McAfee Q4 2006 Earnings Call Transcript

| About: McAfee Inc. (MFE)
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McAfee, Inc. (MFE)

Q4 2006 Earnings Call

February 08. 2007 4:30 pm ET

Executives

Kelsey Doherty - Senior Director of IR

Dale Fuller - Interim CEO and President

Eric Brown - CFO & COO

Analysts

Sarah Friar - Goldman Sachs

Daniel Ives - Friedman, Billings, Ramsey

Heather Bellini - UBS

Todd Raker - Deutsche Bank

Philip Rueppel - Wachovia Securities

Ed Maguire - Merrill Lynch

Brian Essex - Morgan Stanley

Kevin Buttigieg - AG Edwards

John Walsh - Citigroup

[Valerie Zwane] - Bear, Stearns

Matt Scherer - RBC Capital Markets

Rob Owens - Pacific Crest Securities

Katherine Egbert - Jefferies

Sterling Auty - JP Morgan

Presentation

Operator

Good afternoon. My name is Anna, and I will be your conference operator today. At this time, I would like to welcome everyone to the McAfee Q4 2006 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. Ms. Doherty, you may begin your conference.

Kelsey Doherty

Thank you very much. Good afternoon, and thank you for joining us. On today's call are interim President and Chief Executive Officer, Dale Fuller, and our Chief Financial Officer and Chief Operating Officer, Eric Brown. Today's conference call is being recorded, and will be available for replay on McAfee's Investor Relations home page at Investor.McAfee.com.

In a moment I will turn the call over to Dale, who will provide some opening remarks. He will then turn the call over to Eric, who will give details of our Q4 2006 results, and a discussion of guidance for the first quarter and fiscal year 2007. Finally, Dale will conclude with a review of our 2007 strategies. This will be followed by a question and answer session.

In our press release, you will find a GAAP to non-GAAP reconciliation of the unaudited preliminary fourth quarter financial numbers discussed in this conference call. We are pleased to provide summary revenue and bookings results. They are attached to our press release, and on the Investor Relations section of our website. The link is Investor.Mcafee.com, and the summary results are posted under quarterly results. We will post our prepared remarks at the website following the conclusion of today's call.

This conference call including the question and answer session will contain forward-looking statements. These statements include those regarding our preliminary results for the fourth quarter and full year 2006, guidance on revenue, operating income margins, and earnings level for the first quarter and full year 2007.

The expected level and scope of security threats in future periods, expected industry growth rates of the market segments in which McAfee participates, expected new and future product introductions, and the revenue opportunity associated with them, expected integrations of products from recent acquisitions with existing McAfee product lines, expectations regarding McAfee's business segments, statements regarding future partnership opportunities, specific growth initiatives and strategies outlined for 2007 in McAfee's business, and plans regarding future strategic acquisitions and other uses of cash by the Company, including it's future plans for the resumption of its share repurchase program.

Forward-looking statements are based on management's current expectations, and are subject to risks and uncertainties, including that McAfee will make adjustments, which are not yet fully quantified, to it's unaudited preliminary second, third, and fourth quarter results, as well as to it's financial results reported for prior periods as a result of its review of past stock option grants, and that McAfee will restate certain prior period financial statements.

In addition, McAfee may not achieve its planned revenue realization rates, succeed in efforts to grow, build upon its technology leadership or capture market share, or benefit from its strategic alliances or partnerships as anticipated. McAfee customers may not respond as favorably as anticipated to the Company's product or technical support offerings, and the Company may not satisfactorily anticipate or meet its customer's needs or expectations.

The Company's product and service offerings may not continue to interoperate effectively with newly developed operating systems, including Microsoft Vista, and further risks may arise from the review of our past stock option granting practices. Including but not limited to, potential fines and penalties and destructions to our ongoing business and significant legal, litigation, accounting, and other expenses.

In addition, a number of operational and other factors from new product introductions, the mix of products and services sold, the size of deals closed in the quarter, the amount of revenue deferred in a quarter, the integration of acquired businesses, changes in senior management, the competition we face in the market to the greater macroeconomic environment to name a few, may cause our revenue, growth margins and operating results to fluctuate significantly from period to period.

We caution listeners that actual results may vary, perhaps materially from the forward-looking statements referenced in this call, including any forward-looking statements made during the question and answer session. We encourage listeners to review the risk factors contained in today's press release, as well as the Company's filings with the Securities and Exchange Commission, including the Company's first quarter 2006 10-Q filed May 2, 2006, for more detailed information on the risks and uncertainties related to the Company and its business.

Now it is my pleasure to introduce Dale Fuller, our interim President and Chief Executive Officer. Dale.

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Dale Fuller

Thank you Kelsey, and good afternoon and thank you for joining us everyone. And it has been my pleasure to meet many of you on the call at RSA. I am at RSA in San Francisco, and Eric this week has been in our headquarters in Dallas, Texas. So please forgive any delay that Eric and I have in conversation with you as you ask us questions, because we are at different ends of the world here.

I would first like to start off with thanking our employees worldwide for a great fourth quarter and a fantastic close to 2006. As a team we stayed focused. And we were able to successfully grow the business in '06.

When I first joined the management team in October, I said I believed McAfee could do better, and I promised we would be working toward that goal. I and the McAfee executive team spent the first four months conducting a detailed review of the business and our corporate strategy. The results have been that we are focused on growing our customer base and revenues, and through Q4 and going forward into '07 we will be continuing to drive and increase efficiencies in our business.

We have been rationalizing and we will continue to rationalize throughout this year, our products, sales, marketing, and operational efforts, and our go forward strategy. We have to do better in '07 in growing the business and controlling our costs than we did in '06. Through this process we spent our time with our partners, our customers, understanding their needs and expectations, of what a true long term trusted advisor really is.

McAfee's current direction is a reflection of our customers' priorities. One thing I recognized as a result of this review is that the customers' need for security has never been greater. The world is not getting easier. In fact, it's getting more risky every day. It's becoming more complicated. With the number of threats escalating to more than 2000 a day, it is costing everyone from individuals to enterprises around the world more than ever.

Our research alone shows that there will be more threats in the next two years, than there have been over the last 20 combined. Estimates are that North American businesses alone lost more than $67 billion to cyber crime in '06. Globally, this figure exceeds $300 billion.

According to industry analysts, the market segment in which McAfee participates currently are expected to grow to more than $14.2 billion by 2011. This projection represents a compounded annual growth rate of more than 16% over the next 4 years. This creates a meaningful opportunity for McAfee. We are focused on helping our customers protect what they consider valuable. That's all we do. We are not distracted from the task of meeting their needs for security. We think our '06 results reflect the fact that customers recognize our leadership, and the strength of our solutions.

I will be back to talk a little bit more in a minute, but I'd like to turn the call over to Eric to discuss specifics of our results.

Eric Brown

Thank you, Dale. McAfee ended fiscal year 2006 with a solid fourth quarter. Our Q4 2006 results exceeded the guidance we offered on our last call. Q4 2006 revenue of $305 million was up 21%, compared to 253 million in the fourth quarter of last year.

Foreign currency movements positively impacted revenue by approximately 6 million in Q4 2006, as compared to Q4 2005. North American revenue of 167 million accounted for 55% of fourth quarter 2006 revenue, this compares to 58% in Q4 2005.

Consistent with prior quarters, 82% of revenue during the fourth quarter came from the balance sheet. McAfee has a highly ratable business model which creates visibility into future revenue streams. We believe that the growth in our deferred revenue is a positive sign for our future.

The drivers for our Q4 2006 revenue growth included better than expected performance of our network protection appliances, our total protection solutions for enterprise and small/medium business, and our consumer online offerings. In Q4 2006 we reported net income on a GAAP basis of $35 million, or $0.21 per share on a diluted basis. This compares with 39 million, or $0.23 per share for Q4 2005.

Our fourth quarter net income on a non-GAAP basis was 59 million, or $0.36 per share on a diluted basis. This compares to last year's 45 million, or $0.27 per share. Year-over-year we increased our non-GAAP earnings per share by 33%. For the full year 2006, excluding divested businesses, revenue was up 16% over 2005. We closed the year with sales of 1.14 billion. This was at the upper end of our revenue guidance range issued at the beginning of 2006.

For the year, GAAP net income was 138 million, or $0.84 per share on a diluted basis. This compares to our 2005 results of 139 million, or $0.82 per share on a diluted basis. Full year net income on a non-GAAP basis was 227 million, and non-GAAP earnings per share on a diluted basis were $1.39. This compares with our 2005 results of 205 million, or $1.21 per share. We are pleased to have recorded full year double digit gains over 2005 in both revenue and non-GAAP earnings per share.

Bookings for Q4 2006 were 388 million, an increase of 5% year-over-year. This compares to 369 million in Q4 2005. 52% of fourth quarter bookings came from North America versus 56% in the same period last year. Revenue from our consumer business in the fourth quarter $132 million, up 24% year-over-year. Overall consumer bookings in the fourth quarter were 160 million, up 11% year-over-year. Retail revenue was 19 million up 19% year-over-year.

Retail bookings for the fourth quarter were $27 million, down 3% year-over-year. Online consumer revenue in Q4 2006 was 113 million, up 25% year-over-year. Online revenue represented 85% of total consumer revenue. Online consumer bookings in Q4 were 132 million, up 14% year-over-year. During the quarter, we added 2 million net new subscribers, bringing the total number of online subscribers to 24.4 million.

On January 30th of this year, we launched our Microsoft Vista compatible consumer suites. McAfee signed or extended 17 agreements this quarter, and launched 23 online partners. Examples of partnerships include, Dell where from November 2006 through January 2007, McAfee was featured as Dell recommended and Dell default internationally.

We are pleased to announce that McAfee has secured both recommended and default status globally for Dell's February through April 2007 quarter. Earthlink, one of the largest internet providers in the U.S. which began offering McAfee solutions to it's customers in December 2006.

Samsung Electronics starting February 1st, 2007 is offering McAfee VirusScan Plus to their consumer PC and notebook customers worldwide. This is McAfee's first major win in the Korean market, and a Symantec displacement win. Kojima, a Japanese PC retailer, is bundling McAfee Security pre-loaded on PCs distributed through their retail stores. Sudden Link Communications, a Top Ten US operator of cable broadband systems, will offer McAfee virus protection and privacy service in an included model, and will upsell, crosssell McAfee Internet Suite.

Wind Stream, a US telecommunications provider will offer McAfee Solutions as a premium service, and will distribute McAfee SiteAdvisor. And yesterday McAfee and RSA signed a definitive agreement to work together, to enable financial institutions to provide more comprehensive protection for banking and online transactions.

Turning to our corporate segment. Revenue was $173 million, up 18% year-over-year. In Q4 2006, we closed 360 deals over $100,000, 31 deals over 0.5 million, and six deals over $1 million. Bookings for McAfee's Small/medium business were 87 million, down 2% compared to the fourth quarter of 2005. Bookings for McAfee's Large Enterprise Business were 141 million, up 4% compared with the fourth quarter of 2005.

In Q4 2006, our network business continued to form particularly well, led by sales of IntruShield, and year-over-year we saw strength in our management business. Total Protection Solutions, or TOPS, continued to have success with customers who recognize the value of an integrated comprehensive approach leveraging a single agent on the desktop in a centralized management console. We are pleased to announce that TOPS for Small/Medium business was named "Best Network Security Solution" by Small Business Computing last week.

In Q4 2006, TOPS bookings grew by more than 54% compared with Q3 2006, examples of significant customer wins during the quarter are Lloyd's TSB, which made a large antivirus purchase because of McAfee's long term vision and strategy of integration. The second largest bank in Europe, and fifth largest bank worldwide by Market Cap, which purchased IntruShield and Foundstone. An international systems integrator who helped with the sale of Antivirus, IntruShield, and Foundstone to one of the biggest central government departments in the United Kingdom. First National Bank of Omaha, which made a significant TOPS purchase.

And lastly, Princess Cruise Line in North America, which implemented a strategic IntruShield expansion. Before further discussing our fourth quarter 2006 results in detail, I would like to highlight a presentation change on our income statement.

During the fourth quarter, McAfee revised our methodology for reporting technical support expenses, resulting in a greater percentage classified as Cost of Net Revenue, and a lesser percentage being classified as R&D, relative to prior periods. This methodology is being applied to all four quarters of 2006, and will be applied prospectively in 2007. The net effect of this change decreases growth profit margins on both a GAAP and a non-GAAP basis, and also decreases total operating expenses as a percent of revenue. There is no impact to our GAAP or non-GAAP operating income margins.

The net effect of this change was to decrease our gross profit margins on a GAAP and Non-GAAP basis by approximately 2 percentage points, for both the full year and fourth quarter 2006. GAAP gross profit margins for Q4 2006 were 77.5%. Non-GAAP gross profit margins for Q4 2006 were 80.1%. Due to changes in our internal reporting procedures and systems, we now have the ability to specifically identify each of our technical support expenses, as cost of good sold or operating expenses. In prior periods, we classified the expenses by applying estimated allocation percentages. Therefore, we believe the new methodology provides a greater degree of precision in our income statement presentation.

Total GAAP operating expenses were 200 million in Q4 2006. Total non-GAAP operating expenses were 177 million in Q4 2006, compared to 152 million in the fourth quarter of 2005. GAAP sales and marketing expenses were 101 million, non-GAAP sales and marketing expenses were 94 million, or 31% of revenue. GAAP research and development costs were 48 million.

Non-GAAP research and development costs were 45 million, or 15% of revenue. GAAP G&A expenses were 39 million, non-GAAP G&A expenses were 39 million, or 13% of revenue. Our GAAP operating income for Q4 was 37 million, and our GAAP operating income margin for the period was 12.2%. Our Non-GAAP operating income for Q4 was 68 million, and our non-GAAP operating margin for the period was 22.1%. Other income for the quarter was 13 million, compared to 13 million in Q3 2006, and 7 million in Q4 2005, reflecting year-over-year increased cash balances and improved cash in foreign exchange management.

Total employee head count at the end of the year was 3,712, up 33, compared to 3,679 employees reported at the end of Q3 2006. Year-over-year employee head count increased by 13% from the 3,290 reported at the end of Q4 2005. DSOs for Q4 2006 were 50 days, compared to 56 days in the fourth quarter of last year, and within our target range.

The Company's GAAP tax rate for the quarter was 30%. The Company's fourth quarter 2006 non-GAAP tax rate was 27%, compared to 25% in Q4 2005. Deferred revenue was 896 million at the end of Q4 2006, and up 20% year-over-year. Quarter-over-quarter short term deferred revenue grew by 47 million to end the quarter at 703 million, and long term deferred revenue increased by 12 million, to end the quarter at 192 million.

We ended the fourth quarter with cash, cash equivalents, and investments of 1.24 billion, compared to the third quarter balance of 1.23 billion. During the quarter we generated approximately 86 million in cash from operations on a GAAP basis, and we spent approximately 80 million of cash for the acquisitions of Onigma and Citadel.

McAfee's philosophy regarding use of cash remains the same. To intend to use cash to invest in R&D, small to mid sized acquisitions, such as Citadel or Onigma, and for the repurchase of shares. The Company is currently precluded from repurchasing shares due to the ongoing stock option review and pending restatement. McAfee has 246 million in repurchase authorizations available until October 25, 2007.

Guidance: I would now like to provide you with our first quarter and full year 2007 guidance. The following updated guidance replaces and supersedes and previous guidance with respect to future periods, and is valid as of today only. I would like to remind listeners that guidance is based upon management's current expectations, and that actual results may vary perhaps materially from those results anticipated in this guidance.

Consistent with our preliminary results, this guidance excludes any impact from any non-cash charges that could result from our internal review of stock option grant practices. Please see the footnotes in our press release for further details. For the first quarter of 2007, we expect revenue between 280 and $300 million. We expect our GAAP operating income margin to be 9.5 to 11.5%, and our non-GAAP operating income margin to be 21 to 23%.

We assume a GAAP tax rate of 24%, and a non-GAAP tax rate of 27% for the first quarter of 2007. For the first quarter of 2007 we expect GAAP EPS between $0.17 and $0.22 per share, and a non-GAAP EPS of between $0.31 and $0.36 per share on a diluted basis. For the full year 2007, we expect revenue between 1.2 billion and $1.275 billion. We expect our GAAP operating income margin to be 13% to 17%, and non-GAAP operating income margins to be 21 to 25%. We assume a GAAP tax rate of 24%, and a non-GAAP tax rate of 27% for the full year 2007. We expect full year 2007 GAAP EPS between $0.97 and $1.17 per share, and non-GAAP EPS of between $1.45 and $1.55 per share on a diluted basis.

I will now turn the call back over to Dale.

Dale Fuller

Thank you, Eric. And let me discuss how we are going to achieve these goals.

Let me first take a few moments to review some more highlights and accomplishments of '07. We introduced the Total Protection Solution for Enterprise, and SMD, with TOPS we are helping our customers take security to the next level. TOPS advances our security risk management vision. Our cutting edge safe technology through the acquisition of SiteAdvisor was successfully integrated into our offerings and launched in October.

And as of today we are closing in on 30 million people downloading worldwide from that time. Yesterday the Undersecretary of Commerce awarded McAfee with a 'Recognition of Excellence in Innovation.' It is just one of the many awards that SiteAdvisor has won in this last year.

Our other strategic acquisitions added technology for reporting, compliance, remediation, and data leakage prevention. The companies we acquired have been integrated into, include Preventsys , Citadel, Onigma. We are committed to growing our corporate segment and these acquisitions help strengthen our position as a global security provider of choice.

In July, McAfee launched four new consumer security suites, featuring our best-of-breed technology, which we pioneered eight years ago. We were first to market with the Security ever service suite solutions. In 2007, we will continue to build upon our momentum so that we can deliver on the guidance, and increase the value of the McAfee franchise.

In Q4 we started an optimization project, which restructured certain aspects of our field operations, as this year has begun the management team is focused on financial performance. We are going to deploy resources more efficiently, more effectively throughout the organization. And we will continue to rationalize our cost structure to maximize cash flow at McAfee.

Both Eric and I get it. It's all about increasing our revenue growth, and gaining leverage to the bottom line. We know we can do better. The global management team has been tasked with making the decisions necessary to achieve that. Q4 was just the first step, and there are more to come, as we continue to drive sales up and costs down.

We have talented people, as well as the industry leading security technology solutions. We have the ability to drive the business towards best-in-class operating metrics, if we remain focused and disciplined in everything we do. This year you will see McAfee extend its security risk management leadership.

Let me take a few moments just to talk about our major initiatives. We will exploit our position on the desktop, and the power of e-policy Orchestrator, the industry leading centralized management console. We have more than 45 million desktops under management today.

We will lead with host-based data leakage prevention, a powerful next generation solution, which addresses the #1 concern of information security executives worldwide, and that's end point security. As of last week, McAfee's data leakage prevention solution is in the market.

We will provide, we will promote the McAfee brand. You will notice a ramp in our efforts to promote McAfee worldwide. We will use our safe search technology with SiteAdvisor, to build up brand equity and relationships with our end users. We want to be that trusted advisor.

In 2007, you will see us aggressively distribute SiteAdvisor. We look to push the number of downloads into 10s of millions as we go forward. These initiatives reflect a broader vision about what customers need from their next generation solutions. Security risk management, we believe that if a security solution is to be truly valuable to our customers, it must be sophisticated, elegant, and easy to use. Cyber criminals do not take breaks, and neither can you about your safety and security.

So you will see us take new steps to ensure our products are easy to use. Further, you will see us work to keep ahead of the threats before they even occur. We will tap the intelligent, self-correcting, and auto-preventing technologies that we have been developing over the years. I believe we are in a position to deliver on our vision, because we have emerged as the industry experts in security.

Security is our DNA. We have been doing it for more than 17 years. We have more than 130 labs out at the rims or the edges, where the bad guys are, their listening posts. We have well over 1,000 engineers in labs worldwide, whose sole focus is to build and support the industry leading portfolio of products to protect our customers. We are excited about our technology, our security risk management strategy, and the prospects we see in this space. Our focus now is on execution. Bottomline, McAfee had a good 2006. But we have to do better in '07. Thank you for your time.

I will now turn the call back over to Kelsey.

Kelsey Doherty

Thank you, Dale. Before the operator polls for questions, I would like to inform you that McAfee will be presenting at the Merrill Lynch Conference in New York on Tuesday, February 13th. I would also like to announce that we will be hosting Analyst Day 2007 on the morning of Tuesday, June 12th in New York City. Please mark your calendar, details will be forthcoming.

Operator, you may now poll for questions. Thank you very much. Amanda?

Question-and-Answer-Session

Operator

[Operator Instructions]

Your first question is from Sarah Friar.

Sarah Friar - Goldman Sachs

Good afternoon, guys. How are you doing? Eric and Dale give us a quick update first of all on the CEO search, and also the options investigation, any sense of timing on when we can get back to some sense of normalcy here?

Dale Fuller

I think that, this is Dale speaking, I think that with the options review, the major part from the Special Committee is done. We have turned it over to management. Now I am also management, so I will talk about that in a second.

We turned it over to management to start the whole process by going through the details to be presenting, and then getting sign-off through the accounting firms, and then on to the SEC for the final pass here. Timing, there are too many variables still for me to actually predict a time. Other than we believe that we will get it done this year. And Eric can actually make a comment about that in a second.

As for CEO search we have been underway, I would think that we should have an announcement in the next upcoming months. We are down to a short list of probably six or seven candidates, and I think we are getting there very quickly. We have a very detailed process. We are following through and we are very diligent about it. Eric, would you like to say anything about the management's accounting of the stock options?

Eric Brown

I think you covered it Dale. We are not in a position to give a precise date by which we expect to be complete. But we are fully ramped up in terms of our internal team reviewing. Just as a recap, we are going back and looking at 10 plus years of stock option grants at McAfee, dating back to the beginning of 1995. We have already provided an estimated range for the pretax non-cash cost to restate is 100 million to 150 million. And we are working diligently towards completing the exercise.

I will note that because we are a New York Stock Exchange listed company, we don't have the same type of requirements, in terms of filing statements as NASDAQ companies, and so we are current in our filings, and will remain current in our filings until the middle of March, and from that point forward we and any other New York Stock Exchange registrant, automatically have six months in which to complete the required 2006 10-K filing. So we do not anticipate any issues in regards to that.

Operator

Next question comes from Daniel Ives with Friedman, Billings, Ramsey.

Daniel Ives - Friedman, Billings, Ramsey

Hi guys, good quarter. When you look at the consumer business, could you talk about OneCare, and kind of expectations going into maybe like the last two quarters relative to the dent it actually had in the consumer business. Has it been less than anticipated? More? Obviously the consumer business has been very strong. Maybe you could just talk about what's happening in the market, what you guys are seeing?

Eric Brown

Hi Daniel. This is Eric. Based on the data that we are seeing from NPD and other sources, the impact thus far of the consumer retail market of OneCare is deminimus, I think it's fair to say that the market share obtained by OneCare to-date is in the single digit percentages, so it hasn't been much of an impact thus far.

Kelsey Doherty

Next question?

Operator

The next question comes from Heather Bellini with UBS.

Heather Bellini - UBS

Thank you. Let us know from a margin perspective you are obviously guiding to a nice bump up this year. Still looks like you have a lot of room to take that higher if you were to benchmark McAfee versus companies with similar business models. So as you look out, what type of annual progression do you think we could see on average each year, given your focus on efficiency?

Eric Brown

This is Eric, I will respond to that. We have given a somewhat broad range of non-GAAP operating margin guidance for full year 2007. It is 21 to 25%, and to some of Dale's earlier comments, what we have done, if you look at the middle of the range 23%, obviously it is based on assumptions regarding our bookings, revenue expectations, et cetera.

We believe that there may be an opportunity to get more leverage out of the business. We are very focused on efficiencies. We took the first set of steps right at the end of 2006, where we implemented a modest restructuring, principally of the North American field operations. We are getting more focused on revenue and margin per head count. So our expectation is that we will stay quite focused on operating income margins.

One of the other things that we have seen a bit different than what we saw looking back a year to 1.5 years, is better than expected success on the hardware lines, particularly IntruShield, and as you know that is a physical hardware device with a slightly lower unit gross profit margin, and so that mix has to be factored in as well.

Operator

Your next question comes from Todd Raker with Deutsche Bank.

Todd Raker - Deutsche Bank

Hi guys. Can you hear me?

Kelsey Doherty

Yes, we can, Todd.

Todd Raker - Deutsche Bank

Two questions on the consumer side for you. One, can you just talk about OEM royalties, and what you are seeing from a pricing perspective around that? Is there any impact on gross margins from more economics from your OEM partners, and then the second part of that is can you table the inability to penetrate HP as a customer, and what's it going to take to win business there?

Eric Brown

Todd, this is Eric. The first part of your question. The OEM royalties. We haven't noticed any significant change in OEM royalties pricing and outlook. We are in the midst obviously of the Microsoft Vista launch, but to-date it seems to be as expected.

In regards to your question regarding HP, and I could probably extend this answer to any other large PC OEM opportunity, typically the way some of these contracts work there are kind of switching costs, and so the displacement, the cost of displacement is higher. There is an upfront cost.

We remain very focused on expanding our business with PC OEMs. We announced a very nice win with Samsung and the Korean markets are obviously a major distributor. And we are intending to compete for business at all PC OEMs, be it HP, or someone else.

Operator

Your next question comes from Philip Rueppel with Wachovia.

Philip Rueppel - Wachovia Securities

Yes, thanks. Turning to the corporate market could you update us on some of the initiatives that you had put in place earlier in the year, the channel partner expansion progress in the SMB channel, and any indication of how you're doing in particular geographies outside the US?

Dale Fuller

This is Dale. I just came back from a partners conference in China just this weekend, and they represented about 90 of our partners down there that are focused in the marketplace, in the SMB kind of market, and I was with Darrell Rodenbaugh, who is the Head of our SMB practice, or our mid-market practice today.

I think we are now, we have the right team in place on how we are going to be able to execute that, and now it's about execution and getting that. As you can see, as Eric talked about earlier, you saw a decline in SMB business quarter-on-quarter, but I think we have now identified the key steps that we need to have to get after, and get those things back in the positive growth mode.

We think that SMB has the highest potential for us for growth in North America and worldwide, and I think that we are now really on fire to get that done, both from a product standpoint, a solutions standpoint, and also having the right responsible people in charge of it. It is yet to be delivered, but we have those things in place right now.

Eric Brown

The only other comment I would add to Dale's remarks is that we actually feel very good about the product portfolio that we have in place. TOPS, we made some comments about the success quarter-over-quarter with TOPS, a very highly rated product. It's received a number of awards. We think the technology footprint that we have is very well suited for the SMB marketplace.

Operator

The next question comes from Ed Maguire with Merrill Lynch.

Ed Maguire - Merrill Lynch

Yes, good afternoon. I was wondering if you could provide a bit of color around the dynamics in the consumer business. It looks like the bookings were down on a quarterly basis. Could you just comment on what's behind that, and at least your expectations over the next quarter or so, as well as some of the mix your might be seeing in terms of ASPs versus unit growth, as you have introduced a kind of tiered selection of suites?

Dale Fuller

Okay. I think that your consumer bookings overall were pretty much where we were expecting them to come out. I would note that for the Dell quarter, which is November December January, we did not or were not default or recommended in North America. That is a bit different where we were for example in the fourth quarter of 2005, where we had more favorable placement.

We will have both North America and international default and recommended placement for Dell. That's across the board for the February, March, and April Dell quarter, which largely coincides with the second half of our Q2, and so we expect that to contribute a change as it were quarter-over-quarter to the consumer bookings profile.

Operator

Your next question comes from Brian Essex with Morgan Stanley.

Brian Essex - Morgan Stanley

Good afternoon. I was wondering if I could just get an idea of the fully diluted share count in your full year guidance, maybe some granularity in between. If you are precluded from stock repurchases until your filing issues are complete, how you would approach the repurchases? Would it be kind of a moderated average throughout the remainder of the year, or would you accelerate that up front?

Eric Brown

In response to your first question for full year 2007, the diluted share count that one should use in the context of our guidance is approximately 164 million shares. Second part of your question, the share repurchase just to reiterate, we are currently precluded from repurchasing shares.

We will not be in a position to recommence any share repurchase until we are able to refile the financial statements. And then at that point in time, we will have the option to continue the program, and as noted earlier, we have approximately 246 million in authorization, which is available through the end of October of 2007.

Operator

The next question comes from Kevin Buttigieg with AG Edwards.

Kelsey Doherty

Kevin, we can't hear you. Are you on mute?

Kevin Buttigieg - AG Edwards

Sorry about that. I was wondering if you could provide an update on the AOL agreement, since they've changed over their business model. Are you still operating under a prior agreement? Have you signed a new agreement? Is there anything to discuss with us about how that relationship has gone with the changeover now in AOL's business model?

Eric Brown

First of all, AOL is a very valued business partner for McAfee. We have enjoyed years of mutual success together, and today we continue to operate under the original agreement. We are currently actively engaged with AOL, in regards to extending the partnership to work with them in their new media led portal model. Other than that however, I can't provide any specific update at this time.

Operator

Your next question comes from John Walsh with Citigroup.

John Walsh - Citigroup

Good afternoon. Could you talk about maybe some of the assumptions that go into the full year fiscal '07 forecast, and maybe balance between the consumer side impact of Vista, and then the enterprise side of around the RSA conference, what the enterprise customers are most interested in about their IT spending.

Dale Fuller

Eric, why don't you talk about what goes into the forecast, and then I'll talk about what we saw at RSA and customers.

Eric Brown

Okay, very good. Again, just to recap, the full year revenue guidance was 1.2 billion to 1.275 billion for the full year. Depending if your take a midpoint or an upper end point, it is approximately 10% revenue growth year-over-year. We are not expecting any significant changes in mix enterprise versus consumer.

The other point I would make about the guidance is that we are expecting second half of the year compared to the first half of the year, a bit more profitability on a non-GAAP EPS basis in second half versus the first half of the year. So as you are breaking out the guidance into the four quarters, please keep that in mind.

Dale Fuller

And what we saw from the enterprise customers, and I guess even down to the enterprise of one type customers, was that they really needed someone to really focus taking care of things that they considered important, as opposed to what some of our competitors are doing today, is they are focusing on things that are important to the competitors, protecting their operating systems, protecting their network, those type of things, as opposed to really protecting the data, or other things that to them as a customer of ours considers important.

Key things that we saw at RSA, and I heard over and over again from large enterprise customers, including your own, was DLP was key. Leakage of data inadvertently, is happening all around the world, and people don't understand how to stop that. Our DLP technology that we just launched last week actually stops it at the end point. It's fantastic. It's a great product that allows for you then to monitor. It's integration into our ePO product, then allows the Security Officer, or the IT professionals, to see who's attempting to do something maybe they shouldn't be doing. Those are the types of things that we are going to be seeing over this year, really be in the forefront of people's minds on the marketplace today.

Other things we saw that was very interesting to a lot of corporations was our SiteAdvisor product. We make that product free today, and it being implemented throughout in an enterprise today, where that I can monitor control what my people are actually searching for, or shouldn't be searching for. So it prevents someone from opening up a port that could actually be bombarded with a lots of bots and trojans and other things on the inside of my network.

So there are a lot of interesting things that we are seeing there, but the key things I heard form customers, from very large enterprises, is they wanted somebody to help them with the solution that is going to be very sophisticated and elegant, and that is paying attention to them, as to what's important for them. And that goes back to our mission as a Company, is to protect what they consider important.

Next question.

Operator

Your next question comes from John DiFucci with Bear, Stearns.

Valerie Zwane - Bear, Stearns

Hi. This is [Valerie Zwane] for John DiFucci. We have a question on the operating cash flow. You reported around 86 million, which declined from last year, and it's lower than what we had expected. Can you give us some color on in terms of where you saw the weakness come from? Thank you.

Eric Brown

This is Eric Brown. The things to keep in mind for operating cash flow in Q4 of '06 versus what we reported in Q4 2005 are as follows. If you look back at 2005, we had quite a bit of success booking multi-year deals in the fourth quarter of '05, which produced a pretty sharp sequential increase in long term deferred revenue balances. At the end of 2006, we are more cognizant about managing the sales force towards less in the way of longer term deals. Focusing on current renewals.

Our belief is that our enterprise technology once installed is very sticky, and we are invariably quite successful renewing maintenance. Better to do it year by year on a full par value, versus on a multi-year discounted basis. And so that was a deliberate change in our part year-over-year. The net result of that is the build in long term deferred revenue was approximately $30 million less in the fourth quarter of '06, compared to the fourth quarter of '05.

The other thing to keep in mind is that we had a change in terms of deferred tax assets and that accounted for another adverse about 10 million in operating cash flow Q4 2006 versus the fourth quarter of 2005, and the final point is that we had higher OpEx end of '06 versus the end of '05 in part driven by the cash costs of SEC and compliance costs, it's broken out in the face of the GAAP income statement, of about 6 or $7 million. These are the costs for the stock option review and investigations, which will be included nonrecurring. Those would be the three principle items for the cause of change in operating cash flow Q4 '06 versus Q4 '05.

Operator

Your next question from Robert Breza with RBC Capital Market.

Matt Scherer - RBC Capital Markets

Hello, guys. This is Matt for Rob. I had a question. Earlier in the week you announced a strategic alliance with EMC, actually the RSA division. Can you talk about a little bit about that and impact going forward?

Dale Fuller

You have that right there in front of you.

Eric Brown

The EMC announcement.

Dale Fuller

RSA announcement.

Eric Brown

Oh, I am sorry. Yes, McAfee and RSA planned to leverage the McAfee consumer desktop security products, and the RSA adaptive authentication solution, to help enable financial institutions, to provide a more comprehensive protection for banking and online transactions. McAfee can send additional system information to the adaptive authentication server, as authentication parameters for banks to use.

So McAfee consumer customers will be preset to use RSA site key technology, which checks up to 50 different factors, to confirm a person's identity, prior to allowing access to financial services, resources, or transactions. So those are the high level details of the combined partnership offering.

Operator

Your next question comes from Rob Owens of Pacific Crest.

Rob Owens - Pacific Crest Securities

Good afternoon. A couple of questions for you. First, can you give us color on the TOPS upgrade cycle. When will it be meaningful in terms of driving growth, and are you seeing competitive displacements there yet? Second, Dale did you give us a number what you expect to from the balance sheet for Q1?

Eric Brown

Sure. I'll take the second question first. Just to recap. We had in the fourth quarter of '06, we had about 82% of revenue come from the balance sheet. We would expect a similar percentage in the first quarter, so no net change overall.

In regards to TOPS, we are about, first off I'd say that TOPS has been pretty successful. We are continuing the rollout. TOPS grew sequentially, more than 50% Q4 '06 versus Q3 '06, the product was only launched in May of last year.

So again, we are not even a year or so into the upgrade cycle, and the final comment is that TOPS itself, in terms of the bookings and revenue it generates, it's not a pure new product uplift, so a part of TOPS when we transact with a customer, is a maintenance renewal, so it may not generate incremental revenue, but to the extent that customers are producing some of the top advanced versions, particularly the versions that have the McAfee NAC component, those represent incremental new product sales to the customers.

We have also started to see a couple of displacement wins in regards to TOPS, and we'll actually have the sales force in '07 even more focused on competitive wins or competitive knockouts, with TOPS being one of the principle weapons in the arsenal for SMB.

Operator

Our next question is from Katherine Egbert with Jefferies.

Katherine Egbert - Jefferies

Hi. Thanks. You know you have something in the press release about not being able to do stock repurchases, and maybe doing some small M&A, can you talk about that particularly on the heels of Onigma? Will you do more like that, or is that a low end? Give us a sense of where you're going?

Eric Brown

Just to make it very, very clear, what the assumptions are underlying the 2007 revenue guidance that we give. Those exclude, the revenue guidance excludes any potential impact from acquisitions, and so to the extent that we were to acquire anything with significant revenue in '07, we would be providing an update.

So that is a pure organic revenue number. I think that the acquisitions of Onigma at about $20 million, or the asset purchase of Citadel at about $60 million cash, those are somewhat representative of the types of deals that we might do in 2007.

We are very focused as noted earlier on the Security Risk Management solution based approach, and you know, there are a number of technologies where we are looking at buy versus build options. But the acquisitions that we have on our radar screen are relatively modest in size, and similar to what we have done over the past 12 to 18 months in terms of magnitude.

Kelsey Doherty

This will be our last question please.

Operator

Next question comes from Sterling Auty with J.P. Morgan.

Sterling Auty - JP Morgan

Thanks guys. A question for Eric and a question for Dale. Eric, the short term deferred revenue increase in the quarter looks like it is the smallest that it has been in the last two years or three years, is there anything that you can add color there?

And for Dale on DLP talk about moving forward with linking it into EPL. But what I am curious about, is what are customers telling you in terms of who is actually going to handle the remediation. I guess I don't see it as the typical EPL user, as the one that would have to deal with remediation. How do you link them into the process?

Dale Fuller

Go ahead.

Eric Brown

I would say that in terms of the deferred revenue increase are you referring to year-over-year? Or are you referring to sequential Q3 to Q4? Could you please clarify? Maybe we will get a clarification Dale, maybe you would take part two of the question.

Dale Fuller

No problem. So Sterling what we talked about with ELP, and why we need the integration with the ePO, is so that you have a single console management and the whole aspect of that is, that I as a security officer, or I as the person that does the remediation, which is typically the security officer, or the IT professional who wants to know where there are potential points of leakage. That is what the ELP technology basically ties back to the ePO's console is going to do.

As someone they understanding the corporate policy, they understand that that data is not to be copied or not to be disseminated beyond their means, if they are trying to attempt to take it off, then that flags me. I know something is going on, and that I can take proper action.

The whole point of notification that remediation could be removing the person from actually having access to that data any more, or other types of things based on the company. The goal is to provide a means by which not only are we stopping the data from leaking, but identifying where the leakers are.

Operator

Mr. Auty, your line is open.

Sterling Auty - JP Morgan

Yes, I just wondered if there was an opportunity to put ePO maybe in front of additional people.

Dale Fuller

Absolutely.

Sterling Auty - JP Morgan

I think remediation will go beyond just the Security Officer.

Dale Fuller

Absolutely. Yes. Did you want to clarify your first question?

Sterling Auty - JP Morgan

So, on deferred revenue I thought the short term deferred revenue December over September was up by about 29 million. If I compare that December '05 over September '05, and the same thing in '04, I think it looks like this may have been one of the smaller increases in short term deferred revenue. I didn't know if there was other factors going on beyond just the multi-year renewals that you had last year?

Eric Brown

I would say Sterling the multi-year renewal is only going to impact the change long term Q3 versus Q4, this year versus last year. So other than that there is nothing unusual to report I guess, in regards to the long term deferred revenue. The build is a bit smaller on a percent basis, as you noted.

It's also important to note that we are growing the deferred revenue. We are about 900 million at this point in time. We have established a pretty predictable mix, in terms of what comes off the balance sheet as deferred revenue, and so we have got stabilization and visibility into the deferred revenue generation model as well.

Kelsey Doherty

That concludes our call for this afternoon. Thank you very much for your time. We look forward to seeing you as we market over the coming quarter. Good afternoon!

Operator

This completes today's conference call. You may now disconnect. .

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