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Executives

Kate Scolnick – VP, IR

Dave DeWalt – President & CEO

Rocky Pimentel – CFO & COO

Analysts

Michael Turits – Raymond James

Robert Breza – RBC Capital Markets

Daniel Ives – FBR Capital Markets

Phil Winslow – Credit Suisse

John DiFucci – JP Morgan

Todd Raker – Deutsche Bank

Adam Holt – Morgan Stanley

Rob Owens – Pacific Crest

Steve Ashley – Robert W. Baird

Philip Rueppel – Wells Fargo Securities

Heather Bellini – ISI Group

Brent Thill – UBS

Katherine Egbert – Jefferies

Stephanie Withers – Goldman Sachs

Brad Zelnick – Macquarie

Tim Klasell – Thomas Weisel Partners

Kash Rangan – Merrill Lynch

McAfee, Inc. (MFE) Q4 2009 Earnings Call Transcript February 11, 2010 4:30 PM ET

Operator

Good afternoon, ladies and gentlemen. My name is Thea and I will be your conference operator today. At this time, I would like to welcome everyone to the McAfee fourth quarter and full year 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. Thank you.

Ms. Scolnick, you may begin your conference, ma’am.

Kate Scolnick

Thank you. Good afternoon and thank you for joining us today for McAfee’s fourth quarter and year end 2009 conference call. With me today are McAfee President and CEO, Dave DeWalt; and McAfee Chief Financial Officer and Chief Operating Officer, Rocky Pimentel.

You will find in our press release and on our Investor Relations website, a GAAP to non-GAAP reconciliation of the fourth quarter and full-year 2009 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.

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 first quarter of 2010, the assumed tax rate for 2010 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-Q filed November 6, 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.

At this time, it is my pleasure to turn the call over to Dave DeWalt.

Dave DeWalt

Okay, Kate. Thank you very much. And good afternoon, and welcome everyone. Thanks for joining us today.

I am pleased to report that the McAfee’s team executed very well in the fourth quarter of 2009, resulting in another record-setting quarter and capping a great year. This marks the 16th consecutive quarter of double-digit, year-over-year revenue growth for McAfee. We increased market share in all four quarters and continued to strengthen the foundation for the future of our company. I want to thank the entire McAfee team for their support and thank our worldwide partners for their commitment and dedication to providing our customers with the best security solutions.

We are proud to report another “triple double” this quarter, with double digit, year-over-year growth on all three major financial metrics: revenue, operating cash flow and non-GAAP earnings per share, surpassing guidance for revenue and at the high end of our expectations for operating margin and non-GAAP earnings per share.

Specifically, for the fourth quarter of 2009, we reported record revenue of $525.7 million, an increase of 24% year-over-year and up 8% sequentially. We also had record deferred revenue of $1.4 billion, a 9% year-over-year increase and up 6% sequentially. And sales, which are orders received during the quarter, were up 15% year-over-year. Non-GAAP earnings per share reached a record $0.64, representing an increase of 20% year-over-year. And cash flow from operations reached $145 million, an increase of 108% year-over-year.

2009 was a triple-double year with revenue reaching $1.9 billion, an increase of 20% over 2008 and non-GAAP earnings per share reaching $2.42, up 21% from a year ago. Total cash flow from operations for the year grew to $496 million, representing 61% growth from 2008. In 2009, we recorded four quarters of double digit growth in revenue and non-GAAP earnings per share, putting us ahead of many of our peers in terms of performance. We also showed strength in deferred revenue, operating margin, and added significantly to our product portfolio.

Every year, we strive to improve our operating margins. Over the last year, we delivered 200 basis points of margin expansion. We have done this by managing our costs effectively, while investing in our business. And, we have done a very good job absorbing six acquisitions over the last two years. Our outlook for continued growth is promising for many reasons. We have significantly expanded our distribution reach, with many new partnerships around the world. And the threat landscape is continuing to escalate. We also have a strong pipeline of new and enhanced products and services that will help us in our goal to become the number one global security technology provider, from both the individual consumer to the largest enterprises in the world.

McAfee has built a very strong business model. In Q4, 77% of our revenue came off the balance sheet, and 89% of our revenue was recurring in nature. We also have a balanced model, with 36% of our revenue coming from consumer, and 64% of revenue from coming from our corporate in the quarter.

Geographically, we are well positioned, with 57% of our revenue from North America, and 43% from international. We see continued strength in the Americas, where not only the US, but Canada and Latin America performed especially well. We also have seen a revitalization in Europe, Middle East and Africas region, which had its best quarter of the year in Q4 and is showing continued signs of improvement, based on both the economy and a stronger McAfee leadership team.

The Asia Pacific region is also growing substantially and is actually our fastest-growing business in terms of sales. This is the result of investments we have been making in that region and are now paying off. The integration of Secure Computing is another example of our success. I am very pleased to say that through 2009, we saw continued improvement in this business and ended the year with very solid results. In fact, Secure Computing was even more accretive to our 2009 non-GAAP earnings per share than our original acquisition plan. And looking ahead, our overall network business should continue to prosper, due to pent-up refreshes and increasing demand for our network-based security offerings.

Talking about our corporate business, revenue in the fourth quarter of 2009 grew 30% year-over-year to a record $338 million. McAfee closed 623 deals greater than $100,000 in value, including 103 deals greater than $500,000, 33 deals greater than $1 million, with one deal of approximately $5 million. This is the largest number of $1 million plus deals that we have closed in a single quarter ever, bringing the total number of deals over $1 million in all of 2009 to 108.

These larger deals continue to show the standardization decisions that are being made by enterprises, many of which were competitive displacements. Competitive displacements grew 32% in all of 2009 as compared to 2008. And for example, in North America alone, we displaced competitors on 4.5 million nodes during the year. Our sales force is increasingly successful at selling products across the McAfee portfolio, expanding the customer commitment to McAfee, and proving our vision of providing the best possible protection by interlocking security across systems, network and risk and compliance.

When we look at deals over $500,000 in the fourth quarter, 73% of those deals had multiple products. When we look at the same period a year prior, only 31% of the deals over $500,000 had multiple products. Overall, we are delivering on our value proposition of higher protection at a lower total cost of ownership. This proposition is delivering us a consistent mix of large, mid and small-sized deals, resulting in balanced growth, predictability, and ongoing ability to take market share in all key segments of our business.

In our midmarket business we saw substantial sales growth in 2009 versus 2008 at 26% year over year. This performance is a result of our investments in the sales force, updated channel programs, strong leadership, and the success of the introduction of our acquired products. We saw continued adoption of our Total Protection Suites among midmarket customers. This is our most strategic and sticky systems product. For the first time in Q4, this set of suites now represented over half of our total systems business in the mid market. And even more exciting, we saw a 16% increase in our competitive displacement sales in this segment.

Turning to our consumer business, revenue grew 15% year-over-year to a record $188 million in the fourth quarter of 2009. We have continued to expand our consumer business, and are taking market share through a number of strategic partnerships and a continuously-expanding product portfolio. Recently, we announced new or expanded partnerships with AT&T, British Telecom, Facebook, Fujitsu, and Verizon, to name just a few. The business opportunities we see through these strategic relationships are tremendous. For example, our new telco/ISP partnerships have started off very well and on a global basis, McAfee now covers more than 70% of the total broadband subscriber base of the world’s top 10 largest ISPs. Additionally, our e-business model with Adobe Systems and Facebook are important new channels for McAfee this year. In fact, in just a few short weeks, McAfee has dramatically expanded its presence on Facebook, acquiring over 60,000 fans in just a few weeks with access to 400 million Facebook users.

Also, I am extremely pleased to say that our PC OEM strategy is really paying off. The combination of over 60 million Windows 7 licenses sold, PC unit sales growth, and the fact that McAfee ships on more than 50% of the PCs shipped by the top 10 PC OEMs, are all now ingredients for ongoing success. All in all, for 2009, we saw an 84% year over year increase in new registered trial subscribers, setting us up for continued growth in 2010. On top of that, we just launched an update to our 2010 consumer product suites. This is our best consumer product ever, period. With the update, we are delivering the fastest, lightest and most effective consumer PC protection product in the company’s history. The update is being well received and we were just awarded a 4.5 out of 5-star rating from CNET’s Download.com, a higher rating than our major competitor. McAfee has been recognized with numerous industry honors for product performance since its 2009 release, including top awards from AV-Comparatives.org, AV-Test.org and Virus Bulletin.

Additionally, new 2009 offerings such as McAfee Family Protection, along with McAfee Online Backup help us extend the lifecycle of the customer by delivering great value and protection against the ever-increasing threat landscape. And looking into 2010, I have never been more excited about our new product pipeline. We have a number of significant releases coming this year including new products for the Apple’s Macintosh platform for consumers all the way through the enterprise, a major new release of ePolicy Orchestrator, which enables us to cross sell and upsell opportunities from our recent acquisitions, as well as a significant new release of a next generation enterprise firewall and significant updates for data loss prevention and encryption products. And additionally, our Security-as-a-Service offerings will be more attractive than ever in 2010.

As we move forward, we also plan to strengthen existing partnerships, and add new ones. We expect the combination of partnerships, products and a great team at McAfee will fuel our growth. That, combined with a better economic climate and an escalating threat environment, means McAfee is in the right place at the right time. The future has never been brighter.

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

Rocky Pimentel

Thank you, Dave. Good afternoon, everyone. The fourth quarter of 2009 marked another solid quarter for McAfee and we continued to execute well in a challenging environment. Our performance reflects the hard work of our world-class team and focus on operational execution amid signs that the worldwide economy may be stabilizing.

Over the past year, we have been focused on driving operational efficiencies and scalability into our business. We are pleased with the operating margin expansion we achieved this year due to these efforts. In 2009, we made investments in our world-wide sales operations and enhanced our channel strategy, emphasizing the value we place on our partners. We successfully integrated three acquisitions that expand our ability to deliver best in class security solutions to our customers and enter into new markets. And we continue to closely manage our expenses. These improvements in our business contributed to the strong results we achieved in 2009, and position us very well for the opportunities we see for McAfee as we enter 2010.

Turning to the Q4 results. We delivered record revenue of $525.7 million, up 24% year-over-year. These results include a positive impact from currency of approximately $23 million. On a quarter-over-quarter basis, currency had a positive impact of $9 million. We were very pleased with continued strong performance in our consumer business and our corporate business growth was driven primarily by system security, firewall, and our web and email products.

On a geographic basis, we had double-digit year-over-year growth in nearly all of our geographies. North America revenue in Q4 was $299 million, up 28% from last year, and accounted for 57% of revenue. This was another record revenue quarter for North America, marking the 7th consecutive quarter of year-over-year growth at or above 25%. International revenue reached a record $227 million, an increase of 19% over last year, and accounted for 43% of revenue.

As reported in U.S., revenue results in our international geographies, compared to Q4 2008 showed Europe, the Middle East and Africa grew 24%; Asia Pacific grew 6%; Latin America grew 20%; and Japan grew 10%. For the second consecutive quarter, we have seen improved performance from our European operations, and we were especially pleased with the strong recovery we saw in our European mid-market business. We are excited about the launch of our new inside sales operations in Cork, Ireland, and this is a good example of the infrastructure projects we have had underway to ensure our sales capacity matches our growth opportunities. The changes we have made in our European operations in 2009 are starting to have a positive impact, and we are encouraged by the opportunities we see for McAfee in this area of the world, as the global economy shows signs of improvement.

For the fourth quarter, approximately 77% of total revenue came from deferred revenue off the balance sheet, and approximately 89% of fourth quarter revenue was recurring in nature. Looking at our corporate business; this was another record revenue quarter, and we achieved revenue of $338 million, up 30% year-over-year. We also had a record sales quarter with 16% growth year over year.

Our mid-market business did very well this quarter. Our core systems business was very strong and we were particularly pleased to see the growth in our non-systems business, with the success of our Network and Data Protection products.

Our consumer business had an outstanding quarter. Q4 revenues were $188 million, up 15% year over year and up over 6% sequentially. We have also achieved record sales, which were up 13.3% over the same period last year. The strength of our PC OEM business continues to contribute to our cash flow growth, and we did a great job expanding our ISP partnership channel and developing new innovative channels for our products such as with Facebook and Adobe. The success we achieved drove expansion in both our consumer gross margins and consumer operating margin in 2009 over 2008.

Overall, we are very pleased with our growth and profitability in the consumer business. Our focus on diversifying our go-to-market model, backed by our award-winning product portfolio, has resulted in new and exciting partnerships for McAfee and we are reaching hundreds of millions of consumers. Going forward, we plan to continue strengthening the four pillars of our consumer strategy by expanding our distribution model, broadening our award-winning product portfolio, and service and support capabilities, and developing our PC, web and mobile platform delivery. This strategy has helped us deliver consistent growth, despite very challenging consumer confidence and should continue to serve us well as the economy improves.

Turning to other highlights from the income statement, non-GAAP gross profit margin for the fourth quarter was 79.3%, up slightly sequentially and flat year-over-year. Over the course of 2009, we delivered solid gross margins, while scaling our business and integrating our hardware-centric Secure Computing acquisition. Going forward, we see opportunities to expand our margins, as we replace some of our appliance-based products with new virtual appliance software solutions in our network business.

Fourth quarter non-GAAP operating income was $137 million, resulting in a non-GAAP operating margin of 26%, at the high end of our guidance range. We are proud to report this is our third consecutive quarter of non-GAAP operating margin at or above 26%. In 2009, we expanded our operating margin by 200 basis points, reflecting our ability to strike the right balance between expense management and growth opportunities. Achieving this level of margin expansion is particularly gratifying, considering the tough economic conditions we experienced in 2009. Looking ahead, we expect to continue to improve our operating efficiencies and make strategic investments in our infrastructure to support future growth. As a result, we believe we will deliver improved operating margins in 2010.

Total employee headcount at the end of 2009 was 6,144 employees, up 42 employees from the third quarter of 2009. In 2009, we added 581 employees, and year to date in 2010, we have added an additional 72 employees. Continuing, fourth quarter non-GAAP other income was a loss of $1 million compared with $1 million of other income in the third quarter of 2009. This decrease primarily is attributed to foreign currency losses. Q4 non-GAAP net income was $103 million, and non-GAAP earnings per diluted share was $0.64, up 20% year-over-year. And in the fourth quarter, our GAAP and non-GAAP tax rates were 24%.

Turning to a few items on the balance sheet. Net accounts receivable balance at the end of the fourth quarter 2009 was $294 million compared with $232 million for the third quarter. Days sales outstanding were 50 days for the fourth quarter of 2009 as a result of strong cash collections. Prepaid expenses, income taxes and other current assets was $339 million, down 6% quarter over quarter. Deferred revenue at the end of the fourth quarter of 2009 was $1.41 billion, up 9% year-over-year. Currency fluctuations had a positive impact of $9 million on deferred revenue year-over-year and a negative impact of $9 million quarter over quarter. We ended the fourth quarter with $1.1 billion in short-term deferred revenue, up $46 million when compared with the third quarter of 2009. Long-term deferred revenue was up $27 million in the fourth quarter compared to the third quarter of 2009, ending the quarter at $339 million. The composition of our deferred revenue balance at the end of the fourth quarter of 2009 was 67% related to Corporate and 33% to Consumer.

In the fourth quarter, we did not see any significant change in discounting and for the full year 2009, discounting increased approximately 100 basis points over 2008. Fourth quarter contract lengths improved 10% on a year over year basis and also improved approximately 10% for the full year 2009 over 2008. We ended the fourth quarter of 2009 with cash and marketable securities of $950 million. During the quarter, we repaid our $100 million unsecured term loan in accordance with our credit agreement from the prior year. And, in conjunction with this, we amended our credit facility to increase the revolver capacity to $450 million. This facility provides McAfee additional financial flexibility to support our continued growth strategy.

I am also pleased to report that our Board has approved a stock repurchase program of up to $500 million through December 2011. Financial flexibility is a critical strength for McAfee in this marketplace. Looking ahead, we expect to use our cash balances to repurchase stock along with our plans to continue to pursue acquisition opportunities.

Turning to fourth quarter cash flow, I am pleased that we generated total operating cash flow of $145 million. For the year, we generated a record $496 million in operating cash flow, up over 60% from last year, and reflecting the quality of our receivables and the positive impact of our consumer business. As we exit 2009, we expect to have sustained strength in our operating cash flow.

Now, I would like to turn to our outlook. There are signs of an improving economic environment, and as a result, we, along with our technology peers, are expecting modest improvements in IT spending for 2010. Within this outlook, industry analysts estimate McAfee’s addressable market should grow approximately 5% to 9% in 2010 over 2009. In 2010, McAfee is well positioned to achieve organic double-digit revenue, non-GAAP EPS and cash flow growth and continued market share gains. The visibility of our business model, coupled with our team’s consistent execution record, puts us on track to achieve our 17th consecutive quarter of double-digit revenue growth in Q1.

Our business pipeline is very strong, and we have already closed a number of significant transactions. For the first quarter of 2010 we expect to achieve revenues in the range of $500 million to $520 million, GAAP operating income margins in the range of 12% to 16%, non-GAAP operating income margin in the range of 24% to 26%, and non-GAAP earnings per share in a range of $0.60 to $0.64 per share on a fully diluted basis.

Our outlook for Q1 2010 is based on a fully diluted share count in the range of 160 million to 162 million shares compared to a fully diluted share count of 156 million shares in Q1 2009. And we are assuming an annual GAAP tax rate of 26% and an annual non-GAAP tax rate of 24%.

In summary, 2009 illustrates the many milestones we have reached in preparing McAfee to take security leadership to a new level. We are pleased with our revenue, deferred revenue, operational improvements and cash flow performance. Our foundation is solid, and we have a strong balance sheet, positioning us for continued success. On behalf of the Executive Management team, we want to thank our employees worldwide for their continued strong performance.

And now, I will turn it back to Dave for closing comments.

Dave DeWalt

Okay, Rocky, thank you very much. In summary, 2009 was an outstanding year for McAfee. Despite a difficult macro-economic climate in the past year, both the growth rate and the quality of our business improved year over year on all important financial metrics. More importantly, 2009 paved the way for a solid 2010, with product diversification and strong teams in place in all of our leadership positions.

As you may have read in our press release, Rocky is retiring later this year. In anticipation of this upcoming transition, we have initiated a search for a new Chief Financial Officer, and look forward to completing this process later this year. Rocky plans to remain in his role to ease the transition period. As reflected in our record quarterly and annual results, Rocky will leave McAfee in a very strong financial position. On behalf of the McAfee team, I thank him for his continued service and his contributions.

And with that, we will take your questions and pass it over to Kate.

Question-and-Answer Session

Kate Scolnick

Thank you. We are ready for questions. I would like to remind everyone to limit themselves to one question, please.

Operator

(Operator instructions) Our first question will come from Michael Turits of Raymond James.

Michael Turits – Raymond James

Yes. Cash flow was very strong. Deferred revenue looks like it grew a little bit less than your revenues on an organic basis. So, I have a question, where do the – I haven't really parsed the part of cash in the statement yet, but where did that strength really come from and what kind of growth is really sustainable into next year?

Dave DeWalt

Yes, Michael. This is Dave. So, you know, good point here. We had outstanding cash flow results again for the second quarter in a row. This ended with $496 million for the full year, up 60%. Obviously, we have really put controls in place. It shows the quality of our bookings and receivables, and frankly, we have really focused in on making sure we do a great job in this area. So it is showing. In terms of, you know, sustaining that, you know, we said that we think we can continue double-digit growth in revenue, EPS, and cash flow. So obviously, now having 16 consecutive quarters. If you look at the guidance, we are protecting our 17th consecutive double-digit revenue growth quarter. And we think we can achieve this to operate there. In terms of deferred revenue, you know, certainly, we had strong growth. Look at the bookings or sales growth that we called out, 15%, and pretty solid all around. Certainly, there is a mix there between revenue growth and deferred revenue growth. The way you really look at that is revenue plus change in deferred, as you know, and it really gives you the proxy for our sales number. But all in all, it is a very solid number from consumer to mid small and enterprise and we really hit all cylinders. Do you want to add on to that?

Rocky Pimentel

I would like to add. Michael, this is Rocky. I would like to add to Dave’s comments there. You know, we have talked about in the past a proxy of anywhere between non-GAAP operating income and non-GAAP net income as our range on operating cash flow I think over the last several quarters. We are improving that model. So a combination of what you see is the change in deferred, plus what people expect in our performance between non-GAAP operating income and non-GAAP net income are all correlations. So as Dave said, if we can continue to execute in 2010, there should be no reason we shouldn’t be able to deliver another good operating cash flow performance.

Dave DeWalt

We will take the next question.

Operator

The next question will come from Robert Breza with RBC Capital Markets.

Robert Breza – RBC Capital Markets

David, I was wondering if you would answer a question around, as you think about the virtual appliances coming into the market, I mean, how does that kind of change the pricing model and also, how should we think about that flowing in gross margins. Thanks.

Dave DeWalt

Sure, Robert. That is a great question and a pretty insightful one. Obviously, this is a pretty large upside opportunity for the company. We had an outstanding year in my opinion. We only had a 60 basis point decline in gross margins year over year, while having a 200 basis point increase in operating margin. And that was absorbing a very large network business, hardware business into our model. And you know, as we sit here with our network hardware business, it is almost 100% hardware. And as you know, there are other companies out there in the network security space that have done a good job of blending software and hardware models, which results in improved gross margin. So we are going after that, virtual appliances is the way to go after that. We are just introducing those products into the market now. We are incenting our organizations to go after that, and hopefully, we will begin to see some opportunity there on our P&L to really drive that pricing wise. You know, we really have a bundling opportunity here, which is really a consolidation of some of the features in the market that are all point products. It lets us continue to raise our ASPs while doing it, and it just creates a similar opportunity we have on the endpoint, now on the network, and hopefully, the network for virtual appliances. So, we are pretty optimistic there and hopefully, this will work.

Next question.

Operator

The next question will come from Daniel Ives with FBR Capital Markets.

Daniel Ives – FBR Capital Markets

Thank you. In regards to – you know, you have a strong quarter going into next quarter, how are you thinking when you give guidance in regards to disclosure rates for 1Q relative to backlog and maybe anecdotally just talk about your methodology there.

Dave DeWalt

Sure, Daniel; and Rocky, feel free to add on here. You know, certainly, being where we are in February now, we have had a good opportunity to see part of the quarter. So, you know, Rocky alluded to transactions already closing, significant ones. Obviously, we have got a strong visibility to our model. We have talked a little bit about having about 90% of our business be recurring in nature. Obviously, a big block of that is coming directly off the balance sheet as well. So with this model, you get a lot of visibility to what we can do in the marketplace, and certainly, you look at all those factors, you look at your in-period bookings and realization rates for revenue, you look at what is rolling off the balance sheet, you look at what is already closed, and it gives us an opportunity to show another double-digit revenue growth quarter for guidance. And that will be 17 in a row for us. Do you want to add on this?

Rocky Pimentel

Yes, I mean, I think within our pipeline, our pipeline is really strong, our sales force is optimistic about 2010 relative to 2009 and they delivered a pretty good performance in 2009 in light of the challenges the overall marketplace has. So certainly, there is other qualitative factors as well as the pipeline that gives us optimism, I guess.

Dave DeWalt

Next question.

Operator

The next question will come from Phil Winslow of Credit Suisse.

Phil Winslow – Credit Suisse

Good quarter. Dave, why don't you just comment on just the network business versus sort of the endpoint? When you look over the course of 2010 year going forward, what are you sort of more optimistic on just from a growth rate perspective and what would be driving that? Thanks.

Dave DeWalt

Sure. You know, there are a number of things here that we certainly are having in 2010 that we did not have in 2009. I mean, just walking up our market segments for us, I mean consumer, I mean, just look at PC unit growth, certainly look at the Windows 7 refresh, I mean, there is lots of opportunity sitting there for McAfee, particularly now with the amount of distribution capacity the company has and the threat landscape, it is hard to go a day without seeing some major threat escalation. Midmarket has been very powerful for us with the SAAS offering. We are really seeing a movement to the cloud there. And certainly, our top service product had very strong results. Our midmarket at 24% this past quarter was really solid for us.

And then when you kind of go to your question around endpoint or network, the network is a real opportunistic area for the company. We did see so many fragmented point vendors, and we are getting every quarter a notch closer to really having a full suite on a single platform with software or hardware combinations that really puts us in place to really create an interlock of our hardware business and software business on the network, with that of the endpoint. So this is creating a pretty interesting juxtaposition of growth opportunity for the company and hopefully, you are hearing we are pretty bullish on the opportunity overall. We have also shown that we have made investments. Mike DeCesare in the sales organization has added capacity to our model, both in the channel and inside sales region. We have really renewed our European model, we had an outstanding quarter in Q4 in Europe, just continuing to get the leadership really strengthen there. So getting the network business humming and getting Europe humming and then adding that to our US and Asia, you know, it is putting us in an interesting position hopefully for the year.

Next question.

Operator

The next question will come from John DiFucci of JP Morgan.

John DiFucci – JP Morgan

Thank you. I have a follow up to Michael Turits' question and it has to do with cash flow, because as he pointed out, it is very strong. I was just wondering, Dave, is this something, are we starting to see your consumer strategy really start to kick in here. Is that what we are seeing, and could we accelerate this going forward, because this quarter is the first quarter in I think six quarters where we have seen prepaid expenses actually go down sequentially too.

Dave DeWalt

Yes, John, I mean, you are hitting on, you know, something we have been really working hard here at the company on. When you look at our distribution strategy in consumer, it is paying off. We have over 200 distribution partners. They are varied, the distribution model is balanced, we do not have dependencies on any single, you know, distribution partner, and with 13% growth there on a bookings basis, the sales business is really kicking market share. We don't have that same risk that some of our major competitors have either, and that is what you are kind of alluding to. We have a really nice risk/reward balance. There are some charges for PC units, but there is also a rev share, a license fee, if the balance model across, we would have a single major distribution partner that is all loaded with PC units and bounties to that. So this is a chance to really drive the model. Cash flow was up. I would also tell you, we are proud to have the Dell agreement largely behind us. And hopefully, you will see that, $145 million in cash flow this quarter, with Dell largely behind this. There is a small payment still in the quarter coming up, but we are almost all the way through that. And you know, Dell is now looking like an outstanding relationship and contract for the company moving forward. So, you know, we are trying to get ourselves in position here to continue to strengthen our consumer model and I think we have done that.

Next question?

Operator

The next question will come from Todd Raker of Deutsche Bank.

Todd Raker – Deutsche Bank

Can you give us a little more insight on the consumer side? You know, a two-part question for you. One, do you have any large OEM renewals this year, and then, as you look at some of the alternative channels that are starting to build, how should we think about the economic model of those channels versus kind of the OEM deals?

Dave DeWalt

So, Todd, this is Dave. You know, obviously, we haven't really disclosed large OEMs that are up for renewal. I think you know from last year we won a lot of them that were multi-year, and that has kind of set us up for a nice opportunity to keep working hard on those contracts in the more profitable years now, because as you know, with Acer and some of the other big wins that we had, we are moving into a more profitable period of time as we said we would. Those are kind of the right sort of maturation levels for us, both Dell, Acer, and all the other PC OEMs, but now we are getting good balance with the ISPs, and we really try to call out that we have got 70% coverage of the broadband users in the top ten ISP market, and we see these opportunities to really leverage security into that market segment, and as we came into 2009, you know, we largely just had, you know, Comcast. We are coming out of it with Adobe, with Facebook, with AT&T, Verizon, BT, Fujitsu, all the ones I named, much stronger position, partnership wise, worldwide. We have got to get some of those going, some of those are just getting launched. The Verizon one just got off the ground, AT&T just a little while back in the third or fourth quarter timeframe and Facebook just getting a few weeks old. So some of those models need to get their cycle going, but hopefully again, that whole balance keeps yielding what we are trying to do here.

Next question?

Operator

The next question will come from Adam Holt of Morgan Stanley.

Adam Holt – Morgan Stanley

Good afternoon; and Rocky, congratulations on the next chapter.

Dave DeWalt

There is a top slide for retirement items, but we will do that later.

Rocky Pimentel

Hey, Adam, I have to let Dave authorize a top slide countdown.

Adam Holt – Morgan Stanley

Right. That is offline.

Rocky Pimentel

You know, we delivered that $500 million operating cash flow number.

Adam Holt – Morgan Stanley

I know you did. Thank you. I appreciate it. So, I just had a follow-up to that question on the consumer distribution side. So if you look at an 80% plus increase in activations, you know, the expanding consumer channel, the PC bob market beginning to improve. You know, is there any reason to believe that, you know, we shouldn't see the consumer business continue to accelerate like it did in the fourth quarter. And then I guess the co-regularity of that is, you know, some of your competitors are seeing a real material negative impact on operating margins as the PC market starts to improve. You know, do you all anticipate having any of that impact or is there a reason to believe that you won’t actually see that as the PC market starts to accelerate?

Dave DeWalt

Adam, this is Dave. This comment here, you know, we have given guidance here that kind of shows, you know, our nice, I think our opportunity in the first quarter here. I mean, it has got a lot of wind behind its sails, so I think we see that. You know, remember that Q4 is our best quarter for consumer usually. Q1 is the next best, Q3 is the third best and Q2 is I guess the last best. And you know, you have just got to remember that it had seasonality to it, but when you are getting the registrations and you got the units and you are getting some of conversions that we are getting, you know, it gives us a chance to drive it another double-digit quarter. We also know there is FX impacts and you know, we have taken all that into consideration here as you look at our guidance. And certainly, you know, the exchange rates are getting better here, we know that, and we have taken all that in. But consumer wise, (inaudible) team has done an amazing job, we have had a great backend SaaS model, we have got a strong way to help our partners make money and help us. The balance of the partner models is really important, because we have really done rev shares and a combination and a balance to perch that partnering model. So we don't get that same exposure that some of our competitors are getting. We have some bounty to pay on PC units, but it is not as severe, because it is balanced across other ways in which we do the contracts. So hopefully, that helps you kind of see what we see.

Next question.

Operator

The next question will come from Rob Owens of Pacific Crest.

Rob Owens – Pacific Crest

Great, thanks. A couple of questions on the consumer side. With the economy stabilizing, are you seeing any sort of change in conversion rates on consumer? And then as you look at 2010 and talk about margin expansion, would you expect the contribution margin, excuse me, from consumer to increase in 2010? Thanks.

Dave DeWalt

Yes, Rob, this is Dave. So – and Rocky, feel free to add on here. But you know, conversion rates were a challenge in 2009. I mean, I could kind of say it like it is. I mean, certainly consumer confidence wasn’t great. We had outstanding triple digit registrations or subscriber trials in 2009 with the over 80% of the fully year. But conversions were challenging and you know, these are areas we keep working on. We are showing strong growth, I mean, double digit again on a sales basis for consumers. So, it is working. But remember, you know, there are new types of devices, some of those devices are smaller type devices, some of those shipments are heading to emerging markets, they don’t have as good as conversion rates. But generally speaking, we are on more units, there is a major Windows 7 refresh, and you know, the product that we have is wider now too. So I think Family Protection, Online Backup, much better product overall. So, you know, we think we can continue to really grow that business. We think we can continue to expand margins on that. Certainly to your point, you know, we are optimistic that that business is continuing to drive cash flow and margin expansion. I mentioned Dell that is turning out to be an outstanding agreement for us, and so is the other ones like Acer, where it is at, as well as these ISPs. So, the answer is yes.

Next question.

Operator

The next question will come from Steve Ashley of Robert W. Baird.

Steve Ashley – Robert W. Baird

You added a new SDP worldwide channel during 2009. Will there be much investment spending – that was incremental investment spending in 2010 with new initiatives there, and if so, what are some of the new things you might be doing?

Dave DeWalt

Yes, Steve, this is Dave. Yes, absolutely. We have an outstanding leader now worldwide in Mike DeCesare and Alex Thurber. Alex came from Cisco and helped me run the channel business for security over at Cisco, really understands the market well. You know, a lot of this is just love and care of the partners and the channel worldwide, building us more mature programs. We are making more investments into that area. Again, we are seeing real areas in the small mid to drive with our partners. Because now we have the offerings too, MX Logic was a really nice add to our portfolio here. So now we have got cloud and primus-based solutions to those markets for the channels. We are focusing on it a lot more with leadership programs, investments of dollars, and you could see Q4 at 24% in that mid space was good, and we are getting good results out of EMEA now. And one of the other things we did, Steve, was really go after a teller [ph] sales model to complement the channel. We have an outstanding teller center in Plano, Texas another up in Cork, Ireland, as Rocky had mentioned, another one over in Asia. So the combination of teller sales, the combination of channels and focus really is going to be a nice balance to our high-touch enterprise sales model and again, getting diversification of all segments and all geographies is really our goal here and we are starting to get there.

Next question.

Operator

The next question will come from Philip Rueppel of Wells Fargo Securities.

Philip Rueppel – Wells Fargo Securities

Great. Thanks very much. First, a clarification and then, a dig out a little bit on cash flow. From the commentary, did the Q4 cash flow include the anticipated accelerated payment to Dell? And then, as we look forward, would you view the last two quarters with those prepaid cash expenses as more of a surge or is it given the balance of your business something that is likely to plus or minus a bit be consistent over the course of each of the four quarters going forward?

Rocky Pimentel

This is Rocky. I think, yes, the fourth quarter included additional payments to Dell on the deal we just had done into the third quarter or during the third quarter. Hopefully, the reflection of our reduction or decline in prepaid expenses is a reflection of now that we have got the PC OEM side of the business all in place, it should start to uses of the prepaid expense category and as a result, revenue recognition out of the consumer space. We are going to continue to see actual operating margin momentum coming out of the consumer as we go through 2010.

Dave DeWalt

Next question.

Operator

The next question will come from Heather Bellini of the ISI Group.

Heather Bellini – ISI Group

Good afternoon, guys. I was just wondering, you are talking about margins a little bit and the PC deals that you have. I was just wondering what type of margin impact could we see from an uptick in PC shipments this year. I am wondering if you have some contracts where as PC shipments go up, you are paying on a per-unit basis that maybe we need to take into account when thinking about our full year margin forecast.

Dave DeWalt

Heather, this is Dave. So we were just talking about that a little bit in that we really have created our contracts in a way that they are balanced. It isn't just all weighted towards a payment on PC units. And obviously, we saw a very large PC unit growth just in the fourth quarter, third and fourth quarters of 2009. I mean, I think everybody had seen that. It was substantial. And we really didn't have an impact from that. Certainly, you know, we see that continuing here in 2010 as we see PC unit growth continue. We have given guidance here for the first quarter. You can kind of see that. We think we can continue to do double-digit growth across our financial metrics throughout 2010. So hopefully, you are getting a picture here that we are analyzing these contracts. We look at them hard. We include maturation phases of those contracts, and their balance with other types of contracts that, you know, really create a continued sequential improvement year over year on margins as well as on growth of the business.

Next question, please.

Operator

The next question will come from Brent Thill of UBS.

Brent Thill – UBS

Just a follow-up on Heather’s question. So is there any reason not to think you could do 200 basis points for the full year, and I guess just as a follow-up, Dave, to your comment where you didn’t see anything as in related to the uptick in PC units. Sales and marketing, I think as a percent of revenue is your highest you have seen in a while in Q4. So I guess, what caused that uptick in Q4? Was that just the larger contracts you saw in – for the pound, just why that would uptick so much related to what you have seen?

Dave DeWalt

Yes, Brent, I mean, you can sit on it. I mean, when you have higher-than-expected bookings growth, you typically have higher-than-expected commissions. And so, when you really look at the overage for us, we had a really strong bookings quarter. And certainly, when you had that, you know, it drove the expense line there. Now that is really the key. And you know, we also are doing some investments in the CRM area. So our customer relationship management, I think you know, we have got a whole new CRM on-demand system coming live here. So we have been making investments there in our sales productivity. And you know, as a percentage of revenue, it is consistent with prior years. So just look at sales and marketing as a percentage to prior years, it is very consistent. So it is not spiking here suddenly with Q4. You know, it has been fairly normalized and you know, we think we can continue to grow basis point improvements year over year and that is what we are after. We have been doing that three years in a row now, really with solid basis point, triple digit basis point improvements and you know, that's what we tried to do.

Next question.

Operator

The next question will come from Katherine Egbert with Jefferies.

Katherine Egbert – Jefferies

Good afternoon. Back to cash flow. So you have guided to, you know, 10% cash flow growth for the year. Can you give us a sense to how that would flow over the course of the year, kind of, you know, by quarter, do you expect any unusual sort of cash flow upside or downside in any one quarter? And then also, Rocky, do you have another opportunity identified outside of McAfee? Thanks.

Dave DeWalt

Well, the golf course right now.

Rocky Pimentel

My number one opportunity was DeWalt told me that he is a double diamond snowboarder and I am only a single diamond snowboarder and that really, really made me mad. So that is my only other opportunity right now that I'm thinking about. But putting that aside, Katherine, you know, we always talked about the proxy being, you know, for operating cash flow at somewhere between non-GAAP operating income and non-GAAP net income. I think we have demonstrated this year that that proxy is somewhat reliable on a rolling 12-month basis and I think we are standing by as we go into the new year, we don't see, you know, putting aside any business development opportunities, I mean, this normal course of business with our relationships now, we would expect to continue to deliver against that kind of paradigms. So, hopefully, that answers your question.

Dave DeWalt

Next question, please.

Operator

The next question will come from Sarah Friar with Goldman Sachs.

Stephanie Withers – Goldman Sachs

Yes, this is Stephanie Withers on for Sarah. So, on the M&A front, given today's re-upping of the share purchase authorization, what should we expect in terms of share repurchases versus M&A going forward, and where are kind of the pockets in the portfolio that you would really be looking to out bend through acquisition?

Dave DeWalt

Yes, sure, Stephanie. You know, certainly from an M&A front, we have had a strategy since I have come here four years ago to do small medium kind of tuck-in acquisitions. We have been doing that. Certainly, 2009 was a good example of some very nice acquisitions. MX Logic was outstanding. We really made a ton of progress with secure computing this past year. I talked to that, really better than expected on the operating model for Secure. We are really getting ourselves in position there in that network market, solid quarter. These are just examples of kinds of transactions that we have been doing. There is no change in direction for that. Certainly, we have a new credit facility as well that gives us some flexibility for acquisitions. But you know, generally, you know what you see is what you get with us. That is our strategy. We will continue to do that in 2010. We will leverage the buyback as well. Certainly, we think our value right now is highly undervalued. So we will continue to drive that and make sure we are doing the right thing with balancing the company's growth with buyback and acquisitions and in terms of target, I wouldn't really go into any specific area, but let us just say we will continue to be out there when it makes sense for the company.

Next question.

Operator

The next question will come from Brad Zelnick with Macquarie.

Brad Zelnick – Macquarie

Can you hear me?

Dave DeWalt

Hey, Brad. Yes, we can hear you. Maybe not. Next question?

Operator

The next question will come from Tim Klasell with Thomas Weisel Partners.

Tim Klasell – Thomas Weisel Partners

Good afternoon, everybody. Congrats on the quarter. Just going back to the virtual appliance strategy, since that reduces the need for inventory, could that change how you bring that to market since you need physical inventory?

Dave DeWalt

That really changes the way we go to market absolutely. I mean, you know, that is –

Tim Klasell – Thomas Weisel Partners

I mean as far as the channels you use, I should say.

Dave DeWalt

Yes. I mean, we have already launched and are using a virtual appliance for demoing, for proof of concepts into the field. Our sales organization is able to get virtual appliances for firewalls, e-mails, web appliances now. We are able to deliver that in a virtual image, a VM-ware [ph] type image to our customer much more effectively. You know, certainly, it has really got no impact on our channels moving this to do it because they are just going to take the hardware and bundle it with, they just won't run all through our books that way. So the good news here is it is faster to market, you know, the good news is it is better on our gross margins, but we have got to do the right introductions of these technologies, which meant the better part of 2009 getting ourselves ready for these virtual appliances and we are now delivering them. You might have seen a whole new product line for network we released recently and we are making progress here. So hopefully, this is, you know, opportunity for the company, both in margin expansion and market share.

Tim Klasell – Thomas Weisel Partners

What percentage of your customers do you think would be interested in that sort of delivery model?

Dave DeWalt

I would say, Tim, most. And the reason why most is because this kind of technology goes directly into blade architectures right in the data centers. Certainly existing capacity that they might have can be leveraged. Certainly, the OEM manufacturers like this technology as well, because we can get more portability of our appliances, our virtual appliances onto more platforms. So there are a number of areas to go to here. I think most of them like this. I think we have seen that with one of our competitors, who do a pretty blended model of software and hardware already. And you know, we will be following a similar course.

Kate Scolnick

Thanks. We have time for one more question.

Operator

Our final question will come from Kash Rangan with Merrill Lynch.

Kash Rangan – Merrill Lynch

Thank you very much. Dave, question for you. In the consumer security business, how are renewals looking, since you have really made a big first and last couple of years? How are renewals and lifecycles, if you are part of the subscription terms looking like in the consumer security business? And then I guess one for you, Rocky, how should we think about the amortization of deferred costs on the balance sheet as you start to experience revenue recognition schedules from some of the OEM bookings you have had in the last year or so? That is it from me, thanks.

Dave DeWalt

You know, Kash, to your first question, certainly, consumer renewals are tracking up and positive. You know, we have been really seeing some good opportunities here. We are really being selective on partnerships as well that are profitable. So we have done a nice job making sure that the recent agreements we have done are profitable moving forward. But we have also continued to see a strong lifecycle with our consumers and we have averaged around 3.4 years per customer. And now, with the new products, we have a good chance to extend that lifecycle with Family Protection, Online Backup, a better product family overall, you know, for many of the demographics we serve. So, so far, that all looks good, registrations, renewals, you know, all of the core components of consumer and hopefully, we can keep it up.

Rocky, did you want to take the last one?

Rocky Pimentel

Yes, Kash. So, I don't think there is a rule of thumb necessarily quarter to quarter. We expected that decline, unless in another distribution or some other business development deal that we enter into. And clearly, the amortization is sensitive to the bookings timing and the roll-off of the revenue elements, but I think this quarter’s amortization and reduction is somewhat in the range of a proxy, but I think we will just have to be cautious as we go forward, not get too optimistic or too aggressive. But you should see a pattern as long as we don’t have more big distribution deals going into the mix.

Dave DeWalt

Okay. So that does conclude it. I would like to say thank you again to everybody who has dialed in, some partly from a snowstorm in the East Coast, so hopefully, you are safe and sound. I would like to thank all the McAfee employees and partners again, just appreciate all the hard work. We are really taking market share. We really appreciate all the energy this company has and love it. That concludes the call, and we will go from there.

Operator

Ladies and gentlemen, this concludes the McAfee fourth quarter and full year 2009 earnings conference call. You may all disconnect.

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