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McAfee, Inc. (MFE)

Q2 2007 Earnings Call

July 26, 2007 4:30PM ET

Executives

Kelsey Doherty - Sr. Director IR

Dave DeWalt - CEO & President

Eric Brown - COO & CFO

Analysts

Daniel Ives - Friedman, Billings, Ramsey

Derek Bingham - Goldman Sachs

Allen Winefield - Henley and Company

Katherine Egbert - Jefferies & Company

Phil Winslow - Credit Suisse

John DiFucci - Bear Stearns

Ed Maguire - Merrill Lynch

Phillip Rueppel - Wachovia Securities

Brian Essex - Morgan Stanley

Rob Owens - Pacific Crest

Walter Pritchard - Cowen and Company

John Walsh - Citigroup

Robert Stimson - WR Hambrecht

Presentation

Operator

Good afternoon, ladies and gentlemen. My name is Tina, and I will be your conference operator today. At this time, I would like to welcome everyone to the McAfee Q2 2007 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. Today's conference call is being recorded and will be available for replay on McAfee's Investor Relations home page at investor.mcAfee.com.

On today's call are our Chief Executive Officer and President, Dave DeWalt and our Chief Operating Officer and Chief Financial Officer Eric Brown. In a moment, Dave will provide some introductory comments and give you an update on his first 100 days with McAfee then Eric will provide details of our second quarter, discuss our guidance for the third quarter and for fiscal year 2007 and discuss our financial restatement. Dave will close with some color on the second quarter and a discussion of the priorities for his second 100 days with McAfee after which we'll take your questions.

You'll find in our press release and on the Investor Relations section of our web site a GAAP to non-GAAP reconciliation of the unaudited preliminary second quarter financial numbers discussed in this conference call. The link is investor.mcAfee.com and our results are posted under quarterly results. We'll also post our prepared remarks to the web site following the conclusion of today's call.

This conference call including the question-and-answer sessions will contain forward-looking statements. These statements include, among others, those regarding our strategic positioning, our preliminary results for the second quarter of 2007, guidance on revenue, operating income margins and earning levels for the third 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 segment, statements regarding future partnership opportunities, Pacific growth initiatives and strategies outlined for 2007 in McAfee's business. And plans regarding future strategic acquisitions and other uses of cash by McAfee including its 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 to its unaudited preliminary financial results for the second quarter of 2007 and prior periods and restate certain prior period financial statements as a result of its review of past stock option grants.

In addition, McAfee may not achieve its planned revenue realization rates, succeed in its efforts to grow its business, build upon its technology leadership or capture market share or benefit from its strategic relationships 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 needs or expectations.

The company's product and service offerings may not continue to interoperate effectively with newly developed operating systems. The company may experience delays in product development or the release of previously announced products. The company may choose not. (inaudible) previously announced product. 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 disruptions to our ongoing business and significant legal litigation accounting tax 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 macro 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 file 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 turn the call over to our CEO and President, Dave DeWalt.

Dave DeWalt

Okay, Kelsey. Thank you very much. And good afternoon. Welcome, everybody. Thank you for joining us and I'm real pleased to talk a little bit about our second quarter 2007 earnings call. And very excited to report that McAfee had another strong quarter and improved execution. This marks our tenth consecutive quarter of record revenues and our sixth consecutive quarter of double digit growth.

Highlights include year-over-year revenue, increasing 13% to $314.3 million and non-GAAP earnings per share increasing 37% to $0.41per diluted share. Deferred revenue also reached an all-time high of $907 million, up 12% year-over-year. In addition, we closed 11 deals over a million dollars, the largest number of deals closed in any quarter during the last five years. Our consistent performance and our steady growth demonstrate that McAfee's security focus strategy is working.

McAfee's SRN vision is bringing together system security solutions, network security solutions and vulnerability and risk management to offer our customers comprehensive protection under a single management console, single agent architecture. Whether it is our Consumer technology or our Enterprise technology. SRN works for an Enterprise of one to the Enterprise of thousands.

We're becoming the leader in security and the trusted adviser that customers turn to for their security solutions. In addition, our business model is delivering results. We had balanced results from our corporate and our Consumer segments at 58% and 42% of revenue respectively. And balanced revenues from North America and International at 52% and 48% respectively. Moreover, all segments reported solid growth with International revenue growing 20% year-over-year. I'm also especially pleased with our Consumer business growing at 19% year-over-year.

I believe the security risk management market place is one of the hottest technologies to be in right now. Our customers know that the threat environment is growing rapidly because they experience it every day. Important facts are that new malware is increasing exponentially year-over-year. Phishing attacks are up. We saw more than 50,000 phishing attacks in this quarter alone. And data loss is reaching 10 billion in losses per quarter and more than 80% of all e-mail sent is spam.

As a result, cybercrime has become a $100 billion plus problem per year, surpassing the global illegal drug trade in revenues and spawning a new criminal ecosystem where there is a low risk, high-reward opportunity environment for criminals. Further accelerating these trends and our opportunity to protect them is the emergence of new platforms. Platforms such as mobile, video and voice-over IP, social websites like facebook and myspace and new home and car appliances. The importance of security is becoming more and more obvious.

In fact SRN is becoming vitally important to our largest Enterprise customer strategies. Several of the largest financial services companies in the world told me this past quarter they've been seeing an exponential increase in their security budget growing from about 1% of their total IT spend to 10% in a few short years. In addition, SRN is helping us to cross sell and upsell new products to customers that are already running McAfee technology. Our ability to deploy solutions in a multitude of delivery models but help us scale our business.

For example, our suites of technology ship on physical hardware appliances, shrink wrap software as a software as a service model and coming soon as virtual appliances. Evidence of our success was apparent this quarter in displacing targeted competitors. In Q2 alone, we had 54 significant Enterprise displacements resulting in over ten million of business and proving that we're gaining market share. We also added more than 850,000 new ePO desktops during the quarter as a result of these displacements. Customers s are appreciate McAfee's laser focus on security and that we're not distracted by other technologies and businesses.

As you may know, I've just completed my first 100 days at McAfee. During last quarter's earnings call, I set out some very specific goals. One of my goals was to really listen, learn and to contribute to the success of the quarter. I had a chance to meet face-to-face with more than 100 customers, our top partners, our largest shareholders, most of our financial analysts and many M&A prospects. I even had a chance to meet with top government officials.

What I ended up learning is that security is important. And as a result, we generated more than 2,000 press articles and were featured in over 100 television broadcasts globally helping to accomplish another important goal of mine, the expansion of the McAfee brand and our strategy of being the number one security company. We're doing this through a disciplined communication and messaging strategy that targets both internal and external audiences.

Internally, we've implemented regular town halls, business reviews, biweekly management team meetings and rigorous forecasting models. We're also focused on improving communications with our worldwide employees to build a sense of purpose and enthusiasm around McAfee. Externally, we're raising the profile of the company through both print and broadcast.

We have now more than quadrupled our media coverage in the last three months alone driving lead generation and thought leadership. I also outline that our financial restatement was my top priority. McAfee's executive management team and board of directors know that completing the restatement and being able to unlock our balance sheet to resume and expand our stock repurchase program is important to both our employees and our investors. I am pleased that we're making good progress and we're now in the final review and acceptance stage. Eric Brown will provide more details on this later in the call.

Another one of my priorities involved expanding and building a world-class leadership team to help lead McAfee to the next level. In addition to our already talented executives, we announced three strategic hires. A new Worldwide Head of Human Resources, a Chief Marketing Officer and Head of North American Sales. While promoting from within, for the Head of Our Consumer Small Business Segment and Our Deputy General Counsel Positions. In addition, several new executives in Sales, Marketing, Hr and Corporate Development and will be joining McAfee in the next few weeks. Morale is higher and McAfee is quickly becoming the place to work in IT.

And finally and probably my most important long-term strategy was to implement a comprehensive operating model to improve business efficiencies and manage what I'm calling our three by five by three business architecture. This model is comprised of three customer segments, five geographies and three product categories, enabling us to create accountability, alignment and segmentation.

This discipline and these tools will help us optimize our business while allowing us to evaluate fixed, scale and invest based on which businesses are accretive to McAfee in both revenue, growth and profitability. We'll continue to communicate working toward our goal of helping key stakeholders understand where we're heading and how we're building on our position as the leading dedicated security company. So again, I'm pleased with our second quarter results. I'm going to turn the call over to Eric, who will give you more detail on our quarterly performance then I'll come back for final color and comments. Eric?

Eric Brown

Thank you, Dave. Second quarter revenue was $314 million, up 13% from Q2 2006. North America revenue of $163 million accounted for 52% of second quarter 2007 revenue. This compares with North America revenue of $151 million or 54% of revenue in last year's second quarter. North America revenue grew 8% year-over-year.

Outside of North America, we believe we are continuing to capture market share with International revenue in the second quarter of $151 million, up 20% year-over-year. In fact, we registered double digit year-over-year revenue gains across all geographies, Europe, the Middle East and Africa grew 14%. Japan grew 15%. Asia Pacific grew 53% and Latin America grew 80%. Of our total revenue, 85% came from the balance sheet. McAfee has a highly ratable business model and this provides visibility into our future revenue streams.

In addition to the numerous transactions in the Consumer and mid-market space, during Q2, we closed 266 deals of more than $100,000, 24 deals over $500,000, and 11 deals of more than $1 million. In Q2 2006, by comparison we had 4 deals over $1 million.

Corporate revenue in the first quarter was $182 million, up 9% year-over-year. We had solid sales of our management solutions, appliances and our Total Protection Solutions or TOPS. As I look at the network side of our business, I'm particularly optimistic about our new 5 and 10 giga bit, next generation IntruShield appliances due later this year. Not only is the next generation IntruShield platform the first and only network intrusion prevention system appliance to deliver the highest giga bit port density in the industry, but as with all of our other appliances, McAfee tends to deliver them with best in class efficiency and quality.

Turning now to Consumer results, revenue from our Consumer business in the second quarter was $132 million, up 19% year-over-year. In 14 of the last 15 quarters, we've grown our revenue at more than double digit rates year-over-year. Revenue from our on-line business was $115 million for the second quarter up 22% and this continues to be a strategic area focus for the Consumer team. Moving down the income statement, GAAP gross profit margins for the quarter were 77.3% compared with our Q1 2007 results which were 78% and our Q2 2006 results which were 79.4%.

Non-GAAP gross profit margins for the second quarter were 80.2% compared with 80.8% last quarter and 81.6% for Q2 2006. Gross profit margins continue to be affected by growth and Consumer subscriber acquisitions through channels where McAfee pays revenue share to a partner and the slight increase in Consumer revenue weighting versus last quarter. Total GAAP operating expenses in Q2 2007 were $202 million, up 5% compared with last year's $193 million.

Meanwhile, total operating expenses on a non-GAAP basis were $179 million in Q2 2007 which is 6% higher than in Q2 2006 when we had non-GAAP operating expenses of $168 million. Please note that our annual performance assessment and base salary adjustments for employees take effect at the beginning of the second quarter and are included in these results. Quarter-over-quarter, this resulted in a $4 million increase in operating expenses.

GAAP sales and marketing expenses were $94 million. Non-GAAP sales and marketing expenses were $91 million or 29% of revenue. The quarter-over-quarter variance of $7 million in non-GAAP sales and marketing expense was due to increased marketing spend during Q2 and higher sales commissions related to special incentive activities. GAAP research and development costs were $53 million and on a non-GAAP basis, research and development costs were $51 million or 16% of revenue.

The quarter-over-quarter variance of $4 million and non-GAAP R&D expenses was due to investments in our award winning technology, and we are looking forward to the returns on these investments including several important product releases in the second half of this year. As part of our strategy, we're placing a great deal of emphasis on the development of intellectual property.

During Q2 2007, we added 19 new patents bringing McAfee's total patent portfolio to 279. In the first half of 2007, we doubled the rate of internal invention submissions versus last year. Demonstrating our commitment to accelerating leadership and innovation in the security technology sector. GAAP G&A expenses were $39 million.

Non-GAAP G&A expenses were $37 million or 12% of revenue declining $2 million sequentially due to lower outside service fees. Our GAAP operating income for Q2 was $41 million. This results in an operating margin for the period on a GAAP basis of 13.1% compared with the year ago operating margin of 10%. On a non-GAAP basis our operating income for Q2 was $73 million leading to a non-GAAP operating margin of 23.3% up from 21% a year ago.

Other income for the quarter was $19 million. This is from up $14 million in Q1 2007 and $8 million in Q2 2006. During the quarter, we realized approximately $3.5 million in nonrecurring interest received on income tax refunds. Total employee head count at the end of the quarter was 3,850, up 109 from the 3,741 employees that we reported at the end of Q1 2007. The company's GAAP tax rate for the quarter was 17.3%.

On a non-GAAP basis, our tax rate was 27% unchanged from a year ago. In Q2 2007, we reported net income on a GAAP basis of $49 million or $0.30 per share on a diluted basis. year-over-year, we increased our GAAP earnings per share by 55%. Our second quarter net income on a non-GAAP basis was $67 million or $0.41 per share on a diluted basis. year-over-year, we increased our non-GAAP earnings per share by 37%.

Our net accounts receivable balance at the end of Q2, 2007, was $162 million. DSOs were 46 days for Q2 2007 compared with 41 days in the second quarter of last year. We had a record level of deferred revenue at the end of Q2 2007, it was $907million in total. Up 12% on a year-over-year basis, and also up sequentially from Q1 2007 by $13million.

Quarter-over-quarter short term deferred revenue was up at 16 million to end the quarter at 712 million and long-term deferred revenue was down 3 million to end the quarter at 194 million indicating a relatively constant average contract duration. The composition of our deferred revenue balance as of the end of Q2 2007 was 58% corporate and 42% Consumer. The same mix as the prior quarter. We ended the second quarter with cash, cash equivalents and investments of 1.41 billion. This represents be a increase over the first quarter of 5%.

In the quarter, we generate a total of $85 million in GAAP operating cash flow. The cash flow summary for the quarter is as follows. First started with GAAP net income of $49 million. We add $20 million for depreciation and amortization. We add over $7 million of non-cash adjustments to reconcile net income including stock comp and other items. We subtract 4 million for deferred taxes and we add over $13 million for changes in working capital, deferred revenue and other items.

This nets out to a total of approximately $85 million in GAAP operating cash flow which compared to the prior quarter is in line with typical seasonal trends and is also up 12% year-over-year. Operating cash flow for the quarter included approximately 10 million in cash restatement cost and certain other unique items that generally offset each other including tax refund cash inflows and legal settlement cash outflows. Below the operating cash flow line, we use $9 million for capital spending in the second quarter consistent with prior quarters.

Now I would like to update you on the status of our financial restatement. We're currently in the final review and acceptance phase of our financial restatement process. We are seeking approval from various parties including our audit committee, and our former and current auditors regarding the methodology used to review our financial data. Once completed we will submit a preclearance letter to the SEC summarizing the accounting matters and subjective issues involved in a restatement process and the new measurement dates that we're adopting for various stock option grants.

In parallel with this stage of the process, we're drafting the various required SEC filing on forms 10-K and 10-Q and are working closely with both audit firms so they can complete their required procedures in a timely manner. We'll continue to keep you updated on milestones as they're reached throughout the process.

Guidance. I would now like to provide you with our guidance regarding our expectations for our results in the third quarter and the full year 2007. The following updated guidance replaces and supersedes any previous guidance with respect to future periods and is valid as of today only. I would like to remind 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 third quarter of 2007, we expect revenue of between $305 million and $325 million. We expect our GAAP operating income margin to be 11.5% to 14.5%. We expect our operating income margin on a non-GAAP basis to be 21% to 23%. We assume a GAAP tax rate for the third quarter of 24% and a non-GAAP tax rate of 27%. Also for the third quarter of 2007, we expect GAAP EPS between $0.23 and $0.28 per share on a non-GAAP basis, we expect EPS between $0.36 and $0.41 per share on a diluted basis.

For the full year 2007, we expect revenue between $1.26 billion and $1.3 billion. We expect our GAAP operating income margin to be 12.5% to 16.5%. We expect non-GAAP operating income margin to be 23% to 25%. We assume a GAAP tax rate of 24% and a non-GAAP tax rate of 27% for the full year 2007. Also for the full year, we expect 2007 GAAP EPS between $1.07 and $1.27 per share. On a non-GAAP basis for the full year 2007, we expect EPS between $1.61 and $1.71 per share on a diluted basis. I'll now turn the call back over to Dave.

Dave DeWalt

Okay, Eric, thank you very much. So as you just heard from Eric, McAfee had another strong quarter. Let me provide with you a little more color behind some of the numbers Eric talked about. In the Consumer small business segment, our partner led strategy is really working as we signed or extended 19 agreements and launched 70 new or enhanced on-line partners during the second quarter. Examples of some of these important partnerships include Scottrade Inc., they announced an innovative partnership with McAfee to provide Virus Scan Plus With SiteAdvisor to each of its 1.6 million customers.

Scottrade is the first financial services firm to extend security protection as a free service to its customers. M&I Bank, a top 35 bank nationally, will offer their online Consumer and small medium customer subscriptions of Virus Scan Plus, McAfee Internet Suite and Total Protection Solutions for SMB. Scotia Bank in Canada, they're going to offer a Virus Scan Plus, McAfee Internet Suite and SiteAdvisor to its 1.2 million online banking customers.

We also enjoy a good relationship with Dell. From May of 2007 through July of 2007, mcAfee has recommended status in the US and Asia/Pacific. Both recommended and default status for Europe and Latin America. We're also pleased to announce that McAfee has recommended status in North America and Asia Pacific and recommended and default status in Europe and Latin America for Dell's August through October 2007 quarter.

McAfee's SiteAdvisor is now also been downloaded by more than 65 million users worldwide. This is a pretty amazing achievement when you consider we acquired SiteAdvisor just last year and there were fewer than half a million downloads. We also added another award to our list of accolades this quarter when SiteAdvisor was named to PC World's 100 Best Products of 2007. Furthermore, we're very excited about releasing our next generation securities suites later this summer. We'll release on time and leapfrog our competition both in ease of use and features.

Turning to the mid-market, customers with 100 to 1,000 desktops, we grew that segment during Q2 by double digits again year-over-year. We focusing in on mid-market displacements and had success in North America. Which had a 64% increase in displacements versus a year ago. We also rolled out our customer care renewal retention program across Europe and saw over 200 win backs.

As part of our mid-market push, we launched our Secure Internet Gateway 3000 Solution. With the introduction of this latest version of our network protection appliance, we're offering the industry's strongest antispam solution combined with our industry leading SiteAdvisor Safe Search technology, the Secure Internet Gateway is a next generation of web protection.

During Q2 in the Enterprise segment, we released major versions of McAfee's Foundstone, version 6.0, McAfee Remediation Manager version 4.5 and McAfee Policy Auditor version 4.5. Building out our portfolio of our security risk management solutions. We also became the largest security company to offer complete data loss preventions solutions gaining traction with wins in this fast growing quarter.

We heard from our customers that SRN is meeting their needs for integration, simplification and return on investment. During the second quarter, Citrix, a global leader in application delivery made a significant commitment to the SRN strategy based on McAfee. We're seeing many numerous Enterprises make similar decisions.

Customers also say they're choosing McAfee because of our ability to scale. Our efficient use of system resources and the level of protection we offer under e-policy orchestrater. We have been delivering our centralized management console now for more than four years and we have more than 50 million desktops and servers under management.

On the corporate systems security side of our business, TOPS had a particular great quarter with sales growing more than 45% versus Q1 of just 2007. For example, a large media company in Europe replaced a McAfee competitor with TOPS and cited our long-term vision and SRN strategy is the reason. d in North America Tyco Electronics made a similar investment to upgrade to TOPS. McAfee had a very good second quarter in the government business also.

With success at various levels Our US federal customers are adopting our SRN strategy and continuing to view McAfee as a company they can trust for broad an deep scaled deployments. In particular, McAfee has been working with the Department of Defense which, during Q2, moved from a pilot stage to implementation of ePO and HIPS across its install base of 5 million desktops.

The future looks even brighter for us in the Enterprise segment. As we have several major new releases shipping in the second half, including the introduction of ePolicy Orchestrator version 4.0, our fourth generation single console management framework, this enables us to manage not only McAfee products, but also our major competitor's. This award winning product is receiving outstanding feedback in the beta program and we're getting set to launch this shortly.

In addition, we'll be shipping our next generation HIPS product and our data loss prevention 2.0 suites for both the desktop and the gateway. In our Network Business, we'll be introducing our 5 and 10 giga byte IntruShield appliances and our Secure Content Management 4.5 platform on virtual appliances.

Finally in our vulnerability and risk management business, we'll bring to market Risk Analyzer 2.7, which offers troubled ticket integrations. So I believe we're to off a good start in 2007. The McAfee team is focused on delivering a strong finish in the second half of the year. And our goal is to end the year with a 12th consecutive quarter of record revenues and to deliver significant shareholder value. There are several key initiatives that will help us make this happen.

Number one completing our financial restatement and initiating a stock buyback program. Expanding or go to market strategy with major key partnerships with the channel. Executing our M&A strategy with high growth product acquisitions. Delivering our major product introductions I just mentioned. Retaining and recruiting top talent and launching the comprehensive marketing strategy I outlined at the beginning and of course, most importantly, driving improved efficiency in our business. I believe we have the plan, the vision and the strategy and now our goal is to execute.

And with that, I'll turn it back over to Kelsey. Kelsey?

Kelsey Doherty

Thank you, Dave. Before the operator polls for questions, I would like to inform you that Dave will be giving a keynote presentation at the Pacific Crest Conference in Vail, Colorado, on Tuesday, August 7th and McAfee will attend the Citigroup conference in New York City on Wednesday, September 5th.

Operator, you may now poll for questions. Please limit yourself to one question each. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Daniel Ives at Friedman, Billings, Ramsey.

Daniel Ives - Friedman, Billings, Ramsey

Hey, guys, good quarter, question on the buyback once the investigation is done. (inaudible) potentially expanding the buyback? Could you just maybe talk about that? Would you guys maybe consider an accelerating buyback? Could we see that doubling, just given the cash amount and how else would you look at M&As? You mentioned you met with M&A partners. Thanks.

Eric Brown

Thanks, Daniel. This is Eric. In terms of the mechanism for reinitiating the stock buyback, this would be the process. First of all, we need to become current in the filings. At that point, we could reactivate the current authorized buyback program which has approximately $246 million in authorization remaining good through October of this year. Expanding the buyback is a process that would entail the management team sitting with the board of directors to explain the optimal use of cash.

As we stated at analyst day, our view of the cash that we have on the balance sheet today and that which we'll generate through operations in the future, there's three principle areas for deployment of cash. The first being maintenance of a certain minimum cash stock level. Secondly, allocation of capital, $400 million to $500 million was the estimate we gave at analyst day for stock buybacks with the balance of $400 million to $600 million being left available for security acquisitions or M&A.

Dave DeWalt

That was a good segue. You mentioned the M&A strategy, Daniel. We've been looking very carefully as I just came on board 100 days ago. One of the strategies I had was to really triangulate what is some of the hottest technology. What's the biggest opportunities for McAfee to cross sell its current franchise of products. So, I had a chance to look at least 20 different companies and obviously our strategy team helped me in looking at and framing all of the different opportunities out there. We're just looking at small and medium acquisitions.

That's important for us. We're trying to make sure we can bring technologies in and cross sell them and leverage our ePO franchise. This is clearly a major opportunity for the company. We've got 50 million desktops and servers under management. We're finding as we integrate our technologies into kind of the single server, single management console architecture, it really gives us a chance for cross sell. So as you look at our strategy, whatever we can do to leverage that franchise, we're going to do and it gives us the greatest opportunity to make very accretive moves in the market place. So, we'll continue that in the second half as a big part of what I want to accomplish.

Operator

Your next question is from the line of Sarah Friar at Goldman Sachs.

Derek Bingham - Goldman Sachs

Hi, it is Derek Bingham for Sarah. Congratulations on the quarter. I just wanted to ask about bookings. First, we really appreciate the granularity you're giving on the deferred revenue split.. Although I don't believe we have that detail for a year ago period. I was wondering if you could talk to bookings growth year-over-year for the Consumer versus Enterprise and how those compare.

Eric Brown

Yes, this is Eric. Thanks for the question. Yes, we do not provide bookings but we -- as you know, to provide enough granularity in terms of the deferred revenue ending balance split between corporate and Consumer to allow kind of a proxy calculation.

Derek Bingham - Goldman Sachs

Right.

Eric Brown

And if you look at the revenue generated plus the change in deferred and again, we had a sequential increase in deferred going from Q1 to Q2 this year, if you look at that, what you'll find is an increase actually in the bookings growth rate versus the Q1 of 2007. So, the trend line in terms of the bookings trajectory is positive.

I don't have the exact comparisons for Q2 2006 a year ago. But I believe the trend line is also upward for Q1, Q2, '06 as well as Q1, Q2, '07. Now, specifically in regards to Consumer, the growth rate there sequentially Q2 versus Q1 is actually consistent. You'll find growth rates, company Enterprise versus Consumer that are all positive.

Operator

Your next question will come from the line of Allen Winefield at Henley and Company.

Allen Winefield - Henley and Company

Great quarter, guys.

Dave DeWalt

Thanks, Allen.

Allen Winefield - Henley and Company

Could you talk about your product -- I guess the DLP. Is that the information leakage product. and supposedly that's supposed to go from 4 million to I think, 50 million by '07 to '11 and where is your product positioned and who are the competitors you're going up against in that market?

Dave DeWalt

Thanks, Allen. This is Dave. I'll answer that. You're right. DLP is called data loss and prevention but it is a data leakage product. This is one of the bigger trends we're seeing in the market place right now is some of the obstacles and challenges corporations are facing in losing data and challenge in managing that. There is a number of compliances out there that industries are forced to adhere to and we're seeing a good opportunity in this market.

We just released our first version this past quarter and we're seeing some good uptick there. It is both a host based solution which means you can protect the PC so that any content or data can't leave the desktop or the system but we also have a network gateway product which helps to prevent and detect any content that you want to secure from leaving your fire walls. And it is an interesting market opportunity and clearly, we're seeing this as an interesting segment of growth over the next few years.

Kelsey Doherty

Next question, please.

Operator

Your next question will come from the line of Katherine Egbert with Jefferies.

Katherine Egbert - Jefferies & Company

Hi, good afternoon. Can you just review for us again -- you said the Consumer carries a lower gross margin and then can you talk about what the impact of the operating margin the Consumer has? Thanks

Eric Brown

Hi, Katherine. This is Eric. The comment there was looking at Q2 non-GAAP gross profit margin versus Q1 '07 non-GAAP gross profit margin. Fractional difference about .6% in terms of the sequential change. And as you know, our partner led strategy in Consumer versus traditional retail box of frequently involves payments or rev share that impact the gross profit margin and what we had is actually disproportionate success in the partner component of the Consumer business and that led to the slight increase in cost of goods in Q2 versus Q1 of '07.

Operator

Your next question will come from the line of Phil Winslow at Credit Suisse.

Phil Winslow - Credit Suisse

Hi, guys, I just want to spend a moment on the Consumer side of your business. Wondering if you all could just talk about trends you saw during the June quarter. Whether just normal, seasonal or anything different there. Sort of what your expectations are for September. Just very quickly looking at margins and bookings when you do think about your sales force. What is -- sort of a long-term goal you want to get to as far as operating margins and how is the sales force compensation sort of affecting you -- bookings growth.

Dave DeWalt

I'll take the first part, Eric if you want to add on to the second parts. We've been seeing pretty interesting trends on the Consumer side as Eric mentioned earlier. We had some pretty consistent growth from Q1 and Q2 first half of 2007. It is largely been related. We have a couple of components of our Consumer business, our big strategy has been focusing in on the partner and that's where we had a number of new partnerships.

We had 70 new partnerships both on-line and retail. We had 19 partnerships that we extended. And this is really helping to fuel some of the growth and opportunity we're seeing as being able to deliver our Consumer technologies through large partners who reach the Consumer in the small medium business segment. We're also doing well in the McAfee on-line which is a great way for us to convert some of the sales and so pretty positive transit of course.

We have a new product coming out a little bit later in Q3. We code named it falcon but it is a -- our next major generation release for our Internet suites so it has three major suites to it and we're looking forward to a product cycle here in the back half of the year. Eric?

Eric Brown

I think the second part of the question related to kind of Enterprise sales force, compensation and strategy there. So, first of all, we're very fortunate. We brought on board an extremely talented, new head of North American sales Joe Sexton with a deep Enterprise, technology and solution background. So we think that's a tremendous addition to the team here. And again we're really moving more towards this notion of solution selling.

And again, SRN is about a comprehensive solution, playing off of our fourth generation or upcoming fourth generation ePO management console and we're approaching accounts in a slightly different manner and have incented the sales force to do so. We're placing no emphasis on going after new product and solution sales and we've been able to take more mechanized routine -- maintenance renewals and increase renewal rates while actually doing it at a lower total overall cost. So, that -- so far, the approach has been very encouraging. We saw evidence of good progress year-over-year, particularly in the mid-market portion of our Enterprise business so I think that the orientation toward solutions selling from a comp plan perspective and from a product architecture perspective is starting to bear results.

Operator

Your next question will come from the line of John DiFucci with Bear Stearns.

John DiFucci - Bear Stearns

Thank you. Actually two quick questions. One, Eric, you mentioned special incentive activities which drove sales and marketing up a little bit and just kind of wondering what those were and also, other income just to be clear, you said that there was an extra $3.5 million of nonrecurring tax return but it was actually a little bit more than that than we had modeled anyway. And I'm just curious if there's anything else in there that we should be aware of.

Eric Brown

Thanks. I'll take the -- take that -- the second question first. In terms of the other income and expense, we actually had a very positive result for the quarter. And just to assist you with your future modeling, we want to be very specific that when you look at the line item in our Q2 2007 results, you have about $3.5 million which was accrued interest received on an income tax refund. That by its nature is nonrecurring and so kind of on a run rate basis, we would advise that you net out that $3.5 million prospectively.

In regards to your first question about special sales force incentives, a couple of things. One I think that, we spent more in terms of marketing dollars looking at the sales and marketing line item versus the last quarter. The special incentives were oriented toward solutions, installation of ePO and using ePO as a displacement mechanism. And so we think that we have an advantage here. We think ePO is the type of architecture we would like to put into competitor's accounts. Then orienting our activities and incentives along those lines. As you can see, we had record result in terms of competitive displacements for the quarter.

Kelsey Doherty

Next question, please.

Operator

Next, we'll hear from Ed Maguire at Merrill Lynch.

Ed Maguire - Merrill Lynch

Yes, good afternoon. Could you comment a bit on what was driving the large deals in the quarter and more broadly on what you may be seeing in terms of North American corporate spending?

Dave DeWalt

Hey, Ed. This is Dave. So, if you remember, at the last earnings call, we talked a little bit about some of the compensation changes we had made at the beginning of 2007, I think some of these are having a very positive impact on our business and our bookings. First one we outlined was we really split out the way we pay our renewals from our new products and in previous years, sales reps would get paid sort of a dollar for a dollar whether it was renewal or a new product sale. And we split that out and now the sales force has really compensated off driving products.

Eric mentioned we had special incentives to go after an ePO-like product and that resulted in some displacements and things. But the other effect of that is they're after larger transactions and we mentioned in Q1 alone, we had six transactions over $1 million compared to one the prior year. This year, we had 11 -- oh sorry, this quarter we had 11 transactions over a million which was a five-year high. And a very positive number.

And we're continuing to see that build up. There is an opportunity for trusted adviser in the Enterprise in my opinion and our sales force is going after that and ePO is a great framework for us to sell larger transactions, too. And as I mentioned before, the Enterprise or corporate segment as we're calling it a good growth opportunity for us. We have good products. We have our appliances, we got our ePO framework we have got a bunch of new products coming in the second half of the year and a great way for us to continue to drive momentum in the company.

Operator

Your next question will come from the line of Phillip Rueppel at Wachovia Securities.

Phillip Rueppel - Wachovia Securities

Great. Thank you very much. Could you give us a little color on the competitive environment in the Enterprise especially and you know, you mention some key take aways in the past quarter. You've obviously done well then looking forward, you've got a number of new products in one of your major competitors rolling out a new Enterprise endpoint security suitet. How do you see the competition playing out? Will it be much more intensive in the second half and were there any customers that are waiting for some of these new products?

Dave DeWalt

Great question. Thank you. This is Dave. So, you know, the competitive landscape I don't think has changed a whole lot for McAfee from what I can tell. I mentioned that I'd seen about 100 customers face-to-face. I had a chance to see a lot of Chief Security Officers and Chief Information Officers. What's interesting there is there isn't a large competitor to us really calling on that level, consistently and it has given McAfee an opportunity to become that that, trusted adviser and continue to preach to our sales force that this is our opportunity to take.

We don't see a whole lot of Symantec there. I think they've got some bifurcation between their storage management teams and security management teams that doesn't allow them to execute as well as I think they would like. Gives us an opportunity there and we've got good products. Our network intrusion product is world-class. We'll be shipping the 5 and 10 gigs there. Don't have a lot of competition on the high end of performance there.

And we've now been scaling our SCM appliances, Secure Content Management appliances into the Enterprise as well. So we can cross sell our appliance strategy and then also make virtual appliances as well and it is the combination of suites and the combination of ePO that, you know, makes us pretty unique there. But I really think the competitors do have some challenges in the second half. I heard a little bit yesterday about the quote-unquote forklift upgrade.

I think it is true a little bit that there is a major overhaul of the existing products that have to be done by our competitors. It gives us a window of opportunity. Are we strong enough to really take advantage of that? That's what we have to go and prove in the market place. But I can tell you it creates an opportunity for McAfee and you know, we want to go and exploit it. I'm putting programs and incentives in place to really take some market share away from those competitors and creates for a nice ecosystem for us.

The other factor is the partnerships. I heard a little bit of the competitors worried about Google. Google buys Postini. I can tell you what, I looked at that and said that's one of the best news I heard. Postini is a partner of ours. We resell Postini product. Postini also licenses our technology. I looked at that as a great opportunity to partner with Google.

That's a very complimentary product to our sig family, to our 3000 Antispam product line and gives us a great new partnership opportunity. And with Veritas and Symantec creating new competitors and with the Alteras acquisition they've got new competitors there, can we exploit the (inaudible) of partnership opportunities that are there. I think our opportunity is good if we can.

Operator

Your next question will come from the line of Brian Essex with Morgan Stanley.

Brian Essex - Morgan Stanley

Hi, good afternoon. I was wondering if you could focus on the Consumer business a little bit. I just wanted to confirm the Scottrade deal and the bank deal, when will those be included in your Consumer segment. Will the prices be analogous to what you're seeing with AOL and if you could maybe speak to attach rates versus prior periods in that business.

Eric Brown

This is Eric. I'll answer -- at least of portion of those questions. The Consumer partner deals in general, they are announced, but there is also a period of time of integration and deployment. So, they may have different months in the future where they come on-line and start to generate additional subscribers. In regards to the economics, we just are not in a position to talk, tease and seize of the different deals but, as you know, in the past, we've deployed different types of models with partners that typically look like embedded OEMs where we were either paid per download fees, per user fees or sometimes fixed fees for deployments and so we're extending the general business model, business practices with these most recently announced partnerships.

Dave DeWalt

The interesting add-on to that is really the opportunity to go after partnerships in the financial services sector and as you can tell by a couple of the ones we gave color on, it is a new area, new set of Consumers for us to reach. A lot of the financial services companies are looking for, ability to bring security to their Consumers for on-line banking and other types of transactions and we're focused on financial services. As Eric mentioned, these are new. So there is a period of time to get them up and running and getting them really hitting revenue but at the same time, we're pretty excited about the opportunity there.

Operator

Your next question will come from Rob Owens with Pacific Crest.

Rob Owens - Pacific Crest

Good afternoon, guys. As we look at TOPS and the fact that its been out for over a year now, can you give us a sense of how meaningful it is, how well penetrated it is into the install base and is that driving a lot of the competitive displacements? Thanks.

Dave DeWalt

Yes, Rob, this is Dave. You know, I took a hard look at this in the first quarter I was here. I was really trying to analyze opportunity to cross sell the existing products and what we were doing from up selling and cross selling. What I was actually surprised at very pleasantly I might add is the fact that we haven't really converted our whole install base yet. There is a big cross sell opportunity here. We've made good strides. And have a lot of references there. We're upgrading as well and cross selling from our AV franchise, our Antivirus franchise, up to the top suite.

I think we're just hitting the kind of the sweet spot there as we go into the large majority of our own install base for the cross sell and of course, we got some new versions of that coming out next generation releases as well which are easy upgrades to do. But we're also seeing the SMB space, the TOPS for SMB was very strong in the mid-market.

We showed some of the numbers there. We had 200 win backs we talked about where they had lagged in some of the renewal but we're bringing new product out which helps us convert to renewal, sell them some new product and interestingly enough, I think the suite model, while being a year out it takes a little time to get everybody converted. Of course it gives us opportunity to convert to competitors, too. We have a lot in our own install base to keep doing, too.

Operator

Your next question will come from the line of Todd Raker with Deutsche Bank.

Unidentified Analyst

Yes (inaudible) filling in for Todd. Just had a question on the multi-million dollar deals. That's quite a jump here. Is there any specific product or specific geographies where you saw that?

Dave DeWalt

You know, it was pretty equally spread across the geographies. I would say that these are system security deals that we saw a lot of, transactions on and for a lot of reasons, we just talked about having the suite and having ePO and having more of an integrated management and agent architecture.

I think our customers are looking to make more standardization decisions and you know, that was a pretty positive trend and of course, we're inspecting a lot more on these and part of my DNA is to come in and help do larger transactions with the company and leverage the Enterprise but you know, it is systems security largely. And in North America and EMEA contributed to that.

Eric Brown

I would add on the mix of the large deals across industry is really good distribution, financial services, Telco, retail, government, higher education, so, it is a nice -- like I said, distribution of the $1 million plus transactions in Q2.

Operator

Your next question will come from the line of Walter Pritchard with Cowen.

Walter Pritchard - Cowen and Company

Hi, David, wondering if you could talk a little bit about training and solution selling training on -- in both your U.S. business and International. How far away are you through that in terms of getting reps up to speed on selling in that fashion and is that (inaudible) do you think you are hitting full stride?

Dave DeWalt

Good question. Honestly, we're not at full stride. I wish we were. This is the transformation of our sales force. Roger King and the head of sales has done a nice job getting people thinking about solutions selling. We're just integrating that into kind of our everyday speak and our marketing materials and our approaches to sales.

We have a very big July/August time frame solution selling training roll-out. I just attended a worldwide technical conference which was all of our (inaudible) and consultants. They had a week of training. We're trying to systematically do this and you know, periods where, maybe some are a little shorter on selling time and we're focused on making everybody certified on solution selling and really putting rigger and discipline into the model. I think it is the key to the success of McAfee.

Can we upgrade to our TOPS product line and cross sell that but can we also cross sell from the systems line to the network line to the management line and the more we can cross sell and upsell our current base and expand that base, we'll be successful but I don't think we're that far along yet. We're working on it. It is a big part of what we're trying to do this year and be prepared for next year on. How about two more questions, operator.

Operator

Your next question will come from the line of John Walsh at Citi.

John Walsh - Citigroup

Good afternoon. When you look at your raised guidance on the operating margin line item, I assume part of that is due to the slightly low -- higher revenue. What else is driving that range to be able to be moved up? What are some of the kind of the key factors that you looked at?

Eric Brown

This is Eric. I think that you know, as you know through the first half the year, we've actually done pretty well kind of top line versus the original expectation so I think obviously the additional kind of bookings and revenue upside is helping the out margins. We won't see any significant changes as we're halfway through the year here in terms of our operating expense profile so no real surprises there. And we're becoming a bit -- a little bit more efficient as we go throughout the year.

And I think that we've done a nice job in terms of the mid-market. A lot of our efforts there about improving bookings up so cross sell maintenance renewal while simultaneously reducing the cost of doing so. That's probably giving us a little bit of a back half and revised full year leverage on the operating model.

Operator

Your final question will come from the line of Robert Stimson at WR Hambrecht.

Robert Stimson - WR Hambrecht

Good afternoon, everybody. Can you guys just -- I know Dave, at the analyst day, you were kind enough to give us an update on kind of some of the changes you saw on the sales force. I know you talked about some of the compensation changes. Can you just give us an update on that and maybe Eric can follow up with how it is being accounted for and then how it may impact the some of the margins ion the sales and marketing area going forward.

Dave DeWalt

Thanks, Robert. This is Dave. We have really took some aggressive changes in the compensation model and sales force delivery model this past year. I mentioned a little bit earlier, there's two fundamental changes the company made. I think both of which are really proving itself out. From everything we see in the second half will prove out even more. One is to really get the focus on new product sales. To really automate the delivery of our renewal sale and those two changes there were very positive.

We're continuing to see strong renewal, our auto renewal program. We moved some of that offshore as well as leveraged some onshore resources and a variety of models to capture the renewal rate and we took some of our most expensive sales resource and focused them on new product. As a result to that, we're seeing larger deal transactions going down a little bit more strategic transactions with ePO involved. I think the trends are in the right direction.

The other major change we introduced was segmentation. I think this is a critical component to the second half as well as some of the results were. Prior, we really didn't have accountability at each of our segments. We had it in the Consumer's face but we didn't have it in our Enterprise or what we call our corporate and mid-market spaces and we really set upon this year, very distinct quotas, very distinct accountability in our mid-market and as you can tell, some of those numbers have been pretty impressive.

It is still relatively small numbers in the grand scheme of things but when you get dedication, you get accountability, you get focus and put the compensation behind it, you're going to get the results. We're quite pleased with the mid-market a bunch of new products there. Got a highly energized telesale, field sale kind of model hitting that mid-market and we're going after it. So, segmentation, accountability and the bifurcation of the comp have been the big ones then layering on top of that, a real rigorous forecasting model. We layered in and week two, a week six and a week ten forecasting model. We've got eight to ten hours per each of those weeks we put into that.

We look at our gaps. We look at ways to close it and the goal here is to really improve that model and you know, create the efficiencies we're looking for and lastly, it is training. Training, training, training. How do we get everybody up to speed on every product we have and the opportunities that are out there. And make sure they can operate. So, being kind of a sales guy myself, this is a big area and I think there's positives in the second half. Operator, let me wrap up here and maybe just in summary thank everybody for attending today's call. Appreciate the time and the length of our script and things and the questions.

I would like to say we're pretty optimistic in the back half we have a pretty set vision strategy and a plan. It is clear we have to execute on that. It all about execution here. Hopefully you got a sense of our 100 day plan moving forward and our focus on driving shareholder value. Thanks everybody, for coming and that will end the call. Thank you.

Operator

Ladies and gentlemen this does conclude today's teleconference. you may all disconnect.

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Source: McAfee Q2 2007 Earnings Call Transcript
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