Ashley - Robert W. Baird

Adam Holt - Morgan Stanley

Rob Owens - Pacific Crest

Philip Winslow - Credit Suisse

Greg Moskowitz - Auriga USA

Philip Rueppel - Wells Fargo Securities

John DiFucci - JP Morgan

Brad Zelnick - Macquarie Securities

Katherine Egbert - Jefferies & Co.


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 to the McAfee third quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions) Ms. Scolnick, you may begin your conference.

Kate Scolnick

Good afternoon and thank you for joining us today. This Kate Scolnick, Vice President of Investor Relations. It is my pleasure to be here today and join the McAfee team. This afternoon’s conference call is being recorded and will be available for replay on McAfee's Investor Relations homepage at With me on today’s call are our President and Chief Executive Officer, Dave DeWalt, and our Chief Operating Officer and Chief Financial Officer, Rocky Pimentel.

Dave will open this afternoon’s call with a high-level review of the quarter and a strategic discussion and then Rocky will provide financial retails and guidance for the third quarter 2009. Dave will close and we will be pleased to take your questions.

You will find in our press release and on our Investor Relations section of our website, a GAAP to non-GAAP reconciliation of the third quarter 2009 financial results discussed in this conference call. The link is and our results are posted under quarterly results. We will post our prepared remarks to the website following the conclusion of today’s call.

During this conference call and the question-and-answer session, we will make forward-looking statements, regarding future events and the future performance of the company, including our guidance on revenue, operating income margins and earnings levels for the third quarter of 2009, the assumed tax rate for 2009 we used in estimating our guidance, our strategies and opportunities, trends in the security market, our competitive position and momentum, the anticipated benefits of our current, new and future products and the anticipated benefits of our acquisitions, partnerships and alliances. 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 made during this call and the question-and-answer session this afternoon. We encourage listeners to review the risk factors contained in today’s press release as well as the company’s filings with the SEC, including the Form 10-K filed August 7, 2009, 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, our guidance as to revenue, operating income margins, and earning levels discussed during this conference call and the question and answer session replaces and supersedes any previous guidance with respect to future periods and is valid as of today only.

Now, it is my pleasure to turn the call over to Dave.

David G. DeWalt

Thank you, Kate. It's great to have you on the team. I know we worked together for a number of years, and welcome to McAfee.

Good afternoon, and welcome everybody and thanks for joining us this afternoon.

I wanted to start out by thanking all the McAfee employees for their hard work. I know we have about 6000+ employees and great hard work, dedication and passion. I think we have made a lot of progress, great progress, in becoming really the leading global security technology company, taking a lot of market share. We're driving strong financial results and I just can't tell you how proud I am to be part of this team. Thank you.

So with that, I’m pleased to report the third quarter of 2009 was another record-setting quarter for McAfee. This does mark our 15th consecutive quarter of double-digit, year-over-year revenue growth for the company and we're proud to report another triple/double quarter, with double-digit, year-over-year growth on three major financial metrics: revenue, operating cash flow, and non-GAAP earnings per share. We are clearly continuing our market momentum with record revenue of $485.3 million, an increase of 18.5% year-over-year and up 3.5% sequentially. We also had record deferred revenue of $1.33 billion, an increase of 26% year-over-year.

Moreover, we saw strong growth across the world with both our domestic and international geographies delivering record revenues and as expected, operating cash flow rebounded from last quarter and, as a matter of fact, it was our strongest cash flow quarter ever. Cash flow from operations reached $152.0 million, an increase of 74% year-over-year.

Year to date, McAfee has generated $351.0 million in operating cash flow, up 47% over the same period last year. Note that our reported cash flow also includes a payment we accelerated to one of our partners, and more on that partner later.

Non-GAAP earnings per share reached a record $0.62, an increase of 16% over the same period last year

Our focused execution, combined with strong demand for our industry-leading security solutions, again delivered solid results for McAfee. And more importantly, we strengthened our foundation for the future with key, strategic partnership wins around the world. We expect this to help McAfee continue to grow financially and strategically, accelerating our efforts to become the No. 1 global security technology provider from the individual consumer to the largest enterprises.

McAfee has an exceptionally strong business model with great visibility. Approximately 75% to 80% of our revenue each quarter comes off the balance sheet, and 90% of our revenue is recurring.

We have exceptional balance in our model with 36% of our revenue coming from consumer, 64% of revenue from coming from corporate, 56% of revenue from North America, and 44% from international.

This quarter I am especially proud of our consumer business with 12.5% sales growth year-over-year, a number of very strategic partnerships won, an expanded product portfolio, and great leadership, led by Todd Gebhart and his team. Partners are our key to our success and a cornerstone of our strategy. In Q3 we continued to build on our partnership strategy.

Today we are announcing a new partnership that extends our relationship with one of the world’s largest PC manufacturers, Dell. The new agreement extends our premier position with Dell for two more years beginning October 31, with McAfee’s option for a third year.

Our agreement with Dell provides that McAfee will have an exclusive recommended and default placement status for Dell personal computers sold around the world, across all Dell’s consumer product lines. This relationship continues to be very profitable for McAfee and makes great economic sense.

Included in our cash flow success in Q3, we accelerated a payment to Dell and will make a similar-size payment in the fourth quarter. Even with these payments, we are still on track for record operating cash flows for the year.

In addition, I am very pleased to announce another new strategic partnership with Verizon. This partnership will span from consumers to small businesses to the largest corporations globally. Verizon Business has agreed to offer McAfee’s entire line of enterprise security products and services, while we will use Verizon Business’ data center outsourcing, expert consulting, and managed services capabilities.

Additionally, we have agreed to jointly develop a suite of next-generation, cloud-based, managed security services.

Verizon’s consumer business has agreed to offer McAfee as the exclusive security provider to users of its broadband services beginning in 2010. This multi-year arrangement, we believe will further cement our position as the leader of providing security through Internet service providers.

On that same note, today we announced a strategic partnership with AT&T, as well. This partnership also spans from consumers, to small businesses, to large enterprises.

AT&T High Speed Internet customers nationwide now receive McAfee software to help protect them against viruses, spyware, and hackers as part of their subscription service. The enhanced AT&T Internet Security Suite, powered by McAfee, allows customers to surf the Web, shop, and bank online worry-free.

In addition, McAfee is partnering with AT&T to jointly develop enterprise security products and a suite of next-generation, cloud-based managed security services.

In addition, Adobe Systems is another strategic partner on both the corporate and the consumer side of our business. Under our multi-year partnership, Adobe has agreed to let McAfee give Adobe consumers the ability to run a security scan, get a trial subscription to McAfee, or buy McAfee products when downloading an Adobe program or update. Adobe offers hundreds of millions of content downloads each year, opening up another large consumer distribution channel for McAfee.

On the enterprise side, McAfee and Adobe have agreed to deliver and jointly sell an integrated data loss prevention and enterprise digital rights management solution to expand the reach of data protection beyond the enterprise boundaries.

And during the quarter, our partner Lenovo began shipping Windows 7-based consumer PCs that are preinstalled with McAfee VirusScan Plus. Also, as part of our plans to develop a more aggressive partnership in China, Lenovo has agreed to market our products through about 5,000 Lenovo retail outlets in China, opening up a significant new retail channel for McAfee.

The official release of Windows 7 last week is a milestone not only for Microsoft, but for McAfee as well. Nobody delivers a better solution to secure Windows 7 than McAfee. McAfee ships on more than 50% of the PCs shipped by the top 10 PC OEMs, which means many people buying a new PC with Windows 7, will also get McAfee. New PC purchases on both the consumer side and pent-up demand for the corporate side will benefit McAfee all around.

We have expanded our consumer product portfolio. We added the McAfee Family Protection in the second quarter this year and now also offer a new online backup product and our newly released 2010 security suites.

All of our consumer security suites include Active Protection, our in-the-cloud, reputation-based service that provides real-time malware detection and blocking. Active Protection has been available for more than a year and has significantly boosted our detection rates, leading to top rankings by reviewers including AV Comparatives and Computer Bild, one of Europe’s most influential consumer computer magazines.

Also, McAfee was honored with the Fall 2009 STAR Award for Service Excellence from the Technology Services Industry Association specifically for excellence in consumer support. This award reflects our continued dedication to customer service and the consumer experience.

Our winning consumer go-to-market model continues to expand and diversify with the best products and the best support worldwide. We believe we are well positioned to continue consumer revenue growth in the future.

Turning to our corporate business, the broad partnerships I mentioned have also had a positive impact and we saw a new record for million dollar plus deals in the third quarter. We closed 472 deals greater than $100,000 in value, including 74 deals greater than $500,000 and 31 deals valued over $1.0 million.

These 31 deals continue to show the standardization decisions that are being made by the enterprises, many of which were competitive displacements. Corporate revenue reached a record $308.0 million, an increase of 25% year-over-year.

I’m especially thrilled to share that, in Q3, we achieved one of the largest quarterly total node counts sold ever for our flagship enterprise suite, called Total Protection for Endpoint. These results demonstrate strong growth and serve as a reaffirmation that customers continue to see ToPS for the Endpoint can achieve lower costs while ensuring stronger security. ToPS for Endpoint sales grew 13% year-over-year in sales.

Also of note, our third-quarter sales to government, healthcare, and education customers globally grew 34% year-over-year, showing continued strength in that part of our business. This is an area where we can expect to see even more growth in the future.

Our previous acquisitions continue to demonstrate excellent results for McAfee as evidenced by new offerings such as: Expanded application protection in McAfee Firewall Enterprise, a former Secure Computing product; our expanded email security strategy, which combines our MX Logic, Secure Computing, and McAfee technologies; and our new RiskAdvisor 2.0 product, which was originally a Foundstone offering.

Our acquisitions are contributing to our strong financial results. The biggest deal in MX Logic’s history was closed in the third quarter, and after the acquisition by McAfee.

Secure Computing is the key component of the planned offerings in our partnerships with AT&T and Verizon.

Also, in Q3 we signed new deals to ship our Solidcore whitelisting technology on ATMs-banking ATMs—manufactured by Hitachi and Fujitsu, as well as on multifunction printer/copiers/scanners sold by Panasonic/Fujitsu.

Meanwhile, our partnership with hardware makers has resulted in McAfee now shipping on two-thirds of all secure USB drives sold today.

Other highlights from our third quarter corporate business include expanded endpoint protection products for the Apple Macintosh platform; an expanded blade strategy with Hewlett Packard's BladeSystem; a partnership with BMC Software; and an additional 14 partners for our ground breaking Security Innovation Alliance, bringing the total number of SIA partners to 80.

Our midmarket business had a strong third quarter. Overall, we saw double-digit sales growth. Our performance has diversified as license sales grew more than 20%. We also saw more than 20% growth in license upgrades to ToPS. More importantly, we saw users of our competitors’ products move to our Total Protection Suite, with a 53% increase in displacement sales.

We're seeing tremendous adoption of our Security in 15 Minutes Best Practices Methodology for small and medium businesses. We've also just released the Security Paradox, the most comprehensive study of the costs of security for small and medium businesses.

At our FOCUS Security Conference earlier this month we had more than 1,400 attendees, almost 200 of which were mid-market companies, attesting to the strength of our products.

In addition, our midmarket momentum is shown by an expanded agreement with Hewlett Packard which now offers an 18-month subscription to McAfee's Total Protection Service on HP desktop and notebook PCs in EMEA, or Europe, Middle East, and Africa.

HP already is shipping McAfee software globally on its small and medium business systems.

We released McAfee Total Protection Service 5.0, as a Security-as-a-Service solution offering always-on guard protection without additional investment on the on-premise infrastructure.

As these results indicate, we have a growing opportunity to expand our security footprint on almost every layer of the technology stack. We have the products, the partnerships, the momentum and the market conditions continue to be strong.

So with that, let me hand it over to Rocky for a financial review of the quarter and guidance.

Albert A. Pimentel

The third quarter of 2009 marked another great quarter for McAfee. McAfee's achievement of record results from revenue to net income and operating cash flow takes a focused team, diligent execution, and consistent management of our operations. Clearly our business model is working well and our efforts are being rewarded.

Our 2009 strategic operating imperatives include driving operating efficiency, improving our business model and sales productivity, and successful integration of our acquisitions, to ensure we are positioned for a strong 2010 and beyond. We continue to improve our infrastructure to support McAfee's strategies to expand and diversify our product portfolio, address a broader marketplace, and take market share from our competition. I will provide additional color on these imperatives within my remaining comments.

Turning to the Q3 results, we delivered record revenue of $485.3 million, up 18.5% year-over-year, and including a negative impact from currency of approximately $10.0 million. On a quarter over quarter basis, currency had a positive impact of $9.0 million dollars.

On a geographic basis, we had double-digit year-over-year growth in nearly all of our geographies. North America revenue in Q3 was $273.0 million, up 25% from last year, and accounted for 56% of revenue. This was another record revenue quarter for North America, reflecting the contribution of secure computing, strong performance in our endpoint and risk and compliance portfolio, and strong growth in our consumer business.

International revenue reached a record $212.0 million, an increase of 11% over last year, and accounted for 44% of revenue. As reported in U.S. dollars, revenue results in our international geographies, compared to Q3 2008 showed: Europe, the Middle East and Africa grew 4%; Asia Pacific grew 42%; Latin America grew 20%; and Japan grew 16%.

In local currency, international revenue grew 15% year-over-year and grew in each theatre worldwide as follows: Europe, the Middle East and Africa grew 12%; Asia Pacific grew 52%; Latin America grew 20%; and Japan grew 3%.

I’d like to highlight the progress we’ve made in improving our European operations. The third quarter was especially strong in the consumer space and the organizational changes our European leadership has made over this year are showing progress and driving expansion of our sales presence. We are seeing results from these initiatives and are very encouraged by the growth opportunities we see in this area of the world.

For the third quarter, approximately 70% [sic-78%] of total revenue came from deferred revenue off the balance sheet. Approximately 52% of total revenue this quarter came from service and support, and 38% from subscriptions, with 90% of total third quarter revenue recurring in nature.

This was another record revenue quarter for our corporate business and we achieved revenue of $308.0 million, up 25% year-over-year.

Our mid-market focus on building our channel and inside sales capacity continues to pay off. We've focused on diversifying our business outside of primarily anti-virus in this space and in the third quarter non-systems sales grew 18% year-over-year. In systems, we saw sales growth in our Total Protection Suites of more than 30% year-over-year.

On the consumer side, third quarter revenue grew 8% year-over-year to $177.0 million. Consumer highlights include record sales, up 12.5% over the same period last year, and it was our fourth straight quarter of record online sales, including every international geography setting a new record for online sales.

We also saw sales of our Total Protection Suite for consumers in our online business grow 100% year-over-year, demonstrating consumer migration to security suites verses point products.

McAfee continues to deliver above-market revenue growth in the consumer space and our strategic advancements offer new routes to market that we believe position us for future growth. We are reaching hundreds of millions of consumers through various distribution channels.

Alongside improved reach thru PC OEMs, we also are very excited about the non-PC OEM channels. Partnerships like the ones Dave mentioned today, including Adobe, Verizon and AT&T, demonstrate our focus on continuing to expand our diversified consumer portfolio. This adds to our total of more than 200 consumer partners worldwide.

Reviewing the rest of the income statement, non-GAAP gross profit margin for the third quarter was 78.8%, compared with last quarter’s 79.7% and a year-ago gross profit margin of 79.6%. This slight decrease was due primarily to product mix related to our appliances.

As part of our overall enterprise performance initiatives, we continue to focus on the cost performance of our appliance business thru improved supply chain management, better processes around design for manufacturing, and virtualization on partner appliances.

Q3 non-GAAP operating income was $129.0 million, resulting in a non-GAAP operating margin of 26.5%, above the Q3 guidance range provided of 24% to 26%, and exceeding our plan.

Over the past year, we’ve invested in our business to both grow our market share and drive operational efficiencies. As we have discussed in the past, we continue to improve our business processes and invest in technology to improve the efficiency and capabilities of our worldwide sales and marketing functions. We are strengthening our worldwide consumer business thru technology investments in our Web portals and operational infrastructure to enable a leading customer experience, a higher quality of service, and scalability for the future. These investments, once fully deployed, should also contribute to giving us greater cost leverage.

In addition, we continue to enhance our skills for integrating acquisitions and our team has executed well this year. We are committed to having leading competency in acquisition integration and believe we have a scalable framework in place to drive the maximum value from our acquisitions.

These are just a few of the operational projects helping us to take advantage of the opportunities available to us in 2010 and beyond.

Total employee headcount at the end of the quarter was 6,102 employees, up 324 employees from the second quarter of 2009, reflecting approximately 200 employees from the MX Logic acquisition and approximately 120 new McAfee hires, primarily in our sales and research and development organizations. We continue to focus on striking the right balance in our headcount requirements to support our future opportunities.

Continuing, Q3 non-GAAP other income improved from last quarter and was $1.0 million.

On a non-GAAP basis, our tax rate continues to be 24%. For the quarter we had a GAAP tax rate of 16%. The lower GAAP tax rate this quarter is primarily due to tax reserve releases related to various statute expirations.

Q3 non-GAAP net income was $99.0 million. Non-GAAP earnings per diluted share was $0.62, up 16% year-over-year.

Turning to highlights on the balance sheet, net accounts receivable balance at the end of the third quarter 2009 was $232.0 million, down 13% compared with $266.0 million for the second quarter of this year, primarily due to strong cash collections.

Days sales outstanding were 43 days for the third quarter 2009, down 3 days compared to the year-ago period.

Prepaid expenses, income taxes and other current assets was $353.0 million, up 24% compared with $286.0 million for the second quarter of this year, primarily driven by costs related to PC OEM investments. We are excited about our PC OEM business because of the demonstrated profitability and the extended customer lifecycle these partnerships offer.

Deferred revenue at the end of the third quarter 2009 was $1.33 billion, up 26% year-over-year. Currency fluctuations had a positive impact on deferred revenue of $18.0 million year-over-year and $23.0 million quarter-over-quarter.

We ended the third quarter with $1.0 billion in short-term deferred revenue, up $21.0 million when compared with the second quarter of 2009. Long-term deferred revenue was up $5.0 million in the third quarter compared to the second quarter 2009, ending the quarter at $311.0 million.

The composition of our deferred revenue balance at the end of the third quarter of 2009 was 66% related to Corporate and 34% to Consumer. Overall we did not see any significant change in discounting or contract lengths in the quarter.

We ended the third quarter of 2009 with cash and marketable securities of $906.0 million.

During the quarter we expanded our cloud-based security portfolio with the acquisition of MX Logic, which we paid $138.0 million in the third quarter.

McAfee has the broadest Security-as-a-Service portfolio in the industry and we are uniquely positioned in the marketplace to deliver a comprehensive solution for Software-as-a-Service email and Web security. The initial feedback from our customers regarding this transaction has been very positive.

Reflecting upon our Q3 cash flow, I am very pleased that we generated total operating cash flow of $152.0 million, a result of exceptional cash collections and focused worldwide cash management. This includes the Dell payment Dave mentioned previously.

Year to date, we have generated over $350.0 million in operating cash flow. Our performance confirms our understanding of the importance to deliver on this metric.

Considering annual historical trends, we generally look to a range of non-GAAP operating income to non-GAAP net income to be an indicator of operating cash flow.

I want to point out that in the fourth quarter we will repay our $100.0 million term loan that was drawn down early in January. This is in accordance with our agreement. McAfee will continue to have a $100.0 million revolving line of credit after retiring the term loan.

Now I would like to turn to our outlook for the fourth quarter.

While this economic environment has been challenging, we remain confident that we have the right vision, strategy, and business model to continue to deliver strong execution and solid results.

Our product portfolio has never been more diversified and we continue to expand our addressable markets and increase our market share.

For the fourth quarter of 2009 we expect to achieve revenues in the range of $505.0 million to $525.0 million, GAAP operating income margin in the range of 13.0% to 15.0%, non-GAAP operating income margin in the range of 24.0% to 26.0%, and non-GAAP earnings per share in a range of $0.61 to $0.65 per share on a fully diluted basis.

Our forecast is based on a fully diluted share count in the range of 160 to 162 million shares for the fourth quarter and we are assuming an annual tax rate of 24%, both on a GAAP and non-GAAP basis.

In summary, we expect 2009 to continue to be an important year of operational and financial achievements for McAfee and these accomplishments should position us well for continued growth and market share gains in 2010 and beyond.

On behalf of the Executive Management team, we want to thank our employees worldwide for their continued strong performance and commitment. In addition, we would like to welcome the MX Logic team to McAfee and look forward to their contributions in making McAfee the market leader in security.

And now I would like to turn it back to Dave for closing comments.

David G. DeWalt

As Rocky discussed, our third quarter results were very strong. Overall our balanced business model continues to show our ability to deliver triple/double results with double digit, year-over-year growth on revenue, cash flow, and non-GAAP earnings per share.

Looking ahead to 2010, we’re very encouraged by the opportunities we see and we believe McAfee is uniquely positioned to continue to deliver industry-leading growth and to increase our market share.

And with that, l will turn it back over to Kate.

Kate Scolnick

As Rachael polls for questions, I would like to inform you that McAfee plans to attend the Credit Suisse Technology Conference on December 1.

Operator, please poll for questions. In the interest of time, please limit yourself to one question per person.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Michael Turits - Raymond James.

Michael Turits - Raymond James

On the upfront payments to PC OEMs, including Dell, about what do you expect that to be this year. In 2008 it was at $55.0 million. Any idea what that will be in total for this year, including Dell?

David G. DeWalt

What we really talked to this quarter was that we signed a new agreement with Dell. This obviously offers us a two-year exclusive recommended and default positioning with Dell across their consumer product lines. We mentioned that there was a payment already in our cash flow results for Q3. There is a similar size payment in the fourth quarter, but even with that, we see record cash flow results for the year.

So just trying to show you that the Dell deal is sort of done; it's really set up for a couple of years. We can absorb this from a cash flow and profitability point of view very nicely. It sets us up for a couple of years now with one of the largest PC makers. We haven't disclosed anything more than that in terms of payments, but this was a really nice transaction for us to get, one of the pillars.

I think quite honestly, in addition to that, having Verizon, AT&T, and Adobe as well as one of the largest banks in the world, Bank of America, really pushing our technologies now as we move forward, we think we've got a really nice balance to the PC OEM model, as well as other distribution models.

So we are thinking this was a very strategic quarter for the company and as it relates to PC OEMs and distribution, I couldn't be more pleased.


Your next question comes from Daniel Ives – FBR.

Daniel Ives - FBR

Could you just talk about cash flow expectations for Q4?

Albert A. Pimentel

You know, we don't give guidance on cash flow. I think I made guidance in my comments. We look at the annual, historical trends, the cash flow. I think we'll just stand by that range of non-GAAP incomes and non-GAAP net income as a reasonable reference point, but we are not going to make a comment about fourth quarter cash flow.

Certainly, we have demonstrated in the third quarter, I think we've got a better handle on managing our cash flow and as we said, it's a very important metric that we want to make sure we deliver on just like we do with revenues, earnings per share, and operating margin management. So, I'll leave it at that but I think we are pretty encouraged that we have a good process now to go forward with.

David G. DeWalt

And just to add on there, just so you got the script right, what we did talk to was that even with another payment, the full year operating cash flow will be a record for the company. So if you look back you'll see that essentially that gives us a pretty strong cash flow result for the fourth quarter and even with the payment, it's still a very positive year for the company in terms of cash flow and being up 47% after three quarters, year-over-year in the same period, 74% up in the current period, year-over-year, you've got some pretty strong results in our cash flow, and at this point we feel we've got a lot of these co-works locked down for future growth of consumer while absorbing all of that.

So without going into a specific guidance for cash flow, it gives you some ideas of what we're seeing. And now, again, this is a pretty good thing for the company.


Your next question comes from Todd Raker - Deutsche Bank North America.

Todd Raker - Deutsche Bank North America

I just want to ask a question here on guidance, two parts to it. First, if you look at the September quarter, when you guided, what was your expectation around FX sequentially, because if I back out the $9.0 million impact, it looks like you would have been kind of at the absolute low on your revenue guidance range.

And then if you look forward in the December quarter, two questions around guidance. One, what are your FX assumptions, and what is the impact here of MX Logic on that Q4 number?

David G. DeWalt

Certainly what we looked at was as we came into guidance for the quarter, we had really modeled about $1.40 on the exchange rate. It ended at $1.46, averaged $1.42. basically we built most of that into the model, so think of this as a very small in back, not 9 on where we were with our guidance. It's measured in a couple of million dollars at most from where we thought we were with the guidance versus where it really ended up being in terms of a little bit of favorability during the quarter of about $0.02, which equates to a couple of million dollars.

So just giving you a little sense that essentially it isn't on the lower end, it's right in the middle of the guidance range from where we see it. And it wasn't as big as that.

Albert A. Pimentel

And I think to answer the guidance with the assumption in the follow-up id $1.45, $1.46 as the exchange rate on the Euro going into Q4. So that gives you some color on that.


Your next question comes from Robert Breza - RBC Capital Markets.

Robert Breza - RBC Capital Markets

Dave, just one question. As you look at the online backup product, and obviously it's brand new, but just trying to gauge the market size and the opportunity for this and maybe how you think about internally about it progressing, but when do you think that could become like a 10%-type product of the consumer business?

And then Rocky, just as a follow-up, can you just point out what the Dell payment was? I can't seem to find it in the [inaudible].

David G. DeWalt

That's because we didn't give it. But nonetheless, the online backup is a good product for the company. We felt like we had an opportunity to look and evaluate the best online backup products in the market. We ended up building a partnership, as you know, with EMC, this is their Mozy product. We are going to market worldwide with that and a real good opportunity for cross sell.

Last quarter we launched the family protection product. We now have another product in the online backup product, two very strong sort of cross-sell/upsell products for the ToPS for consumer product line and basically this market is pretty unpenetrated. Think of this as many small, double-digit penetrated and it's a big market; green field for really everyone in the market who's in that space.

So with our distribution and with our opportunities to expand, we just got into it with the release this quarter of that product. We are hoping that that product has some real legs for the company moving forward. That says the family protection as well as mentioning the 2010 new suite that we've got, which I know it's a little bit of marketing to say, but we've won a lot of awards for it, we've got very high detection rates, the number one in several of the categories. We have really gotten reviewed vis-à-vis our competition and have very easy to use, easy to deploy, small footprint; everything you're looking for with this product.

And we've created some very elastic scalability with the product, downward, such that we can do things, as I mentioned with the Adobe product line, we now have a light-weight search/scan product that can do a one-time scan. This gives us opportunities to put that into portals that allow us to do scanning. So from the product portfolio of the consumer business, along with the distribution, this was a pretty good quarter for the company, getting that out and online backup is one of the pieces. But not the only piece.

Albert A. Pimentel

And as Dave said, we didn't give specific numbers on the Dell deal, but I will say that somebody earlier in the call made a statement about spending $55.0 million last year on OEM payments, etc. I would say that we are probably in the $50.0 million to $60.0 million range over the next couple of quarters for OEM payments. And we've contemplated it in our outlook for our cash flow and I think we're feeling relatively positive right now that we're managing still within in the comments we've made around cash flow, and in consideration of current commitment on OEM payments.


Your next question comes from Steve Ashley - Robert W. Baird.

Steve Ashley - Robert W. Baird

You talked about the Verizon and AT&T deal, you talked about jointly developing some cloud-based managed services. I wonder if we could get some color on what that might entail and how you might monetize those initiatives in the future.

David G. DeWalt

Certainly these are exciting new opportunities for the company, and as I mentioned, we are continuing to see broad distribution opportunities for security. The ubiquity of security is becoming very obvious; it's everywhere. You know, whether it's on the U.S. beef sticks, as we mentioned, to all types of operating environments, to downloads to now what's really cloud-based managed security services. So in both the Verizon and AT&T case, we've got very different partnerships.

AT&T has been going for some time. We really just announced the consumer part of AT&T, which is now really our VirusScan Plus and our security offerings as a part of the AT&T subscription. AT&T is a very nice distribution partner for us.

Verizon is doing a similar thing that will launch in 2010, to their broadband. It really gives us a nice model that complements others out there in the space worldwide. So we've got a really nice consumer distribution.

And then from the cloud-based managed security solutions, I mentioned secure computing was a component of that as well. This is really email filtering in the cloud. Clean pipes like Web security and email security and of course, we have done some recent acquisitions, i.e. MX Logic as well as appliances, that allow us to build the foundation for clean pipes or managed security services from the telecommunication provider. This reaches nearly every business.

Through these partnerships we look forward to trying to monetize those as we move forward, but they're very exciting relationships that really create a balance from the traditional free load onto a PO OEM to a download with the Delcos to deliver a clean pipe, to the corporate mid-market businesses. And couldn't be more pleased that two of the largest in the world are now working with McAfee and very excited about the future with them.


Your next question comes from Adam Holt - Morgan Stanley.

Adam Holt - Morgan Stanley

My question is about the consumer revenue recognition. If you look at the consumer business in the in-quarter revenue in Q3 versus Q2, it was kind of flattish. And I was wondering, given all the OEM business that's coming online, modest improvements in the PC market, why wouldn't that business be up sequentially, and maybe as we look forward and think about the PC market starting to improve, can you walk us through what the impact of that should be on the P&L and the cash flow.

Albert A. Pimentel

You understand that the consumer revenue is a ratable model, so we're amortizing over the life of the engagements with the consumer. So as you recall, Q3 last year is when we really locked in a big chunk of our additional OEM bookings. So those are now amortizing to revenue and we have been obviously gaining momentum based on the strength of our consumer bookings over the course of 2009.

So would continue to expect to see revenue results from those bookings as we go into 2010 on the consumer side. And now with our new extension of relationships with Dell and our other OEMs, we feel pretty positive about the positioning going into 2010 with some of the driving initiatives of the upgrade cycles and the Windows 7 cycles, and then our reach and distribution. So I think we would continue to see growing strength on the revenue recognition side of consumer.

David G. DeWalt

I would just add on to Rocky's comments that, again, remember that the revenue is a trailing indicator of revenue in that business and that's what you just mentioned. But I called out specifically sales, i.e. bookings, was a 12.5% year-over-year increase. This was a nice growth for the consumer business. We saw some pretty healthy trends there, in terms of the consumer. I mentioned all the partnerships, of course, but generally we did see some increase, quarter-over-quarter, as well as year-over-year and again, such a business that's ratable like that, you won't see that show up right away, but pretty please overall with we were there.


Your next question comes from Rob Owens - Pacific Crest.

Rob Owens - Pacific Crest

Just touching on Adam's question, given a lot of these investments were made during last year, why haven't we seen more of the acceleration, I guess, earlier this year? And if I look just at the general consumer trends, they've been up, but somewhat flattish, especially relative to all the investment you made in 2008. Is this a function of conversion rates? Because I would think given the massive share gains you had last year, that should help make up for the weak PC shipments.

David G. DeWalt

I think you just hit it, in a nutshell. What did we see? A tremendous growth in the amount of capacity that we were shipping on. Obviously those relationships have helped us. We obviously saw a huge increase in the amount of registrations. We showed triple digits the last few quarters. This quarter 65% up in registrations. The challenge has been convergence. And with consumer confidence being as challenged as it has been, we have really offset by the number of units, the number of registrations, by the conversion rate.

Now, we are still seeing double-digit growth in this consumer on a sales basis, bookings basis, but it's not as high as we had certainly hoped had the market been healthy from a macroeconomic consumer confidence point of view. We are hoping again as we go into 2010 PC units continue to grow, certainly year-over-year. We are hoping that consumer confidence improves. We certainly should see some of that. And it puts us in a nice position, I would think, as the economy does improve, even if it's incrementally number of units improve, even if it's just incrementally to continue to grow this business in the ways we have been.

And that's what you try to do if you're us and me, is try to build those foundations and unfortunately the last nine months hasn't been great from consumer confidence and conversion rates, but it is what it is and we're still getting 12.5% sales growth year-over-year. Not bad vis-à-vis everyone else.


Your next question comes from Philip Winslow - Credit Suisse.

Philip Winslow - Credit Suisse

Dave, I was wondering if you would comment on the pricing environment you saw out there, just in the small-to mid-size businesses, large enterprise side, during the quarter and if there were any changes there.

And also just on the network security business, too, in addition to your traditional anti-virus.

David G. DeWalt

Rocky made a comment in his script that we really didn't see any pricing, discounting, contract length changes, that was the good news. Certainly year-over-year we even saw a lengthening of those contracts. That's positive. Quarter-over-quarter about the same. Discounting hasn't really changed. So when you really look at the health of the business, you are kind of looking at the right thing.

And some of you are probably going okay, what's happening with McAfee. Certainly consumer growing at double digit, our small and medium growing at double digit. Largely where we're challenged a bit as a company was the amount of business we got from the larger transactions. And what I mean by that is the total amount of dollars that we got from our 31 deals over $1.0 million, was basically flat to a year ago's 28 deals over $1.0 million.

And that's a bit of macroeconomic effect for the company. We just couldn't do larger deals. We did a lot of standardization decision deals over $1.0 million and even when you look at the number of deals over $100,000, the number went up substantially. I think if I had right it was somewhere going from 349 number of deals over $100,000 last year to 472 deals over $100,000 this year, with the exact same amount of dollars. So really just seeing basically the size of the largest deals is a little bit of what's going here from the corporate bookings on the high-end side.

But again, we tried to call out that consumer good, small and medium business good, corporate pretty good from standardization decisions, you know, worldwide. And of course, probably the biggest challenge is in the network security, getting multi-year deals, refreshes, hardware, things like that, in a bigger amount and it is what it is. That's some of the macroeconomic conditions we saw and just thought it would be important to let you hear that.


Your next question comes from Greg Moskowitz - Auriga USA.

Greg Moskowitz - Auriga USA

Just a couple of questions on my end. Rocky, you had guided MX Logic to be $0.01 to $0.02 dilutive in 2009. Just wondering if you could say what the dilution, if any was in Q3.

And then for Dave, if you could update us on what you are seeing across the major markets in Europe, that would be helpful.

Albert A. Pimentel

We had MX Logic for a month in Q3 so it's pretty nominal. And as we go into Q4 I don’t think we've really changed our view on it at this point. But we certainly, as I said, see really positive response from our customer base around the MX Logic solution and so we are hoping that means we're going to be able to capitalize on things that maybe we hadn't assumed before.

So, as I said, also we're really focused on our integration capabilities and even though we've given that guidance and don't want to change it at this point, I think we feel good about improving upon that as we go into the fourth quarter and then into 2010. So again, no change at this point.

David G. DeWalt

We did say MX Logic had a nice transaction in the quarter. We did have it for one month. Pretty pleased with the performance there. Everything we saw was pretty healthy there. And then we got a larger transaction. And again, you can't see all that because it's not all in revenue. So you still have some of the dilutive effects we talked about earlier.

And towards your question in EMEA, what are we seeing there. We certainly have seen improvements. Certainly Rocky called that out. We had very solid consumer growth in EMEA, particularly on a bookings basis, sales basis. That's been very positive. A lot the shipments, payments, that we've been doing there have been very nicely rewarded here.

We're still challenged on corporate for all the reasons that I talked about, hiring corporate deals, size of those deals, a little bit on the network, but I think the mature markets in particular are a little bit more affected than certainly the emerging markets right now, as we see it, but it is a smaller percentage of our business than the mature, and Europe, as you know, is, for us at least, 47 unique countries that you have to approach a little bit differently, each one, and each one has got a little different tale to tell.

But overall we're seeing improvement. Certainly our leadership is helping there. Certainly our approach. We're building a new tele-sell center in Cork, Ireland. We are focused on really driving new channels with new programs. We're the new worldwide leader in channels and we've really tried to focus in on driving our international business and Europe is a big part of that. So if we are really hitting on that cylinder, too, I think 2010 will be a strong year. We tried to put the foundation in place.

Albert A. Pimentel

And to be clear, my comments about MX Logic, that has all been comprehended in our guidance range that we gave in our prepared comments.


Your next question comes from Philip Rueppel - Wells Fargo Securities.

Philip Rueppel - Wells Fargo Securities

Staying with the enterprise security products, do you sense that, looking at the pipeline going forward, that those issues in the corporate side might improve with year end spending? And then as part of that, is that potentially offset by any fall-off in government? Did you see the government being strong in Q4 with their fiscal year end and does that sort of drop off or does cyber security still remain a big part of the equation going forward?

David G. DeWalt

Very good question. For us in Q3, again I sort of look at in hindsight sometimes and go we had a couple of deals slip through our fingers from Q3 to Q4. A couple of them we just couldn't take to revenue. Those are always some challenges with that quarter, particularly the government when you are trying to ship everything on sometimes the last day, or the last couple of days, and we had a few of them just not get to revenue. And then those are closed now, of course.

And then certainly we still had a big government healthcare education number—34%—on a worldwide basis growth. So to your comment, it's not just U.S. government for us, it's worldwide governments and public sector up 34%. Pretty good number for us. And certainly we continue to see cyber security spending there. Management of patient healthcare records important to everyone and overall just education verticals is pretty important. That sector looks really good.

And to your comment, absolutely you see Q4 as a much stronger quarter than you see the third quarter, at least in terms of pipeline growth and in terms of upside. It's reflected in our guidance but certainly government continues to get strong.

I thought there was a little bit of a malaise over government spend in the U.S., just with the administrative change, and of course we still did a lot of business there, just nothing in the big category like we've been able to do in the past.


Your next question comes from John DiFucci - JP Morgan.

John DiFucci - JP Morgan

I don't want to harp on something that's been asked a couple of times here, and especially because cash flow was so strong, but the strong cash flow really benefitted quite a bit from good collections, the changes in receivables. And we thought we would start to see some benefits from those consumer partnerships that you initiated last year this quarter. And it's really unclear as to whether or not we're seeing that. So I guess the question is, is does it just cost more to be in this business today, or should we expect, going forward, some cash flow improvement here or cash flow uptick from true operating activities versus changes in working capital.

And are those changes in working capital, because it's such a big benefit this quarter, is that going to reverse next quarter?

Albert A. Pimentel

Obviously there are a lot of factors, going in and out of working capital. I think we have improved our business process. We have great cross-functional coordination with sales worldwide. And actually, within the collections, you measure it based on what gets invoiced, but actually consumer collections are up be the consumer bookings are growing and the consumers pay upfront, so it's a very rich business model. So even though we are measuring overall DSO against overall revenue, the consumer collections are immediate with the credit card and those have been definitely benefitting our cash flow.

David G. DeWalt

And I would just add on, certainly I look at this now, even after sort of a lumpy Q2 and a little larger Q3, we are up 47% year-to-date against the same period a year ago. That's a pretty large number for cash flow growth. We talked about a record result for the year, even with a large payment to Dell here in this quarter and next quarter. So when you look at these things you go, okay, what is it that the company's growing on cash flow, pretty strong results overall. Certainly an area where we've been strong. Cash collections is a big part of it no doubt, but lots to be done there.


Your next question comes from Brad Zelnick - Macquarie Securities.

Brad Zelnick - Macquarie Securities

Dave, I'm not going to take a run at the Dell cash flow question the third time, but I was wondering even if qualitatively you can speak to the new deal and perhaps qualitatively talk to the terms. Just go up in perhaps even economics relative to the deal that you did last year.

David G. DeWalt

Certainly this was as important win for the company, as you can imagine. It's a pretty strategic relationship, important pillar to our growth, going forward. This was a transaction, as I mentioned, two years as essentially the default recommended exclusive vendor to their consumer business worldwide at McAfee option third year. So this can extend for multiple years. And certainly we have already absorbed the cash flow impacts of that.

I would point out that this is a very profitable business for the company, going forward. It made tremendous economic sense for the company to do and it shows the strength of our model there. You are seeing a good strong guidance going forward with the company, good optimism, and balance with other partnerships that we've announced.

I would think that this was a very strong move for the company and already done.

Albert A. Pimentel

And let me add a little bit on to that comment. Dell happens to be an OEM with one of the stronger conversion rates from trial so it has a very favorable characteristic from a business model standpoint. When you actually take our know life cycle of our customer base, the conversion rates and the values that we are getting for a subscriber and you do your classic IRR calculation. Our IRR right now on Dell is north of 25% and our interest, which as you know, would be in upper quartile performance in any private equity portfolio.


Your final question comes from Katherine Egbert - Jefferies & Co.

Katherine Egbert - Jefferies & Co.

Dave, if I can just ask you one more time, on the larger deals on the corporate side, did you say the size of the deals are going down and that's why your revenue recognized is flat, or it's a rev wreck issue where they didn't meet the criteria and you pushed them?

And also, what was the exact percentage of revenue off the balance sheet this quarter?

David G. DeWalt

I'll talk them in reverse order. It's 78%--I'll correct a little type comment that Rocky made. It's 78%. He mentioned 70%, it's 78%. It's in the press release as well. And the total amount of business that came from the large deals, what I mentioned there was flat year-over-year. So the total amount of revenue from 31 deals was essentially to the 28 deals the year prior. And that's just related to, you know, we did a couple of more deals, but overall the big deals are a little bit smaller than they were the year prior, but we did more of them, and it shows the standardization still happening, especially when you look at the other statistic I gave you, was over $100,000 deals growing essentially from 349 deals a year ago to 472, equaling the same amount of money.

It just kind of shows you a little bit of what's happened there of just macroeconomic-wise, and particularly the hardware side of the business, and that is an element of what we're dealing with here, as we come out of this economic scenario we're in.


This concludes McAfee third quarter 2009 earnings conference call.

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