Kate Scolnick - Vice President, Investor Relations
David DeWalt - Chief Executive Officer, President and Director
Jonathan Chadwick - Chief Financial Officer
Keith Weiss - Morgan Stanley
David Hafner - JP Morgan Chase & Co
Gary Spivak - Noble Financial Group
Brent Thill - UBS Investment Bank
Philip Winslow - Crédit Suisse AG
Walter Pritchard - Citigroup Inc
Steven Ashley - Robert W. Baird & Co. Incorporated
Daniel Ives - FBR Capital Markets & Co.
Rob Owens - Pacific Crest Securities, Inc.
Ryan Lee - ISI Group Inc.
Stephanie Withers - Goldman Sachs Group Inc.
Todd Raker - Deutsche Bank AG
Michael Turits - Raymond James & Associates
McAfee (MFE) Q2 2010 Earnings Call July 29, 2010 4:30 PM ET
Good afternoon, ladies and gentlemen. My name is Fia, and I will be your conference operator today. At this time, I would like to welcome everyone to the McAfee Second Quarter 2010 Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Ms. Scolnick. Ma'am, you may begin.
Thank you. Good afternoon, and thank you for joining us today for McAfee’s Second Quarter 2010 Conference Call. With me today are McAfee President and Chief Executive Officer, Dave DeWalt; and McAfee Chief Financial Officer, Jonathan Chadwick. You will find in our press release and on our Investor Relations website, a GAAP to non-GAAP reconciliation of the second quarter 2010 financial results as discussed in this conference call. The link is investor.mcafee.com, and our results are posted under Quarterly Results. We are providing a slide presentation during today's call and we will post these slides along with our prepared remarks to the website following the conclusion of today's call. For your reference we will be providing a rule of thumb for our foreign exchange assumptions during today’s call and this will be posted to our website following the 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 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 May 7, 2010, 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 earnings 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.
Okay, thank you, Kate. Good afternoon, and welcome, everyone. Thanks for joining us for our call today. Before we really get started, let me start things off with officially introducing and welcoming our new CFO, Jonathan Chadwick. As many of you saw, Jonathan came on board about 45 days ago and personally, I cannot be more pleased to have him on our team. And as expected, he's really hit the ground running. Jonathan brings a very unique set of skills to our management team after 13 years at Cisco in a number of key management roles and a focus on M&A and strategy for their company. Jonathan, you want to say a few words before we get started?
Sure. Thank you, Dave, for that really warm welcome. I’m truly excited to be here today as part of the McAfee team. I really do see this as being a great time to be at McAfee and in the security technology market. This has been a great month or so and I want to thank all the McAfee team members that have made me feel so welcome from day one. And I'm also looking forward to working with many of you within our shareholder community over the coming months.
Welcome, Jonathan. I'll practice your accent. All right, well let's get started. Q2 was a really challenging, emotional, but really rewarding quarter, probably the most I've had in my career. In the face of some very difficult adversities, McAfee emerged stronger than ever, and I for one am very optimistic, more optimistic than ever while I've been here at McAfee.
Today, I'd like to discuss and comment on five major themes that capture the essence of the opportunity and the optimism I see in the market and for the company. First, I see continued improvement in the macroeconomic conditions for IT. We’ve seen multiple successive quarters of improvement in spending, in most segments worldwide. This, coupled with the dramatically improving market expansion for security endpoints creates a strong positive business dynamic for McAfee.
In addition, McAfee managed to overcome significant adversity and turn this into a market advantage through focused Q2 initiatives. As a result, I believe McAfee, in one of its best quarters in years as highlighted by exceptional execution in bookings, operating expenses, big deal contracts, major PC OEM extensions, new partnerships and outstanding cash flow from operations. I believe the future never looked brighter as we're now set to drive market share growth for years to come.
And with that opening, I want to further explain the optimism that is pervasive here at McAfee. First, we have to look at our core security market. For many years, McAfee primarily had one product, antivirus, and sold on one major platform, PCs. We experienced a near doubling of our company from just over $1 billion in sales in 2006 to more than $2 billion in 2010 as we expanded our single-product focus to a full suite. Our conversion programs have worked well with more than 50% of our installed base now using multiple stickier McAfee products from Total Protection for Consumers, to ToPS and the Enterprise.
The market for PCs remains very strong as we’ve seen 20%+ growth in units shipped just in the first half of 2010. This, coupled with the fact that we now have extended our agreements with two of the three largest PC device manufacturers for several more years, secures our opportunity for a long time. McAfee will ship on more than 25% of all PCs shipped worldwide through just these two partnerships, far exceeding that of HP and our primary rival. These expanded relationships do not require the use of upfront cash and are accreditory [ph 21:18] results for the terms of the contracts.
Add in our over 220 partnerships across PC OEMs, ISPs, financial firms, social networks and others, and we have access to more than 50% of the market including more than half of the consumer PC units shipped by the top 10 manufacturers.
Our ever-broadening suite enabled us to grow our Consumer business in Q2 to $191 million, up 9% on a constant currency basis. As a solid sign of the market’s strength, our top end suites for consumers grew 63%. And now as we watch the explosion of new devices, our opportunity has grown dramatically. In fact, we estimate that our market will expand from approximately 1 billion devices in the PC market to more than 50 billion IP-connected devices worldwide. This is where our strategy is really paying off.
McAfee has put the pieces in place to capture this market opportunity for devices such as Smart phones, ATM machines, point-of-sale devices, USB-connected devices, cars, TVs and many, many more. Over the past few years, we’ve worked hard to dramatically expand the breadth of our product offerings. We have broadened our security footprint to help customers respond whether on any kind of endpoint, the network or in the cloud and across the whole technology stack.
As another example of that, today, I'm very pleased to be announcing our next-generation mobility platform that enables us to capture market share from Consumer segments to Enterprises for all Smart phones, tablets and slates with the broadest feature set in the industry. Our acquisition of the WaveSecure mobile security service, coupled with the Trust Digital and our own mobile products, gives us a very unique advantage.
Worldwide mobile phone sales totaled 315 million units in the first quarter of 2010, a 17% increase from the same period in 2009 according to Gartner. Smart phone sales reached 54 million units, an increase of nearly 50% from the first quarter of 2009.
In addition to the major PC OEM contract extensions and the acquisition of WaveSecure, we're pleased to announce the signing of an agreement with Verizon Business to market McAfee Verizon cobranded SSL products and solutions utilizing Verizon's SSL technology and certificates to secure online transactions. This strategic relationship provides us with yet another compelling value proposition that we believe will be very disruptive in the marketplace.
Furthering our strategy, you may have seen earlier this week our announcement with Polycom to secure unified communications, thus extending the types of devices McAfee can secure. And recently, we announced that McAfee now has relationships to provide security on USB drives sold by 2/3 of the world's secure USB drive makers.
All-in-all, we pioneered an open security risk management platform, leveraging our security management product called ePolicy Orchestrator, to more than 100 partners in our security alliance program. Through strategic alliances and partnerships, McAfee technology today is included in more third-party devices, appliances and in ever more products than before. We've created a bridge from the PC-centric world to a world where everything is digital and everything is connected. More importantly, we're continuing to gain competitive advantage by developing and acquiring the right technologies for where the security market is headed.
The success of our strategy is really clearly reflected in our deals. We closed a near-record number of million-dollar deals plus in Q2. Over 80% of these transactions included multiple McAfee products and longer contract terms. Customers are securing and managing more connected devices with McAfee, enabling us to fulfill our strategy of silicon and satellite secure device management, all integrated to our cloud and on-premise management platforms.
Another important sign of the opportunity in the market is the way we turned an adverse event into opportunity. I don't want to over-dramatize this, but few events in life end up providing an opportunity as the event we experienced this past quarter. I'm talking about our false-positive incident. For those who have not followed our company closely, this was a security update that we released in late April that impacted some of our customers, albeit a small percentage of our overall customer base. We had approximately 1,600 Enterprise customers and 11,000 Consumer customers affected. I'm very proud to state now that not only did we respond quickly and very effectively to these customers, we've resiled [ph 26:06] 99% more of the issues related to these incidences. And we did so without losing any Corporate customers and without any legal actions. And more importantly, in a quarter where we had a near record number of $1 million-plus deals, some of our largest deals in the quarter were with affected customers.
For example, we had a very large educational institution, one of the world's largest pharmaceutical companies and a major global financial institution, all increased their commitment to McAfee by purchasing more McAfee products in the past quarter than they ever have done before. I believe this reflects the fact that our customers are really engaging in the strategic importance of McAfee, and many have raised the level of importance of our company as a critical partner within their IT infrastructure and made us a trusted security adviser. You will see and hear more about our new Global Trust and Safety Initiative that will set new industry standards in the areas of quality assurance, technical innovations, support and services and community awareness.
When I net out the total estimated impact of a false-positive incident in Q2, our bookings impact to the extra discounts and offers were about $15 million. The revenue impact due to deferrals was about $6 million of deferred revenue not recognized from the balance sheet, and revenue was also negatively impacted by another approximately $14 million. Cost and expenses were approximately $2 million, and the total cash to customers was just $3 million. And this is all included in the above impact. In summary, the impact of the false-positive to our Q2 revenue results were greater than we anticipated with the biggest difference being against our expectations of lower in-period revenue from sales deals related to the incident.
As I’ve said many times, but I'd really like to express my heartfelt thanks and gratitude to our employees for their hard work and to our customers and partners for their continued support of McAfee.
Looking ahead, I'm very pleased that this event’s behind us, and we’re moving forward as a company, stronger than ever before. Our pipeline for Q3 is strong, and we'll talk a little bit more about that later in the call. Now let me turn the call over to Jonathan, and we'll cover our strong Q2 results. Jonathan?
Thank you, Dave. Again, I'm very excited to be part of the McAfee family and again, I truly appreciate the warm welcome and look forward to working with you all. I do see a tremendous amount of opportunity in this market and internally within McAfee to drive value to our customers, partners, shareholders and employees.
Now turning to Q2 results in more detail. I'm pleased to report that McAfee had a very good Q2 on a number of fronts. On a constant currency basis, we achieved strong year-over-year growth in each of our major metrics. Non-GAAP revenue, up 7%; non-GAAP net income, up 9%; non-GAAP earnings per share, up 10%; deferred revenue, up 10%; and cash flow from operations, up 160% year-over-year.
Now I'd like to go into a little bit more detail on our Q2 revenue results. Our non-GAAP revenue was $495 million, up 6% year-over-year and up 7% on a constant currency basis. We observed a high level of foreign exchange headwind this quarter with $5 million year-over-year and $12 million quarter-over-quarter. We had approximately $14 million of lower in-period revenue as new sales orders came in at lower revenue realization rates. This realization was lower than anticipated with the lowest level for the past four quarters. This means that more revenue than normal was deferred to future periods and therefore not recognized as revenue in Q2. These deferrals were largely caused by extension of contract durations with certain corporate customers as part of their Q2 false-positive resolution. So when you net out the effects of foreign exchange, and the false-positive issue on this quarter's revenue, you see we would have been comfortably within the range of the revenue guidance Dave shared with you back in May.
Now turning to our Q2 non-GAAP revenue results on a geographic basis. North America revenue in Q2 was $289 million, up 9% from last year and up 9% on a constant currency basis. North America revenue accounted for 58% of consolidated revenue. International revenue was $207 million, up 2% from last year and up 4% on a constant currency basis. International revenue accounted for 42% of consolidated revenue, and we saw mid-double digit growth in Asia-Pacific, single digit growth in Latin America and Japan while EMEA was slightly down year-over-year.
On a segment basis, in Q2 our Corporate business achieved non-GAAP revenue of $305 million, up 5% year-over-year and up 6% on a constant currency basis. We continued to see strength in large multi-element sales orders. In Q2, we saw a total of 30 sales deals over $1 million in size compared to 19 deals in Q1 2010 and 28 in Q2 of last year.
In addition, we saw increases in the number of sales orders above $100,000 with a total of 474 deals this quarter compared to 384 deals last quarter and 452 the year before that. The percentage of these corporate transactions with multiple element solutions also continues to grow reinforcing our end-to-end integrated security strategy.
In SMB, we saw high-single digit growth year-over-year, and we were particularly pleased with the contributions from MX Logic this quarter. The key takeaway here is that the overall growth in the number of large transactions we're seeing and the high percentage of multiple elements within these large deals is a key indicator of the momentum we're seeing in our Corporate business.
We achieved an all-time record in our Consumer business with Q2 revenue of $191 million, up 8% year-over-year and up 9% on a constant currency basis. Year-over-year, our Q2 online sales were up double digits and our online renewal sales increased 20%.
Now moving down the income statement. Q2 non-GAAP gross profit margin for the second quarter was 78.2%, up 10 basis points sequentially. Now as a reminder, our strategy encompasses a broad portfolio of offerings including software, hardware, services and cloud-based solutions. Consequently, mix can be challenging to forecast. However, margins across all of our segments in Q2 remained relatively consistent quarter-over-quarter.
Operating margins in Q2 were $258 million, down 3% sequentially and up 4% over Q2 last year. In Q2, our marketing expenses decreased as we optimized one of our OEM partner agreements. We remain focused on aligning our business operations and cost structure to withstand significant foreign-exchange headwinds we have experienced while also continuing to invest in our business.
During Q2, we completed a restructuring that effectively streamlines our business under four business units: endpoint, content, risk and compliance, and network security. We also improved efficiencies in our sales operations. These cost reductions were both in real terms and against our original plan for 2010. They have also enabled us to target our investments to areas likely to provide the best return in the next few quarters while continuing to invest in our portfolio of product and solution offerings. In addition, we continue to reshape our go-to-market headcount and resources to focus on those markets and customers which provide us the best growth opportunities.
For example, we were able to take some non-quota-carrying sales overlays in our Network business and redeploy a number of these resources in direct quota-carrying positions.
As of June 30, we had 6,088 employees worldwide, which is roughly flat with our headcount in Q1, but headcount with direct quota responsibility increased 3%.
We do expect to manage expenses tightly going forward given the continued currency headwinds. Q2 non-GAAP operating income was $129 million, up 3% year-over-year. I was pleased to see that our Q2 non-GAAP operating margin was 26.1% compared to 25.2%, sequentially, slightly ahead of our anticipated margin range reflecting good cost control and the OEM extension I've mentioned earlier. The effects of foreign exchange on revenue expenses had a total negative impact to operating income of approximately $7 million quarter-over-quarter. Overall, we were pleased with operating margin and performance this quarter despite many of the challenges we were facing.
In Q2, our non-GAAP tax rate was 24%. Q2 non-GAAP net income was $98 million, up 4% over Q2 last year, and non-GAAP net income as a percentage of revenue was 20%, slightly improved from last quarter. Non-GAAP earnings per share were $0.63, up 5% both sequentially and year-over-year. And within this, foreign exchange headwinds had a negative impact of $0.04.
Now turning to some balance sheet highlights. Net accounts receivable balance at the end of Q2 2010 was $244 million compared with $231 million for the first quarter of 2010. DSO, or days sales outstanding, were 45 days for the second quarter 2010 compared to 41 days in Q1 and 51 days in the prior year. Both of these metrics reflect continued solid working capital management.
Deferred revenue at the end of Q2 was $1.4 billion, up 5% year-over-year. On a constant currency basis, deferred revenue was up 10% year-over-year. The composition of our deferred revenue balance at the end of Q2 was 65% in relation to our Corporate business and 35% in relation to our Consumer business. Approximately 80% of our Q2 2010 revenue was from the balance sheet, and approximately 91% was recurring in nature from services, support and subscriptions.
During the quarter, we generated $134 million of operating cash flow, up 152% from Q2 '09 and down $23 million, sequentially. Another reminder, Q1 is typically a seasonally stronger cash collections period following our seasonally larger Q4 sales period.
And just a comment on Q2 cash usage. We completed the acquisition of Trust Digital this quarter, and we're excited about this development in our mobile strategy. We look forward to integrating Trust Digital's Mobile Management Platform into our offerings and expanding the endpoint reach of our business. And I’d personally like to welcome Trust Digital's employees to the company.
During Q2, we repurchased approximately 4.6 million shares for $150 million at an average price of $32.30 per share. Year-to-date, we’ve deployed $300 million towards repurchasing 8.3 million shares at an average price of $35.97 per share. We have $200 million remaining in our current authorization.
Cash and marketable securities at quarter end were $804 million compared to $902 million in Q1 2010. The change in our cash position was mostly due to stock repurchase, acquisitions and seasonally normal changes in our operating cash flow.
I’d just like to finish my formal financial overview remarks with a comment on McAfee's long-term performance. Over the last few years, McAfee's been on a consistent and strong growth journey and delivered solid performance. Over this time, we've expanded our addressable markets, deepened the breadth of security solutions we offer and successfully integrated acquisitions, which position us well for the future. Our leadership position in digital security’s paying off, and we are focused on continuing our trajectory of growth profitability for our shareholders.
So in summary, McAfee demonstrated good operational execution in Q2 across many aspects of our business, and I'm particularly pleased with the operating margin performance and cash flow generation. Despite foreign currency headwinds, the health of the business remains strong, and we are optimistic about the company's near-term and longer-term prospects. And I'd like to thank our employees for their particularly hard work this quarter, and now I'll turn the call back to Dave for his comments.
All right. Thanks, Jonathan. Great to have you. We really appreciate you on board. Great overview. I made the point that McAfee's market is growing, our strategy is working, and our financial performance continues to be strong. Q2 was a good quarter for McAfee, and I believe our sales booking and operating cash flow are the most important metrics we can really see the health of the business.
I gave you a detailed overview of the financial impact of the false-positive resolution in the quarter, and that's now behind us.
Looking ahead, I truly believe the future is bright for McAfee, and we're headed in the back half of the year well positioned to achieve many of our 2010 strategic goals. Unlike any other security provider, McAfee offers a full complement of consumer and corporate security products, services and solutions covering all the bases, endpoint, network and the cloud. We've shifted this company's effective opportunity from a very good foundation of Antivirus business to a business that continues to lead the market while entering a greenfield of new market opportunities such as our stronger push into mobile with our Trust Digital and WaveSecure acquisitions. We have a world-class PC OEM partnership model, and we've really diversified our Consumer business to other channels that are really starting to produce, ISPs, financial service companies like Bank of America, Facebook, Adobe among many others. And I hope you've seen the huge product cycle we're in. We essentially have new products and refresh cycles going on in all of our business units, and in particular, our Consumer business coming soon.
To summarize and move into our outlook, we remain very excited about the opportunities we see in 2010. And to start off the year, there were a number of factors driving my confidence and optimism that remains true now. I believe we have the right ingredients to continue to be the leader in the digital security market, we have a very strong product cycle and product portfolio to help customers from consumers to enterprises from network to endpoint, from individual PCs to the cloud. We’ve got an incredible network of partners and alliances covering many key areas of government, telecommunications, technology and more. To provide specific color on our current bookings forecast, our estimates show accelerated growth quarter-over-quarter of about $30 million, just in Q3. This represents a forecasted growth of over 10% year-over-year after adjusting for foreign exchange impact.
And one more data point that I'll share is over the last six quarters, we've achieved an average 99% of our forecasted sales order bookings. This is just one reason for my confidence and optimism in McAfee's business prospects for Q3, and our goal of another triple-double year on a constant currency basis. Now I'd like to turn the call back over to Jonathan for our Q3 outlook. Jonathan?
Thanks, Dave. Let me remind you again that our comments include forward-looking statements. You should review our recent SEC filings that identify important risk factors and that actual results could differ materially from those contained in the forward-looking statements. The guidance we're providing is on a non-GAAP basis with reconciliation to GAAP. As Dave discussed, we are optimistic about McAfee's prospects and our ability to achieve strong performance this year. I do want to remind you, first, that we are facing some unprecedented foreign exchange headwinds. We are expecting that these will especially affect our revenue over the foreseeable future. Based on currency movements, as we last spoke with you at our Analysts Day, we are expecting approximately $8 million of negative revenue impact sequentially going into Q3.
On a year-over-year basis, this translates to as much as $18 million and $25 million in Q3 and Q4, respectively. We highly encourage you to take this into account as you construct your own analysis for the second half. Our outlook for your information, assumes a $1.27 U.S. dollar to euro exchange rate for Q3, and we're anticipating a strengthening of the dollar in Q4.
Apart from these comments, we’ll be providing guidance for the third quarter only. The third quarter of 2010, we expect to achieve revenue in the range of $505 million to $520 million, up 4% to 7% year-over-year. From a sequential perspective, we expect to see approximately 2% to 5% growth.
As I stated earlier, forecasting gross margin is challenging due to the mix of our digital security product and services portfolio that may be sold in any period. We expect to manage gross margins and operating expenses together to achieve a target operating income range.
We expect to achieve non-GAAP operating income margin in the range of 24% to 26% in the third quarter and non-GAAP earnings per share in the range of $0.62 per share to $0.66 per share on a fully diluted basis. We expect to continue to generate between $100 million to $150 million in operating cash flow per quarter or approximately $550 million in cash flow for 2010. For Q3, we expect to be at the lower end of this range.
Our outlook for Q3 is based on a fully diluted share count in the range of 154 million to 156 million shares compared to a fully diluted share count of 160 million shares in Q3, 2009. And we're assuming an annual non-GAAP tax rate of 24%.
Within our Q3 non-GAAP guidance assumptions, we estimate the following rule of thumb: For every $0.01 movement in the euro, revenue is impacted by approximately $1.3 million, and non-GAAP earnings per share is impacted by approximately half a penny. As Kate mentioned in her opening comments, we have provided a currency rule of thumb for you on our website. I'll now turn the call back to Dave for his summary and conclusions.
All right. Before we take some questions in closing, I hope you had a good understanding of the opportunity McAfee has this year: a stabilizing global economy, the security market poised to grow faster than the overall IT and its exponential growth in threats, regulations and devices. Simply put, the opportunity in security is one that I still have a lot of greenfield and is a great business. I firmly believe McAfee is very competitively positioned in this business with a good diversified model, strong product portfolios, top-notch partners and strategic alliances and a very strong management team. In fact, in the time I've been at McAfee, I've never been more encouraged by the opportunities I see now.
Today, I’ve really tried to give you a straightforward overview of what's happening at McAfee, our opportunity, our strategy and our success and as a result, and what’s probably most important is how bright the future is for the company, both in Q3 and long beyond. On behalf of the executive management team, I want to thank all the employees of McAfee worldwide for their hard work and continued performance. And with that, Jonathan and I would like to open up the call for questions. Operator?
[Operator Instructions] The first question will come from Daniel Ives with FBR.
Daniel Ives - FBR Capital Markets & Co.
Talk about federal assumptions in 3Q and kind of like what you're seeing when you're talking to customers.
Hey, Daniel. Dave DeWalt here. So, yes, I mean the Federal markets, I'm assuming you're thinking U.S. Federal markets. We certainly have seen some very positive momentum in our business over the last few years. As you know, we've made a lot of strides in winning not just the Department of Defense and Intelligence communities, but also the civilian agencies, but on top of that, the public sector state and local’s been strong for the company. So just from assumption point of view, we continue to see a solid growth path in our government operations and a very strong pipeline both in the Network business, particularly for Gateways and our IPS and Firewall business, but also in the endpoint as well. And importantly, now we're seeing so many more devices, and this is for the government. How do they manage phones and iPods, just like every other company they need to figure out a way to manage that. We think we're really well positioned there particularly here for year end, as well as for budgeting for next year.
The next question will come from Steve Ashley with Robert W. Baird.
Steven Ashley - Robert W. Baird & Co. Incorporated
You talked about extending a couple of your OEM agreements and you also talked about maybe optimizing and changing some of the terms. I was wondering if you could identify the OEMs, and secondly if you could give us any color on the adjustment of the terms.
Sure, Steve, great. Yes, we commented to that. We're just trying to make sure we kind of show you and just protect -- you'll see some announcements coming at some point here. But certainly, what it is, is two of the top three manufacturers, I'm sure you can figure that out. We did extend those contracts for multiple years, and we felt like they were very strong contracts for the company and for the partner. We have very successful partnerships with these firms and really now we've got a chance when you couple really the next biggest manufacturer we’re shipping 36-plus percent of all the PC units, just the two we extended are over 25%. So we’ve really created ourselves a multiyear kind of foundation for the consumer that really now is able to be leveraged and grown. And of course, most of these manufacturers are doing much more than just traditional PCs as we think of with Windows. So a lot of opportunity for the company and very positive. Do you want to comment, Jonathan?
I think the only two points I'd make here is I was pleased to look at those two contracts in general. I mean just look at the accretive nature of them to our overall results. I think it's really important we understand that. And also the rearrangement of the renegotiation and extension of those contracts gives us enhanced predictability as we go forward, not just top line, but also bottom line.
The next question will come from Sarah Friar with Goldman Sachs.
Stephanie Withers - Goldman Sachs Group Inc.
This is Stephanie Withers, on for Sarah. I’m wondering if you could give us a little more granularity on the kind of lagging revenue growth in EMEA, whether there are specific markets that stood out in terms of lagging performance or better performance.
Yes, Stephanie, this is Dave. Obviously when you look at the international markets, not where we wanted it to be. We did have very strong results in North America, and obviously, a lot of market share gains there. We had very strong results in Asia-Pacific. Europe still is one of our challenged areas, although I can tell you we’ve made a lot of progress. 6% growth overall, when you really look at Consumer and Corporate put together, with currency adjusted. And certainly, we feel like we're making progress in that market and a lot of opportunity overall. So nothing to draw upon specific, just to say it’s an area for us to continue to improve and execute on.
The next question will come from Heather Bellini with ISI Group.
Ryan Lee - ISI Group Inc.
Actually this is Ryan Lee, in for Heather. Just had a quick question about the enterprise market. It sounds like you guys are closing a lot of deals. What are you guys seeing in terms of pricing and increased competition or/and the contract duration on these deals? Are you seeing more one-year deals or multi-year deals?
Sure, Ryan. I would tell you we had a very strong and probably our best area of execution outside of Consumers really. It’s been in the higher-end Enterprise, 30 deals over $1 million, our second highest in the company's history, our best ever Q2 quarter for number of million dollars deals. If you looked at what Jonathan showed in deals over $500k, deals over $100k, really an Enterprise strength. We were very, very solid and this despite some of the adversity I mentioned as well that we felt like – we didn’t see really any price issues. We had to do a little more discounting, we showed that, the normal on some of the resolutions we had. But generally, we got longer contract lengths, we've got longer commitments from our customers, the number of verticals and industries that we were able to close large deals was excellent, not just governments and banks and telcos, but I mentioned education and pharmaceutical and probably the best element that I saw was 80-plus percent of those big deals had multi-elements to it meaning network, endpoint, cloud combinations and it really played to our strategy, particularly in the high-end Corporate. We're taking market share, we're winning against our competition and I think we have the right strategy there, and as I mentioned we're optimistic about Q3 and the second half of the year with that same play.
I think the thing I would add to this, Dave, is obviously we did talk about the impact of the false-positive. We did work with customers as we solved some of those issues and, again, I’d say that's a Q2 event and what we're looking to do is really move forward. Based on the strength of the pipeline it's very encouraging.
The next question will come from John DiFucci with JP Morgan.
David Hafner - JP Morgan Chase & Co
This is Dave Hafner, on for John. Gents, can you give us an update on how in-house telesales in Europe are resting? I know that was kind of an issue last quarter.
Yes, Dave, again yes, you were right. We’ve made a lot of progress there, I would say. Certainly in Q1 we were in a bit of a transition because we had our outsource provider operating as an expense base, as well as the inside group now that we've built in Cork. So we kind of had double. We've now gotten that in production. It's still ramping I would tell you, but certainly we feel pretty optimistic about the impact there, especially with the number of sales heads that we’ve put in place. And for total sales, they can ramp a little bit faster and I just was out there a little while ago and the energy level’s fantastic, lot of great things going on. And, Jonathan, you want to comment there too, but great facility.
I was looking at some of those numbers earlier on, Dave, and again, relatively early stage, but really set up nicely and the productivity’s ramping. I think a couple of additional points, just operational matters they bring out. So as we think about productivity, one of the major things we've done this quarter is roll out a new CRM platform, or we’re in the process of rolling out to our field operations. We’re expecting good productivity coming out of that over the next coming quarters. And then we were also pleased to see that we worked hard considering the complexity of our offering especially in some of the larger deals. We really had no operational issues this quarter alone in terms of executions through the quarter so I was really pleased to see that.
The other point that Jonathan made earlier was we did some restructuring to really get the business units better aligned around solutions, and as he pointed out, we had a 3% increase in sales capacity as well so some of this is really building for the future as well in our productivity coming online with Europe, but also with other parts of the world.
The next question will come from Michael Turits with Raymond James.
Michael Turits - Raymond James & Associates
On the Corporate side, 3% constant currency growth and there’s probably a couple of points of non-organic in there. So basically, it's looking like Corporate is flat right now. The first question is can you just talk a little bit about the components of the Corporate business? What's growing? What's not growing? And why is it so slow? And then the other question is just if you could be a little bit more clear about the impact of the DAT file issue and how you're handling that, if you're pulling that back into non-GAAP revenues this quarter, are you going to pull that out of future quarters when that amortizes?
Michael, maybe I can take the first part. Jonathan, feel free to add in here. Now just for a correction, in our year-over-year growth on Corporate was 5%. When you look at currency adjusted it’s 6%, just to make sure we got that right and when you certainly look at what we've been doing in the marketplace, I feel like we've made a lot of progress. Our SMB business, as Jonathan alluded to, was solid. MX Logic was really a standout this past quarter, a cloud kind of delivery of security. The over $1 million, and over $500k, over $100k transaction types were pretty strong. Really the challenges really are in the, I would say, some of the mid-segments, probably outside the U.S. a little bit, mostly in Europe. If you kind of looked at a balance there. But how we’re handling the DAT files and things, that's behind us. We largely had that completed. I thought it was an extraordinary effort what we went through just in terms of resolving customers, the commitment we weighed, really going out of our way to show our customers that we were going to stand behind them and they showed it back by really purchasing from us, extending their contracts with us. The only real challenge we ended up having was despite a strong bookings quarter was the yield of revenue from those bookings. And Jonathan talked a little bit about some of the numbers there that despite the strong bookings numbers, we didn't quite get the revenue yield, mostly related to that DAT and because of concessions and the way we have to take revenue and tally on that, but again, look at bookings, look at cash flow, look at contracts, number of deals, we saw a lot of price solid data points in the business particularly Corporate and I think we're on the right track there.
A couple of data points and just to specifically answer your question about the non-GAAP we did feel like it was appropriate this quarter to really call out the impact of accounting on deferred revenue brought forth in the prior period that we’d otherwise have recognized this quarter. So that was the $6 million. We'll break that out if it's anyway significant going forward, and we’re not anticipating it being particularly significant in any one particular quarter. I think the sort of key takeaway on that when you do look at that $6 million to $20 million total revenue impact this quarter for items related to the false-positive, it’s substantially all of that that’s sitting now in deferred revenue. And you saw that with deferred revenue up 10% on a constant currency basis. So again, future benefit for us. We’ll manage that appropriately as we go forward.
The next question will be from Todd Raker with Deutsche Bank.
Todd Raker - Deutsche Bank AG
Hey, just wanted to follow up on the Q OEM renewals. Two questions for you. First of all, you mentioned that there were no upfront cash payments, but are there any significant cash payments during the terms of the transactions being next year or the year after? And then secondly, if you look at these -- what drove the decision to renew them early? Was it a McAfee-driven decision or was it a partner decision? And are you guys happy with how the metrics of these transactions are working out, paid conversion, et cetera?
I can start. Jonathan, feel free to add in. Yes, we were very pleased that we were able to really secure a multiyear commitment out of these top PC OEMs and I'm sure you can guess who they are, but this was a very solid relationship foundation for us as you can see. Pretty strong. It's really a shared revenue sort of agreement and that's really what gets it. It's risk and reward together, and this is the basis for how we built and diversified our portfolio of consumer partnerships and of course, I pointed out also, we've got some very strong partnerships outside of the PC OEMs going. And the Facebook numbers look great, the Adobe numbers look good, we’re diversifying with banks and I would tell you that’s certainly a really good shared partnership model that we closed in the quarter. And you can see what the units that we're getting out of these deals versus some of our competition we've really got, I think, the foundation set that we wanted to do.
The next question will come from Rob Owens with Pacific Crest.
Rob Owens - Pacific Crest Securities, Inc.
Dave, I want to drill down a little bit into the mobile market. Just what the market appetite’s like right now? What enterprises are saying? And as you've made two acquisitions in the space, maybe give us a sense of some targets you’d hoped to achieve? And when it can hit a revenue run rate that can actually move the needle given your scale?
Yes, Rob, I think you're very insightful here because we've really seen a tipping point the last few quarters, and kudos to Apple and Rim and others who have really penetrated the markets, but I'll make some comments around two different markets. First is corporate. We've seen a mass influx of corporate Smart phones, kind of consumerization in the corporate model is heavily upon us right now. There’s hardly a day goes by where we don't get requests for some new device type to be connected to the network. And of course, how do you manage that securely? So Corporate is really seeing some trends right now where Apple, iPhone, iPads, Android phones, name your favorite Smart phone, you have to manage it securely. So the Trust Digital deal that we did I thought was ideal in combining with our EPO platform. Now we can manage not only PC Windows-types devices, but Smart phones through the same console, single-agent, single console and really manage kind of all devices there. And of course, we're seeing deals with ATMs and point-of-sale registers and all kinds of endpoints there. But Smart phones, I'm really seeing an inflection point now, and I'm starting to see a lot of phone access. It's just adding more nodes to what we can manage. And it’s really creating an elasticity to our endpoint model just like we did ToPS on Windows, we’re doing ToPS on mobile. And the consumer space, we’re earlier on, I would say in security, but we're excited about the prospects there. We clearly see not just the device manufacturers beginning to push for things like secure commerce, secure web browsing and safe searching and shopping from your device. But also the telecommunications companies are really beginning to look at opportunities there, because they also see the ability to go to a store, activate a security feature, kind of an insurance card. If you lose your phone, you can wipe it, lock it, kill it, encrypt it, locate it. And there is a suite of features here that we think the consumers will purchase at time of activation or later on this via the cloud. So we’re in early days Consumer, but I think this is exciting. I think the holiday period, you’ll see a lot more of this and especially going in 2011 and we’re there. We’ve really now got the pieces, a very strong company in what's called 10-Q, but the product line’s called WaveSecure based out of Singapore, very internationalized, Chinese support, other language support, we can go global with our telecommunications partnerships, they've already done SingTel, which is one of them in Singapore and we feel like we could replicate that model, the Telcos, with Smart phone management from McAfee. So again, excited about the space. I see a lot of good points now after a few years finally it’s kind of here, both Corporate and Consumer.
The next question will come from Walter Pritchard with Citi.
Walter Pritchard - Citigroup Inc
Dave, I'm wondering if you could update us on the, or I guess maybe Jonathan, on the revenue recognition going into Q3. I’m just wondering if we should see things revert to sort of a normal revenue yield on contracts in line with what you saw maybe last year, Q3 or a typical quarter?
Yes, Walter, it's Jonathan, then, because you can’t tell from the accent difference. As you can imagine, I spent a lot of time looking at that coming in, and looking out, well, obviously what we saw in Q2. And part of the reason for showing you the analysis in Q2 was to stair-step you through clearly the significant impact we saw from the false-positive in Q2. We spent a lot of time, I spent a lot of time with the team and with Dave going through the forecast, both in terms of the bookings forecast, but also then the realization rates going into Q3. So I think at this point, we do strongly believe that the DAT is behind us based on all the really proactive reach-out we did, and that was the major driver of everything that occurred to our numbers in Q2. So I gave you the numbers, and that's the guidance we’re giving at this point and I think we're very, very confident in them.
The next question will come from Keith Weiss with Morgan Stanley.
Keith Weiss - Morgan Stanley
You guys saw a nice uplift in margins this quarter, up to 26.1% on a non-GAAP basis. In your guidance at the midpoint you’re going back down to 25%. Any particular reason, any structural reason that your margins are going to tick back down in third quarter?
It's Jonathan again, Keith. We've given you a range on guidance. We were at the upper end of our guidance range this quarter. We did manage expenses tightly this quarter. We expected to do that, but we are going to continue to invest in the business. I just ask you to model what you think is the right number for the outlook. I think what we're very focusing in on as we’ve talked about before is margin expansion. In any one particular quarter you're going to have issues that we have to manage up or down, but I think that guidance range is certainly the range I think you should be modeling in the immediate term. And obviously we’ve modeled an EPS range for you there as well. I think the main thing is to think about margin and margin, not just in one quarter, but over multiple quarters. But I think the range we've given you is absolutely appropriate.
The next question will come from Phil Winslow with Crédit Suisse.
Philip Winslow - Crédit Suisse AG
Hi, this is Dennis for Phil. Can you discuss what you're seeing in the mid market? Are there any major changes there from Q1?
Dennis, this is Dave. So mid-market, I'd say is a tale of a few things. I mentioned earlier we thought the Enterprise upper end was pretty solid, the SMB was pretty solid. As you kind of get in the middle, probably a little softer for us. Honestly, it hasn't been that big of a focus for us as a company for quite some time. We continue to build our telesales operations, we continue to build out our channels, we continue to build out our solutions. We're getting more and more focused on that market. I would tell you that I think there's a lot of opportunity there. One of the areas we continue to look to do is to leverage our cloud services to that market. Jonathan mentioned the MX Logic's success that we had, and that product is centered towards the mid and small space. Some of the things we've done with our McAfee SECURE is centered towards that as well, which is our vulnerability scanning products for retailers. And that’ll also we haven't talked a whole lot about the Verizon partnership as well. Really offering us SSL sort of certificates, as well as kind of online secure transaction management, another product centered towards those spaces. So when you start to put together new products and telesales and a number of other kind of vectors of driving, I think we've got a good opportunity in mid as well.
The next question will come from Brent Thill with UBS.
Brent Thill - UBS Investment Bank
This is Reid for Brent. In your Consumer business, the recession hit your conversion rates. Can you talk a little bit about what you're seeing now, with your conversion renewal rates, with improving macro?
Yes, sure. This is Dave. Certainly, I felt like our Consumer business has been really one of the biggest pride points of the company. We've had quite a few quarters here where we’ve just seen continued increase of our Consumer business, both bookings and revenues, conversion rates. We've been really getting some success in our online subscribers, particularly from our PC OEM partners, and that's been growing pretty dramatically. Certainly, as you look at different markets and different partners, it tells different stories, but I would tell you we've seen at least some solid consistency, if not improvement here. And really the second half is such a bigger part of the year for Consumer. Q3 we have a big launch coming up of a Consumer 2011 product. And then of course, we have the holidays. We now have offerings with the WaveSecure acquisition that gives us both mobile as well as PC for the consumer market. And we think that conversion rates can continue to improve, and certainly, I'd say the only tighter areas may be retail, but PC OEM partnerships, ISPs, pretty solid and the outlook looks pretty good there.
Just to ride on a little bit, so although the retail space perhaps as you had anticipated given the consumer was a little bit softer. The online sales were up very healthily, so I commented on that in the script.
The final question will come from Gary Spivak with Noble Financial Group.
Gary Spivak - Noble Financial Group
I just want to ask again about the $6.1 million that you're adding back to non-GAAP net income. Do I understand it correctly that is expected to be recognized into GAAP in Q3 in its entirety and then you'll be reducing GAAP revenue next quarter by that amount?
No. Gary, what we’re expecting, well, first of all, that $6.1 million related to revenue, just to clarify again, related to revenue we would otherwise have recognized from the balance sheet. It’s a direct impact of specific accounting. The piece is in deferred revenue. I do not anticipate that coming in, in Q3 alone. I actually expect it to come in over multiple quarters. So I would not be modeling that into the guidance in any significant way that I gave you for Q3.
Great, thank you. I'll turn the call to Dave for a final comment.
Okay, thank you, everybody for joining us, and we appreciate the questions and the insights as well. Obviously, we feel very confident and optimistic about the business year, and we just appreciate everybody's time. So thank you. Have a good day.
Ladies and gentlemen, this concludes today's McAfee Second Quarter 2010 Earnings Conference Call. You may all disconnect.
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